January 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 January 26, we expect the Fed to leave rates unchanged between zero and 0.25%, citing a risk to economic growth as the reason for leaving rates low.

Inflation

  • The year-over-year consumer price index (CPI) released in December shows inflation at 3.4%. Expect the next release to be toward the 3.1% range. Estimating the next couple of months using the current calculation methods, we expect this to drop below 3%.

Economic Activity

  • We suspect that Europe did not have an immediate solution to problems in its New Year’s resolution. Good thing, too, because that would just shift the media’s focus to the exact same debt problems in the United States.
  • These same debt problems do not make the U.S. convulse as much as Europe, because the currency issue does not carry the same significance as it does in the European problem.
  • Prognosticators are issuing 2012 economic growth forecasts, and we feel the 2.5% average is above what the economy can generate organically. Sure, the deficit spending “wand” can magically make this number appear by the end of the year, especially in an election year – but that would not be core economic growth and would leave an even higher deficit to wrestle with.
  • As this is being written, the U.S. has quietly pushed up against its debt ceiling limit once again. As of September 21, 2011, the debt ceiling was raised to $15.19 trillion, and public debt on December 29, 2011, was $15.08 trillion. By the end of January, U.S. debt will likely be near 100% of nominal gross domestic product (GDP), which is currently at $15.176 trillion. Expect the debt ceiling to be quietly raised to over $16 trillion sometime in the first quarter of 2012, with the idea of avoiding the debt ceiling as an election-time issue. Amazingly, a $1 trillion increase may not be enough to meet that goal. The U.S. will finish the year with debt exceeding 100% of GDP and no workable plan to stop it from rising further.

Fixed Income

  • Fixed income returns come from the combination of interest income and market value changes. Over time, coupon income dictates 90% of the return on fixed income securities. The yield on the 2.625% Treasury bond due November 2021 was 3.3% on December 31, 2010, and finished December 31, 2011, at 1.69%. This decline in interest rates produced a market value return of 13.25%, while interest income was only 3.3%. These two components combined for a total return on this bond of 16.55% in 2011! Unfortunately, the only way to capture this return is to sell the bond. If the bond is held to maturity, the investor will earn an annualized return of 3.3%, not the whopping 16.55%. Now the good part: In order for the 10-year Treasury to do a repeat in 2012, the yield would have to be negative -0.25% at the end of the year. Chances of reaching that level are not good.

Stock Market

  • Good earnings, companies focused on controlling costs, good dividends, slowly strengthening economic conditions, attractive P/E ratios and an economic boost from increased spending in an election year are some of the reasons to believe the stock market is positioned to push higher. However, the stock market is moved by emotions as much as it is core fundamentals, and sometimes these are polarized conditions. Europe’s debt problems, China’s potentially slowing economy, federal budget problems in the U.S. and continued social unrest are some of the events that may play into investor psychology. Putting it all together, we expect forward progress, but continued market volatility on the way there.

View previous Economic Outlook newsletters.

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