Hennion & Walsh Blog

Using the Effective Federal Funds Rate as a proxy for interest rates, it is reasonable to conclude that interest rates are at historic lows and likely to only go higher.

The Federal Reserve engaged in its most recent round of quantitative easing in an effort to help spur the economy, boost jobs and raise inflation (yes, raise inflation) by supplying the market with more liquidity to meet loan demand. The problem is, as we see it at Hennion & Walsh, that there is no demand in the market for more loans.

Anti-government protests in Egypt reached a fevered pitch in Cairo on Friday as demonstrators were demanding an end to the thirty year rule of incumbent President Hosni Mubarak, who is now 82 years old. At the core of the protests are frustrations over high rates of unemployment, rampant inflation (Ex. rising food prices) and increasing poverty levels across this Middle East country. These frustrations have been percolating over the past few years but have intensified over preceding weeks.

As part of our annual portfolio reconstitution process at Hennion & Walsh, we strive to build forward looking, asset allocation-oriented portfolios based on our internal views of where we believe both the markets and economy are heading for the next year. For your benefit, as we did last year, we have provided our four potential scenarios for 2011, based upon information available to our research team at this point in time, with an internal probability assigned to each, below:

One of Investors Business Daily’s headlines on Monday, May 9, 2011, was, “Private Hiring Best in Five Years, But Jobless Rate Rises.” With respect to the former, non-farm employment increased by 244,000 jobs in April of 2011, according to the Bureau of Labor & Statistics, beating Moody’s Consensus Estimate of 185,000 jobs. Interestingly, the private sector led the way this time around, adding 268,000 jobs while net increases in the public sector were actually slightly negative. Some investors seized on the news, potentially believing that the data results provide evidence that the economic recovery is transitioning from the days of Government led economic stimulus to a self-sustaining economy driven by the private sector.

Many U.S. Corporations continue to have very healthy balance sheets with significant percentages of cash on hand. To this end, according to a January 10, 2011 report entitled, A Cash Buildup and Business Investment, by Robert Sadowski of the Federal Reserve Bank of Cleveland, highlighted cash holdings and other liquid assets as a share of total corporate assets rising around by approximately 2% since the start of the most recent recession. This share; 7.4% as of September 2010, is the highest relative cash % for U.S. corporations since the mid-1950s. The cash on hand could support potential business expansions, dividend increases, stock buy-backs and/or mergers or acquisitions (M&A). All of these potential deployments of cash listed above could be positive not only for the each respective company but also for the stock market and economy as a whole.

While I believe that yesterday’s 512 point decline in the stock market (which marked the 9th largest single day point decline in history), as measured by the Dow Jones Industrial Average (DJIA), was extreme, I do believe that a form of a stock market correction, with respect to the now 29 month long bull market, was long overdue.

After markets closed for the week, credit rating agency Standard & Poor’s (S&P) announced on Friday, August 5, 2011, that it had cut the sovereign debt rating of the United States of America to AA+ from AAA. The ratings cut was the first downgrade of the U.S. AAA credit rating by S&P since S&P initially granted the AAA rating to the U.S. in 1941.

The labor picture is not improving in the U.S. and prospects for any type of a much needed short-intermediate term recovery grow more and more dubious with each passing jobs report.

While the headline of this commentary may come as a surprise to many, it was the exact sentiment conveyed by Federal Reserve Bank of Philadelphia President Charles Plosser on Tuesday, September 25. The statement runs afoul of the public comments made by Federal Reserve Chairman Ben Bernanke who recently stated that the Federal Reserve intends to extend its accommodative credit stance (i.e. keep interest rates at historic lows) through the middle of 2015 – at least. In providing the Federal Reserve rationale behind the extension, Bernanke cited a concern with future economic growth without improvements in the labor market. A correlation between job growth and economic growth certainly appears to be evident as economic growth has been sluggish, as have gains in job creations, during this recovery from the “Great Recession.”

Spain, which has the 4th largest economy in Europe, is currently struggling with high unemployment (the highest unemployment rate in Europe), increased borrowing costs, a stressed banking system and rising tensions amongst its citizens as it relates to austerity measures being considered by Spanish Prime Minister Mariano Rajoy. Does this sound all too familiar? Take out the word “Spain” and insert the word “Greece” and the first sentence might have been the beginning of one of our market commentaries from several months ago.

Since the end of the 4th quarter of 2011, the U.S. economy has been contracting. 2nd Q GDP’s most recent revision came in at 1.3% - a pretty concerning level - with most components revised down from previous estimates. Moody’s Economics Group reported that this third estimate was a downward revision from the 1.5% reported in the advance release and a reduction from 1.7% in the second release. While some of the slowdown came primarily from a decline in farm inventories, due to the drought in the mid-west, consumer service spending, exports and durable goods all declined as well. Barron’s noted that business activity contracted in September, for the first time in 3 years, while durable goods orders declined 13% in August vs. July - the biggest decrease in three years as well. Unfortunately, the most recent news doesn’t appear to be getting any better. As Bespoke Investment Group put it in their September 28, 2012 “Week in Review” article, “It certainly wasn’t a great week on the economic front, as 11 reports came in worse than expected, versus just 6 that came in better than expected,” and, “It’s hard to imagine where this market would be without QE3.”

Momentum continues to build in the housing market, domestically and internationally, and it appears that the real estate recovery is for real. On the domestic front, we have taken notice of a positive trend in pricing, volume, inventory and sentiment across the country. For these reasons, we contend that housing will remain as one of the brightest areas of the U.S. economy and will likely be an engine of future growth for the anemic state of the current U.S. economic recovery.