January 2013 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 27-year veteran of the Investment Management team.
Federal Reserve Monetary Policy
- At the next Federal Reserve meeting on January 25, we expect the Fed to leave rates unchanged between zero and 0.25%. The Fed continues to indicate rates would remain near these lows until 2015.
- The year-over-year consumer price index (CPI) released in December shows inflation at 1.8%. We continue to be bothered about the difference between price changes reported by this index and the actual costs experienced by consumers.
- Supposedly, everyone is celebrating because politicians came to an agreement to avoid the “fiscal cliff.” The “fiscal cliff” is only a symptom of the ongoing “fiscal crisis” that remains completely ignored by politicians.
- Trillion-dollar deficits are the problem. Forget about the top 1%, 2% or even 10%. Doubling income taxes on everyone who currently pays them would not even cover this level of deficit spending. That is a big problem.
- At the end of the year, the U.S. had hit its debt ceiling once again. We are now $16.4 trillion in debt and on our way to $17.4 trillion in debt by the end of this fiscal year, with no end in sight. Debt now exceeds gross domestic product by 3% and will exceed GDP by 6 to 7% by the end of the year.
- Normally, “bond vigilantes” would take care of this situation by boycotting U.S. government bonds and demanding higher interest rates. This market mechanism has been neutralized by using the Federal Reserve to print money and purchase bonds issued by the government to finance our debt.
- This leaves everyone wondering when the music will stop.
- While it was a good sound bite, the “fiscal cliff” agreement is little consolation when we have not addressed the “fiscal crisis.”
- If the first couple of days in January are any indication, bond buyers may be getting weary of the market, as demonstrated by the slight rise in interest rates.
- Rising interest rates hurt fixed income returns. If the bond market continues down this path, we expect it may catch some people by surprise when they see negative bond returns, leaving them wondering how “fixed” fixed income really is.
- The fixed income market will struggle this year to deliver the same attractive returns it has over the past few years.
- Look for average corporate profit increases this year, as companies have harvested the low-hanging fruit over the last couple of years.
- Corporate revenue increases above overall economic growth will require taking customers from competitors or some new, whiz-bang feature that everyone feels they need right now. This had been working for Apple, but the glow has appeared to dull a bit even there.
- Corporate cash balances are attractive and can be used for dividends or stock buy-backs. We suspect investors would like either option.
- Near term, the market tends to like the fiscal cliff solution – but don’t lose sight of the fact big spending problems in the U.S. could take some of the shine off of the recent success.
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