April Economic Outlook
This is a monthly newsletter by Greg Sweeney, CFA, Chief Investment Officer, at Bell State Bank & Trust. Sweeney holds a bachelor’s degree in business from the University of North Dakota, is a CFA charter holder, and is a 25-year veteran of the Investment Management team.
Federal Reserve Monetary Policy
- At the next Federal Reserve meeting on April 25, we expect the Fed to leave rates unchanged between zero and 0.25%. The Fed indicated rates would remain near these lows until late 2014.
- The year-over-year consumer price index (CPI) released in March shows inflation at 2.9%. The next release on April 13 could push a bit higher on fuel prices, but given the number rolling off from last year, we don’t expect it to be much above 3%.
- Three themes we see exerting influence on the economy moving forward are: (1) expiring tax cuts and by relation federal debt and deficits; (2) Greece-like symptoms developing in Spain and Italy; and (3) unpredictable actions by the Federal Reserve.
- Expiring tax cuts: This is likely a toxic topic going into the election, which suggests it won’t be discussed by Congress until after November. Before that time, people who pay taxes will have already begun to prepare for the impact, which generally means decreasing consumption so that they have money to pay for increased taxes. Early estimates suggest this will result in a drag of about $500 billion on gross domestic product (GDP) or about 3% at current GDP levels. That is a big enough number to erase the 2% growth expected this year.
- Europe: Expect Spain and Italy to appear in the news more often with “Greece-like” symptoms. We would not rule out Greece ‘s problems reappearing, either. These challenges have a tendency to rob the pockets of economic strength, which are trying to exert themselves, of their enthusiasm.
- Federal Reserve: Expect pressure to remain high on the Fed to “do something” about stimulating growth in the economy. Just the suggestion that the Fed may not jump into QE3 sent 10-year yields 40 basis points higher in March. It is hard to tell what would happen if the Fed actually began formal discussions about a halt to quantative easing. If we were doctors, we might diagnose the economy and markets as being hooked on an addicitive drug. Many of us know intuitively how hard addictions are to correct. For an economic example, look at the void in solutions to federal debt and deficits.
- The ghost of “interest rates yet to come” provided investors a glimpse of what happens to fixed income returns when interest rise from such a low base. The 10-year Treasury started March with a 1.97% yield and finished the month with a 2.21% yield. This 24-basis-point increase in interest rates resulted in a loss of 1.94% … enough to wipe out a full year’s interest income.
- We don’t see rising interest rates as a near-term threat to fixed income investors, but at some point, the reality of negative real interest income will register, and a correction will occur in fixed income markets. In the absence of knowing when this will happen, we try to maintain a defensive portfolio position by keeping the average bond maturity on the shorter side of the range.
- Forecasts suggest corporate earnings growth is slowing. Interest rates are low, causing investors to look to other markets for investment opportunities; but looking at the stock market on a relative basis against bonds may take a back seat to evaluating the stock market on its future earnings prospects.
- Fed policy affects stocks too. Any suggestion from the Fed toward implementing QE3 should have the tendency to help the stock market.
- For our part, we continue to look for companies that have growing earnings with good cash flow from operations, along with a host of other criteria. There is a tendency to compare returns to various popular indexes, but it is important to remember that the characteristics of companies that make it into our managed portfolios are not the same as those of all of the other stocks in a particular index.