Balance is Key in Challenging Economic Conditions
By Greg Sweeney, Chief Investment Officer, CFA, Bell State Bank & Trust
Recent media headlines have covered topics such as pharmaceutical shortages, deteriorating infrastructure, municipal bankruptcies, declining percentage of working population and increasing reliance on social programs. There are also growing levels of unfunded or unaffordable government mandates, regulation and laws intended to legislate prosperity while stifling it in practice.
Two interesting observations come from these headlines. First, these are the same challenges facing the characters in the famous novel Atlas Shrugged, which is still a top seller 60 years after it was written.
Second, it is hard to reconcile the struggles represented by these headlines with reports of good economic news: declining unemployment, prospective declines in the Federal Reserve’s quantitative easing (QE) program, rising tax collections, strong auto sales, and increasing gross domestic product.
Politicians claim in media interviews that 7 million new jobs have been created over the last five years.
If that is the case, we wonder why the same number of people are working today as were working five years ago (see graph below). If federal deficit spending over the same time period is to be credited for the “increased” jobs, then the cost was $835,000 per job created (assuming there is no federal deficit reported for the month of September 2013).
While the intent of programs like the Affordable Care Act is noble, early indications of the outcome appear to be quite different than anticipated. The cost of the program looks like it will be more than expected. Smaller companies are cutting the work week of employees from full time to 29.5 hours per week to avoid operating losses due to increased healthcare charges and/or fines. Larger corporations may see this regulation as a renewed call to ship jobs overseas. Fewer jobs and fewer dollars earned by consumers to cover higher costs are not a very good foundation for growth.
Where do things go from here? We look for continued growth in the economy similar to recent monthly levels, around 1.5%. This could be interrupted as the Federal Reserve fiddles with its quantitative easing program, federal deficit ceiling negotiations and government shutdown concerns continue, or unforeseen events occur similar to the situation in Syria, but generally speaking, we see continued slow growth.
Translating the effect of this economic data on the stock and bond markets is more difficult. Why? Because the Federal Reserve’s QE Program has had the effect of separating the performance of the stock and bond markets from the signals generated by the economy. As the Federal Reserve currently considers shifting away from QE (tapering), market reactions could be quite noticeable; for example, 10-year U.S. Treasury bond yields over the last four months rose from 1.65% to 2.85%. Rising rates erode the value of bonds.
What should investors do? These conditions are challenging.
In the past, the Federal Reserve had its hand on one lever: raising or lowering the federal funds rate. Even with only one lever, it was hard to get it right without disrupting the economy. Today there are three levers: the federal fund rate, quantitative easing and tapering.
It is impossible to know what will happen or when it might happen. In these environments, having a comfortable balance between stocks and bonds, with a sprinkling of real estate and bit of excess cash to take advantage of market opportunities, tends to be as comfortable as things get.
The global climate will continue to change, but our commitment to our clients remains steadfast.
If you’d like to talk more about investment scenario planning, call Greg Sweeney to start the conversation.
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