March 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 March 13, 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, but there is more dissension among the Fed members on this subject.
- The year-over-year consumer price index (CPI) released in February shows inflation at 1.6%. Even though gasoline prices have risen materially, we expect the reported number to be about the same on the next release date.
- If the economy were a sporting event with only two teams allowed on the field, the current game would be between the Feds and the Fundamentals.
- The Federal Reserve is using its hurry-up offense and is in full stimulation mode, printing money to buy Treasury bonds and mortgage bonds in an effort to drive interest rates lower. Its goal is to lower the cost of borrowing money, which will allow consumers access to more loans at lower rates. That is expected to increase consumer demand and create more jobs. Howard Cosell might be questioning this strategy at a point when the Fed appears to be “winning” the game with lots of time left on the clock.
- The Fundamentalist team sees consumers with no more income today than 6 years ago. They see lackluster growth in gross domestic product (GDP) that would be negative without federal deficit spending. They see unemployment stubbornly high, a government funding debate later this month, and rising social costs as demographics shift. They believe they have the right strategy for the game but appear to be losing.
- Once again we are reminded of the long-standing market mantra, “Don’t fight the Fed,” intended to remind people that the Fed can print an indefinite amount of money.
- What causes the Fed to quit printing money? In short, inflation. Some experts suggest inflation is benign, but consumers have a sense it is not. The real mystery is determining how far apart these two perspectives remain.
- Bond yields reversed their rise and drifted below 2% on the 10-year Treasury.
- The continued low yield environment suggests that bond investors still see trouble in the economy and are willing to accept low coupon payments to have the security of bonds. At the same time, stock investors appear to have no doubt that the future of the economy is well lit and void of all concerns.
- The thing we know with a high level of confidence is that one of these perspectives is wrong.
- With various stock indexes looking like they are headed to new highs, we are reminded of model rockets. When a rocket lifts off from the launch pad, it is in boost phase, meaning it is under the power of the motor. At some point, the fuel is exhausted, but the rocket continues to go higher. This is the coast phase, meaning that the rocket continues to glide upward in spite of a motor that is no longer functioning. As much as half of the rocket altitude is gained during coasting (at least for model rockets) on the way to its apogee (highest point).
- The Federal Reserve printed approximately $2 trillion in the last 4 years, and the federal government has run trillion-dollar deficits over the same period to boost the economy. Even when the motor is exhausted (think sequestration, for example), the market can continue to rise in the coast phase.
- The apogee in model rocketing is a matter of physics: thrust, aerodynamics, atmosphere, wind and friction can be calculated to determine the highest point in advance. Unfortunately, the stock market does not lend itself to this same level of certainty. The best level of defense for investors is a proper allocation to match their personal investment profile.
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