Something I have done before is keep you updated on economic developments and thoughts in the industry in an email newsletter format. Going forward I am going to start posting here, and include links via a newsletter to these and others. This way, you can come to the website and read any time, without having to search for email, and you can easily pass this on to anyone whom you believe would find this of value.
So… Whats going on?
This week we will discuss information from Fidelity’s Capital Markets group. (tip: click on the individual graphics to view them full size)
The Big Picture
Are we looking at a looming economic slowdown? Don’t be surprised if the European recession spills over.
There are 4 things you may be concerned about.
- Equity market volatility
- Potentially rising inflation & interest rates
- Government debt and the fiscal cliff
- Finding yield (interest) in a low rate environment
Stock market corrections happen quite frequently, to the tune of every 3 to 4 years. Recent corrections are largely driven by concerns over the situation in Europe. As per the Capital Research and Management Company, the average frequency of a 5% correction is 3 times per year. There is usually a 10% correction once per year, and a correction of 20% or more every 3.5 years.
As far as our exposure to europe, the fact is, the exposure we have to the Euro area is limited on a variety of fronts. Europe accounts for only 23% of American exports, and represents 14% of the US GDP. The Euro-Zone area as a whole is only 62% of the total European exposure. Furthermore, the US Banks have a fairly limited exposure to the debt of Portugal, Ireland, Italy, Greece & Spain.
American investors ought to use this opportunity to seek out attractive entry points and take advantage of anticipated improving US economy. Most of the consensus is that real estate and natural resources will be the drivers. At the current housing starts levels, the excess supply of homes in the United States will gradually be worked off over the next 2 to 3 years due to new household creation and existing home supply depreciation.
Furthermore, the United States is positioned to be a growing exporter and producer of Crude Oil and Natural Gas. In fact, by 2015, the US may be the largest producer of crude world wide. Oil combined with Natural Gas will potentially created numerous jobs on our soil. The numerous manufacturing jobs coming back to the states is just the cherry on top.
Bottom line, current stock valuations are compelling for long term investors.
Rising Inflation & Interest Rates
As per Fidelity’s economic group, nominal GDP growth is likely to be muted over the intermediate term as continued consumer deleveraging results in low real GDP growth and inflation. Low growth results in low inflation as there tends to be excess capacity or slack in the economy. One such example is the labor market. After shedding many jobs during downturn, the companies became quite lean, and even in an improving economy, the companies are slow on hiring while productivity is so high.
Commodity prices can also impact inflation, however over longer periods of time, it is minimal. The slowing economic growth abroad is currently resulting in easing commodity prices.
The low market yields for US Debt reflect the fact that the US does not face the same type of constraints as the Euro area. Thus, US interest rates are highly unlikely to increase due to a perceived solvency constraint.
The Debt and the Pending Fiscal Cliff
It is no secret that the debt is rising, and there are some issues coming up at year end. The potential fiscal cliff is significant relative to GDP. Such declines in spending and increases in taxes would be detrimental as US consumers are still deleveraging and do not have the capacity to pick up the slack. As per other countries’ financial crises, we know that the deficit eventually shrinks on its own as tax revenues improve and spending on automatic stabilizers decreases because of higher employment levels. As the economy improves, so will the debt.
Finding Yield in a Low Rate Environment
The average interest rate nationally for a 1 year CD, as per BankRate.com is .33%. The average for a 5 year CD is 1.12%. As per the Burea of Labor Statistics, the year over year inflation is 2.3%. Now that is what we call safely losing money over time.
The reality is, there are a variety of fixed income options, with varying levels of risk, that offer attractive yields at compelling valuations. If you or someone you know is losing money over time, let’s talk. Send us an email, or schedule a meeting, or request a call back at your convenience.
I hope you found this information useful, and now are armed to carry on an educated conversation at your next shindig. If you found this of value, comment below, or let us know. Better yet, share this with someone you think would benefit from this, or drag them to our office… or invite them to our upcoming seminars.
As always, thank you.
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