Learning from Greece
One of the challenges composing a quarterly investment newsletter is that often things don't change that much from quarter to quarter. The big picture, which we first articulated in 2009, is that this economic cycle would take much longer than usual to achieve desirable employment and annual GDP growth. Significant excesses worldwide, from government and personal debt accumulation to imprudent lending and investing, left the economy with a deep wound that only time (and some very creative monetary policies) could heal.
So that's where we are, expecting continued lethargic economic growth with gradually increasing interest rates. Such an environment should favor equity investments over bonds, though not without occasional bumps in the road. Market declines attributable to limited military action taken by the United States against Syria will likely be short-lived and represent buying opportunities. The same would apply to the usual shenanigans in Washington if budget talks temporarily break down.
The impact of any change by the Federal Reserve concerning their quantitative easing program might be a little more problematic. If you recall, the Fed has been financing most of the U.S. debt and the mortgage market by "printing" $85 billion each month and using the funds to buy treasury securities and mortgage backed bonds. This caused interest rates to move to extraordinarily low levels not seen in at least a generation. The low interest rate environment helped the depressed real estate market recover to the point where residential home inventories are now at the lowest levels in eight years. In turn, home prices grew at double-digit rates during the past year, causing concern that another housing bubble might be developing.
In response, the Fed announced in June that they might slowly reduce their bond purchases before the specter of inflation reappeared. Just the thought of the Fed doing this caused interest rates to move markedly higher, with 30-year fixed rate mortgages increasing from 3.3% to 4.8%.
The latest economic news continues to be mixed, though promising. Orders in July for long-lasting U.S. manufactured goods declined by the largest amount in nearly a year. Even after excluding orders for military products and large aircraft, both volatile areas on a month-to-month basis, capital goods orders fell 3.3% in July after four straight months of gains. Also, the number of non-farm jobs increased by only 162,000 in July and the Labor Department reduced the previous estimates for new jobs created in May and June.
On the other hand, U.S. auto sales are up 8% from a year ago, with annual production at nearly 16 million vehicles, which is close to record levels achieved in 2007 before the Great Recession started. Overall construction spending in July, including housing, commercial and public projects, grew to $900 billion and June's figures were also revised higher. Spending on new home construction in July rose to the highest level since September 2008. Applications for permits to build single-family homes rose for the third straight month in June to the highest level since May 2008. And New home sales moved 38% higher in June compared to a year earlier, with the biggest annual gain in 21 years. New home activity is important to the economy because it is estimated that each new home built creates three jobs for a year and generates approximately $90,000 in tax revenue. In addition, housing is historically considered to be one of the best leading indicators for the economy.
Also, the Baltic Dry Index is up more than 60% from a year ago, accelerating considerably during the past few months. The index tracks shipping activity costs for a range of dry commodities including coal, iron ore and grain on 23 major shipping routes. These commodities tend to consist of raw material used to produce finished goods like concrete, steel, food and electricity, so the index is considered a good indicator of future economic growth.
Last, but not least, buried a few weeks ago on page 10 in the Wall Street Journal was an article titled: "Greece Swings to a Budget Surplus". This should have been front page news, after all the worries we've had with Greece! For the first seven months of the year, Greece ran a $3.5 billion surplus, compared to a similar deficit during the same period the previous year. Granted this is what is known as a "primary surplus", which does not include interest payments on debt and social security spending - two big items in Greece - but it's progress! Government spending is down 20% and revenue is up over 10%. Maybe our elected officials could take a few lessons from the Greek Parliament.