by Sinclair Noe
DOW – 68 = 15,821
SPX – 7 = 1785
NAS – 4 = 4033
10 YR YLD + .03 = 2.87%
OIL + .18 = 97.38
GOLD – 18.20 = 1226.10
SILV – .28 = 19.54
Nelson Mandela is dead. News reports say the former South African President died peacefully at his home. He was 95. Nelson Mandela will be remembered as the person who, more than any other, brought an end to apartheid, the heartless policy of “separate development” in which white, black and South Asian South Africans were obliged to live apart. It is part of his towering achievement that the very notion of racial segregation is anathema throughout the civilized world.
Yes, the stock market was down again today but the economy is doing better than you thought. Third quarter gross domestic product grew at a 3.6% pace, revised up from earlier estimates of 2.8%. Wow, sounds great, until you dig into the numbers. A large part of the revision, almost half, comes from an increase in inventories. Businesses were stocking the shelves. Were they predicting a gang-buster holiday shopping season or were they caught flat-footed by a lack of demand? We won’t know with certainty until we get through the fourth quarter, but most indications are that the economy is still slogging forward, and there doesn’t seem to be a need for such a large inventory buildup. We know businesses accumulated more than $116 billion in inventories in the quarter, the most since the first quarter of 1998.
Growth in consumer spending, which accounts for more than two-thirds of US economic activity, was revised down to a 1.4% rate, the lowest since the fourth quarter of 2009. That line about consumer spending is a bit misleading, and I always have to issue a caveat, because the economy is about much more than consumers, but still. Consumer spending had previously been estimated to have increased at a 1.5% pace. A sluggish start to the holiday shopping season offered another reason for caution on the economy’s near-term prospects. Several big retailers reported disappointing November sales, with some relying on bargains to lure shoppers. And so, there is a strong possibility businesses will still have inventory on the shelves after the holidays, and there will be no need for new orders to replenish the stocks, and that will likely weigh down GDP growth in the fourth quarter and into the New Year.
Consumers are holding onto the purse strings. Some companies that reported sales gains had to offer more bargains to attract shoppers. The need to keep discounting, which stems from sagging consumer confidence and shoppers trained to wait for bargains, will persist through the remainder of the season. Retailers have created this expectation; just check your inbox; I’ll bet you’re getting more and more promotional e-mails from national chains. Why rush when there might be a better deal next week.
Meanwhile, the Commerce Department reported that after-tax corporate profits in the third quarter increased at a 2.6 percent pace in the third quarter, slowing from the prior quarter’s 3.5 percent pace.So profits are still growing, quite nicely, but they are growing slower. Dividends decreased $179 billion in the third quarter, in contrast to an increase of $273 billion in the second; part of that decrease is from dividends paid by Fannie Mae to the federal government in the second quarter.
The knee jerk reaction on Wall Street was that the GDP number was stronger than estimates and Wall Street looks at good news as bad news, based upon the idea that the Fed will taper from Quantitative Easing; that speculation was enough to push treasury yields to 3-month highs, but a closer examination of the numbers shows the GDP numbers to be a little less than robust. Atlanta Federal Reserve Bank President Dennis Lockhart summed it up by saying: “I am not prepared to interpret the revised third quarter number as an indication that the economy is on a much stronger track.”
Another number in the report was the price index for gross domestic purchases, which came in at 1.8%, up 0.2% from the second quarter. These measures of inflation are important because the Fed has repeatedly promised not to raise the so-called fed funds rate, now at nearly zero, until the jobless rate falls below 6.5% or inflation rises above 2.5%; those are the thresholds, rather than the targets. The Fed has targeted an inflation rate of 2%; that would be the sweet spot. And as long as inflation remains below target, that provides justification to keep the fed funds target rates in the zero range.
Why is that important? Markets are jittery about the Fed starting the process of ending some $85 billion in bond purchases each month. The purchases of Treasurys and mortgage-backed securities are meant to keep interest rates low and stimulate the economy. The tapering of bond purchases, however, is likely to trigger an increase in interest rates of all kinds and that could dampen economic growth. When the Federal Reserve first hinted during the summer that it would soon scale back, mortgage rates surged and interest rates also rose in many developing countries.
A new research report by the Cleveland Fed indicates that when the inflation rate remains low, it would be justification for the Fed to maintain its Zero Interest Rate Policy. In other words, the Fed will try a balancing act; keeping the fed funds rate lower for longer, to ease the worries of investors and let the economy more gradually acclimate to a future that at some point, might include higher interest rates.
An interesting point to ponder is that inflation remains tame, perhaps even disinflationary, even as the stock market has moved to record highs. Now you might suspect that a rising stock market, even a frothy stock market, even a bubblicious stock market might have an inflationary impact on the economy; then again, maybe not. Here we are in a stock market boom, and deflation is a greater concern, and apparently a guide for Fed policy. Go figure.
Today, the European Central Bank and the Bank of England left interest rates unchanged. Deflation is a big concern in the Eurozone. Producer price inflation (PPI) fell to -1.4% in the eurozone in October. This is how deflation becomes lodged in the price chain. Prices are sticky for a while as you approach zero inflation, but once you break through the ice into deflation things can move fast; an example would be Greece.
We seem to have a glut of things, and you know the old story about supply and demand. China’s fixed capital investment over the past year has been $4 trillion; that represents an 8 fold increase in the past 10 years, and it compare with $3 trillion for the entire EU and $3 trillion for the US. China is a vast new source of supply for a saturated global economy. Meanwhile, today’s data on GDP suggests US businesses are a bit saturated as well. Europe’s slide towards deflation is replicating what happened in Japan in the 1990s at the onset of its lost decade.
Japan is now fighting back with a strong monetary stimulus program called Abenomics, an easy money policy after the abject failure of a tight money policy. The result of tight money was that fiscal policy had to carry the entire burden instead. Budget deficits exploded as Japan battled the slump. Public debt ballooned to 245% of GDP. ECB President Mario Draghi says the central bankers are fully aware of downside risks of protracted low inflation. The ECB has been behind the curve for most of the past three years, needlessly causing a double-dip recession that caused havoc to public finances; so I guess its no surprise they took no action today.
In other economic news, the Department of Labor released its weekly jobless claims report this morning, and these results were also better-than-expected. Seasonally-adjusted claims fell by 23,000 to 298,000, significantly beating the 320,000 claims economists had predicted. Combined with yesterday’s ADP payroll report, this would seem to bode well for tomorrow’s monthly jobs report, but this weekly claims report was over the Thanksgiving holiday week, and the results might be slightly distorted. Still, it was the third straight weekly drop in initial claims. Not bad.
Look for 180,000 new jobs and the unemployment rate to go from 7.3% to 7.2%.
Regulators are reportedly ready to approve a tough version of what is known as the “Volcker Rule,” part of the Dodd-Frank financial-reform act, which prohibits banks from proprietary trading, which is fancy talk for “gambling with their own money.” Regulators were originally planning to leave a big loophole in the Volcker Rule by letting banks do what’s known as “portfolio hedging”. This is basically proprietary trading by another name, because it lets banks claim that any kind of trading they do is hedging against losses somewhere in their massive, multi-trillion-dollar portfolios.
One reason why the Volker Rule might actually have teeth is the London Whale. Remember the $6 billion loss that was, according to Jamie Dimon, a portfolio hedge? Not exactly. Bankers warn that this version of the Volcker Rule means mega-banks will not be able to protect themselves from future economic calamities, which means they have no choice but to get smaller and take fewer risks.
Sounds about right.