http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights.htmlEconomic Insightsen_usCopyright 2012 Lord Abbetthttp://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/chinas-stock-market-can-bejing-keep-it-steady.htmlChina's Stock Market: Can Beijing Keep It Steady?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The Chinese economy likely will sustain a pace of growth strong enough to stabilize stock prices.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>A stock market bubble has burst. From their peak last June to their recent lows, Chinese stock prices have fallen more than 30%. Valuations have collapsed. Prices at the peak amounted to more than 26 times historical earnings; by mid-July, they stood closer to 19 times.<sup>1</sup> That movement alone would seem adequate to correct any excesses, especially given China’s growth potential and the valiant remedial measures to which Beijing has resorted. But busts, like booms, are more emotional than rational in nature. They end only when the panic exhausts itself.</p> <p>When that time comes, prices should again connect to fundamentals, and these look supportive of an advance, even from today’s levels. Valuations no longer look as stretched as they did, certainly not relative to Chinese growth prospects. No one, of course, expects China’s economy to return to the 10–12% annual pace of growth it once maintained, but a 5–7% real yearly pace of advance is a reasonable expectation, especially given Beijing’s need to keep producing jobs for an otherwise restive population and the resources it has at its disposal to secure that growth. There are, as always, significant risks, not the least of which is the slow-motion real estate correction still going on in China. But the probabilities for equities nonetheless favor a return to gains—once the present panic runs its course.</p> <p><b>The Backdrop<br> </b>As with so many ugly eventualities, the Chinese stock market bubble began with the best intentions. Beijing promoted stock buying as part of its general efforts to revitalize the economy and reorient it from its heavy dependence on exports toward more domestic sources of growth. The reasoning, outlined by Chinese president Xi Jinping, held that a rising, active stock market would encourage the launch of new businesses and draw foreign investment into the country. With that inflow, he looked for a broadening of the economy as well as access to global best practice. He also looked for rising equity prices to help the county’s heavily indebted business sector, allowing it to raise monies through stock offering, repay debt, and create more resilient and dynamic financial structures. Wider ownership of stocks, particularly the issues of state enterprises, President Xi and his colleagues in government argued, would force greater efficiencies and rationalities on these huge firms, promote consolidations in overbuilt industries, and generally reinvigorate what had become a less than dynamic aspect of China’s economy.<sup>2</sup></p> <p>For a while, the plan seemed to work well. Interest in the stock market increased. More of the middle class began to buy equities. Prices on the Shanghai Index<sup>3</sup> rose from 10 times historical earnings last summer toward a not unreasonable 17 times earnings late in 2014.<sup>4</sup> The business environment did not respond immediately, but then no one expected it to do so. Starting with this new year, however, things began to get out of hand. A large number of individual investors, with no experience in equities and even less advice, began to chase market gains. Significantly, they began to buy on margin, which expanded five-fold during the first half of this year, to peak in June equivalent to $323 billion.<sup>5</sup> Prices surged well ahead of earnings. The distinct preference for riskier stocks allowed the Shanghai exchange to outperform the larger, more stable Chinese companies listed in Hong Kong and New York. At its peak, the composite index stood more than 150% above its levels of last summer. The preference for risk allowed the smaller-stock-oriented Shenzhen Index<sup>6</sup> to rise even faster.<sup>7</sup></p> <p>Though this bubble could have inflated for some time, a bust was inevitable, and it came in June. Not surprisingly, the worst damage occurred among smaller stocks. While prices on the Shanghai exchange fell a bit more than 32% from their peak to recent lows, prices on the Shenzhen exchange fell more than 40%.<sup>8</sup> Meanwhile, the smart money in China seems to have sold out throughout the latter stages of the rally, clearly to those inexperienced, new investors. According to Bank of America Merrill Lynch, major shareholders in Chinese firms sold ¥360 billion ($58 billion) in equities on balance during the first five months of the year (the most recent period for which data are available), well up from the ¥190 billion sold during a comparable period in 2014 and ¥100 billion in prior years.<sup>9</sup> These better informed investors seem to have redeployed their monies to real estate, at least if reports from brokers in such far-flung locales as Sydney, London, and New York are reliable.</p> <p>The Chinese government has pulled out all the stops to stabilize this situation. The People’s Bank of China (PBC) has cut rates. Beijing has ordered state-run companies and brokerage operations to buy stocks outright. Officials have stopped all new issuance and also have suspended trading on up to 40% of the outstanding listings on China’s two main exchanges. China has even created an entity to hold up demand by facilitating still more margin purchases, some reportedly backed by home mortgages.<sup>10</sup> As of mid-July, though, these measures have done little to stem the bearish tide.<sup>11</sup> The extraordinary government response may actually have added to the selling pressure by inadvertently convincing investors that their panic was justified. From Beijing’s point of view, however, it had little choice. The sudden bust has called the government’s whole economic-fiscal agenda into question. Losses, according to recent reports in both the <i>New York Times </i>and the <i>Wall Street Journal,</i> have brought out atypical criticism of the ruling Chinese Communist Party, even among everyday Chinese. That small investors are the biggest losers particularly worries the country’s leadership, for it vividly recalls the social unrest, even rioting, that immediately accompanied the recession of 2008. Damage control was essential for political if not only financial reasons.<sup>12</sup></p> <p><b>Prospects<br> </b>Once the current panic plays itself out, market prospects should again connect to the fundamentals: market valuation and growth prospects. Even today’s multiples, at about 19 times historical annual earnings (and only slightly pricier than American stocks), could reasonably form a base once the bearish psychology has dissipated. Though the greater risk and volatility in Chinese stocks would seem to demand a lower valuation multiple for them than for American stocks, that economy’s greater potential for economic and earnings growth could more than compensate. The crucial matter, then, looking beyond the panic, is those growth prospects. They are, to be sure, nowhere near what they were some years ago, when the Chinese economy maintained real growth rates of 10–12% a year, and there are risks, as always, but Chinese growth should nonetheless exceed that of the world’s developed economies, including the United States, and so warrant multiples at least at equal levels, despite higher levels of volatility.</p> <p>Set against this prospect are arguments that the market crash alone will kill the economy—China’s 1929 moment, as some media reports have it. Such bear arguments are weak on several accounts. For one, stock losses to date are actually less severe than they were in 2008, and that downdraft did not bring down China’s economy.<sup>13</sup> For another, Chinese managements are generally less sensitive to stock price movements than are their American counterparts, especially in the dominant state-owned firms. At base, stocks in China, and other emerging markets, have less real impact because they are simply less integral to the economy than they are in the United States and other developed economies. Consider that the value of stocks in China has trended around 50–60% of the country’s gross domestic product (GDP), compared with 130% in this county.<sup>14</sup> This difference goes a long way to explain the volatility of the Chinese market, and other emerging markets. Small relative to their respective economies, any economic change that increases flows into or out of these markets is bound to have a greater price impact than in more mature financial arrangements. By the same token, movements in relatively smaller, less integrated emerging stock markets have a less direct and profound impact on the respective real economies. &nbsp;&nbsp;</p> <p>Then, of course, Beijing has tremendous resources with which to counter any ill effects on the economy. The Chinese government has the equivalent of $4.0 trillion in foreign exchange reserves—some 35% of GDP—that it could deploy to bolster the economy.<sup>15</sup> More, the Chinese government’s relatively low debt levels give it fiscal options not available to, say, the United States. Though there is a lot of private debt in China, public debt outstanding amounts to only about 25% of GDP,<sup>16</sup> compared with Washington’s debt burden of more than 100% of GDP.<sup>17</sup> These resources could, should Beijing decide it was necessary, enable the government to remount the massive stimulus it used so successfully to counter the effects of the 2008–09 global recession.</p> <p>China’s command economy also allows Beijing to deploy such a stimulus rapidly, if circumstances demand it. The government may be having trouble stemming the immediate stock market retreat, but the history of 2008–09 shows that such economic stimulus efforts can work to great effect. Indeed, if matters demand it, Beijing would have little choice. It knows that the constant flow of people from the countryside into the cities makes a rapid rate of jobs growth imperative, for social as well as political stability. As already indicated, Beijing learned in the recession of 2008–09 that the country’s lack of a social safety net can lead to trouble on the least interruption in jobs growth. At that time, six, seven years ago, rioting started almost immediately after any layoffs or factory closings. Communist Party officials were attacked, even murdered in the provinces. Beijing had little choice then but to implement that stimulus. The country’s stability—and their livelihood, perhaps their lives—depended on it. This pressure may have abated in recent years, but the need to sustain a 5–7% real rate of growth persists, and for the same reasons. There can, then, be little doubt that Beijing will do all that it can to sustain this necessary pace of advance.</p> <p>To be sure, China back in 2008–09 was not facing the slow-motion real estate correction it faces today. But the effects of that, though hardly small, are easy to exaggerate, especially among Americans, who naturally draw parallels to their own country’s highly destructive real estate problems in 2008–09. Unlike in China today, America’s biggest debt problem was less its size than that the debt was so widespread, so much so, in fact, financial institutions began to distrust each other’s ability to meet their obligations. Financial dealing dried up, and the economy suffered accordingly. In China, though the overhang of questionable debt is large, it is far less widespread. Households, for instance, are far from over leveraged, as they were in the United States. Until recently, a Chinese homebuyer had to put down 20% for his or her first home and 50% on a second home. The debt in China is concentrated in local and provincial governments, making it much easier for the authorities to contain and make less of a threat to the financial system than was the subprime situation Washington faced in 2008–09.<sup>18</sup></p> <p>Nor is the chance of a contagion among emerging markets as likely as some of the more panic-struck commentators have suggested. Part of this fear harkens back to the Asian collapse of the late 1990s, the so-called “Asian contagion.” But circumstances have changed since then. These other Asian countries have generally improved their finances during the intervening 15–20 years, ridding themselves of the fixed exchange-rate policies that destroyed their flexibility and the dependence on dollar-denominated debt that so facilitated the transmission of financial losses from one country to another.<sup>19</sup> To be sure, commodity prices and commodity exporters have suffered. Part of this is an old story, a basic reflection of the less-intense Chinese demand for such products due to the ongoing change in the nature of that economy and its commensurately slower growth pace. Commodity prices have long since begun to adjust to this development, as have the commodity-exporting economies. The sudden recent commodity price declines, in some cases to levels not seen since the 2009 global recession,<sup>20</sup> reflect an erroneous expectation that the drop in stock prices will destroy the Chinese economy and so wipe it out. This misses the clear fact that the economy there is not likely to respond as intensely to stock-market losses as the bears seem to believe it will.</p> <p>Though China will never return to the rapid 10–12% real annual growth rates of the past, this analysis shows an economy that likely will sustain real growth rates approaching and perhaps exceeding 6%. That is more than twice the rate at which the United States is growing. And since corporate earnings should more or less track real growth, there is every reason to expect Chinese stocks, immediate vulnerabilities aside and despite their greater volatility, to sustain multiples somewhere near those prevalent in the United States and other developed markets. If such a conclusion fails to point to a renewed boom, it does at least suggest a return to fundamentally based gains after the present, bearish psychology runs its course. Meanwhile, any sign that China is succeeding in its fundamental effort to reorient its economy from its present export base to a more domestic engine of growth should point to less volatility and the capacity for stocks to sustain greater multiples and produce stronger gains.</p> <p><b>Conclusion &nbsp;<br> </b>None of this pretends that all is well or risk free. On the contrary, risks about bearish psychology could renew the sell-off and extend it for a while yet. Certainly, the bears will impose volatility. Delays in remedial action could create still more fear. Should policy failure allow the economy to falter or fail to get ahead of a move toward social discord, then the economy would suffer, but more from the social unrest and policy failure than the stock-price declines themselves. Though distinct possibilities, these adverse outcomes are, however, not probabilities. The likelihoods still favor continued economic growth. Even if it were slower than it was in the not too distant past, such a pace of advance should prove sufficient to meet the economy’s crucial job-creation needs and still remain considerably faster than growth in the United States and the rest of the developed world. On that basis, it also should prove sufficient eventually to stabilize stock prices and, subsequently, make at least modest gains.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 27 Jul 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-housing.htmlU.S. Housing: Building Strength<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Even with an expected rise in interest rates, the sector should see a faster pace of growth—not enough, however, to give a major boost to the overall economy.&nbsp;</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Housing should accelerate in coming months and quarters. &nbsp;Even with the extra growth, the sector will fall far short of past booms and hardly offer the general economy enough of a fillip to change the slow-growth nature of the overall recovery. But otherwise, residential real estate can look for enough additional support, even with an expected rise in interest rates, to make the frustratingly slow slog of the past few years into a slightly less frustrating slog going forward. &nbsp; &nbsp; &nbsp; &nbsp;</p> <p><b>A Disappointing Recovery So Far &nbsp; &nbsp; &nbsp;&nbsp;<br> </b>Up until now, the housing recovery has given ample cause for frustration. The last four to five months are indicative. Starts of new homes came into the year showing no growth. They fell steeply in February, by 16.7%, rose modestly in March, and surged by 22.1% in April, only to fall back to 11.1% in May. The inordinately cold winter weather might explain some of the up-and-down behavior, but this erratic pattern is little different from that of the prior five months, during which two months reported starts falling. Nor is it much different from the entire period going back to the beginning of the recovery in 2009. The net of all this misleading monthly gyration was indeed a slow slog, during which residential construction expanded at barely more than a 5% average annual rate. Sales have presented a similarly frustrating picture. Existing home sales show three down months in the last eight, plus two with barely any change. Though some months looked good enough to cause a stir, they show only a 6.1% net gain over the past 12 months.<sup>1</sup></p> <p>To be sure, these net growth figures are faster than the overall economy’s real annual growth rate of 2.0–2.5%. On that basis, housing might look robust, but considering the hole created by the Great Recession, the performance hardly constitutes much of a comeback. Housing starts, after all, remain even now more than 50% below the peak of 2007 and 20% below the average level of home construction during the 1970s, 1980s, and the mid- to late 1990s. Sales of new homes trail past benchmarks by even more. As of last April (the most recent month for which data are available), these remain some 63% below their former peak and about 30% below the average of the 1970s, 1980s, and the mid- to late 1990s. On this basis, the recovery so far does look very much like a slow slog.<sup>2</sup></p> <p><b>Some Pickup to Come<br> </b>Under almost any circumstances, it will be a long time before the sector comes up to its historical norms. It may in fact never get there, since, even after immigration, low birth rates in the United States have slowed the fundamental rate of new family formation. Such very long-term considerations and perspectives aside, however, at least four considerations should support some housing pickup in the period just ahead.</p> <p>Increased lending is one of these. Throughout this recovery, banks and other lenders have held back lending for anything to do with residential real estate. They cut it almost 2.5% a year on average between 2010 and 2014—a major impediment to home ownership and to a faster recovery. But now they have begun to change. The year 2014 saw the first uptick in such lending. This year, banks have built on that tentative start. Lending has increased only at a 1.5% annual rate so far—hardly a flood of liquidity—but it is a major change from the last five years and a reason to except more activity in the sector, especially since, to date, a lack of available funds has been the major impediment to new sales.<sup>3</sup></p> <p>Combined with this new willingness to lend, affordability presents a second favorable consideration. The National Association of Realtors compiles an affordability index by comparing the cost of supporting a mortgage on the average home in the country to the average household income. Largely because housing prices have risen slightly faster than incomes, affordability has deteriorated some in the past couple of years, falling about 7.1% last year and about 2.1% so far this year through April (the latest month for which data are available). But because housing prices fell so precipitously during the crisis, even the losses in affordability during recent years still leave housing considerably more affordable than it was during the boom and even in the 1990s, before the great price surges. The picture suggests that housing will remain historically affordable, even as the Federal Reserve begins the modest interest-rate increases it has indicated. Indeed, affordability might even improve in the coming months, as the increased hiring rates&nbsp; that have developed of late add to the pace of income growth. It is noteworthy in this regard that the modest acceleration in hiring late last year and the additional income it created actually improved affordability some 16.3% during the second half of 2014.<sup>4</sup>&nbsp; &nbsp;</p> <p>The modest improvement in labor markets might help in a third way by spurring an increase in family formation. The long-term demographics limiting the growth of family formation are one thing. More cyclically, the lack of jobs growth had an impact by forcing an increased&nbsp; number of young people to remain in their parental home and forgo establishing an independent residence. Between 2010 and 2014, for example, the Census Bureau reports, the percentage of people between the ages of 18 and 24 who remained in their parents’ home increased from about 58% to 60% for men and 49% to 53% for women. The percentage of people between the ages of 25 and 34 who remained in their parents’ home increased from about 16% to 18% for men and 10% to 12% for women. No data exist on 2015 yet, but it is doubtful that the improved jobs market would raise these figures meaningfully and likely that it will bring some of these young people out to form households of their own. It also is probable that some will buy, because, as a fourth consideration in this equation, rents are rising rapidly. Since 2011, rents nationally have risen almost 20%—faster than incomes and faster than the cost of supporting a mortgage.<sup>5</sup></p> <p>None of this suggests a housing boom. It does not even suggest that home buying and construction will re-approach historical levels anytime soon. But it does suggest a pickup in the sector from the off-again/on-again pattern exhibited so far in the recovery and the resulting sluggish pace of advance.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 20 Jul 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/greece-four-fateful-factors.htmlGreece: Four Fateful Factors<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>While we await the disposition of Greece’s latest fiscal rescue, here are the issues that could influence the nation’s future—bailout or no.&nbsp;</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Europe has countered Greece’s proposed bailout deal. Athens’ latest proposals had shown a greater willingness to compromise than previously, but Europe has asked for more spending cuts, tax increases, labor market reform, and sales of state assets. Now the deal awaits ratification by the Greek and European parliaments. If all agree, Europe and financial markets should enjoy a period of renewed stability, at least for a while. But, as with so much in this soap opera of negotiations, nothing is assured. Still, for all the remaining uncertainty, four underlying considerations can place matters in perspective:&nbsp;</p> <p><b>1) The Vote<br> </b>The dramatic Greek referendum on July 5 clearly meant nothing. The initial proposals from Athens had already flown in the face of that vote. Ratification of the new, harsher deal will stray further from the sentiments expressed by Greek voters. The vote was, of course, never binding. Still, it was clearly done to give the government guidance. The ruling Syriza party, among all its other problems, faced huge political difficulties as it went into this last, desperate round of negotiations. It had promised the Greek people both to keep the country in the euro <i>and</i> to rid it of the austerity and reform demands of the country’s creditors, the so-called troika of the European Union (EU), the European Central Bank (ECB), and the International Monetary Fund (IMF). As these promises came to look increasingly incompatible, the government needed to retest domestic political feeling. The Greek people made clear that the rejection of reform and austerity was primary. That result should have given Athens a stronger hand in its negotiations. Clearly, it was not enough.<sup>1 </sup>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p><b>2)&nbsp; Default<br> </b>Default, should it come, is not much threat to Europe’s economy or its financial markets. Greece is a small economy. Its gross domestic product (GDP) is barely 6.5% of Germany’s, and its outstanding debt amounts to barely 1.0% of Europe’s banking assets. Even if that debt were widely distributed, default would hardly threaten the continent’s financial stability. And since the debt is now held largely by governments and other official bodies, the financial system has an additional buffer against uncertainties in this regard. Meanwhile, the ECB’s bond-buying program should stem any fears that Greek default would force unmanageable borrowing costs on Italy, Spain, and others in Europe’s troubled periphery.<sup>2</sup>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;</p> <p><b>3) Exit<br> </b>Greece will suffer horribly if it were to leave the currency union. A return to a national currency, presumably a new drachma, would no doubt help Greek exports, for the new currency would surely lose value on foreign exchange markets and, accordingly, bring down the global price of everything Greece sells to the world, including tourism. But otherwise, a depreciating new drachma would cause hardship by destroying the global buying power of all its residents’ incomes and savings. What is more, the likelihood that the new currency would continue to depreciate would make lenders even more wary than they already are. Not only would they fear default, as they already do, but, with an exit, they also would worry about the future global worth of any loan denominated in the new drachma. Meanwhile, the eurozone would suffer little. Indeed, the absence of this weak economy and the endless uncertainties it has imposed could actually lift European economic and financial prospects as well as the euro’s foreign exchange value. Of course, the exit of any member country could raise questions about the durability and character of Europe’s grand experiment with union, but it would be hard to raise more troubling questions than the drama of the past few weeks has already. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;</p> <p><b>4) Risk<br> </b>The greatest risk to Europe and world financial markets would develop if bank depositors in Italy, Spain, and other countries of Europe’s periphery were to follow the Greek example and withdraw their deposits from their banks. The ECB has only limited powers to offset such a money flight. Its much-vaunted quantitative-easing program aims to channel funds to governments, not local banks. It speaks to the ECB’s inadequacies in this regard that Athens, even as the ECB had opened an emergency credit line, has had to impose credit controls and bank closures to stop the outflows. Seeing the troubles in Greece, it is entirely conceivable that Italians, Spaniards, and others will decide to play it safe and move their money out of local banks, even in the absence of particular problems in their country. Enough movement in this direction would force severe liquidity shortages on a big part of Europe, constrain already weak economies, and make it that much harder for them to meet their debt obligations. Worse, a widespread loss of bank liquidity could precipitate a full-blown financial crisis. Financial transactions could slow or stop altogether, as doubt about the soundness of all financial institutions would make all reluctant to do business with each other, much as happened in the United States in 2007–08, when a similar wariness developed—in that case, around each firm’s exposure to subprime loans.<sup>3</sup>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p><b>A Tentative Conclusion<br> </b>If all parties approve a deal, matters will stabilize for a while—but only for a while. It will take much time before the proposals currently on the table can make Greece viable. It is not clear that they can at all. Either way, another period of crisis is all but assured. If, on the other hand, this latest round of negotiations fails, the risks of an immediate exit will again rise, as will the chance of money flight from the periphery generally. On this second, more threatening prospect, probabilities, thankfully, remain low, since there has been little sign that depositors’ fears extended beyond Greece even during the worst of this latest round of crisis. Still, the potential is serious. What has become clear in this latest round of negotiations is that the Greek government at least now knows it has much more at stake in this exchange than does the rest of Europe, which might even gain from a Greek exit. Berlin, after all, has already pushed for a &quot;temporary exit.&quot;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 13 Jul 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/emerging-market-stocks-back-on-map.htmlEmerging-Market Stocks: Back on the Map<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>After the volatility of the past few years, conditions once again appear favorable for this asset class.&nbsp;</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Once an unquestioned investment favorite, emerging markets have given investors a wild ride during the past few years, and have, generally, disappointed. They could not help but do so given the expectations that had prevailed. Now, many of these markets are coming back. Interest in the area has risen accordingly, but people remain wary. That is probably healthy, though there is good reason to reconsider this asset class now. Emerging markets, of course, are no place for those who dislike volatility or for those with a short-term investment horizon. But for the longer-term investor, things look favorable. These equity markets show value that should pay off, especially for those economies adjusting to the new global environment.</p> <p><b>A Little Historical Perspective &nbsp; &nbsp; &nbsp;&nbsp;<br> </b>Just prior to the financial crisis of 2008–09 and Great Recession, consensus saw emerging economies as the place for universally rapid growth, where equities would produce superior returns. China’s economy, for instance, had grown at a rate of 10–12% a year in real terms during the prior five years. India had shown real annual growth rates averaging near 9.0% during that time. Brazil had a much lower average growth of some 4.0%, but showed individual years where real growth approached or exceeded 6.0%.<sup>1</sup> China’s Shanghai Composite Index<sup>2</sup> averaged price gains of 31.1% a year during the five years leading up to 2007’s pre-crisis peak. India’s SENSEX Index<sup>3</sup> did even better, averaging 38.0% a year. Smaller markets did well, too. Indonesia’s JKSE Composite<sup>4</sup> showed annual price gains of 45.2%, while Brazil’s Bovespa Index<sup>5</sup> averaged 34.4%.<sup>6</sup> And this is just a sampling. The pattern was widespread. Consensus wisdom viewed emerging economies as on track to grow at rapid rates and produce great equity returns indefinitely.</p> <p>The crisis interrupted the pattern, but it seemed to return with the initial recovery of 2009. China’s economy, for example, grew 9.2% in real terms that year, and India’s 8.5%. Brazil’s averaged a decline for the year, but more detailed quarterly and monthly figures pointed to strength. Similar growth spurts appeared throughout most of the emerging world, where the equity markets showed their old verve as well. Chinese stock prices rose almost 80% in 2009, India’s 81%, Indonesia’s 87%, and Brazil’s 73%. The attractive pattern was fairly consistent across the sector.</p> <p>Disappointment set in after 2010. All these emerging economies slowed, some very abruptly, and their equity markets underperformed accordingly. China’s real annual growth rate trended down, to an annual pace of just above 7.0% by 2013. Its Shanghai stock composite averaged price declines of 9.2% a year during those four years. India’s economy grew at closer to a rate of 5.5–6.5% during much of this period, barely more than half its pre-crisis pace. Its SENSEX Stock Index saw an average annual price advance of less than 5.0%. Brazil, under tremendous economic strain, barely escaped a relapse into recession, and grew only about 2.0% a year from 2011 to 2013. Its equity market accordingly saw price gains of merely 2.3% a year. Indonesia, along with other oil-based economies, did better because of rising energy prices during that time. Even then, its equity market advance of 13.4% a year during this time paled in comparison with its pre-crisis performance.</p> <p>It is now apparent, even to consensus thinking, that the great growth and equity gains of 2002–07 were far from fundamental. Instead, they arose from the confluence of near perfect conditions. Global trade at the time was growing much faster than the developed economies generally, providing opportunities for the export-oriented emerging economies, which, in one way or another, was just about all of them. Commodity prices, including oil, were rising, benefiting that not insignificant portion of emerging economies that depend on commodities exports. At the same time, developed countries kept their interest rates low, providing a free flow of global liquidity and effectively giving emerging markets an abundance of investment monies that not only benefited their overall growth and productivity but also that directly supported their financial markets. And since many of these countries had liberalized their economies in the 1990s, they were perfectly positioned to realize all these special benefits.<sup>7</sup>&nbsp; &nbsp;&nbsp;</p> <p><b>Prospects<br> </b>If the future cannot promise this remarkable confluence of positives, emerging markets can nonetheless still make satisfactory gains. They certainly show relative value. Emerging market multiples stand on average 20% below U.S. equity multiples and 8–10% below those in Europe and Japan.<sup>8</sup> On that basis alone, emerging markets should generate relatively good returns, even in the absence of perfection. All they require is some slight improvement in the fundamentals that retarded performance in the 2009–13 period. And this is likely.</p> <p>One such factor is policy. Tightening fiscal and monetary policies contributed much to the disappointing economic and market performances of 2009–13. Economic managers in these countries were not actively trying to slow growth during this time. The problem was that they had eased policy so much in 2008–09 to contend with the crisis that efforts to normalize things in recovery had the effect of restraint. Now that most of these policy adjustments have run their course, these economies should feel a sense of policy relief going forward, even if their economic managers simply adopt a neutral policy stance, though some, China most notably, have moved toward more stimulative policies for the time being. In part for this reason, the International Monetary Fund (IMF) expects 5.2% annual real growth rates for emerging economies as a whole during the next five years, up from the 2009–14 period and notably twice as fast as its expectations for the United States and more than three times its expectations for either the eurozone or Japan.<sup>9</sup></p> <p>Trade, too, should accelerate modestly. No one expects a return to the growth pace that prevailed before the crisis, but neither should these economies suffer the shock that beset them in the years following the crisis, when every expectation of the time faced disappointment. On the contrary, the IMF actually expects a modest uptick in world trade in part because of the U.S. dollar’s recent strength, but not exclusively for that reason. Such projections should, of course, be taken with more than a little salt, but it is indicative nonetheless that the IMF looks for emerging economy exports to accelerate, from the 5.0% annual pace they averaged between 2009 and 2014 to 6.5% during the next few years. The projected growth pace is still slower than between 2002 and 2007, but it is nonetheless a marked uptick from recent years—a 30% jump in fact.<sup>10</sup></p> <p>Even the decision by the U.S. Federal Reserve to notch back its monetary ease may not have the retarding effect some expect. To be sure, the Fed caused considerable concern among emerging-market investors in 2013 when it announced its intention to taper off its quantitative easing program, though when it actually did the tapering, these markets stood up reasonably well. Now, the Fed plans to dry up still more excess dollar liquidity by gradually raising interest rates. By itself, this policy posture would tend to hold back both growth in emerging economies and gains in their markets. But these actions are not happening by themselves. While the Fed is pulling back, both the European Central Bank (ECB) and the Bank of Japan have announced significant quantitative easing programs and have pushed interest rates down toward zero, into negative territory in some cases.<sup>11</sup> Such new flows of liquidity should more than offset the Fed’s plans for dollar liquidity, allowing a continued robust expansion in global money flows over the next few years.</p> <p><b>Ways to Differentiate Among Markets<br> </b>Apart from these largely favorable general considerations, a number of other perspectives should help investors differentiate among emerging economies and markets. One is relative movements in the value of the dollar and the euro. Since the dollar will likely continue to rise against the euro, those that depend relatively more on American markets and less on European markets would seem to have an advantage. This is, of course, no place to list all 50-plus markets usually grouped in the asset class. Still, there are standouts. Latin America economies would seem to have the edge in this regard over the European emerging economies and those of the Middle East and North Africa. Asia offers a mixed picture. Of the economies often singled out in emerging-markets discussions, China, India, Malaysia, and Vietnam would seem to have an advantage in this regard, while Russia, Turkey, and Egypt would seem to face a disadvantage.<sup>12</sup></p> <p>The ongoing slowdown in Chinese growth would seem to disadvantage economies that count on China as a major market. That would include Africa, Central Asia, Russia, Vietnam, Indonesia, Malaysia, and, in Latin America, Chile and Argentina. Those with less of a problem in this regard include India, Europe’s emerging economies, and much of the rest of Latin America, except Brazil and to a lesser extent Mexico. Since the generally slow pace of growth globally, and particularly the slowdown in China, should keep a lid on commodity prices, those emerging economies that depend a lot on sales in this area would seem to face disadvantages relative to others. In this respect, the oil economies in Latin America, Africa, the Middle East, and Central Asia look less desirable, including Russia. In addition, Peru, Brazil, Thailand, Malaysia, Indonesia, and the Philippines face disadvantages, at least in this context. The European emerging markets face the least problem in this regard.<sup>13</sup></p> <p>Longer term, the key to emerging economies, and so to the best investment returns, is their ability to make the fundamental structural changes demanded at each stage of development. In this respect, there are three key considerations to guide investment decisions. The first of these is the commitment of each economy to education and training. This in large part should determine a particular economy’s ability to leverage the technologies and the best practices of the developed economies. On this front, China, Singapore, Taiwan, and Hong Kong lead, as does India, though in a less comprehensive way. The European emerging economies score relatively high in this regard as well. A second support is each economy’s ability to receive these technologies and best practices. This requires an openness in both in trade and finance. Here the mix changes. Singapore, Hong Kong, Malaysia, Taiwan, and most of emerging Europe score high. Vietnam scores high on trade openness, but low when it comes to finance. Sadly, frequently mentioned names in emerging markets discussions—Russia, China, Brazil, India, Mexico, Indonesia, and Turkey—all score poorly on questions of trade and financial openness.<sup>14</sup></p> <p>This discussion hardly answers all the questions about this investment class. That would take a book. Clearly, many markets that look good in one respect appear less so in another. Some of the positives have a shorter-term nature than others. Three takeaways emerge from this mélange of considerations: 1) Circumstances, though not likely to return to the universally favorable environment of earlier this century, probably will support emerging market investments going forward, certainly better than in the 2009–13 period. 2) All these economies have tremendous development potential, if only they will open themselves to, and put themselves in a position to, leverage the technological and best practices on offer from the developed economies through trade and investments. 3) Except in rare cases, any single factor—favorable or unfavorable—will face balancing influences from other factors.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="separator">&nbsp;</span></p> <p><span class="legal"><sup>1</sup>&nbsp;Economic data from the World Bank.<br> <sup>2&nbsp;</sup>The Shanghai Composite Index is a capitalization-weighted index of stocks, and is comprised of all the A shares (available only to local investors) and B shares (available only to foreign investors) listed on the Shanghai Stock Exchange. The index tracks the daily price movement of all shares on the exchange.<br> <sup>3</sup>&nbsp;The BSE Sensex (Bombay Stock Exchange Sensitive Index) is a value-weighted index composed of 30 stocks, and consists of the 30 largest and most actively traded stocks, representative of various sectors, on the Bombay Stock Exchange.<br> <sup>4</sup>&nbsp;The JKSE Composite is a modified capitalization-weighted index of all stocks listed on the regular board of the Indonesia Stock Exchange. The index was developed with a base index value of 100 as of August 10, 1982.<br> <sup>5</sup>&nbsp;The Bovespa Index is a market capitalization-weighted index that tracks the performance of a basket of stocks that trade on the Sao Paulo Exchange.<br> <sup>6</sup>&nbsp;All market data herein from Bloomberg.<br> <sup>7</sup>&nbsp;See, “Emerging Markets in Transition: Growth Prospects and Challenges<i>,</i>”<i>&nbsp;</i>IMF Staff Discussion Note, June 2014.<br> <sup>8</sup>&nbsp;Data from Bloomberg.<br> <sup>9</sup>&nbsp;Data from the International Monetary Fund (IMF).<br> <sup>10</sup>&nbsp;Ibid.<br> <sup>11</sup>&nbsp;See Federal Reserve, the European Central Bank, and IMF websites.<br> <sup>12&nbsp;</sup>“Emerging Markets in Transition: Growth Prospects and Challenges<i>,</i>”&nbsp;<i>op. cit.<br> </i><sup>13</sup>&nbsp;Ibid.<br> <sup>14</sup>&nbsp;Ibid.</span></p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 6 Jul 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/greece-weighing-risks.htmlGreece: Weighing the Risks<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Amid the uncertainty, what should investors be watching now?</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>It seems Greece has chosen default and capital controls. Even so, Athens can still cut a deal that would relieve both. Either way, it will remain unclear for a while whether the country stays in the common currency. In some respects, this situation is entirely manageable. That fact has fostered a dangerous complacency, for in other respects, this situation carries considerable risk—for the eurozone, for European finance in general, and for global finance.</p> <p>As many media discussions have implied, the debt part of the financial equation is not especially threatening. Greece, for one thing, is a small economy. Its gross domestic product (GDP) is barely 6.5% of Germany’s. For another, Greece’s outstanding debt amounts to barely 1.0% of Europe’s banking assets. Even if that debt were widely held, default would hardly threaten the Continent’s financial stability. And since the debt is now largely held by governments and other official bodies, the financial system has an additional buffer against uncertainty. Meanwhile, the European Central Bank’s (ECB) bond-buying program should stem any fears that Greek default will force unsustainable borrowing costs on Italy, Spain, and others in the eurozone’s troubled periphery.<sup>1</sup>&nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>But the financial equation extends beyond debt management. For all the protections on that front, European economics and finance remain highly vulnerable should bank depositors in the periphery follow the Greek example and withdraw their deposits from their banks.</p> <p>Events in Greece have already made this danger apparent. There, depositors have consistently withdrawn their funds from Greek banks. Many of those moving their money explicitly fear a Greek departure from the eurozone and a re-denomination of Greek deposits into some kind of new drachma that, given Greece’s troubles, would surely depreciate in value. They have sought to neutralize this risk by moving their assets to safer repositories overseas or simply to the local Greek branches of seemingly more secure German or Dutch banks. Some of those putting their money in motion in this way might have less specific concerns, but nonetheless share a prudent sense that their liquid wealth might better reside in places distant from their own troubled country. Whatever the motivations, the outflows, which European Union (EU) officials recently estimated at some €2.0 billion a day, have already limited liquidity at Greek banks, constrained flows of lendable funds to Greek consumers and businesses, and, in so doing, made a weak economy that much weaker. Meanwhile, capital controls to keep the money in place will hardly encourage bank lending or instill confidence in the economy’s future.<sup>2</sup>&nbsp; &nbsp; &nbsp;</p> <p>The ECB can only do so much to alleviate these strains. After all, the bond buying of its much-vaunted quantitative-easing program aims to channel funds to governments, not local banks and other deposit-taking institutions. It has opened an emergency credit line for Greek banks, but it is in no position to re-liquefy the banks if the current uneasiness turns into a panic. More frightening, this weakness in the system of official support leaves a potential for considerable harm should Italian, Spanish, or other depositors in the eurozone’s periphery follow the Greek example. Even with great faith in their government’s commitment to the euro, Italians, Spaniards, and others still might take their money out of local banks just to play it safe. There is, after all, little cost to such a move. Athens’ resort to capital controls only tends to raise the fear level elsewhere and encourage such behavior in the near term. Should such outflows gain momentum, little could be done to save these countries from a shortage of liquidity, with all the associated economic and financial harms that would go with it. These nations would then have still more trouble making good on their debt obligations, and the ECB would have to struggle still harder to support their finances.&nbsp;</p> <p>Such trends could, in the extreme, precipitate a full-blown financial crisis. Widespread concern over bank illiquidity would cause doubt about the ability of banks to fulfill their obligations. People and other institutions would then shy away from transacting any business with them. And since no one could know which firms had liquidity problems, that wariness could extend to just about all. Financial flows could then freeze up, shutting down the great amount of economic activity that depends on them. This is exactly what happened in the United States in 2007–08, when a similar wariness developed around each firm’s exposure to subprime loans. If the cause this time in Europe has different roots, the result could well be the same. And because all financial institutions in the world deal with each other, the situation would quickly spread around the globe, as America’s financial problems did seven years ago. &nbsp; &nbsp;&nbsp;</p> <p>So far, there is little sign that depositors’ fears extend beyond Greece. On that basis, it would seem that this frightening prospect is less than likely. But it is hard to dismiss the possibility out of hand, demanding serious attention to Greek matters and not the insouciant attitude some have displayed.&nbsp; &nbsp;</p> <p><span class="separator">&nbsp;</span></p> <p><span class="legal"><sup>1&nbsp;</sup>See, “The Worst Is Yet to Come: Greece and Europe’s Woes Aren’t Over,”&nbsp;<i>The National Interest,&nbsp;</i>June 27, 2015.<br> <sup>2</sup>&nbsp;See, Nicholas Paphitis and Pan Pylas, “Greece Gets Temporary Lifeline, Turns Hope to New Summit,” Associated Press, June 19, 2015.</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 29 Jun 2015 14:12:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/stocks-a-wary-good-sign-for-bulls.htmlStocks: A Wary Good Sign for Bulls<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Even amid a multiyear market advance, retail equity investors remain cautious. Here’s why that could actually help extend the rally</i>.</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>At base, it is a good sign for the equity rally: retail investors continue to sell stocks on balance. In the past, a stock rally of the huge proportions exhibited during the past few years would have induced a flood of retail investment dollars <i>into</i> equity mutual funds. That has not even begun to happen, at least according to the Investment Company Institute (ICI). No doubt this reluctance to buy stocks reflects the newfound caution households have shown in every aspect of spending and saving—a matter discussed from different perspectives in this space at various times. Whatever the cause, however, it bodes well for the durability of the equity rally, suggesting that any push from the retail investor has yet to emerge and that the market is a long way from the overpricing that such a push causes in its later stages. &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>To be sure, the ICI does report that amounts in equity mutual funds have increased. Assets in domestic U.S. equity funds have increased 9.8% during the past 12 months through April 2015 (the most recent period for which data are available).<sup>1</sup> Assets in world equity funds have increased 8.6% during this time. But especially in the case of domestic equities, the growth in assets was more than accounted for by rising stock prices. On balance, investors have withdrawn monies—and that pattern has persisted. In the four-week period from late April to late May (the most recent period for which data are available), mutual fund investors withdrew $19.4 billion from domestic U.S. equity mutual funds on a base of about $6.5 trillion. In contrast, retail investors have sustained their enormous $2.6 trillion in money market holdings, despite the minuscule rates paid in such investments, and increased their bond holdings, especially in the municipal area, where assets have increased 10.2% during the 12 months to last April. And those patterns, too, show no sign of shifting. Taxable and municipal bond mutual funds during the four weeks to late May saw $8.6 billion in net inflows on a base of $3.6 trillion. &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>The caution about equities is understandable. Investors have suffered two terrible bear markets during the past 15 years. In each, investors saw losses of 50% or more in equity asset values. The reticence about equities also fits a larger pattern. Households since the Great Recession of 2008–09 have shown an atypical caution in all aspects of budgeting and finance. They have avoided debt, keeping its growth slower than the pace at which their incomes have expanded. They have kept their spending growth in tandem with income growth. Such behavior stands in stark contrast to the way households conducted themselves during the 40-plus years prior to the Great Recession, when they spent aggressively, increased their debt faster than their incomes grew, and favored high-return/high-risk investments. Their wariness of equities now, and eagerness to accept low yields in seemingly safer fixed-income investments, would seem to dovetail with the rest of their new prudence and caution.</p> <p>The question for the future is whether American households have really changed their spots. If they have not changed fundamentally and do revert back to older, more aggressive patterns, then they should at some future date chase the equity rally. The flow of funds into stocks will, as in the past, extend the rally, though in time it will create the overpricing that would lead to the next bear market. If they have indeed changed, then future money flows should remain subdued and the rally likely would unfold in a more muted way than in the more distant past, delaying that time when overpricing becomes worrisome. Either way, the present circumstance suggests that today’s equity investor has time before he or she needs to worry about excessive pricing and could rather look forward to an extension of the rally in one form or another.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> <p><span class="legal"><sup>1</sup>&nbsp;All data herein from Investment Company Institute<b>.</b></span></p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 22 Jun 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/stocks-keep-your-eye-on-the-bull.htmlStocks: Keep Your Eye on the Bull<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Valuations remain attractive, leaving equities plenty of room to advance despite a sluggish U.S. recovery.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Since the equity rally of the past few years has brought most stock indexes to new highs, investors increasingly have expressed skepticism about the possibility of future gains. It is an understandable concern—but it also is misplaced. Stocks still carry attractive valuations, if not as attractive as in past years, and so have ample ability to continue to rise, even if, as expected, the economy only lumbers along the shallow recovery path it has traveled to date. &nbsp; &nbsp;&nbsp;</p> <p><b>Straight Price-to-Earnings Multiples<br> </b>There are probably as many ways to gauge value as there are analysts and strategists in the financial community. One of the most straight forward is an historical assessment of simple price-to-earnings [P/E] multiples. Here the picture remains at least mildly positive. &nbsp; &nbsp;&nbsp;</p> <p>P/E multiples on most stock indexes today are just a touch over their 35-year average. The multiple on the S&amp;P 500 Index,<sup>1</sup> for example, stands about 22 times the earnings recorded for the four quarters ended this past March and about 18 times consensus earnings for the next four quarters. Since stocks over the past 35 years have averaged about 18 times the previous year’s earnings, the most conservative investor today could characterize the market as “fairly valued,” or only slightly richer. Because, historically, a rising stock market typically goes well above such norms before peaking, a conservative expectation would look for no further expansion in multiples, for stocks to rise in tandem with earnings. Since in a slow-growing economy the companies in the S&amp;P 500 should generate 5–6% earnings growth over the next four quarters, such a conservative view would look for market prices to move up by about that amount. With dividend yields of just under 2.0%, investors could expect a 7–8% total return on equities, hardly comparable to the great gains of last year and the year before, but enough to warrant attention.<sup>2</sup></p> <p><b>Compared to Bonds and Cash<br> </b>Equity valuations look much better when compared to bonds and cash. The way to compare stocks to bonds is to turn traditional multiples on their head and express earnings as a percentage yield on current stock prices. This measure for the S&amp;P 500 (at the time of writing) equals 4.6%, or about 250 basis points (bps) above the yield on 10-year Treasury bonds. Since, historically, stocks yield 200 bps <i>less</i> than the yield on 10-year Treasuries,<sup>3</sup> not more as now, this situation suggests strongly that stocks remain attractively underpriced relative to these bonds and, by implication, corporate bonds as well. On this basis, relatively attractive valuations would persist even if Treasury and other bond yields were to rise by 100 bps, although not especially likely anytime soon. If the historical relationship were to reestablish itself, stocks could do very well indeed, though such a dramatic move is also hardly likely. But even within very muted expectations, the picture remains one of strong valuation support for future stock gains.<sup>4</sup></p> <p>A similar picture emerges from a comparison of dividend yields to interest rates on certificates of deposit and other cash equivalents. Today’s stock dividend yield of about 2.0% stands some 180–190 bps above the best cash rates available to even the most resourceful financial advisor.<sup>5</sup> Historically, the situation is just the reverse. Cash on average over the past 35-plus years offers rates some 200 bps <i>above</i> stock dividend rates, not below them, as now.<sup>6</sup> The historical relationship stands to reason. The best cash can ever offer is the stated yield. But with stocks, history supports an expectation that the price will rise over time and that companies will raise their dividends over time. Because stocks offer these two additional ways to make money, they typically have offered less up-front yield from dividends than cash investments pay. The fact that matters today is the reverse shout that equities still offer good relative value. More than that, that fact argues that equities will still offer value for some time after the Federal Reserve begins to raise interest rates, as stated.</p> <p><b>Conclusion<br> </b>Though there are always shocks that might prevent equities from realizing their value, probabilities suggest that the market will continue to rise on the basis of this still-attractive pricing, as it has during the past five-plus years, despite disappointingly slow economic growth. Comparisons are less stark than they were one or two or three years ago, suggesting that future gains will track a less dramatic path than last year and in 2013. But still, the figures argue for further gains in equities going forward.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="legal"><sup>1&nbsp;</sup>The S&amp;P 500<sup>®</sup>&nbsp;Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries. An index is unmanaged , does not reflect the deduction of fees or expenses, and is not available for direct investment.<br> <sup>2&nbsp;</sup>Data from Standard &amp; Poor’s.<br> <sup>3</sup>&nbsp;Data from Bloomberg.<br> <sup>4</sup>&nbsp;Data from FactSet.<br> <sup>5</sup>&nbsp;Data from Bloomberg.<br> <sup>6</sup>&nbsp;Data from FactSet.</span></p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 15 Jun 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-consumer-nay-big-spender.htmlU.S. Consumer: Nay, Big Spender<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Households are shunning debt and boosting savings, keeping the recovery in check.&nbsp;</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The Great Recession of 2008–09 seems to have fundamentally changed the American consumer. For at least 30 years prior to that economic and financial upheaval, households in this country could only be described as financially aggressive. They spent freely, accrued debt at a rapid pace, and relegated savings to the status of an afterthought. In so doing, they helped propel rapid overall economic growth.</p> <p>But since the debacle of 2008–09, households have avoided debt and have paid close attention to their rates of savings. Their behavior has contributed to the historically slow pace of this recovery, but at the same time, it also has spared the economy the kinds of excesses that might have precipitated another recession. Looking forward, the critical question is whether the consumer will revert to his or her earlier patterns. It may be too early to give a definite answer, but it is, nonetheless, safe to say that such a reversion is not likely anytime soon. &nbsp; &nbsp; &nbsp;</p> <p>The old, free-spending American householder has received a lot of comment over the years—and statistics bear out the picture that the commentary painted. Between 1977 and 2007, for example, consumers increased spending more than 7.0% a year, even though incomes from wages and salaries grew at only&nbsp; 6.4% a year. That difference may not seem great when stated in annual terms, but over 30 years, it amounts to a cumulative difference of almost 20%. It is, then, no surprise that during this time, the rate at which household’s saved fell, from 10.2% of aftertax income to a mere 3.0%, while overall household debt increased a whopping 9.4% a year.<sup>1</sup>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>But the Great Recession seems to have sobered up everyone. Between 2007 and 2011, household debt actually fell, by almost $825 billion, or about 6.0%, an unprecedented event. Mortgage debt led the decline: it fell by about 9.0%, or by $915 billion—hardly surprising since the financial crisis revolved around mortgage debt. But households also have shown a reluctance to use other forms of debt, which have grown only 4.5%. Meanwhile, households have strived to reestablish savings flows, bringing their rate of savings from a low of 2.7% of aftertax income in 2007’s third quarter, to 6.0% by 2011. That rate, of course, remained below where it stood in 1977 and earlier years, but since the only way to raise it would have been to keep spending along a slower path than income, the change could only be described as a wrenching departure from former habits.<sup>2</sup>&nbsp; &nbsp;&nbsp;</p> <p>What may be more remarkable, and thus suggests a different kind of consumer, is how households have remained highly cautious even as the recovery persisted. While incomes from wages and salaries grew 4.5% a year between 2011 and 2014, people resisted any temptation to leverage the gains, as most likely they would have in earlier times. Households increased overall debt at an annual rate of only 1.4%, and mortgage debt actually continued to fall, dropping 3.3% over that three-year span. The same cautious pattern has prevailed so far in 2015. Though household incomes from wages and salaries continued to rise at a 4.5% annual rate between December 2014 and March 2015 (the most recent period for which complete data are available), overall household debt expanded at an annual rate of only 2.6% during the first quarter.<sup>3</sup>&nbsp; &nbsp;</p> <p>The behavior of savings is in many respects most interesting and more indicative of the changed attitude. Whenever, it seems, the savings rate has dipped below 5.0% of disposable income, households in subsequent quarters have restrained spending enough to reestablish a substantial savings rate cushion above 5.0%. In early 2010, for instance, when savings fell briefly toward 5.0%, households restrained spending growth to a mere 3.4% annual rate for the following two quarters, even as their overall incomes grew at a 5.1% annual pace, a difference that permitted them to bring their rate of savings back up to 5.8% by the third quarter of that year.<sup>4</sup></p> <p>Even now, almost six full years into this recovery, the same pattern persists. When in the third quarter of 2014, the rate of savings fell to 4.8%, households again slowed their spending sufficiently enough to bring their savings rates back up to 5.7% by February of this year. This restraint is that much more remarkable, because the drop in energy prices during the second half last year increased the overall real spending power of existing household incomes by four full percentage points. Instead of spending this windfall, as they most likely would have done in the past, households actually saved more than the entire real benefit from falling energy costs.<sup>5</sup></p> <p>Though many journalists and Wall Street commentators are fond of declaring “watersheds” or “sea changes” or “tectonic shifts” or whatever metaphor they like to use, it is too soon to say that American householders have changed fundamentally. In time, economic conditions, particularly in the jobs market, may improve enough to bring out the old, aggressive ways, especially as memories of 2008–09 fade. That reversion to type is probably a good long-term bet. But especially given the recent response to oil prices, it also is probably a long way off. Consumers, then, though they will doubtless go through bouts of rapid spending growth, will likely remain restrained and, in so doing, will help keep the overall recovery slow. Disappointing as that may be, it also does suggest that for the time being the economy will avoid the dangerous excesses that would otherwise threaten recession.</p> <p><span class="separator">&nbsp;</span></p> <p>&nbsp;</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 8 Jun 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/fed-what-could-accelerate-liftoff.htmlThe Fed: What Could Accelerate "Liftoff"?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Data signaling nascent U.S. wage inflation could figure into the timing of interest-rate hikes by the U.S. Federal Reserve, even if growth in the broader economy remains slow.</i><b></b></h3> <p><b>&nbsp;</b></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The debate over Federal Reserve rate hikes seems to tip with each new economic statistic. Disappointing gross domestic product (GDP) figures for the first quarter caused consensus opinion to look for a delay in any rate hike, and possibly a rethink by the Fed’s Open Market Committee (FOMC). Strong employment figures and a tick down in the nation’s official unemployment rate had the opposite effect. The Fed surely does take note of each new bit of data, but just as surely it bases policy on a more fundamental picture of economic conditions. Fed chairwoman Janet Yellen tries to bring that point home during each testimony, stressing the Fed’s desire to “normalize” rate levels.<sup>1</sup> There also still is discussion—at the Fed, if not on Wall Street—of the need to adjust policy <i>before</i> any inflationary pressure emerges. On this last point, Fed policymakers surely factor wage trends into their calculations. And here there is a suggestion—though just a suggestion—of the beginnings of those inflationary pressures against which the Fed wants to guard the economy.&nbsp;</p> <p>Certainly, recent Labor Department employment cost measures must have caught the attention of policymakers, especially those sensitive to inflation potential. For the three-month period ended March (the most recent period for which complete data are available), total compensation for all civilian workers rose at a 2.8% annual rate, up from 2.0% during the last three months of 2014. As Table 1 shows, the rolling 12-month figures on labor compensation also suggest the beginnings of some upward pressure, if only the beginnings. This time last year, total compensation had only increased 1.8% over the prior 12 months. The measure has accelerated steadily since, to reach the 2.6% gain recorded for the 12 months ended this past March. It is perhaps more a sign of pressure that, as the table shows, compensation in the private economy has accelerated faster than the overall economy and that the acceleration in wages and salaries has outpaced that in benefits.<sup>2</sup>&nbsp; &nbsp; &nbsp;</p> <p>Those who would dismiss the notion of any such pressure would likely do so in two ways. One would argue that productivity growth can blunt any ultimate inflationary consequence. And, indeed, except during the temporarily depressed first quarter, when output per hour fell at a 1.9% annual rate, productivity has grown enough to restrain any advance in labor costs per unit of production, the so-called unit labor costs. These have remained below 2.0%, which, after all, is the Fed’s informal inflation target. But since productivity growth has followed a decelerating trend—dropping from a 1.2% rate of advance in 2013 to a 0.5% advance in 2014, and at the same slow pace over the 12-month period ended in this year’s first quarter—this means of discounting the acceleration in compensation may be losing its force.<sup>3</sup></p> <p>The second argument handy to dismiss inflationary concerns would call attention to the outsized number of discouraged and part-time workers in the economy. Their competition for full-time work, it would argue, could well put a lid on compensation growth and, consequently, the inflationary pressure that might ordinarily result from it. There is no doubt something to this argument, but a look at the industry detail on wages, salaries, and benefits suggests that this seeming labor slack could have less impact than it otherwise might. The occupations that are seeing the greatest compensation gains are also those that demand greater levels of training and education. The last Labor Department report for the three months through March indicates the greatest wage and salary gains in professional and business services, sales of professional products, technical services, and aircraft manufacturing. These are not occupations in which today’s discouraged and part-time workers would likely compete. Occupations where these frustrated workers do compete, and so can hold back compensation gains, are already trending relatively slowly. In this recent period, mining, for instance, elementary and secondary teaching, installation and repair, administrative support, and transportation services show the slowest compensation gains.<sup>4</sup></p> <p>None of this is to suggest that the economy is on the brink of an inflationary breakout. Nor does it suggest that the Fed has missed the boat on inflation protection. What it does say is that the pressures on the Fed are much less one-dimensional than the consensus chatter in the financial community seems to suggest, that from the Fed’s broader perspective, matters might offer ample reason for modest interest rate hikes, even with little sign of an acceleration in the pace of the overall economic recovery.</p> <p><span class="separator">&nbsp;</span></p> <p><span class="rte_txt_green"><b>Table 1. Compensation Gains</b></span><br> <b>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; 12 Months Ended</b></p> <table class=no_style border="0" cellspacing="0" cellpadding="0"> <tbody><tr><td width="145">&nbsp;</td> <td width="114"><p><b>March<br> 2014</b></p> </td> <td width="90"><p><b>June<br> 2014</b></p> </td> <td width="102"><p><b>Sept.<br> 2014</b></p> </td> <td width="102"><p><b>Dec.<br> 2014</b></p> </td> <td width="85"><p><b>March<br> 2015</b></p> </td> </tr><tr><td width="275" valign="bottom"><p>Total Compensation</p> </td> <td width="114" valign="bottom"><p>1.8%</p> </td> <td width="90" valign="bottom"><p>2.0%</p> </td> <td width="102" valign="bottom"><p>2.2%</p> </td> <td width="102" valign="bottom"><p>2.2%</p> </td> <td width="85" valign="bottom"><p>2.6%</p> </td> </tr><tr><td width="275" valign="bottom"><p>Wages and Salaries</p> </td> <td width="114" valign="bottom"><p>1.6</p> </td> <td width="90" valign="bottom"><p>1.8</p> </td> <td width="102" valign="bottom"><p>2.1</p> </td> <td width="102" valign="bottom"><p>2.1</p> </td> <td width="85" valign="bottom"><p>2.6</p> </td> </tr><tr><td width="275" valign="bottom"><p>Benefits</p> </td> <td width="114" valign="bottom"><p>2.1</p> </td> <td width="90" valign="bottom"><p>2.5</p> </td> <td width="102" valign="bottom"><p>2.4</p> </td> <td width="102" valign="bottom"><p>2.6</p> </td> <td width="85" valign="bottom"><p>2.7</p> </td> </tr><tr><td width="275" valign="bottom" align="left"><p>Private Economy<br> Compensation</p> </td> <td width="114" valign="bottom"><p>1.7</p> </td> <td width="90" valign="bottom"><p>2.0</p> </td> <td width="102" valign="bottom"><p>2.3</p> </td> <td width="102" valign="bottom"><p>2.3</p> </td> <td width="85" valign="bottom"><p>2.8</p> </td> </tr><tr><td width="275" valign="bottom"><p>Wages and Salaries</p> </td> <td width="114" valign="bottom"><p>1.7</p> </td> <td width="90" valign="bottom"><p>1.9</p> </td> <td width="102" valign="bottom"><p>2.3</p> </td> <td width="102" valign="bottom"><p>2.2</p> </td> <td width="85" valign="bottom"><p>2.8</p> </td> </tr><tr><td width="275" valign="bottom"><p>Benefits</p> </td> <td width="114" valign="bottom"><p>1.8</p> </td> <td width="90" valign="bottom"><p>2.4</p> </td> <td width="102" valign="bottom"><p>2.3</p> </td> <td width="102" valign="bottom"><p>2.5</p> </td> <td width="85" valign="bottom"><p>2.6</p> </td> </tr></tbody></table> <p><span class="separator">&nbsp;</span></p> <p><span class="legal">Source: Department of Labor.</span></p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 1 Jun 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/how-is-capital-spending-trending.htmlHow Is Capital Spending Trending?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The current pace of expenditures on property, plant, and equipment dampens the likelihood of an accelerated economic recovery</i>.<b></b></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The emerging picture on capital spending is far from encouraging. To be sure, a number of temporary influences beset the quarter just past, a circumstance that likely will produce a bounce in the spring and possibly the summer quarter as well. But behind such quarter-to-quarter swings, fundamentals point to a still slow pace of such spending and, by implication, in the general recovery as well. Matters could be worse. The capital spending picture is not so bad that it will scotch the general recovery. At the same time, it argues strongly against any expectation of a general economic acceleration, much less a return to historical real growth rates, anytime soon.</p> <p><b>Short-Term Swings &nbsp;&nbsp;<br> </b>Recent statistics certainly make for grim reading. During the six-month period ended March 31, 2015 (the most recent period for which data are available), sales and orders of new non-defense capital goods have fallen at an annual rate of about a 5.0%. Were it not for the volatile aircraft segment, orders would have fallen at an annual pace of 11.3%. Broader measures, reported in the country’s national income and product accounts, show even steeper declines. According to these, sales after inflation barely increased during the first quarter this year, expanding at a rate of a mere 0.1% annually in real terms. Computer sales to business fell at a whopping 29.2% annual rate, while sales of industrial equipment fell at a rate of 7.9%. New real commercial and industrial construction fell at a startling 23.1% annual pace, and the greatest drop, a 48.7% decline, was recorded for wells and mining. The only broad category that increased substantially was spending on intellectual capital, which in real terms expanded at a rate of 7.8%—and even that was a slowdown from the almost 10% rate averaged during the two prior quarters.<sup>1</sup></p> <p>These reports, do, however, overstate the problem. Capital spending in recent months, like much of the rest of the economy, suffered unduly from three more or less transitory influences. A protracted dock strike on the West Coast effectively blocked a major avenue for exports of capital equipment, especially computers, not a small part of the whole. Inordinately cold and stormy weather during the first three months of the year had a depressing effect on equipment sales as well. It had a still more depressing effect on construction, explaining the remarkable decline recorded in that area during the quarter. The precipitous drop in oil prices during the second half of 2014 prompted the industry to slow exploration activity abruptly during the latter months of that year and the opening months of this one, leading to the tremendous drop in spending on all sorts of drilling and pipeline equipment.</p> <p>But the strike has ended, as has the cold and stormy weather, inviting at least a partial reversal of their depressing effects in coming months. On this basis, the current quarter could easily witness a surge in sales of capital goods as well as a major uptick in commercial and industrial construction. There is also reason to look for relative stability in new spending on drilling equipment. To be sure, oil prices have risen only slightly, hardly enough to renew the pattern of widespread drilling and exploration that dominated much of 2013 and the first half of 2014. But there is ample reason to believe that the cutbacks of past months have already adjusted levels of activity to lower prices so that the industry no longer has need for further sharp cutbacks, certainly not of the sort suffered during the first quarter. Some of the drilling that was cancelled might even return. On these bases, the second and possibly third quarter could see a surge in spending on both equipment and construction that, except in the energy space, more or less recovers the ground lost in the first quarter.</p> <p><b>Still, the Underlying Trends Don’t Look Good<br> </b>Beneath these down/up gyrations, the fundamentals look weak, if not in outright decline. Orders for non-defense capital goods, including or excluding the volatile aircraft sector, show decreases over the last 12 months. The former fell 2.6%, while the latter fell 1.8%. These data are only available in nominal terms. When combined with the Commerce Department’s 1.1% inflation estimate for the sector, a real measure of these orders would, respectively, approach declines of 3.7% for overall non-defense capital goods orders and 2.9% when aircraft is excluded. To be sure, sales have held up during the past year, despite the orders decline. In real terms, sales of non-defense capital goods have risen an estimated 3.6% during the past 12 months, 1.6% after removing aircraft from the equation. But the sales are done, while the orders reflect on the future. It is doubtful that sales will follow orders down point for point, but the outlook is clearly soft. &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>It is also less than encouraging that capital spending was slowing even before the special depressing effects of the year’s first quarter. The rate of expansion in real overall spending by business on equipment, premises, and intellectual capital actually peaked as long ago as the fourth quarter of 2013 at an annual growth pace of 10.4%. It slowed to an average 7.1% annual growth rate during the first three quarters of 2014 and then slowed further to a 4.7% annual rate of gain in the fourth quarter, well before the first quarter distortions. The subsectors of structures and equipment spending followed the same slowing pattern, with growth in equipment spending all but stopping during last year’s fourth quarter, growing at only a 0.6% annual rate, before slowing even further to a negligible 0.1% rate of advance under the first quarter’s transitory constraints.</p> <p>The only exception—and indeed, one bright spot—are patterns of spending on intellectual products, most notably research and development (R&amp;D). Overall, such spending gained momentum throughout 2014, rising from a relatively slow 3.6% real annual growth rate at the end of 2013 to a 10.3% real annual rate of advance by the end of 2014. Even under the special retardants of the quarter just passed, this kind of spending continued to grow at the real 7.8% annual pace quoted earlier. This pattern was even more exaggerated in the R&amp;D subcategory. It rose from a 3.6% real annual growth pace at the close of 2013 to a 17.2% rate at the end of 2014, sustaining a 12.3% annual rate of expansion even during the first quarter’s constrained environment.</p> <p><b>Broader Implications &nbsp;&nbsp;<br> </b>This middling underlying picture, apart from R&amp;D, is not, however, so weak that it threatens an outright decline. It is, consequently, not likely to derail the recovery. Instead, it makes one more argument to expect the historically slow pace of overall economic growth to continue going forward. This prospect may not offer much inspiration, but it is hardly shocking, nor should it be. It is, after all, the sort of recovery to which everyone has grown familiar with during the past five-plus years. In time, as political matters clarify and the adverse legacy of the Great Recession wears off, the pace of growth, including in capital spending, may well pick up, but the data to date suggest that such a time is still relatively distant.</p> <p>There is a still longer-term concern that requires attention. Weak business spending on equipment and premises says little good about future rates of productivity growth. Fewer relationships are better linked than the positive influence of capital spending on productivity. Not only does such spending give workers more support, and so tends to enhance labor productivity, but by bringing new techniques and technologies into production processes—or, as economists say, embodied in the new equipment and facilities—the capital spending also produces an acceleration in what economists call total factor productivity, that is, the output from labor, land, and capital combined. The most recent evidence comes from the tremendous surge in capital spending that took place in the 1990s, largely in response to the technological revolution. After a time lag, during which business integrated the new technologies into its practices and processes, productivity surged in the early years of this century. Labor output per hour, for example, jumped from 1.7–1.8% annual rates of increase in the mid-to-late 1990s to more than 3.0% annual rates of increase, on average, between 2000 and 2005.<sup>2</sup></p> <p>Today’s substandard rates of capital spending suggest, then, slow productivity growth going forward, perhaps no better than the 1.5% annual growth rate for labor productivity averaged during the past five years. Even the one bright spot in today’s picture, rapid growth in R&amp;D spending, can only offer so much encouragement. Unless the results of all the research and development inspires other sorts of capital spending, it will take a long while to filter into business practice and procedure and, accordingly, into an improved productivity picture. The hope then is that the R&amp;D inspires spending on the new equipment and premises that can bring it into business and manufacturing practice. If recent figures are any indication, that prospect will remain a hope, not an expectation, for a while to come.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Tue, 26 May 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/china-great-wall-of-worry.htmlChina: A Great Wall of Worry<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Beijing likely will find a way to mitigate the effects of a slowing economy and soaring debt levels—but the risks are high.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The economic and financial risks in China are at once more manageable than much of today’s commentary suggests and, however, more dire. There can be no doubt that the country faces severe problems. Economic growth has slowed, raising questions about the viability of China’s development model, while an overhang of debt, much linked to the so-called shadow banking system and excessive real estate development, threatens financial crisis and outright recession. Though probabilities suggest that China can contain any financial fallout and sustain an acceptable growth path, the consequences of failure would be much worse than today’s popular fears. Failure would, in fact, likely lead to widespread civil unrest, rioting, and, possibly, political instability—prospects that certainly should motivate Beijing to deal effectively with the problems.</p> <p><b>Financial Embarrassments &nbsp;<br> </b>The explosion in debt seems the most acute issue. Up until 2007, credit in China, both public and private, expanded at a pace only slightly faster than the overall economy. But since Beijing eased credit in 2009 to contend with global recession, debt use in China has far outpaced economic growth. The value of all debt outstanding has jumped from 187% of gross domestic product (GDP) in 2007 to about 285% at present—a bit more than the U.S. and other developed economies, but remarkably and troublingly high for an emerging economy. Mexico, for instance, still has total debt levels less than its GDP, while India’s stands at about 125% of its GDP. Even Argentina has overall debt levels of less than 150% of GDP. Adding to this troubling picture is the fact that China’s so-called shadow, or unofficial, banking system has led the debt expansion, growing 37% annually since 2007, and now accounts for about one-third of all Chinese lending.<sup>1</sup></p> <p>To American eyes, it is no doubt particularly ominous that much of this credit expansion has gone into real estate, about 40–45% of it in fact. As in the United States earlier in this century, enhanced credit flows first expanded housing demand and pushed up real estate prices. By 2010–11, Chinese real estate prices were rising 10–15% a year. A building surge followed this demand, also enhanced by easy credit flows from the shadow banking system and also because local authorities used their particular access to the state-run banking system to procure financing for developers. Numerous articles and television specials have documented the overbuilding that resulted. As this burgeoning supply overtook demand, real estate prices first moderated, but more recently have begun to fall, 20% nationally, in fact, over the past 12 months. After the experiences of 2007–09, this picture naturally raises fears of bankruptcies, disruptions in credit flows, and intractable recession.<sup>2</sup></p> <p><b>Economic Troubles, Too<br> </b>At the same time, China’s pace of economic growth has slowed. The slowdown reflects in part the real estate bust, but it is more widespread than that. All of it threatens to compound the country’s financial problems. &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>Clearly, the real estate contraction is a major contributor. The country’s official housing index fell 5.7% in February (the most recent month for which data are available) and 5.1% in January. Perhaps even more worrisome, exports, the historical engine of Chinese growth, have weakened, too. March recorded a 15.0% decline from a year-ago levels. The country’s trade surplus has collapsed. Admittedly, China’s trade figures are highly volatile, and could yet reverse. Still, the poor reading still raises warning flags. Capital spending, too, has hit a snag. An official index of new orders signals slow growth at best, as does China’s own purchasing managers survey. Industrial production rose only 5.6% in March, a major tick down from the 6.8% recorded in February. Against such a background, it is hardly a surprise that the overall economy has disappointed. Real GDP for this year’s first quarter expanded at an annual rate of only 5.3%. Developed economies might well envy such a pace at growth, but it is a major comedown in China, which saw 7.1% growth last year and 7.8% in 2013.<sup>3</sup></p> <p>Slower economic growth certainly makes the debt overhang more of a concern, since it means less of the income and wealth needed to discharge those financial obligations. Were China expanding at the 10–12% annual pace recorded some years ago, today’s debt overhang would look much more manageable than it does now, with growth about half as fast. Perhaps still more ominous, China faces a deflationary threat. Producer price measures have been falling since 2012. To be sure, the latest consumer price index release showed an increase. But at an annualized rate of 1.4%, the figure is less than half the official target of 3.5% and barely more than half the 2–2.5% consumer price inflation recorded this time last year. Should a generalized deflation emerge, the real value of the debt outstanding would rise on an ongoing basis, demanding even more real income and wealth generation to discharge, a situation with significant default threats embedded in it.<sup>4</sup></p> <p><b>Still, Not Necessarily a Collapse<br> </b>It would be a mistake, however, to take this picture, ominous as it is, and despair, as some seem to have done. Fundamental considerations make the slow growth look less generally dark than it might seem on the surface, while Beijing has significant resources to contain the situation and powerful reasons to do so.</p> <p>Certainly, the construction cutbacks, though they have clearly contributed to the overall economic slowdown, carry the seeds of a rebalancing. It will take time, of course, for the supply-demand balance to re-right itself. The overbuilding was massive. Projects will continue to fail and losses will continue to detract from prospects for some time. But at least the correction has begun. Nor does the slowdown necessarily imply a failure in China’s development model. Indeed, it could actually reflect a difficult, though necessary shift in that model. Beijing has long known that export-led growth is unsustainable. Even a decade ago, official economic analyses noted how the economy could not depend on exports indefinitely or the capital spending used to support their growth. Beijing, accordingly, has tried to shift the country’s economic focus toward the naturally slower-growing domestic economy. To the extent that the overall growth slowdown reflects some success in this economic reorientation, it is rather more encouraging than it is ominous. The jury is still out, of course, but recent signs of double-digit retail sales growth, despite the much slower overall figure, do at least offer a tentative sign that perhaps this essential shift is occurring.</p> <p>Beijing’s ample financial resources need consideration, too. If overall debt in China has blown up, the central government has kept public debt well-contained. It amounts to only 27% of China’s GDP, far less than the 100% in the United States or the 250% in Japan. Beijing could assume all the questionable debt associated with real estate, but its outstanding obligations would rise only to some 75% of GDP, hardly a happy number, but still less of a weight than in most every developed country in the world. Since much of the vulnerable debt lies with local governments, such a transfer would be much less difficult than, for instance, when Washington tried to bolster the U.S. financial system during the subprime crisis. Alternatively, should the economic situation reach a more desperate pass, the enviable state of government finances leaves room for significant fiscal stimulus of the sort China implemented in 2009. Memories of the civil unrest and rioting back then should motivate Beijing to use all its resources without restraint should the situation seem to demand it.<sup>5</sup></p> <p>For the time being, China has decided to address its difficulties with monetary stimulus. The People’s Bank of China, in March, cut its benchmark interest rate, from 5.6% to 5.35%. The rate was 6.0% late last year. The object is to thwart any deflationary tendencies and to stimulate the economy by promoting borrowing, including for real estate purchases, presumably to ease the housing glut. In this regard, China also has eased requirements for borrowers to get a mortgage. In certain contexts, this would seem to invite a return of a destructive real estate bubble. Certainly, such moves would have done so during the American real estate crisis. But in this respect, the situation in China is different. In the United States, the leverage lay with the homeowner, and it would have been foolish to encourage more borrowing on his or her part. In China, the leverage lies not with the homeowner but with local governments and developers. Until recently, homebuyers, by law, had to put down a payment of at least 20% on their first home and 50% on a second home. Encouraging them to use a bit more credit and buy at today’s depressed prices hardly runs the same risk of default that the United States would have incurred during its crisis.<sup>6</sup></p> <p><b>Conclusion<br> </b>No matter how one slices and dices China’s situation, it is far from easy or pretty. Likelihoods point clearly to bankruptcies and losses. These, among other considerations, will keep China’s economy growing slower than it otherwise might for some months and quarters to come. Still, given the risk to Beijing should it fail to contain financial pressures and sustain at least present growth rates, there is every reason to expect the government to use its still ample resources to avoid such an outcome. China will certainly go through rough times, as it has now for some time, but it likely will avoid the panic and recession of popular fears, much less the social disaster that would occur were it to fail.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 18 May 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-economy-variable-speed-recovery.htmlU.S. Economy: A Variable-Speed Recovery<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>A flat first quarter likely will be followed by one or two quarters of accelerated growth. Then it’s back to the muddle.&nbsp;</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Economic growth seems to have all but stopped during the first quarter. Preliminary Commerce Department figures on real gross domestic product (GDP) show only a 0.2% annual rate of expansion.<sup>1</sup> Even though much that held the quarter back was temporary, this news will surely scotch the widespread talk of an acceleration in the recovery that cropped up around the strong second- and third-quarter reports last year. Such an acceleration, however, was never likely, because all that has kept this recovery substandard to date remains in place. But for those who like to talk about accelerations, the news in the second and possibly third quarters this year likely will provide ammunition. Some catch-up will almost surely occur as the weights holding down the first quarter lift. But if the recently reported weakness overstates the downside, the likely future surge will overstate on the high side. A continued, slow recovery will almost surely prevail.</p> <p><b>How the Quarter Looked &nbsp;<br> </b>Four temporary factors conspired to depress economic activity during the quarter just passed: 1) a prolonged dock strike on the West Coast did more to slow flows of exports than imports; 2) dollar strength buoyed imports, while also constraining exports; 3) the consumer, distrusting the durability of low oil prices, saved rather than spent the spare income that accrued from reduced fuel costs; and 4) unusually severe winter weather contributed to slow consumer spending and especially constrained construction activity. To some extent, this is a rerun of last year’s experience, and just like last year, a catch-up will likely follow. If these new weather patterns hold, they eventually will be reflected in the Commerce Department’s seasonal adjustment procedures, but it is too early for that. &nbsp; &nbsp;</p> <p>Evidence of all this is clear in the Commerce Department report. Exports during the first quarter fell a steep 7.2% at an annual rate. To some extent, this weakness reflects the dollar’s building strength. Dollar appreciation had already begun to slow exports growth last year, which grew at an annual rate of only 4.5% during the fourth quarter of 2014, well down from the 11.1% pace recorded last spring. The dock strike, however, was likely a much bigger factor. The suddenness of the drop alone testifies to its overriding influence. Currency effects typically unfold gradually. Also pointing to the strike, goods exports accounted for more than the overall drop; they fell at a 13.3% annual rate. Service exports—which have need for neither ships nor longshoremen—grew a healthy 7.3% in the first quarter. A buildup in inventories, of those products that could not be loaded during the strike, mitigated the effect on the overall GDP, but did not offset it. &nbsp;&nbsp;</p> <p>Meanwhile, the household sector, some 70% of the economy, curtailed its spending during the quarter. Overall consumer outlays increased at an annual rate of only 1.9%, far slower than the 3.9% rate averaged during the prior three quarters or the 4.0% expansion in household income recorded for this year’s first quarter. The slow pace of spending is even more remarkable given that low fuel prices freed up monies for other sorts of spending. Outlays so trailed income growth that household savings rates jumped from 4.6% of aftertax income during last year’s final quarter to 5.5% during the quarter just passed. Had consumers believed that the savings on fuel would last, they no doubt would have spent more freely. Had they just kept up with overall income growth and spent only half of what they saved on fuel, real GDP growth would have approached 2.0% in the first quarter. &nbsp;</p> <p>In addition to this source of consumer restraint, cold and stormy weather in the opening months of the year likely held back spending as well. The biggest impact of weather, however, fell less on the consumer than on construction spending. In the residential space, growth slowed from a 5.3% average annual pace in the prior three quarters to only 1.3% during this year’s first quarter. Weather effects had an even greater impact on commercial construction, which fell at a striking 23.1% annual rate during the first quarter, a sharp drop from the 7.8% average annual pace of advance during the prior three quarters and far worse than the slow, but still positive 2.9% annualized growth rate recorded during last year’s weather-oppressed first quarter. Surely there is more at work here than weather, but the latter played a significant role.</p> <p><b>Going Forward, Bounce Is Likely &nbsp;<br> </b>If this picture of weakness overdraws the underlying state of the economy, it nonetheless also sets the stage for a spring bounce. Contributing directly to such a turn is the end of the dock strike. To be sure, renewed activity at West Coast ports will allow in a greater flow of imports, but it will have a disproportionately greater impact on exports, whereby manufacturers, mining firms, and shippers will strive to make good on orders that the work stoppage prevented them from filling in the past few months. If exports simply recoup the ground they lost during the winter quarter, even without the least net expansion, this sector would add 1.25 percentage points to the overall growth pace of real GDP in the spring quarter. The dollar, of course, is still strong, leaving reason to expect slow growth at best beyond such a catch-up, but the pace of dollar appreciation has moderated, offering some reason to expect only a moderate further deterioration in the country’s trade balance. &nbsp; &nbsp; &nbsp;</p> <p>Making its own pleasant contribution to a turn is the indisputable fact that spring has arrived. The warm weather has lifted the weight on the construction sector that was clearly in evidence last January, February, and March. Even if there were no attempt to make up for ground lost during the past three months, and commercial as well as residential construction simply resume their former, relatively moderate pace of advance, the spring and summer quarters could enjoy an additional percentage point of overall real growth or more. Indeed, monthly data indicate that such a turn may already be in process. By March (the most recent month for which overall construction data are available), the situation appeared to have stabilized. March data on new housing starts showed a modest 2.0% uptick from February. Though little data are available as yet on commercial construction, a 3.5% March upturn in non-defense capital goods orders, after many months of net declines, speaks to a greater willingness by business to spend.</p> <p>Consumer spending too will almost surely respond positively to the warmer weather. Retail sales were, in fact, already on an upswing in March, showing a 0.9% jump over February levels, over 11.0% at an annual rate. That pace is not likely to continue, but it puts spending levels at the beginning of the second quarter already well above the first-quarter average. If households simply keep spending up with recent income growth, the consumer will add an additional 0.7 percentage points to the overall pace of real GDP growth from the first quarter showing. And then there is the question of oil prices. The drop in fuel prices during the second half of 2014 effectively added some 4.0% to households’ real disposable income. Though they saved just about all of it, persistently lower fuel prices could increase household confidence that this relief will last and so also encourage them to spend more of the monies freed up by lower fuel bills. They might be that much more willing to spend because they have already raised their rate of savings. There is, of course, no telling if they will respond in this way and, if they do, by how much. But the potential clearly exists for a surprise on the high side.</p> <p><b>A Warning<br> </b>The stage, then, is set for overall real GDP growth of more than 3.0% during the second and possibly the third quarter. If the statistical stars line up right, one or the other of these quarterly reports could show significantly more growth. Doubtless such news could rejuvenate once-popular forecasts of an acceleration in the recovery. That is what happened last year. Such a view would, however, likely mislead as much as it did last year and as much as the picture of weakness in first quarter has created some fears about future growth. This recovery has remained fundamentally slow, and likely will continue to proceed that way (for reasons covered at other times in this space, and too involved to examine here now). Just as last year, the net of all the quarter-to-quarter ups and downs should average close to a slow annual real growth pace of near 2.5%.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 11 May 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/fed-and-ecb-high-stakes-balancing-act.htmlThe Fed and the ECB: A High-Stakes Balancing Act<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>So far, the two central banks have been able to leverage each other’s policies to the benefit of global markets—but significant risks remain.</i>&nbsp;&nbsp;</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>It might remind some of a choreographed duel in a stage play: the U.S. Federal Reserve and the European Central Bank (ECB) are carefully playing off each other’s moves. The result is that each has leveraged the other’s policies to exert the greatest impact on global audiences—that is, markets, particularly currency markets. It probably was not planned this way, but so far, it is enhancing global prospects. Such matters, however, whether on stage or in policy circles, carry significant risks.</p> <p>Here is the state of play at the moment. The ECB faces a desperate situation. Despite a smattering of favorable statistics, it is beset by a triple threat: the potential for deflation, the prospect of a third recessionary dip, and the likelihood of financial turmoil, especially should negotiations with Greece fail to reach an acceptable accommodation. In response, the ECB has pushed down interest rates, in some cases into negative territory, and initiated a truly massive bond-buying program, what central bankers call quantitative easing. On its own, such a policy agenda would tend to depress the value of the euro, especially next to the U.S. dollar. But because at the same time the Fed has stopped its program of quantitative easing, thus slowing the flow of dollar liquidity into markets, and has planned gradual interest-rate hikes, the currency effects have received a major fillip. &nbsp;</p> <p>For the time being, this choreography, accidental or otherwise, seems to be working well. The euro has fallen some 25% against the dollar during the past 12 months, brightening prospects for eurozone exports without, if recent evidence is any indication, unduly impairing U.S. growth prospects. Given the parlous state of the eurozone these days, borrowing some growth momentum from the United States in this way would seem to enhance the longer-term interests of both regions. After all, the U.S. economy is not so strong that it could withstand the financial-economic crisis that could otherwise engulf the eurozone and spread quickly across the Atlantic. Meanwhile, the emerging economies, which could suffer from the slowdown in the flow of dollar liquidity, should benefit from a substitute in the expanded flood of euro liquidity, and any prosperity there can only enhance global growth prospects.<sup>1</sup></p> <p>But investors trying to negotiate the situation also must realize that this is a very delicate balance indeed. Should U.S. policymakers try to resist the dollar’s rise, say, by postponing rate increases or returning to quantitative easing, the chance of a eurozone collapse would multiply and so also would the risks of financial strains and an economic setback in the United States. On the other side, should the ECB push current trends to extremes—if the dollar, for instance, were to quickly rise another 20–30%—then the U.S. recovery would come under threat and with it so would the wellspring of growth in today’s global system. With central bankers on both sides of the Atlantic aware of the balance, the odds favor continued favorable trade-offs, but the risk of a mishap is clearly present. The greatest threat comes from politics.</p> <p>On the American side, there is this recent push in Congress to exert more oversight over the Fed. To some extent, the effort is entirely reasonable. The Fed, after all, is the product of congressional legislation. Congress has a right—nay, an obligation—to audit it, review its success, and ensure that the central bank’s leadership is executing its powers according to law. But if Congress were to extend its influence to direct policy, the chance of countermeasures against the ECB would rise and so too would risks to the present, careful monetary policy balance.<sup>2</sup></p> <p>Matters on the European side are more complex. The euro’s decline so far has benefited the stronger economies in the union, most notably Germany. The weaker, less cost-effective economies in Europe’s so-called periphery would need much more euro depreciation to make themselves globally competitive. Should their needs create an ascendant political pressure on the ECB, then the risk of a still more aggressive policy aimed at radical euro depreciation would rise and with it the chance that excessive dollar appreciation would stall the U.S. economy and bring down the global economy with it.<sup>3</sup>&nbsp; &nbsp; &nbsp; &nbsp;</p> <p>For the time being, the central banks have managed to carry out this ballet successfully. It remains en pointe and likely will continue that way as long as they retain control, at least it is more likely to do so than otherwise. In general, then, circumstances point to a benign investment environment. But significant risks exist, and investors cannot ignore them.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 4 May 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/ma-bubble-trouble-ahead.htmlM&A: Bubble Trouble Ahead?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Talk of an unsustainable surge in mergers and acquisitions is premature. The current level of activity suggests that corporate managers will continue to buy rather than build.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Some buzz has developed of late on the subject of mergers and acquisitions (M&amp;A). A recent piece in <i>Business Insider</i> is indicative. It talks about an M&amp;A surge, and identifies it as a sign of a bubble. Such talk is wrong on two counts. The statistics show no such surge, and even if there were, it would hardly signal a toppy market. On the contrary, it would suggest that values are still attractive enough to impel decision makers to buy rather than to build. Matters would look ominous if there were a surge in initial public offerings (IPOs), but there is certainly no sign of that.<sup>1</sup>&nbsp; &nbsp;</p> <p>To be sure, M&amp;A activity has picked up. That is only typical of ongoing cyclical recoveries. The upward trend, however, could hardly be characterized as a “surge.” Table 1 lays out the figures. The number of deals, 938 last February (the most recent month for which data are available) is up a noticeable but hardly overwhelming 4.5% from February 2014. It is actually down 4.6% from last December and off 10.2% from a crest in January 2014. On this basis, one might even see a falling-off in M&amp;A activity. The value of deals, at $114.3 billion in February, is probably more important and on a stronger uptrend. It is up more than 25% from the $154.3 billion averaged in February 2014 and up 10% from last December. But even here, the figures are far from overwhelming. February’s measure is, after all, still 41% below the strikingly high $194.0 billion in November 2014. Rather than play too close a game with the statistics, a fair judgment might conclude that M&amp;A activity, both deals and volumes, are about holding their own after a real surge earlier in 2014.<sup>2</sup>&nbsp; &nbsp; &nbsp;&nbsp;</p> <p>There is some sign that a pickup will take place. In a recent CNBC poll, some 56% of companies said that they plan an acquisition in the coming year, up from 40% last October and the first time since 2010 that more than half plan to do something. But even if such plans were to generate a surge later this year, it would make a bullish argument for equities, not the bearish one accompanying much of this recent buzz.<sup>3</sup></p> <p>M&amp;A, quite simply, is a vote of confidence in market values and the future generally. Companies buy each other when they see a reason to expand and when other firms look attractively cheap. The same goes for private equity, which is no less in the acquisition business than corporations. If these decision makers saw stocks as expensive, they would pursue their expansion with direct investments in new equipment, premises, and in a hiring program. Since they are buying these days and doing relatively little building, they have effectively announced that stock values still make a purchase the more attractive way to expand. To be sure, managements sometimes get swept up in a bubble and purchase at exorbitant prices. But such mistakes, even if sometimes dramatic, are more the exception than the rule. The continued broad flow of M&amp;A activity now, even if a surge fails to materialize, announces that this “smart money” still thinks stocks are cheap. &nbsp;&nbsp;</p> <p>Initial public offerings would tell a very different story. Unlike M&amp;A, an increase in these would announce that managements and investment bankers see prices as high, a time to get a premium price for the firm. Of course, people make mistakes from time to time, but a general run of IPOs would raise a red flag about market pricing and valuations. Here, patterns confirm that few decision makers see matters this dangerous way. According to the latest statistics, IPOs have actually fallen off this year. First quarter figures show only 34 deals valued at $5.4 billion, down from 68 deals valued at $16.2 billion in the fourth quarter last year and 64 deals valued at $10.6 billion in 2014’s first quarter. In fact, the most recent quarter is the slowest in two years, hardly a sign that owners or investment bankers see any urgency to cash in on high prices.<sup>4</sup>&nbsp;&nbsp;</p> <p><span class="separator">&nbsp;</span></p> <p><b><span class="rte_txt_green">Table 1. M&amp;A Activity</span> </b>(monthly rates)</p> <table class=no_style border="0" cellspacing="0" cellpadding="0"> <tbody><tr><td width="213" valign="top"><p><b>Period</b></p> </td> <td width="213" valign="top"><p><b>Number of Deals</b></p> </td> <td width="213" valign="top"><p><b>Value ($ in bil.)</b></p> </td> </tr><tr><td width="213" valign="top"><p>2013 4Q</p> </td> <td width="213" valign="top"><p>817</p> </td> <td width="213" valign="top"><p>$79.6</p> </td> </tr><tr><td width="213" valign="top"><p>2014 1Q</p> </td> <td width="213" valign="top"><p>959</p> </td> <td width="213" valign="top"><p>$108.7</p> </td> </tr><tr><td width="213" valign="top"><p>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; 2Q</p> </td> <td width="213" valign="top"><p>1,000</p> </td> <td width="213" valign="top"><p>&nbsp;154.8</p> </td> </tr><tr><td width="213" valign="top"><p>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; 3Q</p> </td> <td width="213" valign="top"><p>1,003</p> </td> <td width="213" valign="top"><p>&nbsp;108.1</p> </td> </tr><tr><td width="213" valign="top"><p>October</p> </td> <td width="213" valign="top"><p>1,123</p> </td> <td width="213" valign="top"><p>&nbsp;96.5</p> </td> </tr><tr><td width="213" valign="top"><p>November</p> </td> <td width="213" valign="top"><p>1,006</p> </td> <td width="213" valign="top"><p>&nbsp;194.0</p> </td> </tr><tr><td width="213" valign="top"><p>December</p> </td> <td width="213" valign="top"><p>983</p> </td> <td width="213" valign="top"><p>&nbsp;103.6</p> </td> </tr><tr><td width="213" valign="top"><p>2015 January</p> </td> <td width="213" valign="top"><p>995</p> </td> <td width="213" valign="top"><p>$78.4</p> </td> </tr><tr><td width="213" valign="top"><p>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; February</p> </td> <td width="213" valign="top"><p>938</p> </td> <td width="213" valign="top"><p>114.3</p> </td> </tr></tbody></table> <p><span class="separator">&nbsp;</span></p> <p><span class="legal">Source: FactSet.</span></p> <p><span class="separator">&nbsp;</span></p> <p>Some of this misplaced buzz may reflect the sudden and still novel growth of overseas financing. It seems that because the European Central Bank has flooded the eurozone with liquidity, the resulting low interest rates and bond yields there have begun to attract many American borrowers. Though data is far from comprehensive, what figures are available indicate that so far this year American companies have raised nearly €30 billion on European markets in some 24 deals, up from eight deals and €7 billion on average last year. Since they have no doubt brought some of this money home to support their acquisition strategies, some observers might feel a strangeness about today’s M&amp;A activity, enough to distract them from more favorable fundamental interpretations. But beneath novelty, it hardly looks ominous. On the contrary, it really just announces that U.S. securities and markets will gain from the liquidity being created in Europe even as the U.S. Federal Reserve begins, very tentatively and very gradually, to step back from its policy of pouring liquidity on markets.<sup>5</sup></p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 27 Apr 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-budget-fiscal-political-calculations.htmlU.S. Budget: The Fiscal and Political Calculations<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>A compromise budget from the House and Senate will not affect U.S. revenues and spending—but it may help Republicans frame key policy debates ahead of the 2016 election.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The House of Representatives and the Senate have each passed budgets. That the Senate passed a budget at all is remarkable. Though the law requires it, the upper house has failed to pass a budget for the past six years. Now the House and the Senate will go into conference to negotiate differences and vote again on a compromise budget. This is likely to work out. The budgets are not that different.</p> <p>After this step, matters become more political than practical. The agreed budget is not binding. It does not require President Obama’s signature. Votes on appropriations will determine actual spending, and they will require that signature. As with President Obama’s budget from earlier in the year, this document will control neither spending nor revenue generation. It will only set out Republican budget priorities, as the president’s budget set out Democratic priorities. These then will at most set out the parameters of debate over more specific budget issues as they emerge in coming weeks and months.</p> <p><b>The Major Features<br> </b>Here are the broad outlines of the House and Senate proposals, at least as they presently stand:</p> <p><b><i>Overall<br> </i></b>On spending overall for 2016, the GOP budgets differ only slightly from President Obama’s figures or current law. That only stands to reason. Much of the outlays are on autopilot, and take time to adjust. Over the longer, 10-year period in which priorities become clearer, the Republican proposal would cut cumulatively some $5 trillion out of the spending presently budgeted and slightly more out of the president’s proposals. Against these general spending differences, President Obama’s budget proposed some $1.8 trillion in tax increases cumulatively over a 10-year period, while the Republican budgets, unsurprisingly, would block any new taxes. Entirely on the basis of their spending cuts, the GOP budgets claim to reach something near balance within 10 years, while current law, according to the Congressional Budget Office (CBO), would produce a deficit of slightly more than $800 billion.<sup>1</sup></p> <p><b><i>Entitlements<br> </i></b>The biggest differences lie in the area of entitlements. Neither the House nor the Senate plan would touch Social Security. Both would, however, repeal the Affordable Care Act (ACA), which accounts for the bulk of the expected cuts in outlays. The full amount does not appear in deficit reduction because both GOP budgets also would repeal the 2.3% excise tax on medical device makers. In addition, these budget proposals would slow the growth of Medicare spending, from the 6.4% a year foreseen in current law to about 5.5%; slow Medicaid and the Children’s Health Insurance Plan (CHIP) spending, from the current law’s 5.6% annual rate of increase to about a 4.2% rate; and slow welfare spending, mostly food stamps, from the current law of 3.5% annual growth rate to a 3.3% annual rate of <i>decline</i>. The Senate plan offers much less detail on exactly how it would achieve its savings than does the House plan, which more or less embraces Congressman Paul Ryan’s (R-WI) proposals of a couple of years ago, seeking block grants for Medicaid, in order, the legislation says, to encourage states to economize, and a partial privatization of Medicare, allowing seniors to choose between the program as it exists or private insurance. On the welfare reform, specifics are sparse.<sup>2</sup></p> <p><b><i>Defense<br> </i></b>On defense, the plans ostensibly stick to the sequester levels set in 2011. Since President Obama proposed raising the defense budget 7% above the sequester levels, this makes the GOP budgets look harder on the Pentagon than the White House. But both the House and the Senate would actually be more generous by allowing for a separate special fund for what they call Overseas Contingency Operations (OCO). This would not be subject to the 2011 caps, and that would give the Pentagon access to an additional $45–85 billion, allowing defense spending to rise some 2.4% a year or more under Republican plans, beginning in 2016, more from the Senate than the House. On non-defense discretionary spending, which constitutes less than 10% of all federal spending, the Senate proposal would cut a cumulative $238 billion from the amounts built into current law, a reduction of about 3.0%. Neither the House nor the Senate proposals offer much detail on how to achieve these cuts, except to point to the perennial effort to eliminate “waste.”</p> <p><b><i>Interest Expenses<br> </i></b>Both the president’s budget and the two GOP alternatives are reasonably realistic about interest expenses. They all take their cue from Congressional Budget Office estimates that interest rates will rise gradually over the next few years and hold those levels for the rest of the 10-year forecast horizon—about 350 basis points (bps) on short-term rates and 250 bps on longer-term rates. Although interest-rate expectations are similar, Republican plans budget lower overall interest expenses than the current budget baseline, amounting to about 20% by the end of this long-term period, because they anticipate narrower deficits than either current law or the president’s budget. Even with these savings, the rise expected in interest rates will increase interest expenses in the House and the Senate versions, from some 6% of all spending at present to some 12% at the end of the 10-year forecast period. &nbsp; &nbsp; &nbsp;</p> <p><b><i>Prospects<br> </i></b>As already indicated, this budget is not binding. It will not go to President Obama for a signature and so cannot suffer a veto, which it almost certainly would if it required a presidential signature. But for all this, the passage of these budgets and the likely reconciliation vote are not without political impact. They make clear Republican priorities and underscore differences from the Democrats—clear distinctions that will influence detailed appropriations legislation later in this session and also have use by both sides during the 2016 election. More immediately, a reconciliation vote would lay the groundwork for a vote to repeal the ACA. This would otherwise be impossible in the Senate, for the Democrats would surely filibuster such legislation. But since reconciliation rules prohibit the filibuster, a passage of such legislation could allow Congress to send such a repeal to the White House, as early as later this year. No doubt President Obama would veto it. Since the Republicans in the Senate do not have the votes to override a veto, the ACA law would stand, at least for the time being. But for good or bad, a powerful political point will be made.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 20 Apr 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-labor-not-so-great-participation-rate.htmlU.S. Labor: A Not-So-Great Participation Rate<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The percentage of Americans either working or looking for work is lower than pre-recession levels. Here’s what it could mean for the economy—and Fed policy.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Measuring unemployment presents a policy and a forecasting problem of considerable concern. Americans appear to have become less inclined to work these days, especially since the Great Recession of 2008–09. The so-called participation rate—the portion of the population older than 16 who either are working or looking for work—after rising from 59% in the early 1960s to 67.5% by the turn of the century, had drifted back down to about 65.5% just before the 2008–09 recession, and since then has fallen precipitously, closing in on 63%. These changes may seem minor here on the page, but the difference from the peak participation rate at the turn of the century to the present rate amounts to some 6.7 million people.<sup>1</sup> Their behavior going forward could easily change perceptions of the economy’s strength, its reality, and, possibly, policy.</p> <p>The degree of concern in this matter hinges on which explanation for the drop forecasters, analysts, and policymakers prefer. On one side are those who describe the fall-off in terms of discouraged job seekers. These analysts worry that the poor jobs market has convinced many to give up looking, but that they will flood back to the search as the labor market improves. Because these people will not find work immediately, the measured unemployment rate will rise, causing the Federal Reserve to regret any decision to raise interest rates in the interim. On the other side are those who consider the drop in participation as a reflection of demographic shifts, particularly the aging of the population. They see the situation as much more stable, consider the headline unemployment rate an accurate reflection of the economic fundamentals, and see less risk should the Fed go ahead with its plan to raise interest rates gradually and eventually shrink the central bank’s balance sheet. &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>In the thick of the debate over causes, and by implication how matters will work out going forward, is James Bullard, president of the Federal Reserve Bank of St. Louis. He has assembled considerable evidence to support the notion that the new, lower labor-force participation rate has less to do with frustrated job seekers and instead is a stable reflection of the changing age composition of the population. Through this line of analysis, Bullard argues that the growing proportion of older people, retirees, in the total population over the age of 16 quite naturally reduces measures of participation. He concludes from this that the situation is not likely to change anytime soon, at least not quickly, that today’s relatively low 5.5% rate of unemployment is an accurate reflection of the state of the labor market and is not at all liable to a sudden rise, and that, consequently, there is little risk to the Fed going ahead with its plan to raise interest rates gradually.<sup>2</sup>&nbsp;&nbsp;</p> <p>But for all the academic and policy analysis Bullard has assembled, a significant measure of doubt remains. For one, Bullard has long stressed the need to raise rates—and for reasons well beyond questions of labor force participation. His policy preference leaves him with a strong desire to find relative stability in the participation situation. None of this is to suggest that such a fair-minded person would consciously tilt the evidence. Rather, it is a simple recognition that even the best of minds is vulnerable to biases. Second is the speed at which the participation rate has fallen during the great recession and since. Demographic influences trend to unfold gradually. A purely demographic influence might have allowed a gradual decline, such as occurred in the early years of this century. But the sudden drop since the Great Recession suggests that something else is also happening: that in addition to a growing proportion of retirees, a frustration with the job search has perhaps also induced people of prime working age to give up for the time being. Third, Bullard’s careful assembly of evidence also turned up studies that ascribe a considerable portion of the drop in participation since 2007 to cyclical instead of demographic considerations; some of these studies point to half of it, some to all of it.<sup>3</sup> <b><i>&nbsp; &nbsp;&nbsp;</i></b></p> <p>Since a truly balanced assessment of these positions leaves the field open to just about any conclusion, it is worth looking at matters through the lens of limiting assumptions. If reality is likely a combination of the demographic and cyclical explanations, then it is reasonable to work from the possibility that, say, half the drop in participation since 2007 is cyclical and so subject to a reversal should the jobs market improve further. That perspective would imply that a population of some 3.7 million frustrated job seekers could come back to the search. If all of them were suddenly to do that, the headline unemployment rate would climb some 2.5 percentage points, to 8.0%. But even if eventually this many people could plausibly return to the job search, they are unlikely to flood back to the market all at once. Practically, then, policymakers at worst would have to cope with perhaps a more manageable rise in the unemployment rate, to 6.5% of the workforce.<sup>4</sup></p> <p>This higher unemployment rate would certainly paint a less robust economic picture than many have now. It might even sway some on the Federal Open Market Committee, the body that actually sets monetary policy. The balance of influence might then slow the implementation of the planned interest-rate increases. But since the Fed considers more than just the unemployment rate when setting policy, and since such an unemployment rate is not much different from policymakers’ original target for a policy change, it is not likely to reverse the underlying decision to raise interest rates gradually or seek ways to trim down the Fed’s balance sheet. Still, it would create a lot of doubt among market participants and, with it, market volatility.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 13 Apr 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-economy-getting-the-jobs-recovery-to-work-harder.htmlU.S. Economy: Getting the Jobs Recovery to Work Harder<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Even with the recent improvement, the pace of U.S. employment growth still lags earlier labor-market rebounds by a significant margin. What needs to be done to speed up the pace?</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>One of the most unfortunate aspects of this generally troubling recovery is the atypically slow pace of employment growth. Until relatively recently, the economy was creating new jobs at a slower pace than even the so-called “jobless recovery” of earlier in this century. It was doing so at barely half the pace of recoveries in the 1980s and 1990s. Explanations dwelt on fears left by the severity of the Great Recession and the burdens of increased regulation as well as complex legislation. But there was little way to verify these explanations and so gain some clarity about how matters might play out going forward. Now new research from the Federal Reserve Bank of St. Louis suggests that these explanations are valid and, in the process, indicates what needs to change for matters to improve. &nbsp; &nbsp;&nbsp;</p> <p><b>The Basic Statistics<br> </b>Though recent, relatively strong employment growth has created something of an optimistic buzz, no one can otherwise deny the fundamentally substandard nature of this jobs recovery. The first two years of the cyclical upturn, 2010 and 2011, for example, saw payroll growth of, on average, only 143,000 jobs a month. That pace improved to 193,000 a month in 2012 and 2013. In the past 12 months, it has jumped again to an average of 274,000 a month. Though this is a gratifying trend in many respects, even the improved pace of job creation falls short of the 309,000 a month averaged for two full years during the cyclical recovery of the early 1980s or the 320,000 a month averaged for a year during the recovery of the early 1990s. It also falls well short of the 342,000 a month averaged for two years in the recovery of the late 1970s. The shortfall looks even worse when considering that the labor force and the economy during those earlier periods was significantly smaller than it is today. The only comparison where recent experience looks respectable is with the recovery early in this century, when jobs growth averaged about 200,000 a month for two and a half years. Yet even that offers little comfort. That earlier recovery should have been more muted, for it followed a very mild recession in which job losses were tiny compared with the devastation of 2008–09, when payrolls declined 700,000–800,000 a month for several months in a row.<sup>1</sup>&nbsp; &nbsp; &nbsp;</p> <p><b>Drilling Down a Little Deeper<br> </b>Now researchers at the Federal Reserve Bank of St. Louis, Maria E. Canon and Yang Liu, have revealed some of what is happening beneath these aggregates.<sup>2</sup> They have disaggregated employment growth according to the sizes of firms doing the hiring, defining small companies as those with 49 or fewer employees, medium-sized firms as those with between 50–499 employees, and large firms as those with 500 or more employees. The researchers reveal that small firms for some time now have accounted for more than half the new jobs created in this economy, with the balance taken up fairly evenly between medium and large firms. This relationship is widely known. Less well known is the authors’ finding that the relative importance of small firms has grown over the last 20-plus years. Going into the Great Recession, small companies, research shows, accounted for fully 56.3% of all job creation. The authors’ further observation that this uptrend has broken since the Great Recession pinpoints the source of this recovery’s disappointing experience. Small firms—the long-standing engine of U.S. job creation—have simply ceased to hire as they once did.</p> <p><b>The Whys and Wherefores &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;<br> </b>If this changed behavior accounts for much of the poor jobs growth exhibited in this recovery, it also points to reasons. As the St. Louis Fed research also documents, small firms are much more sensitive to economic and regulatory changes than are medium-sized or large firms. It stands to reason. Smaller firms are generally less well capitalized than their larger counterparts and have fewer sources of financial support. They have limited resources with which to respond to the compliance demands by government. In hard times or when government presses, the smaller firms cut back on their hiring more dramatically than larger firms and then more than make up the difference when circumstances provide relief. Their comparative failure to do so this time points to a general lack of such relief—a fact that seems to have roots in three influences.</p> <p>One of these is the shock of the Great Recession of 2008–09. Business declined so far so fast then that many firms, even after engaging in the extensive layoffs already referred to, had trouble meeting payroll. There can be little doubt that the greatest such problems occurred among the smallest firms, with their relative lack of capital and financial recourse. It is little wonder, then, that companies of all sizes, but especially smaller firms, continue to hoard cash and proceed with the greatest caution, especially when it comes to hiring, even now six years into the recovery.</p> <p>The second of these influences is the impact of the sweeping legislation passed in 2009 and 2010, in particular the Affordable Care Act and the Dodd-Frank financial reform law. Whatever the merits of these laws, there is no denying that they changed the rules radically and so unavoidably increased uncertainties among employers about the ultimate cost of employees as well as the cost and availability of credit. Those uncertainties have lingered, because even now, some five years after they were signed into law, all their provisions and demands are not yet settled. Because smaller firms can least afford to make a mistake, they have responded disproportionately.</p> <p>The third influence is the increased burden of bookkeeping and compliance imposed by this complex legislation as well as the great increase in regulatory reach. All firms have reacted by going more slowly and more cautiously on any expansions and hiring, smaller firms especially. Unlike their larger counterparts, they can neither justify nor afford the sometimes huge commitment in the time demanded of compliance. &nbsp; &nbsp; &nbsp; &nbsp;</p> <p><b>Prospects &nbsp;&nbsp;<br> </b>It would seem then that at least three things have to change in order to reestablish small-firm behavior and recapture old rates of jobs creation. Only time will heal the scars of 2008–09. Perhaps bitter memories of those difficult years are beginning to fade, explaining why jobs growth has become more respectable during the last nine to 12 months. It may take still longer for the complex and still vague legislation passed in 2009 and 2010 to become clearer. In this regard, rollbacks, repeals, whatever their virtues or vices, could be counterproductive, for they would only introduce new uncertainties and so make business still more hesitant. The key, then, is some clarity in which businesses, especially small businesses, can have confidence in their calculations of the cost of a new employee as well as of the cost and availability of credit. Clarity also will relieve some of the administrative burdens by allowing firms to put routinized, cheaper, and so less troublesome compliance procedures in place. Only then will managements move forward as aggressively as they once did. A pause in the growth of regulations too would offer similar relief and encouragement for very much the same reasons. Because all this will take time, the improvement in labor markets is likely to unfold only gradually, implying a long wait to see jobs growth comparable to past recoveries.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 6 Apr 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-economy-are-consumers-a-spent-force.htmlU.S. Economy: Are Consumers a Spent Force?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>Americans are saving more, while keeping consumption and borrowing in check. What does this signal for the broader economy?</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The American consumer seems to have changed fundamentally. After decades of aggressive, some would say reckless spending and borrowing, households since the Great Recession of 2008–09 have exhibited an atypical caution about both spending and borrowing. That caution itself has contributed to the disappointingly slow pace of overall economic recovery and, until recently, the poor rate of jobs growth as well—trends that have fed back to exacerbate the consumer caution born in the recession. Whatever the causes or other feedback loops involved, recent declines in retail sales speak to the persistent nature of this new consumer hesitancy and the likelihood that it, and its more general retarding effects, will persist. &nbsp; &nbsp; &nbsp;</p> <p><b>The Old American Consumer and the Great Recession<br> </b>For decades before the Great Recession, the American consumer could only be described as a spending enthusiast. He and she seemed to spend each additional dollar of income and borrow to buy what their current incomes could not support. During the housing boom between 2003 and 2007, for example, these well-established patterns reached extremes. Households leveraged rising real estate values and used their homes as if they were an ATM, so to speak. Spending rose at a rate of almost 6.0% a year, far faster than the 5.5% rate of income growth. According to the Federal Reserve, household borrowing during this time jumped $4.6 trillion or at a 10.0% annual rate. Most telling of all, household savings rates remained minuscule, averaging a mere 3.5% of aftertax income and falling at times to as little as 2.0%.<sup>1</sup>&nbsp;&nbsp;</p> <p>The carnage of the Great Recession showed the downside to such behavior. The burden of debt payments had risen to almost 20.0% of aftertax income.<sup>2</sup> Even those who kept their jobs and incomes had to cut back on spending when the flow of credit dried up. Of course, it was that much worse for the 8.7 million people who lost their jobs during that time. Many who had leveraged themselves to buy more real estate than was prudent lost their homes, as delinquency rates climbed to an astronomical level of 11.3% of outstanding residential mortgages.<sup>3</sup> As real estate values fell, many of those who managed to hang on found themselves stuck with mortgages that exceeded the value of their property. To say it was a sobering experience, even for those who kept their jobs, would stand as a gross understatement. The slow pace of recovery after 2009 only reinforced the new cautious attitude. Jobs especially disappointed, at times growing at only half the rate to which the United States had become accustomed. The weak labor market even caused households to question what had been well-worn paths to middle-class security. &nbsp;</p> <p><b>A New Attitude<br> </b>And so a change has occurred. Households have budgeted with a reinforced caution that seems foreign to their otherwise long-standing earlier behavior. Though slow jobs growth in this recovery has kept income growth comparably sluggish, consumers have kept their spending growth even slower and governed their use of debt still more exactingly. According to the Commerce Department, incomes grew 4.1% a year between 2009 and 2013, but spending increased only 3.6% a year. Fed statistics actually show that households cut their debt outstanding by 2.0% during that time. Consumers maintained a savings rate of almost 6.0% of aftertax income, which is high indeed by past standards. After those brief periods when spending outpaced income and household savings rates fell below 5.0%, subsequent quarters saw remarkable (at least for Americans) and spreading restraint as families strived to reestablish their higher savings rates. In late 2013, for example, when such relative spending growth pushed that rate down to 4.8%, the early part of 2014 saw spending growth enough below income growth to push the savings rate back up above 5.0% by the spring quarter.<sup>4</sup>&nbsp; &nbsp; &nbsp; &nbsp;</p> <p>Little speaks so thoroughly to this new attitude and its seeming staying power than consumers’ reactions to the recent drop in energy prices. During the past eight months, the price of a barrel of oil has fallen by more than half, with comparable declines in the prices of gasoline, natural gas, and fuel oil, if not electricity. Since, according to the Labor Department, the average American budgets 8–10% of his or her spending on such fuels, the price decline was tantamount to a 4.5% jump in real income.<sup>5</sup> In the past, households would have quickly spent that boon, effectively redirecting the savings at the pump to additional outlays on all kinds of goods and services. But that is not what has happened. During the past few months, as the full effect of energy savings have hit household budgets, spending, far from picking up, has actually declined. Retail sales have dropped for the last three consecutive months by a cumulative 3.8%, and broadly, too, not just the obvious decline of monies spent at the pump. The move is still more remarkable because hiring and, thus aggregate incomes, have picked up at the same time. A lack of data makes it impossible to know if households have used the break on fuel expenses to pay down debt, but it is apparent that savings rates have jumped, by more than half a percent of aftertax income in fact, through January 2015 (the latest period for which complete data are available).<sup>6</sup>&nbsp;&nbsp;</p> <p><b>Conclusion &nbsp;&nbsp;<br> </b>Perhaps households distrust the staying power of low oil prices. That would be wise. Though the world has found many new sources of oil and gas, still 30–35% of its oil passes through the Persian Gulf, a region prone to the kinds of trouble that could easily raise prices again very quickly. But even if the household distrust were misguided, it speaks to the continuing influence of the new caution born during the Great Recession and evident since. In time, older, more expansive attitudes may well reassert themselves. But for the time being, it appears the self-restraint will prevail, slowing the pace of consumer spending growth, and—since the household sector still constitutes some 70% of this economy—the pace of overall economic growth as well.<sup>7</sup></p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 30 Mar 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-trade-shortchanged-by-a-strong-dollar.htmlU.S. Trade: Shortchanged by a Strong Dollar?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Worries that the elevated value of the greenback will crimp U.S. exports—and hurt corporate profits—are overstated.</i><b></b></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The dollar certainly has put on a show of late. Over the last six months, it has gained some 13% against the yen, 21% against the euro, and 12% against the world when weighting various currencies according to their importance in U.S. trade.<sup>1</sup> Some believe these gains confer bragging rights for Americans. The investment community has shown more concern than anything else. It fears that the appreciation will price out U.S. exports from global markets and so threaten the U.S. economy’s manufacturing renaissance. There also is a concern that a higher-priced dollar will detract from the translation of foreign earnings for those firms that have major overseas operations. These are legitimate concerns, but they may easily be overstated.</p> <p><b>The Translation Effect<br> </b>The translation effect is mostly a matter of bookkeeping. A firm with a major operation in, say, Europe, makes that part of its earnings in euros. To produce a consolidated earnings statement in U.S. dollars, it must translate those euro earnings into dollars, even if it never actually converts the money. The stronger the dollar, the less these earnings will count in dollar terms, making the consolidated earnings look weaker than otherwise. Because the Wall Street analytical community often fails to fully account for this effect, it can surprise investors when earnings are announced. But there is seldom much impact on the U.S. economy or even the real performance of the company in question. &nbsp; &nbsp;</p> <p>For one thing, the shortfall in dollar sales only occurs in the quarter in which the dollar appreciates. If the dollar then retains its new, higher level, the dollar level of the following quarter’s sales may remain lower than before the dollar appreciated, but the earnings decline does not recur. For the translation effect to do further damage, the dollar would have to appreciate quarter after quarter. This translation effect hits exporters less than companies with ongoing operations overseas. Exporters typically write their contracts in dollars. A rise in the dollar may affect sales (a matter discussed in the next section), but there is no translation effect except in those very rare instances when the trade contract is written in a depreciating foreign currency. &nbsp; &nbsp;&nbsp;</p> <p>Even among the firms that have large overseas operations, the impact, particularly on the U.S. economy, is usually small. Some of these firms are so entrenched in those foreign markets that they do all their sourcing and production there, as well as the sales. Many, because of the United States’ virtually unique corporate tax code, have no intention of ever repatriating the earnings from such operations. In such cases, the currency effect truly is just a matter of bookkeeping. The impact on U.S. economic activity is next to nothing because so little of the production has roots in the domestic economy. The firm itself has no reason to react in any substantive way, or even change what it is doing at all, for that matter. With costs and revenues fully denominated in a foreign currency, the dollar only matters in a consolidated statement, not in the underlying profitability of the overseas operation. &nbsp; &nbsp; &nbsp;</p> <p>There are, however, some firms that do supply their overseas effort with materials produced in the United States. The dollar’s appreciation in such a case could raise costs to the operation and, accordingly, reduce its profitability, thereby enlarging the effect beyond one of bookkeeping. Of course, that increased cost may prompt management to source elsewhere than in the United States, in which case the firm could protect the overseas operation’s profitability, but do so only at the expense of reduced economic activity in the domestic economy.</p> <p><b>Trade<br> </b>Besides these effects, the dollar’s rise, which has pushed up the price of U.S.-based production to the rest of the world and reduced foreign prices to Americans, will adversely affect the country’s balance of trade and, by implication, the overall economy. That effect is already evident. Exports growth has slowed. After rising 4.0% during 2013, total exports of goods and services from the United States have expanded by only 1.4% this past year. Imports have accelerated. After expanding a mere 1.1% in 2013, they jumped 3.4% this past year. The balance of imports and exports has inevitably deteriorated from an annualized deficit of $400 billion at the end of 2013, down from a deficit of more than $506 billion at the close of the prior year, to an annualized deficit of more than $512 billion recently, giving up more than all the gains of 2013.<sup>2</sup>&nbsp;&nbsp;</p> <p>The deterioration, however, was highly inconsistent across industries. Because higher-value-added products are less price sensitive, they have suffered less from currency swings than lower-value-added, commodity-like products, which are more easily sourced elsewhere and so are much more sensitive to the price effects of the dollar’s recent rise. This distinction clearly is evident in the classic divide between goods and services.&nbsp;</p> <p>Fully half this country’s service exports and slightly more than half of its imports lie in sophisticated, less price-sensitive areas such as financial and other business services, telecommunications, and licensing fees for intellectual capital. Accordingly, service exports have hardly slowed at all, despite the dollar’s rise, growing 3.1% in the past year, a barely noticeable deceleration from the 3.2% expansion in 2013. Imports showed a similar insensitivity, accelerating hardly at all from 3.1% growth in 2013 to 3.2% during this past year.</p> <p>It is a different story for trade in goods. Because so many of these are lower-value, commodity-like items, currency shifts have had a much greater impact here than in services. Goods exports overall slowed markedly from a 4.0% growth pace in 2013 to only a 1.4% pace of advance during this past year. Goods imports similarly showed a more marked acceleration in response to the price effects of the dollar’s appreciation. After growing only 0.8% in 2013, imports jumped 3.4% during the past year. The difference between high- and low-value-added items is still more evident in subsectors of U.S. trade. For example, exports of capital goods, generally a high-value item, held up well despite the dollar’s rise, gaining 3.0% during the past year, while exports of industrial supplies, generally lower-value, more commodity-like items, suffered a decline of 0.4%. Excluding the special case of crude oil and other petroleum products, exports of this subgroup actually dropped a sharp 3.3%. The immense detail of other product sectors and subsectors, though too much to go through here, also testifies to the greater sensitivity of lower-value-added products in both imports and exports and the relative insensitivity of higher-value items to currency shifts.</p> <p><b>Looking Forward &nbsp;<br> </b>To be sure, imports and exports last year responded to more than just the dollar’s rise. Still, the consistency of the pattern signals what to expect in the future as the dollar continues to make gains. Especially as the Federal Reserve likely will raise interest rates, further dollar strength should cause a faster deterioration in U.S. trade, as imports rise above where they would otherwise be and exports fall below where they would otherwise be. The overall effect will reinforce other factors that are already keeping this recovery historically slow, though even the combination of effects is unlikely to precipitate a recession. And because the most damage will occur among low-value products, the net effect at the margin will reinforce the ongoing shift in this country’s economic focus and the flows of investment monies toward higher value-added products and processes.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 23 Mar 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/japan-why-stagnation-is-the-abe-normal.htmlJapan: Why Stagnation Is the "Abe Normal"<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>Until the prime minister draws the &quot;third arrow&quot;—structural reform—from his quiver, Japan's economic and investment prospects will remain limited.</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Japanese prime minister Shinzo Abe has politicked exquisitely. He has done public relations even better. Yet it is with economic policy that he has fallen short. His program, called “Abenomics,” has simply failed to lift Japan’s economy from shallows in which it has wallowed for more than 20 years now. That is hardly surprising. Despite all the fanfare, little that he has implemented is new, while he has neglected the one novel and promising aspect of his agenda, structural reform. Until he (or someone else) takes this fundamental aspect of policy seriously enough to actually do something, Japan’s economic prospects will remain mediocre.</p> <p><b>Abe’s Initial Splash<br> </b>Since the time Abe first took office in 2013, he has touted his supposedly novel plan to revitalize the economy. His agenda consists of three initiatives—“arrows” he calls them. The first arrow is a massive government stimulus program, mostly on new infrastructure, amounting to as much as 3.5% of Japan’s gross domestic product (GDP). The second arrow consists of extremely easy monetary policies, including an increase in the Bank of Japan’s (BoJ) inflation target, from 1.0 to 2.0%, and a large injection of liquidity into the system through a quantitative easing that would, the government claims, expand the central bank’s balance sheet by 1.0% of GDP in the first year. The third arrow would aim at structural reforms to make Japan’s economy more dynamic and growth oriented, including efforts to streamline energy, environmental, and healthcare regulation, and take steps to cope with the rising average age of the population and the resulting overhang of dependent retirees.<sup>1</sup></p> <p>At present, Abe has only let loose the first two arrows. For a while, these seemed to be sufficient. Japan’s financial markets responded well, as did its economy. The country’s real GDP expanded at an annual rate of 3.7% during the first three quarter of 2013—a major turnabout from the half-percent decline recorded in 2012. That rate fell modestly in fourth quarter 2013, but jumped again at an impressive 6.6% annualized rate in 2014’s first quarter. By that time, it appeared as though Abenomics was working, even with its third arrow still held in the prime minister’s quiver. But then the skein of good news began to unravel. The economy fell a hard 7.4% at an annualized rate in the spring quarter last year, and continued to decline at a less precipitous but still severe 2.0% annualized rate during the summer quarter. Preliminary data for the fourth quarter point to a rise, but only barely, at an annualized rate of 0.2%.<sup>2 </sup>&nbsp; &nbsp;&nbsp;</p> <p><b>Why Things Have Fallen Apart<br> </b>At base, the recovery faltered, because what Abe has done is essentially a reprise of past failed policies. Floods of infrastructure spending certainly are an old story for Japan. Tokyo has turned to this “solution” frequently throughout the country’s long period of stagnation, so much so, in fact, that the government now carries on outstanding debt burden in excess of 260% of the country’s GDP—by far the highest in the developed world. To be sure, all this past spending also has created a world-class infrastructure in Japan, rail, roads, and ports of all kinds, and that, no doubt, has contributed to the country’s still great wealth. But the world’s shiniest and newest infrastructure offers less return from additional spending than a less impressive structure would. It clearly has with Abe’s recent effort.<sup>3</sup>&nbsp; &nbsp;&nbsp;</p> <p>There is an ominous side to the infrastructure spending that also speaks to why it has had a limited effect. Prime Minister Abe’s Liberal Democratic Party (LPD), since it became the leading party of Japan in the mid-1950s, has notoriously rewarded its supporters, regions, and firms with infrastructure contracts. The current policy would seem only to extend that old and, incidentally, economically inefficient pattern. As if to underscore continuities with these less than optimal past practices, the LDP not too long ago promised to offset the ill effects of scheduled consumer tax increases by spending more on infrastructure—in other words, use tax moneys to reward its favorites in areas where there may be no real need.<sup>4</sup></p> <p>Abe’s second arrow, easy monetary policy, including quantitative easing, may avoid the corruptions of the past, but it, too, is hardly new. The BoJ resorted to it in the mid-1990s, when Japan tried to recover from its earlier real estate collapse. The policy failed again later in the 1990s, when the BoJ tried to use it to offset the effects of the general Asian financial collapse (referred to commonly as the Asian contagion). The program is reminiscent of still earlier BoJ policies that aimed to promote exports by using easy money to depress the foreign exchange value of the yen. This time, though the yen did decline in response to the bank’s policy, it did so in a very different economy than Japan once had. The country’s wealth, high average wage rate, and more recently huge overhang of dependent retirees have rendered it much more consumer driven and much less export driven than it once was. Today, exports constitute a mere 15% of the economy, less than half what they once were. Little wonder then that the old yen-depressing approach has had little lasting effect.<sup>5</sup>&nbsp;&nbsp;</p> <p><b>Abe’s Unused Third Arrow &nbsp;<br> </b>Meanwhile, Abe has done little or nothing about structural reform. Here, Japan has a great need and, consequently, a great potential response to effective policies. Its structural problems run wide and deep. A high wage structure makes it increasingly difficult to compete against the rest of emerging Asia, most particularly China, while an aging population, in which already one person in five is of retirement age, makes it impossible for the country to recapture its old position as the world’s workshop. To remedy such economic impediments, Japan needs to uncover new sources of labor and economic efficiency as well as reorient its economic focus away from broad-level exports, where it competes directly with China, toward higher-value products, where it has comparative advantages that can support its relatively high wage structure. Yet however much promise there is in policy initiatives to serve these critical needs, Abe has failed even to define his fundamental structural reforms, much less implement them.<sup>6</sup></p> <p>To be fair, Abe has taken two tentative steps. To supplement Japan’s shrinking workforce, he has pledged to increase childcare facilities to bring more women into the paid workforce. The potential here is huge. Japan has the lowest women’s labor participation rate in the developed world, less than 50%. But his effort so far is small indeed next to the actual need, so much so it looks more like a pilot program than a policy initiative. Abe has also has made arrangements to allow a few more foreign workers into Japan under very strict conditions. This, too, is only a minor adjustment in the face of pressing needs, though questions remain about the effectiveness of any immigration in Japan’s still xenophobic culture.<sup>7</sup></p> <p>While playing small ball in those instances where he has acted, Abe has otherwise ignored other critical aspects of the economy’s structural failings. One involves Japan’s notoriously inefficient distribution network. Instead of the large national warehouse, shipping, and retail outlets in evidence elsewhere in the developed world, it still has a vast numbers of small, largely family owned arrangements, many of which fall short of even regional scope. The approach protects much small business, which has its virtues, but it also is notably inefficient and expensive, and it uses more labor than otherwise, an especially unfortunate quality in a nation with a large overhang of retirees and a shrinking working-age population. Yet Abe’s supposedly reformist program has done nothing to alter the licensing and zoning practices that perpetuate this system, something it could otherwise easily do in Japan’s highly centralized system of government.<sup>8</sup></p> <p>The country also would benefit from reforms in its overarching industrial structure. It has an extremely top-down approach of economic organization. A close association of politicians, bureaucrats, and big business (referred to popularly as the “iron triangle”) has long set the economy’s priorities and direction. In the more distant past, when Japan trailed Western development, the approach worked well. The iron triangle could use trends in the United States to identify developmental directions and set the country’s economic agenda accordingly. But after Japan caught up to the West some 25 years ago, it has needed more innovation and new development of its own to meet the demands of a developed, high-wage economy. Those requirements are best met by new firms, experimenting with new technologies as well as novel business strategies. To be sure, even the iron triangle has managed innovations. Japan leads in robotics, for instance. But an economy of Japan’s size and scope needs more than a single line of development. Only newer firms can bring such a broad-based effort, and the big business leg of the triangle naturally has resisted. Yet, Abe’s supposedly reformist team has not even considered policies that might improve this situation.<sup>9</sup></p> <p><b>Prospects&nbsp;<br> </b>If Abe were to release his third arrow and actually begin these and other structural reforms, Japan’s economic prospects almost surely would pick up, greatly and durably. Its investment climate would become that much more attractive in tandem with such an improvement. While, however, Abe continues to rely on the backward-looking and less and less effective policies that constitute his first two arrows, those economic and investment prospects will remain limited, as they have for more than 20 years now.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 16 Mar 2015 09:15:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/stock-and-bond-funds-grow-with-the-flows.htmlStock and Bond Funds Grow with the Flows<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>No redistribution here: Even as equity fund flows have turned positive, bond funds continue to see inflows. Here’s a closer look at the trend—and what it means for investors.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>At last, mutual fund investors are moving money toward domestic equities. The investment community has long wondered when this would happen, when the great stock rally would induce the retail investor to return to the equity market. Yet throughout all the gains, right through last December, investors continued to pull their money out of domestic U.S. equity funds. Even as January seems to have brought that looked-for change, things are unfolding differently than the common wisdom had expected. It had anticipated that when investors made their move toward stocks, they would redistribute funds away from bonds. But, in fact, all major classes of funds have seen inflows so far this year. It would seem that rather than a redistribution the flows reflect a general growth in wealth.</p> <p>Still, the renewed interest in equities is significant. It should persist, and, contrary to popular belief, it likely will accelerate as the Federal Reserve raises interest rates later this year. The inflows eventually should help the stock market realize its remaining value. In the fullness of time, such flows, as they gain momentum, will create an overvaluation and set the stage for the next cyclical equity correction. That circumstance is, however, a long way off, given both the tentative nature of current inflows and still-attractive equity valuations.</p> <p><b>The Unfolding Picture in Equities<br> </b>Outflows in the face of a strong equity rally had created a strange picture. History would have indicated a redistribution in favor of equities long before now, not the least because fixed-income yields, especially on better-quality credits, were less than compelling. In all likelihood, the change failed to occur because the huge losses of 2008–09 had unnerved equity investors, especially since most also could remember the great losses of 2000–02. Many financial advisors were also reluctant to push equity investing for fear that another downdraft would jeopardize their practice. So, even as recently as 2014, net outflows brought down assets in domestic equity funds by 1.0%, despite a 14.04% total market return,<sup>1</sup> at least as measured by the S&amp;P 500<sup>®</sup> Index.<sup>2</sup>&nbsp;&nbsp;</p> <p>Only foreign equities attracted interest. These consistently saw inflows through much of this time, even though foreign stocks showed more volatility and less net gain than domestic U.S. equity funds. Investors evidently had fewer bad memories of overseas stocks than of domestic stocks, surely less because the foreign alternative had protected them than because fewer mutual-fund buyers had experienced those losses and so felt less bruised. Hybrid funds also attracted net inflows during this time, likely because scarred equity investors felt that they offered some protection against the sudden downdrafts in stocks that they feared.</p> <p>But beginning with this new year, these strange patterns began to change, at least in part. In the weeks through late February (the most recent period for which data are available), net flows into U.S. equity mutual funds turned from negative to a positive average of $1.6 billion a week—not a shabby gain, even on a base of $6.2 trillion outstanding in such funds at the end of 2014. Flows into foreign stocks held up, growing on average at $1.0 billion a week, which actually is a faster relative growth on this category’s year-end 2014 base of $2.1 trillion. Hybrid funds also continued their gains, growing slightly more than $950 million a week, also a greater proportion of their base of $1.3 trillion. &nbsp; &nbsp;&nbsp;</p> <p><b>Redistribution<br> </b>But as indicated, none of this reflects the long-awaited redistribution away from bonds. On the contrary, flows into both taxable and municipal bond funds have held up well so far this year. Bond funds overall have enjoyed inflows averaging $4.0 billion a week during this recent time, far higher than equities and faster relative to their outstandings at $3.4 trillion. Taxable bond funds have enjoyed inflows averaging $3.0 billion a week, while tax-exempt funds have seen inflows of $1.0 billion a week—this last a particularly strong 9.2% annualized rate of gain on the $566 billion outstanding amount in such funds as 2014 closed. Fed statistics confirm that these patterns reflect less a redistribution than a general increase in wealth, showing in the four quarters through the end of September 2014( the most recent period for which data are available) household net worth up some $5.1 trillion, or 6.7%.</p> <p>This pattern of broad-based net additions to holdings should persist until later this year, when the Fed, as promised, begins to raise interest rates. At such a time, bond yields will rise, modestly, no doubt, but enough to create capital losses in long bond funds, which have returned their coupon or better over much of the last seven-plus years. Money will want to turn elsewhere. Shorter-term funds are a clear choice. Some monies will likely go to lesser credits and municipals, which, because of relatively favorable valuation spreads, will suffer less than higher-quality issues, such as Treasuries, agencies, and the best corporate credits. Given the Fed’s determination to raise interest rates, albeit gradually, this general relative return pattern should persist, sustaining these newer fund flows.</p> <p>Equities should benefit from the redistributions, too. Though under other circumstances rising rates would raise questions about stock investing, equities at present show sufficient enough value to withstand anything but the most powerful of rate hikes, something that is hardly likely. Dozens of metrics can illustrate the extent of this value. One is adequate here to make the point. Presently, stocks on average yield about 2.0% on dividends alone, well above cash yields, which are negligible. Historically, cash yields 200 basis points <i>higher</i> than stocks, not the nearly 200 basis points <i>lower</i> than stocks do today. The gap speaks not only to the value remaining in stocks but also to how much of an adjustment is necessary before rate increases can erase that attractive relative value.</p> <p>As indicated, flows into equities eventually should help stocks realize their value, especially as those flows gain momentum. That is plain. It also is plain that such a day is a long way off, likely ensuring that equity inflows will build and persist for the foreseeable future.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="legal"><sup>1</sup>All data herein from the Investment Company Institute (ICI).<br> <sup>2</sup>The S&amp;P 500<sup>®</sup>&nbsp;Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries. An index is unmanaged, does not reflect the deduction of fees or expenses, and is not available for direct investment.</span></p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 9 Mar 2015 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/greek-tragedy-averted-for-now.htmlA Greek Tragedy Averted—for Now<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>While the Tsipras government has bought itself some time, the possibility of a Greek exit from the eurozone remains quite real—as does the risk to global financial markets.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Greece and the European Union (EU) have bought themselves four months before they must re-engage their negotiations. The reprieve is welcome, and shows a clear desire by both sides to reach an accommodation; but a Greek exit, even an unraveling of the common currency, remains a possibility. Arduous negotiations are still ahead for Greek prime minister Alex Tsipras and finance officials from other eurozone nations. And the potential for failure in the next round of Greek–EU talks carries immense risks, including a financial crisis that would spread quickly across the Atlantic, east to west.</p> <p>Still, probabilities presently favor some accommodation among these negotiators to hold together the eurozone and buy still more time to resolve the Continent’s ongoing fiscal–financial crisis. The terrifying nature of such a prospect alone—and other narrower calculations of national interest as well—make it clear to all that they have too much to lose from failure. Still, investors need to know the downside—if not only to brace their portfolios for it immediately but also to make plans for such adjustments should the probabilities shift. &nbsp; &nbsp;</p> <p><b>The Disaster Scenario<br> </b>If the only problem were Greece, Europe would have little reason for fear. Greece is, after all, small. Its economy amounts to little more than 6.0% of the German economy and much less of the entire eurozone.<sup>1</sup> All Athens’s public debt amounts to barely 1.0% of European bank assets.<sup>2</sup> But a great threat remains nonetheless because a Greek–European rupture could start a chain reaction of defaults or restructurings among the rest of the Continent’s beleaguered periphery.</p> <p>Even if Greece or these other nations were to stay in the common currency, a denial of support would force Athens to default on or reschedule its existing debt. Creditors in such a case would naturally lend less freely to all the troubled countries of Europe’s periphery and demand higher interest rates to cover the perceived risk. Such difficulties would raise the demands for EU aide, perhaps to unsupportable levels. Higher financing costs and less credit availability could then force defaults on, or reschedulings of, these countries’ debts, whatever other EU aid was available and whatever their former commitment. Were Italy, say, or Spain, and perhaps France and Belgium to default or restructure, the loss of wealth among financial institutions and other creditors would reach proportions that could threaten the stability of the European financial system and so threaten a still deeper economic decline than already exists in Europe. These events also would threaten the world financial system and the global economy, for though U.S. banks, for instance, own little Italian, Spanish, or Greek government debt, they do hold a lot of the obligations of financial institutions that do own a substantial amount of such sovereign debt.</p> <p>The ensuing crisis would be large and unmanageable even if these questionable credits were to remain inside the currency union. If those reneging on their obligations were expelled from the eurozone or choose to leave, the crisis could get infinitely more severe. At the very least, such a move would create tremendous administrative confusion. If Greece, for instance, were to return to the drachma, how would Athens treat its outstanding euro-denominated debt? Given the state of that country’s economy and its public finances, an effort to honor the obligation in euros would certainly present a dubious prospect. The same concerns would emerge with Spain, Italy, and others. If Greece or one of these other countries were to convert the debt into their revived national currencies, the losses from depreciation would immediately destroy still more wealth and continue to do so with further depreciations going forward. Europe’s financial system would then become still weaker, deepening any crisis there and around the world. &nbsp;&nbsp;</p> <p><b>Although Possible, Such Disasters Are, However, Improbable<br> </b>If such terrible prospects alone will likely motivate Greek and EU negotiators to avoid a rupture, there also are narrower, more calibrated interests that will prompt both sides to come to an accommodation or at least paper over differences in a muddle for which the EU has become infamous during this crisis. It may have been a mistake for Greece to even join the euro, but having done so, it has much to lose by leaving it now—something Athens knows could easily follow from intransigence. Other nations involved—Italy, Spain, France, Belgium, et al—have similar benefits to lose from an unraveling of the union, or their place in the union, even if at the start it may have been a bad idea for them to join as well. Nor do the Germans—crucially important because they are Europe’s paymasters these days—want to see the euro threatened.&nbsp;</p> <p>Greece offers an illustration of what all the poorer countries on Europe’s periphery stand to lose. For one, the union and the eurozone have brought it huge wealth transfers for the rich regions of Europe. The EU and the eurozone have largely paid for highways, bridges, ports, and other important pieces of economic and social infrastructures that had not existed and would not exist were it not for membership. The ability of people to move freely across the union’s borders has provided a great benefit as well. Greece has relatively few sources of income, but the nation benefits greatly from remittances from its nationals living and working elsewhere in the more prosperous areas of the EU and particularly the eurozone. An end to the affiliation would close down these important transfers as well. A return to a depreciated Greek drachma or Italian lire, or whatever, might help exports, but savers in these countries would quickly lose global purchasing power, a loss of wealth, potential credit, and investment that would weigh on the economy. To be sure, Greece’s new government probably does not count these savers as constituents, and so cares little for them, but it does care deeply about the more general economic hardship that would surely accompany such a wealth loss. Italy, Spain, and others could make very similar calculations.&nbsp;</p> <p>The Germans also have narrow pro-euro interests. It is surely ironic that Berlin, of all European governments, was most skeptical of the common currency, and yet Germany has benefited especially from it. To see why, consider where the German exports would be if the country still used its deutschmark. Money is pouring into Germany, as the only large and viable economy on the Continent. Such flows would have pushed the deutschmark up to astronomical levels, pricing German exports off global and even European markets. Especially because the euro encompasses many weaker economies, it has declined in value and certainly stayed lower than a German deutschemark would have, protecting German producers by allowing them to price their products much more competitively than they otherwise could. Berlin, no doubt well aware of the effect, has every interest in protecting the eurozone, and, what is more, keeping its membership broad. It needs an agreement to secure this arrangement. &nbsp; &nbsp;</p> <p><b>A Tentative Conclusion &nbsp;&nbsp;<br> </b>Risks remain, and great risks they are. For that reason alone, it is fair to say that danger for American investors comes from the east. But for all the reasonable fears and concerns, the interests of all involved argue that the eurozone will avoid such a disastrous outcome, even if it involves endless negotiations and a glossing over of differences. No doubt, the Continent’s fiscal–financial crisis would then remain ongoing, but that is better than the alternative. If investors need to remain aware and wary of the potential downside, the probabilities at the moment do look more benign.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 2 Mar 2015 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-economy-will-growth-be-roaring-or-boring.htmlU.S. Economy: Will Growth Be Roaring, or Boring?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Here’s a look at key indicators—and what they signal for the pace of U.S. economic activity.</i><b></b></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>While economies in Europe and Japan teeter into and out of recession, the U.S. economy has shown a measure of strength. Many look for a further growth acceleration as 2015 unfolds, including the forecasters at the Federal Reserve, the White House, and the International Monetary Fund (IMF). Such an economic pickup could very well occur. A selection of indicators does indeed point in that direction. At the same time, much in this economy still reflects the growth-retarding influences that have kept this recovery substandard to date. The mix puts probabilities on the side of continued growth to be sure, but perhaps not the acceleration popularly expected at the moment.<sup>1</sup></p> <p>To put this reality into more concrete terms, this week’s discussion will offer a perspective on various popular economic measures, identifying those that point to acceleration and those that tend to dampen enthusiasm.</p> <p><b>From the Top Down<br> </b>The biggest support for optimism grows out of two indicators in particular: a recent acceleration in employment growth and strong readings on gross domestic product during last year’s middle quarters. The Labor Department reports that payrolls have expanded on average by some 282,000 a month during the past six months, far better than earlier in the recovery and almost on a par with past cyclical recoveries.<sup>2</sup> Unemployment has dropped much faster than anyone expected, falling from 6.6% of the workforce in January 2014 to 5.7% this past January. The real economy overall, after a weather-induced annualized drop of 2.1% during the first quarter last year, sprang back at an annualized rate of 4.6% in the second quarter and a still stronger 5.0% rate during the third quarter. The slower 2.6% rate of growth preliminarily reported for the fourth quarter disappointed some, but the picture nonetheless has offered encouragement.<sup>3</sup></p> <p>As good as this overall picture looks—and it does indeed look good—it requires significant caveats. The second and third quarter surges reflected a catch-up from the artificially depressed first quarter, a point that the fourth quarter slowdown seems to confirm. The average annualized growth for the four quarters came to 2.5%, not much different than other years of this slow recovery. The surge also reflects non-repeatable events. The summer quarter, for instance, saw a 16.0% annualized jump in defense spending.<sup>4</sup> That certainly will not likely persist, even with continued operations against ISIS (Islamic State of Iraq and Syria). On the employment front, the relatively strong gains, especially in the strongest months at the close of 2014, reflected disproportionately high concentrations of hiring in temporary help services and restaurants, while finance, manufacturing, and retail have lagged. Not only does such a relative shift in emphasis explain why average weekly wages failed on average to track the expanding headcount but also it raises questions about the breadth of this recent advance. As if to underscore the chance of a pause or a return to slower growth, the Fed’s measure of industrial production, which had picked up nicely in spring and summer, slowed to a paltry rate of expansion in December 2014 and January 2015.<sup>5</sup> And the Institute of Supply Management (ISM) index of manufacturing activity signaled a slowdown.<sup>6</sup></p> <p><b>Business Spending and Housing<br> </b>Part of last year’s growth surge involved a pickup in new business spending on capital equipment and premises. After barely growing at all during first quarter 2014, business spending on new equipment surged at better than an 11.0% annualized rate on average during the second and third quarters. Spending on new structures also surged during this time, at an annualized rate of 8.7%. Things slowed during the year’s final quarter, with equipment spending actually dropping at a 1.9% rate and structures growth slowing to only an annualized 2.6% pace of advance. Apart from what happened in the fourth quarter, there is an additional reason to question the durability of those strong midyear trends. Such surges have occurred before in this recovery and petered out. The early quarters of 2012, for instance, enjoyed an almost 20% annualized jump in spending on new structures, which subsequently turned into a decline. Though continued strong rates of bank lending to business, at a 10.3% annualized pace during the last six months or so, suggests that the 2015 economy may avoid such a relapse, recent declines in new orders for capital goods, at almost a 7.0% annualized rate for the past three months, raises a warning flag.<sup>7</sup></p> <p>Meanwhile, the housing market continues its notably slow pace of recovery. Sales of new homes have picked up nicely, growing 10.3% during the last six months, but sales of existing homes have shown a less impressive 0.2% rate of advance during this time. New home construction, which had gotten ahead of sales earlier in 2013, has all but ceased growing. Permits for new construction have grown only 1.0% during the past 12 months.<sup>8</sup> Real estate prices have risen on balance, but in a sign that the picture may well remain subdued, December showed a slight 0.2% dip in home prices nationally.<sup>9</sup> One month’s data hardly signal a new adverse trend, but the data do argue against any expectation of an imminent pick up. None of this is surprising, given the increase in mortgage rates and the continued reluctance by financial institutions to lend for residential real estate.&nbsp; According to Fed data, bank lending in the area, after a tentative rise midyear 2014, has again begun to decline.<sup>10</sup></p> <p><b>The U.S. Consumer<br> </b>The consumer still is 70% of the U.S. economy, but has played only a muted role in the recent growth surge.&nbsp; Real spending on goods and services has increased an annualized 3.3% during the last three quarters, a pickup to be sure from annualized growth of barely more than 1.0% during first quarter 2014, but otherwise little different from the average growth rate of 2.8% in 2013. The recent pickup in jobs growth does offer a basis for accelerated consumer spending going forward, but perhaps because of the shift in the composition of new jobs, household incomes have shown little acceleration, growing at an annualized pace of 3.7% during the last six months, no faster whatsoever than the prior 12 months.<sup>11</sup> Of course, the slide in energy prices will allow those incomes to buy more, but energy prices would have to keep falling at the same pace to extend any such real spendable income surge, and that is not likely.</p> <p>Overarching these possibilities is the clear caution that seems to continue to dominate household spending decisions. Whenever spending growth exceeds income growth, households, unlike periods in the more distant past, curtail spending apparently in an effort to keep up savings rates. Thus, when spending shot ahead of income growth late in 2013 and rates of saving, accordingly, fell from 5.2% of aftertax incomes to 4.4%, households subsequently curtailed spending growth to reestablish a savings rate above 5.0% by the middle of 2014. Now that spending has again picked up faster than income growth, consumers may well do the same thing this year and slow the overall pace of economic advance.<sup>12</sup></p> <p>Retail sales statistics recently gave a tentative sign that just such a pattern may prevail. Despite about a 3.0% boost to real spendable income from the drop in energy prices, these nominal figures actually fell 1.6% this past December and January. To be sure, much of the drop reflected a decline in nominal spending at the gas pump. It took a lot fewer dollars to fill the tank, and dollar (as opposed to gallon) sales at gasoline stations fell 6.5% in December alone. But spending cutbacks were more widespread, with drops recorded in spending on autos, electronics, appliances, clothing, sporting goods, and building materials. It is only one month’s data, of course, but it does offer a sign of continued spending caution among households.<sup>13</sup></p> <p><b>Pulling the Many Threads Together <br> </b>This is hardly a depressing picture of the economy. On the contrary, it offers many indicators of relative strength, some of which even support popular expectations of a durable acceleration in the pace of growth. But it does also argue that much of what has kept this recovery slow for the past five years or so remains in place. Whatever the real <i>possibilities</i> of a pickup in the economy’s growth pace, the <i>probabilities</i> still point to a historically subdued rate of recovery. &nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 23 Feb 2015 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/student-debt-grading-the-threat.htmlStudent Debt: Grading the Threat<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Could widespread defaults on the $1.2 trillion in U.S. student debt cripple the economy? Not likely.&nbsp;</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Student debt problems have received considerable attention of late. The general media have focused on individual hardships and broken dreams. The financial media have focused on how much will likely go unpaid, often referring to the potential for loss as a “bomb.” By noting that student debt is second only to mortgage debt as a line item of household liabilities, much of this financial discussion sensationalizes the problem by drawing an implicit parallel to the mortgage-debt trouble that seemed to have Wall Street on the brink of collapse during the financial crisis of 2008–09. The reality, though far from happy, is less dangerous. Prospective student debt failures are neither large enough nor widespread enough to threaten anything near those troubles of six-plus years ago.</p> <p>According to the U.S. Treasury, student debt in the United States has indeed exploded, growing more than 300% during the past nine years. It presently stands at about $1.2 trillion. That is not a small figure. A careful parsing of consumer credit categories confirms that student debt is one of the highest costs among household liabilities. The reports indicate that default rates already approach 20%. Debt forgiveness rules promoted by the Obama administration (“forbearance,” in Washington’s way of speaking) will mean that an estimated additional $125 billion, or 10%, of this outstanding amount will also never get repaid, bringing the total expected loss to some $365 billion.<sup>1</sup></p> <p>Large as this number looks, it needs perspective to gauge potential financial impact. According to the Federal Reserve, all forms of non-mortgage credit in the household sector amounted to $9.4 trillion at the end of the third quarter (the most recent period for which data are available). Mortgage debt outstanding amounts to $13.4 trillion. Potential losses on student loans, then, would amount to 12.8% of all non-mortgage consumer credit, 9.0% of mortgage debt outstanding, and 8.5% of total household liabilities. That is a significant portion of the total, to be sure, but well short of something that could bring down financial markets. Put another way, this student debt figure amounts to a mere 1.5% of the estimated of $81.3 trillion in household net worth and only 1.2% of the estimated of $95.4 trillion in total household assets.<sup>2</sup>&nbsp; &nbsp;&nbsp;</p> <p>What makes this prospective loss still more manageable is that the federal government holds the bulk of it. In 2010, the federal government took over the student loan business, ceased offering subsidies to private lenders, and lodged the bulk of the outstanding debt with the Department of Education, where it remains. Today, only some 16–17% of outstanding student debt lies in private hands, and that portion is dwindling as these debts are repaid or written off. Any mass failure, then, will fall almost entirely on the taxpayer. And in this context, it matters not whether the debt is forgiven or in default: it amounts to a failure to repay either way. Though this is hardly good news for the taxpayer, it certainly fails to constitute a financial game-changer for the private sector. Nor is the amount overpowering in the context of the federal budget. The potential loss amounts to a mere 10.0% of the $3.7 trillion in total annual federal outlays estimated for 2014 and 14.0% of the $2.6 trillion total annual flow of spending for what Washington refers to as “human resources,” mostly entitlement programs.<sup>3</sup></p> <p>None of this discussion aims to label prospective student debt losses a welcome event. The individual distress involved is, of course, incalculable. Only slightly more yielding to quantification is the contribution the whole program has made to the inflation of college costs over past years and prospectively. But as the cause of another financial disaster, the matter can only be described as exaggerated.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Tue, 17 Feb 2015 09:12:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/currencies-what-to-watch-for-after-the-swiss-surprise.htmlCurrencies: What to Watch for after the Swiss Surprise<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Switzerland’s decision to scrap the franc-euro peg has grabbed the headlines, but the bigger story remains the continued dominance of the U.S. dollar.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Not too long ago, the Swiss National Bank (SNB) gave up the peg it had maintained for years between its franc and the euro. Market reaction was sudden. Within minutes of the announcement, the franc (or &quot;swissie&quot; as it is called in currency trading circles) rose almost 40% against the euro. Several articles in the financial media described these events as the start of a “currency war.” That is a catchy phrase. It is, however, misplaced. Recent and likely currency moves are much less a matter of targeted war-like policies than they are a reflection of economic and financial fundamentals that have and, for the time being at least, will continue to favor the swissie, and the U.S. dollar, over the euro and most other currencies. The only targeted currency policy was Switzerland’s efforts to keep its franc cheap, and the central bank’s action signals defeat, not the start of a war.&nbsp;</p> <p><b>The Swiss Story<br> </b>The story surrounding Switzerland’s action certainly is the most dramatic aspect of the currency picture. It began in 2011, when the eurozone’s ongoing fiscal-financial crisis prompted many to search for a safe haven from the euro. So between late 2009 and August 2011, money flooded into the Swiss franc, raising its value some 25% against the euro. Afraid that this appreciation would hurt Swiss exports and, so, the Swiss economy, the SNB decided to intervene actively in currency markets. By selling francs and buying euros to offset the pricing effects of other inflows, it held the franc rigidly at 1.20 to €1. Since Switzerland can, theoretically, create as many francs as it wishes, the presumption was that the bank could maintain such policies indefinitely.<sup>1</sup>&nbsp; &nbsp;</p> <p>It is now, however, evident that it could not. The decision to abandon the peg seems to have grown most immediately out of the European Central Bank’s (ECB) turn to quantitative easing. Concerned over the threat of deflation in the eurozone and an intensification of the region’s fiscal-financial crisis, the ECB has earmarked some €1.14 trillion to buy bonds directly on European financial markets. The SNB could see that even a small part of such a flood of euros could overwhelm its sales of francs. The bank also may have abandoned the peg because it feared the inflationary effects of so much money creation and from following the euro down on global currency markets, though the ongoing threat of deflation in the eurozone would make such a prospect distant indeed. As it is, the sharp appreciation in the franc will tend to intensify deflationary pressure in Switzerland.<sup>2</sup></p> <p>Still, the SNB has not capitulated entirely. To dissuade people from buying its currency, it has driven down short-term interest rates a half-percentage point deeper into negative territory than they already were. Now, a depositor in Swiss francs must <i>pay</i> up to 1.25% interest for the privilege of leaving money in the bank. From the currency’s action recently, these negative rates are hardly discouraging enough to stem the tide seeking a safe haven in Swiss banks and in the franc.<sup>3</sup></p> <p><b>The Bigger Currency Story &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;<br> </b>If the tale from Zurich offers the most drama, the larger currency story concerns the rise in the U.S. dollar. Once written off as having lost its supremacy, the dollar has gained markedly during the past six months or so, jumping almost 18% against the euro and almost 12% against the pound sterling. The overall dollar index shows about a 15% rise against a composite of world currencies during this time.<sup> 4</sup></p> <p>As much as Europe may welcome the euro’s slide as a spur to exports and, hence, economic prospects, these currency moves hardly resulted from targeted policies. Instead, they reflect the more attractive environment offered in the United States for all sorts of investment. U.S. bonds, for instance, offer much more attractive returns. Yields on 10-year U.S. Treasury bonds pay 1.5 percentage points more than German government 10-year yields. Meanwhile, U.S. government finances, though hardly robust by historical standards, still look much less precarious than European finances, where most of the periphery still cannot shoulder their debt obligations without help from the European Union (EU) and the ECB, and where Greece has again brought up the prospect of debt repudiation or rescheduling. Relative economic conditions in the United States are similarly attractive. Recent strong U.S. real gross domestic product (GDP) growth may overstate the economy’s underlying strength, but the United States is definitely growing and considerably more robustly than the eurozone, where the economy can claim only a technical distinction from recession. Though British interest rates, finances, and economics more closely resemble those in the United States than they do the eurozone, its economic ties to the Continent tend to pull sterling along with the euro.<sup> 5</sup></p> <p><b>Prospects<br> </b>Since there is little prospect that relative economic and financial conditions will turn about anytime soon, it appears that the U.S. dollar will continue to gain going forward. The latest round of trouble with Greece will only increase European uncertainties and exaggerate the differences favoring the United States. If the U.S. Federal Reserve follows through with its promise to raise interest rates, it will add further to the yield spreads favoring the dollar.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 9 Feb 2015 09:57:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/tax-reform-no-hope-for-change.htmlTax Reform: No Hope for Change<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The latest proposals from the White House all but ensure that no progress will be made on sorely needed tax-code fixes in 2015.&nbsp;</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>President Obama has made a bold series of tax and spending proposals. In a reprise of the positions he promoted earlier in his tenure, his latest plans would tax the wealthy and Wall Street in order to spend more on poorer people and the middle class. The Republican-dominated Congress is not likely to embrace such proposals for any number of reasons, but especially because they fly in the face of the sort of reforms that have gathered bipartisan support in the past. Indeed, this push from the White House would seem to all but ensure the failure of reform this year.</p> <p>The president is looking for a raft of benefits to middle-class and lower-income Americans. These include two years of free community college; a $175 billion tax cut for those in the middle class who pay taxes; legislation to guarantee a week of paid sick leave; larger earned income and child tax credits; and discounted mortgages. The government would pay the $235 billion estimated cost of those benefits, at least that part of the cost that would fall on the budget as opposed to employers and lenders, by raising taxes on the wealthy and on the investment community. The president would, for instance, increase the top tax rate on capital gains, from 23.8% today to 28%, and insist that heirs pay full capital gains when they inherit. He also would impose a fee on the assets of the top 100 financial firms in the country.<sup>1</sup></p> <p>Republicans, predictably, have criticized the initiative. Senator Orrin Hatch (R-UT), the new Senate’s top tax writer, complained that such measures would penalize “small business, savers, and investors.” He challenged the White House to stop pushing tax hikes and “start working with Congress to fix our broken tax code.”<sup>2</sup> But aside from the usual partisan posturing—from both sides—a more fundamental resistance might reflect the conflict between these new proposals the bases for tax reform entertained by both sides of the aisle and, ironically, also President Obama.</p> <p>On the personal tax code, the drift of thinking for many years would seek to reduce statutory rates and broaden the tax base by eliminating write-offs and other breaks. Such features dominated the bipartisan Bowles-Simpson plans commissioned by the president in 2010. Those proposals failed less because of this suggestion than because Republicans rejected their tendency to raise taxes overall and Democrats rejected to their imposition of spending restraint. Few objected to the rate cutting and base broadening. These proposals were so popular, in fact, that President Obama resuscitated them in his State of the Union address the following year. Republican-backed budgets proposed by Representative Paul Ryan (R-WI) followed this shared recommendation to reduce rates, broaden the base, and eliminate deductions. Then last year, Representative Dave Camp (R-MI) put forward proposals that also included these basic principles.<sup>3</sup>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>On the corporate code, the consensus for change has been even stronger. At every level of government, there is concern that the current tax code puts U.S.-based firms at a distinct competitive disadvantage in the global economy. The U.S. statutory rate of 35% is now the highest in the developed world. The difference is far from marginal, either. It averages between seven and 11 percentage points above those of other countries. All sides in the debate advocate a reduction in the statutory rate, with the elimination of tax breaks to make up some, all, or more than all of the difference in revenues, depending on how business-friendly the proposer is. The consensus is so strong to reduce the statutory rate that even President Obama and Rep. Camp are close on the matter. The president once proposed a 28% rate, while Rep. Camp sought a 25% rate.<sup>4</sup></p> <p>The other huge focus of reform is the treatment of overseas earnings. All in Washington seem to agree that the code’s insistence on taxing the worldwide earnings of U.S.-based firms, whenever they earn it, hurts the economy in two ways. Because payment is due on the repatriation, the rule creates a reluctance among U.S.-based firms to bring home their overseas earnings. These monies either accumulate abroad or are reinvested there, neither of which adds to American jobs nor increases the productive power of this economy. The second evil Washington’s tax code breeds is the increasingly popular practice called “inversion,” in which U.S.-based companies find ways to incorporate overseas where they can avoid the U.S. tax code for all but their U.S.-based earnings. Though so far the U.S. Treasury has sought only punitive responses to this corporate practice, even those in government can see it would improve matters to adopt the approach used universally by other developed countries to tax earnings only where they occur.<sup>5</sup>&nbsp; &nbsp; &nbsp;&nbsp;</p> <p>Much as such measures had gained support over the years, it was never likely that they would pass into law anytime soon. The partisanship within Congress and between Congress and the White House was too intense even before the president’s announcement, and is more so now. Even if the White House were open to the reforms it had previously endorsed, Republicans are reluctant to send the president legislation that could burnish his image, including legislation that suits its longer-term agenda. On the contrary, Republican would much rather send him bills that could embarrass him by forcing a veto. Nor is President Obama, in these last years of his administration, prepared to yield to Congress any more than he did during the past six years, which was precious little. Even if all parties were eager to make progress, tax reform has foundered on details so many times in the past that it could easily do so again in the future. If a new tax code was never likely, it is even less likely now.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 2 Feb 2015 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/is-cheap-oil-here-to-stay.htmlIs Cheap Oil Here to Stay?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The answer to that question depends on three key factors. Here’s a closer look at each.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The recent collapse of oil prices raises questions not only about why but also, more significantly, about whether the new low-price regime will last. The answer on oil, as always, requires a look at three component considerations: 1) actual global demand for oil and gas; 2) actual global supply; and 3) anxieties, usually based on geopolitics, about the first and second considerations. Each changes constantly, seldom as forecast, but it is the third, the least stable of the three, that causes the sudden, dramatic price moves, including this recent one. Moderating demand and increasing supplies have played a role in the recent drama, to be sure, but the price decline stems largely from an abatement in geopolitical anxieties, at least as they pertain to oil. Such concerns will, however, likely return, confirming the now well-established historical rule that no oil price regime lasts long.</p> <p><b>Moderated Demand<br> </b>The demand part of the picture is the most straightforward. The use of oil and gas, in developed economies especially, has grown at a much slower pace than overall levels of commercial activity (or than was forecast at intervals along the way). To some small extent, this shortfall has its roots in the growth of alternative energy sources—solar, wind, bio-mass, and the like. But for all the political emphasis and investment interest, this area accounts for the least of the change. According to the Energy Information Administration (EIA), alternatives amount to only 9.5% of all energy consumed in the United States. The figure is slightly higher in other developed economies and slightly lower in emerging economics. No doubt, the development of alternatives has kept oil and gas prices lower than they otherwise would have been, but not significantly, and certainly not with the kind of sudden impact that would account for recent dramatic price moves.<sup>1</sup>&nbsp; &nbsp; &nbsp;&nbsp;</p> <p>Hydrocarbon efficiencies and conservation have played a bigger role. Even in the 1980s and 1990s, when the global economy was increasing at a brisk pace, efficiencies held the growth of global oil demand to a mere 2.0% a year. In the early years of this century, global energy demand accelerated, largely because emerging economies became a larger part of the picture, and they have neither the infrastructure nor the wealth to apply the efficiencies that had become commonplace in the United States, Japan, and Europe. Still, the application of efficiencies continued. The United States today, for instance, produces a dollar of gross domestic product (GDP) with less than half the oil and gas it required 20–30 years ago.<sup>2</sup>&nbsp; &nbsp;</p> <p>While there can be no doubt that these efficiency gains in North America and elsewhere have made room for recent price declines, the poor performance of the world economy has had a more immediate demand effect. Japan, after a brief surge, has fallen into recession. Europe, under the weight of its fiscal-financial crisis, also has performed poorly. From a technical standpoint, the eurozone may have avoided the recession designation, but only technicalities have distinguished its economic performance from recession. China is growing at much slower pace than previously; while its economy expanded in real terms at 10–12% a year not too long ago, it now struggles to sustain a 6% real growth rate. Other emerging economies, including India, have slowed along similar lines. The U.S. economy has accelerated of late, but it is far from apparent that the new, more rapid growth pace is sustainable.<sup>3</sup></p> <p><b>Rising Supply<br> </b>More than slowed demand, a surge in global oil and gas supplies has made still more room for price declines. On this point, fracking is the star of the show. This technology has increased U.S. oil and gas production by more than half during the past five years. The surge has added fully 4.0% to global oil flows since 2009, a not insignificant difference. In addition, technological advances also have enabled Canada to access its tar sands deposits more cost effectively than in the past. That country has increased its overall production by more than a third during this time, adding another 1.2% to overall global output. Meanwhile, other new technologies have allowed producers to extract more oil and gas from existing conventional wells, enabling production in some places to pick up even in the absence of new finds.<sup>4</sup></p> <p>Beyond such tangible gains, prospective new sources also have factored into future supply assessments and, accordingly, into prices. Playing a large role in this part of the story is a major South Atlantic find made by Petrobras, the Brazilian oil company. This Lula field (as it is called) has the potential to add the equivalent of 6.5 billion barrels to known global oil and gas reserves, 13 billion barrels when combined with other new Brazilian fields. When fully developed, these sources should pump the equivalent of 4 million barrels of oil a day onto world markets, a 5.2% addition to current global flows. More recently, Australia has announced a shale find that its engineers estimate could increase known global reserves by 12%. The find is too new yet to yield estimates of production flows. Preliminary Exxon drilling in Russia’s arctic region had reported good prospects, though such activity has all but stopped because of the economic sanctions imposed on Russia. Potentials also have gained from the possibility that new but conventional extraction technologies will spread from North America to other parts of the world. Engineers estimate that Russia could increase production by 50% in this way, even in the absence of any new finds.<sup>5</sup></p> <p>Nor will the price declines reduce new North American flows anytime soon. The concern on this front stems from the perception that fracking and tar-sands extraction cost more than pumping from conventional wells. To be sure, if prices stay low for an extended time, pumping from these sources might well slow at the margins. But the fact is that tar sands and shale production are not as fragile as some suggest. Production costs can indeed sometimes run high. In some parts of a fracking field, it could cost $90 a barrel to lift oil. But other spots in the same field might cost only $20 to lift the oil. The crucial point is that developers contract for whole fields and for relatively long times. They will, as a consequence, continue to work them entirely for the foreseeable future. On average, as engineers suggest, tar sands and shale are largely profitable as long as oil remains above $50 a barrel—and prices would have to remain below that level for quite some time to have a significant impact on production flows.<sup>6</sup></p> <p><b>Anxieties Rise, Then Fall<br> </b>This basic supply-demand picture suggests about $60 a barrel as a fundamental market-clearing price, the level that equates fundamental supply and basic demand for oil and gas, all else equal. Such a condition has, however, prevailed for some time. Though it has made room for the sudden price drop of the last few months, it certainly cannot account for it. After all, these underlying supply-demand conditions prevailed last spring, when prices topped $100 a barrel. An explanation of that seemingly high anomaly and the more recent, sudden price drop requires a consideration of the third, more volatile pricing influence: the largely geopolitically based anxieties over supply and demand.</p> <p>These looked very different only six months ago, when oil prices were uncomfortably high. Russia then had just moved on the Crimea and eastern Ukraine. Many voiced concerns about what the Kremlin would do with oil shipments in response to Ukrainian resistance and Western economic sanctions. At the same time, the military advances by ISIS (Islamic State of Iraq and Syria) in Iraq and Syria were at flood stage. Concerns prevailed about what would happen in the then-considered likely event that ISIS gained control over much or all of Iraq’s oil. Initial ambiguities about Washington’s response to ISIS added to the general anxieties. At the same time, doubts about the course of negotiations over Iran’s nuclear program raised fears that tensions in the Persian Gulf would intensify. Though production gains in the United States, Canada, and elsewhere had given long-term hope that global supply would diversify away from these less-than-reliable regions, the unmistakable fact was, and remains, that the Persian Gulf and Russia account for almost 44% of global oil and gas output. That fact and this mélange of anxieties understandably prompted markets to bid a considerable risk premium into the price of oil, more than $40 a barrel above the $60 basic supply-demand benchmark at its peak.</p> <p>The intervening months, however, have seen much of this anxiety dissipate. Washington’s position on ISIS now is clearer than it was. These radical jihadists have suffered military reverses, quelling former fears about them gaining control of Iraq’s oil. What is more, it has become clear in the interim that ISIS happily sells what oil it has, raising confidence that the oil would find its way to market even if ISIS captured all of Iraq’s oil. Also, since prices peaked, Iran and the West cordially have agreed to differ on a nuclear deal, easing oil supply, if not nuclear proliferation, anxieties. And it has become increasingly apparent that Russia is too oil dependent to use it as a weapon, at least not as readily as many feared last spring. The risk premium, accordingly, has collapsed.</p> <p><b>Technical Influences and Likelihoods<br> </b>In this turmoil, technical factors have brought prices below the $60 benchmark associated with underlying supply and demand. A part of this is simply market momentum. When the prices of any asset make as sudden a move as oil has, traders tend to place buy and sell orders to position themselves for a continuation of the trend, and these alone can actually extend the trend, at least for a time. The low prices also have had an economically perverse effect on production. Instead of inducing production cuts (as the textbooks say they should), Iran and Russia in particular have done the reverse. It seems they are so dependent on oil sales for income that they have stepped up production to make up for lower prices. Their behavior stands to reason. Some 80% of Russia’s export revenue comes from oil, and the Kremlin depends on oil for 50% of its revenues. Figures on Iran are not substantively different. Very little current data exist on its actions, but oil traders provide considerable anecdotal support that these countries have increased sales. Meanwhile, Saudi Arabia, eager to increase the economic pressure on Iran especially, refuses to cut back on its production, as it might have done to stabilize prices in the past. The subsequent oil glut has increased inventories and created an acute, immediate additional downward price pressure.<sup>7</sup></p> <p>This kind of movement can carry on for a while, and might even push prices down further. Eventually, the market will clear its excesses and, in the absence of some shock, return prices to the $60 level that reflects underlying supply and demand. But this tidy calculation comes with a warning: It can happen only in the absence of shocks—and shocks, in fact, are likely. The recent dissipation in geopolitical anxieties is far from durable. Moreover, neither Russia nor the Persian Gulf is a predictable or reliable place. Russian president Vladimir Putin is a desperate man. Spillovers from Syria’s wars, gains by ISIS, renewed animosity between Iran and the West, and a long list of less definable, troubling events in the Middle East could easily raise anxieties again and force oil markets to re-impose a significant risk premium on prices. Today’s new low price is far from secure, much less a new normal, as some have suggested. Any number of headlines could drive prices back above $100 a barrel very quickly, even more rapidly than they have fallen. &nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 26 Jan 2015 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/setting-the-scene-for-2015-video.htmlVideo: Setting the Scene for 2015<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>What can investors expect from the Federal Reserve, the economy, and financial markets in 2015?</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <hr class="separator_grey"> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Wed, 21 Jan 2015 11:42:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/greece-perilous-odyssey.htmlGreece's Perilous Odyssey<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>At best, the black sheep of the eurozone family is a troubling source of uncertainty for policymakers and global markets—at worst, it’s a potential disaster.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Greeks will go to the polls on January 25. The outcome may lead to debt repudiation, other severe losses on assets, and the beginning of the end of the common currency. Even if Europe avoids the worst, the best anyone can hope for is heightened levels of uncertainty. It is not a pretty picture, and the blame for this mess is so widespread that it would take a book just to name the people and institutions responsible.</p> <p><b>The Story So Far<br> </b>Greece has for some time occupied the epicenter of Europe’s troubles. It was, after all, Athens that in 2009 triggered the Continent’s still-raging fiscal-financial crisis by admitting that it had misled about its financial health. Since then, Greece has received two European Union (EU) bailouts, totaling €240 billion, each conditioned on budget austerity and other economic reforms pressed by the EU, the European Central Bank (ECB), and the International Monetary Fund (IMF), the so-called troika. These reforms included measures to privatize government assets and steps to make the economy more dynamic and competitive through labor market and regulatory reforms. Greece has stuck to its promised budget austerity, though not without considerable angst and political close calls. Though troika monitors remain disappointed about other reform efforts, they had pretty much concluded that Athens had come far enough to emerge from bailout strictures. The country’s budget had balanced, they noted, and the economy was beginning to grow, albeit haltingly and from a deep recession.<sup>1</sup></p> <p>But crisis has found Greece again. This latest phase arises from a quirk in Greece’s political process. The largely ceremonial position of president is vacant. Prime Minister Antonis Samaras of the new Democracy party—center-right, pro-austerity, pro-cooperation with the troika—put forward Stavros Dimas for the post. Normally, this would have been a political non-event. Dimas ran unopposed. But the left-leaning, anti-austerity Syriza party, then leading in the polls, realized that a failure to get sufficient votes would trigger a general election. It worked with other opposition parties, including the far-right and actively anti-Europe Golden Dawn party, to vote down Dimas. Prime Minister Samaras had to call an election. Perhaps because Syriza’s lead in the polls had by then narrowed, he decided on an earlier rather than a later date. Now this quirk has raised the chance of an anti-austerity coalition coming into power in Athens and with it possibly an end to Greek cooperation with the troika, even an end to Greek membership in the common currency.<sup>2</sup>&nbsp; &nbsp;</p> <p><b>Uncertainties Inside Uncertainties<br> </b>It is entirely possible that Samaras will return to office. Syriza’s lead has already shrunk from double-digits not too long ago to only three percentage points, according to some polls, well within their statistical margin of error. But even with a Samaras victory, uncertainties would remain. No doubt chastened by his defeat in the presidential poll and by the need to have called an election, he could easily show a greater willingness to soften austerity policies and delay other reforms still longer. Europe in time might find him and his new coalition much less cooperative than he or it once were. And this is the most stable and predictable of the potential environments that could emerge from the Greek vote.<sup>3</sup>&nbsp; &nbsp;&nbsp;</p> <p>A Syriza victory, with its volatile leader, Alexis Tsipras, as prime minister, would open a myriad of possibilities, one more destabilizing than the other. Actually, there is no way to know what sort of agenda he might put in place. He has over the last couple of years talked out of so many sides of his mouth that Greeks going to the polls later this month really cannot know for what or against what they are voting. When Syriza first gained popularity, Tsipras expressed unrestrained hostility to Greece’s membership in the euro and argued that Athens should repudiate much of its debt. More recently, he has softened his resistance to euro membership, though he still espouses a determination to tear up the austerity conditions imposed by the troika. His current position on debt repudiation remains ambiguous. All this could, of course, change again after a newly elected Prime Minister Tsipras had time to meet with German chancellor Angela Merkel, ECB president Mario Draghi, and the IMF.<sup>4</sup>&nbsp; &nbsp; &nbsp;</p> <p>Against such a backdrop, the election promises anything from an ambiguous moderation in Greece’s playbook all the way to an exit from the common currency, what journalists in the early days of the current crisis referred to as “Grexit.” It is little wonder, then, that markets quickly upped the interest rate charged on Greek borrowing, from about 5.5% a few weeks ago to 9.5% right after the election was called.<sup>5</sup></p> <p><b>Possibilities—Some Helpful, Most Destructive &nbsp; &nbsp; &nbsp;&nbsp;<br> </b>For the Greeks, these more extreme possibilities could cut two ways. On the positive side, an exit from the euro and a return to a depreciated drachma would aid growth by making Greek goods and services cheaper to the rest of the world and, accordingly, more competitive. Debtors within Greece would benefit, too, having the ability to discharge their obligations in a currency much depreciated against the euro. On the negative side, such a prospect would destroy wealth. Greek savers would see the global purchasing power of their assets drop with a drachma depreciation, whatever initial conversion rate the government determined.</p> <p>For those holding the outstanding overhang of euro-denominated Greek debt, the matter could get even more complex. An outright repudiation would, of course, bring complete losses to lenders, most directly to banks elsewhere in Europe and indirectly to anyone who holds equity in or the debt obligations of these European banks. That would include many American financial institutions and investors. A rescheduling of the debt, perhaps by lengthening maturities or arbitrarily reducing the stated interest payments, would cause less drastic immediate losses, but losses nonetheless. These hardships would occur whether Greece stayed in the euro or exited, though it is an open question whether the rest of the eurozone would allow Greece to remain in the common currency after repudiating its debt or unilaterally rescheduling it.</p> <p>An exit from the euro would add still more complications. Greece could return to the drachma and still honor its euro debt, though the government would face a great burden in doing so, since it would take a lot of depreciated drachmas to meet those euro obligations. It is possible, if not especially likely, that Greece could exit the euro and insist on rescheduling the outstanding debt in drachma, imposing a huge loss on lenders, though not as much as with outright repudiation. No doubt such a move would create international lawsuits and take years to resolve. In any of these possibilities, Greece would find it much more difficult and expensive to borrow on international financial markets, especially with a return to the drachma, for then lenders would insist on a special premium to protect them against possible future currency losses, certainly a greater premium than they would demand with euro-denominated debt.</p> <p>In one respect, Greece can matter only little to Europe or the eurozone. It is too small to threaten the basics of either European economics or finance. Its gross domestic product (GDP), at the equivalent of $243 billion in 2013, is not even a fifth the size of Spain’s, only slightly more than one-tenth the size of Italy’s, and barely more than one-twentieth the size of Germany’s economy. Greece’s outstanding debts amount to only 1.0% of all European bank assets. It would not be a happy day if those Greek assets were to become worthless, but it would hardly become the stuff of a financial catastrophe. The financial system would remain no less sound than it is presently, and Europe’s economy might even look marginally stronger with Greece gone.<sup>6</sup></p> <p>But in another respect, a Greek exit or debt rescheduling could have serious ramifications by pointing up alternatives for other beleaguered members of Europe’s periphery. Any debt repudiation, with or without an exit from the common currency, could tempt other heavily indebted nations to fellow suit, entirely or partially, as a way to ease their immediate burdens. Even if Greece were to take no more drastic a step than to renegotiate the austerity strictures of its bailout, others might ask for similar concessions. Granting them would undermine EU efforts at control and delay the continent’s return to overall financial health. It also could erode critical German support by putting the lie to the promises Berlin gave to convince German taxpayers to bankroll the bailout. And if Athens were to withdraw from the euro, questions about the ultimate viability of the common currency would grow, complicating any efforts at financial healing and making it that much more difficult to hold this experiment together.&nbsp;</p> <p><b>Likelihoods &nbsp; &nbsp;<br> </b>To assess which of these directions is likely, however, is clearly impossible at this juncture. What is clear, though, is that for the foreseeable future, Europe will labor under more uncertainty than previously, and with three prospects: 1) Greece will continue for some time to pay considerably higher borrowing rates than it did just a few weeks ago, which could in time undermine some of the budget gains the country has made even if in the interim Athens holds to its austerity promises; 2) to the extent that Greek intransigence grows, fears over a general turn in this direction elsewhere in Europe’s periphery will tend to raise borrowing costs there, even if these governments make no overt statements or actions to step away from austerity; and 3) prospects for the eurozone will remain ever more doubtful than in the past, weighing further on the euro’s value and making it still more difficult than it already is for the zone’s leadership, particularly at the ECB, to plan or otherwise conduct its business effectively. &nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Tue, 20 Jan 2015 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/central-banks-power-shortage.htmlCentral Banks' Power Shortage<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The Federal Reserve and the European Central Bank face significant limitations on what they can do to solve economic problems.</i><b></b></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Pity the central bankers. The media from time to time may characterize them as the all-powerful shapers of economic destiny, but in reality they have only the bluntest of policy tools at their disposal, can seldom accomplish much on their own, and, when they do act on their own, they often find themselves beset by unintended consequences. All these limitations and the attendant risks have become increasingly apparent as the U.S. Federal Reserve and the European Central Bank (ECB) continue to deal almost single-handedly with their respective financial-economic crises.</p> <p><b>Facing Many Constraints<br> </b>The root of the bankers’ problem is straightforward enough: they cannot deal directly with the underlying causes of the crises they are called on to manage. The American crisis, for instance, started with a real estate collapse and evolved into severe federal budget problems in an extremely sluggish recovery. The Fed has done what it could to ease the attendant strains. By increasing flows of liquidity, it has made credit in general more available, decreased its cost, and, by so reducing the threat of defaults, prevented panic from spreading to otherwise healthy sectors. But for all the relief provided in this way, none of the Fed’s actions have diminished the debt overhang or promised more effective budget control. Only the government and private players can do that. Europe, similarly, has faced a debt overhang from misguided budget policies. The ECB also has used a flood of liquidity to ease immediate strains and stop a contagion in markets. But it, too, has had to wait on others—in this case, the governments of Europe’s so-called periphery—to remedy the underlying problems. The most, then, the central banks have done, or could do, is buy time for others to address the causes of crisis. &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>Central bankers face still other constraints. They know well that they cannot buy time indefinitely. The longer they maintain extraordinary flows of liquidity, the more they increase the risk of other problems. One is financial bubbles. Some suggest that a bubble has already formed in U.S. Treasury and German government debt. Were these or any other bubble to burst, Europe or America would find itself involved in a new financial-economic crisis. The extra liquidity flows also impose longer-term risks of an increase in inflationary pressure, with all its attendant evils. Yet because central banks cannot simply withdraw the liquidity support without risking financial upheaval and recession, at least not until those who can implement fundamental solutions do so, they face what only can be described as a Hobson’s choice (that is, a choice, or not, of only one option), whereby every day they must deal with pressures both to increase and decrease liquidity in markets. &nbsp;&nbsp;</p> <p><b>Two Strategies<br> </b>Policymakers at the Fed seem at the moment to have decided to split the difference between the two extremes. As sufficiently worried as they are about the longer-term dangers of excess liquidity, Fed policymakers have ended their former practice of buying government and mortgage debt outright—a tactic referred to as quantitative easing. They plan to curtail amounts of liquidity further sometime in 2015 by raising interest rates.<sup>1</sup>&nbsp;But because they still have no fundamental remedy for the underlying problems, monetary policymakers remain especially concerned about moving too far or too fast. Fed chairperson Janet Yellen has acknowledged this precarious balancing act by making clear the Fed’s willingness to postpone or soften any part of its planned policy change. Such a halfway approach hardly gives confidence on either side, but, in the circumstance, this is the best the Fed can offer.</p> <p>The ECB is in an even tighter spot. Like the Fed, it worries about financial bubbles and, in the fullness of time, even inflation. But the greater severity of its debt crisis makes it harder still to think about ending extraordinary liquidity flows. The decision by Europe’s periphery to adopt only half the suggested remedies has intensified the pressure on the bank.<sup>2</sup>&nbsp;Germany, the ECB, and the European Union (EU) have stressed correctives that include both budget control—in order to maintain credibility in capital markets and avoid a relapse into crisis—and steps to make these economies more flexible and growth oriented—in order to produce sufficient new wealth to overcome the otherwise ill effects of austerity and ultimately discharge the debt overhang decisively. Because these governments have opted only for the budget control and not the economic reform, strong recessionary pressures have developed and even the threat of near-term deflation, both of which have compounded the financial crisis and postponed indefinitely the time when the ECB can consider efforts to forestall any of the ill effects of strong liquidity flows.&nbsp;</p> <p><b>Future Pressure &nbsp; &nbsp; &nbsp; &nbsp;<br> </b>It is a frightening and increasingly unstable picture. One Wall Street veteran has characterized it and the central bankers in an especially cruel way: “They may not know what they are doing,” he has said, “but they are afraid to stop.”<sup>3</sup> There is an element of truth here, but it nonetheless overstates. The central bankers do know what they are doing. They are just stuck because others—those with the power to fix matters—either cannot or will not step up to their obligations. The Fed may succeed with its cautious unwinding, even if Washington fails to remedy its budget and economic policy problems. The ECB, however, can entertain no such hope. Circumstances compel it to maintain extraordinary flows of liquidity, whatever its legitimate fears about the dangers involved.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 12 Jan 2015 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-municipal-finances-on-the-mend.htmlU.S. Municipal Finances On the Mend<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>While much work still needs to be done, the financial condition of state and local governments in the United States continues to improve. What does this mean for investors?</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>State and local governments in the United States continue to improve their finances. They are, of course, a long way from financial health, though some are further along that road than others. It will take years, perhaps decades, maybe longer before investors can declare this sector financially sound in any conventional sense of that phrase. But there is improvement nonetheless, despite some inflammatory and misleading headlines, and that should relieve many of the fears people have about investing in the sector.&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;</p> <p>These governments have improved matters in the same basic way that anyone would dig out of a financial hole. Though their revenues have grown only slowly, largely because of the substandard pace of the economy’s recovery, they have nonetheless kept outlays growth to an even slower pace. Thus, between 2010 and 2013, total receipts in the state and local sector of the U.S. economy grew at only a 2.1% annual rate, but these governments kept spending growth to an even slower 1.6% average annual rate. (All government finance data presented herein are from the U.S. Federal Reserve.) Mostly they accomplished this through severe restraint on discretionary spending, which only grew at a 1.4% annual pace. This more than offset the 2.6% growth pace of outlays for social benefits.</p> <p>The figures are larger for the most recent four quarters, but these governments have nonetheless stuck to the same program. An 11.1% surge in transfers from the federal government pushed up receipts 4.4% during this recent time. To be sure, these governments succumbed to the temptation to spend much of this extraordinary flow. They pushed up social benefits payments 10.6%. But because they only increased their discretionary outlays 2.4% during this time, overall outlays still grew at a slower pace than receipts.</p> <p>These efforts have allowed state and local governments to improve their net savings flows impressively. After accounting for depreciation, these, according to Federal Reserve statistics, averaged an annualized $91.4 billion during the third quarter this year, the most recent period for which data are available. Though this figure is a still only a modest 4.1% of total revenue, it is nonetheless a 75.1% improvement over the $52.2 billion in net savings averaged in 2010. What is perhaps even more encouraging is that the current rate of net savings from revenues is almost 60% above the 2010 rate.</p> <p>Such improvements, though modest by many standards, have enabled state and local governments to improve their balance sheets. Between 2010, for instance, and the third quarter this year, the most recent period for which data are available, they have increased their holdings of financial assets 4.2% and cut their total liabilities of every kind almost a full percent. They have also cut back on their reliance on debt. Between 2010 and this year’s summer quarter, the outstanding volume of municipal debt of any kind had dropped almost 4.5% or by just under $132 billion. The outstanding amount of long-term municipal debt had fallen 3.6% or $105 billion, while the amount of short-term debt used by these governments has dropped by more than half. Short-term debt today constitutes only 1.3% of all municipal debt outstanding, down from 2.1% in 2010.</p> <p>All this improvement, though welcome, is modest compared to the needs of state and local financing that became so apparent in 2009. Still, the picture of improvement should relieve investors of their worst fears concerning this area, if not in every particular, then in general. Meanwhile, the decreasing volume of debt, both the new flows and outstanding amounts, should further enhance the attractiveness of such holdings, especially since U.S. municipal yields, at just about every maturity and credit rating, still stand near historic highs next to U.S. Treasury and corporate debt.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 5 Jan 2015 09:30:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-consumers-spend-more-bah-humbug.htmlU.S. Consumers: Spend More? Bah, Humbug<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>Despite an improving labor market and lower oil prices, consumer outlays should continue to expand at a slow pace. Here’s why.</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Sometimes, something says something good about the economy’s growth prospects. Two quarters of relatively strong advances in real gross domestic product (GDP) and more recently falling oil prices and strong November jobs numbers offer such signs. They are welcome. Still, reason remains to curb levels of enthusiasm. The employment figures have given plenty of false signals in the past, and many of the same forces dampening growth so far in this recovery remain in place. Especially for the consumer, fully 70% of the economy, seems unwilling to act as aggressively as in the past and so is less likely to propel the overall pace of growth.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;</p> <p>The most recent good news is a pickup in the pace of hiring. Recent reports for November indicate 321,000 new jobs created during the month and upward revisions in previous months’ estimates.<sup>1</sup> While this is indeed news, it is important to keep in mind that individual months in the past have shown surges that have then petered out. In January 2012, for instance, payrolls rose by 360,000 only to slow to a disappointing 96,000 by April. What is more important, and as a consequence more encouraging, is the general improvement this year over 2013. Every month this year, except weather–depressed January, has reported payroll increases over 200,000. Only five months showed such gains in 2013 and a still smaller portion in 2012. The 2.0% growth in payrolls so far this year compares to only 1.7% in 2013 and a 1.6% yearly rate averaged between 2010 and 2012. The jobs picture still has many troubling weak spots, but the trend is encouraging.<b><i></i></b></p> <p>Presumably, the additional jobs will increase household incomes, encourage more consumer spending, and so accelerate the pace of overall economic growth. If the percentage point increase in employment were to translate directly into income, it would raise wages and salaries growth from the 4.3% pace averaged during the last twelve months toward 5.1%. Since wages and salaries constitute about half of all income in this economy, overall income flows would accordingly rise from the 3.9% recorded during the past twelve months toward 4.6%. With taxes still rising as a percent of gross income, spendable income growth would then register about a 4.5% nominal annual rate of increase. And if households were then to spend the increase, the overall pace of nominal consumer spending would accelerate from the 3.9% rate averaged during the past twelve months to about 4.5%, or about 3.0% in real terms. That would accelerate the economy’s overall 2.3% rate of real growth averaged during the past four quarters up to about 2.8%, an improvement but still short of the economy’s long-term average growth rate of 3.2% and its average growth rate of closer to 3.8%.<sup>2</sup>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;</p> <p>But these are big “ifs.” For one, it is not apparent that the recent accelerated pace of employment growth can persist. False starts in the past issue a warning, and all the factors that so far have kept back hiring remain in place. Managements certainly continue to carry scars from the great recession that temper their impulse to expand, what the great economist John Maynard Keynes referred to as their “animal spirits.” Continued uncertainty about costs and the ultimate requirements of the Affordable Care Act and even the Dodd-Frank financial reform legislation will continue to reinforce such hesitations. Meanwhile, households, too, have shown an atypical caution about spending. Compared to past recoveries and the past in general, they have spent less aggressively in this recovery and saved more. On average, households have saved well over 5.0% of their after-tax income in this cycle, low by international standards but high by past American standards. What is more impressive, and indicative of how they will likely behave going forward, is how households, whenever their savings rates have fallen below trend, have quickly corrected by slowing their rate of spending.&nbsp;&nbsp;&nbsp;</p> <p>On balance, then, the consumer should hold to a comparatively slow rate of expansion even if the improved hiring trend is durable. It should come in below a 3.0% yearly rate. The current quarter may prove an exception, however. The recent precipitous drop in oil and gasoline prices will leave the consumer at least temporarily better off. Because energy absorbs almost 10% of the average household budget, the recent drop in price amounts to about a 2.5%&nbsp; jump in real spendable income, a good portion of which consumers will no doubt use to improve the holidays, making the fourth-quarter GDP look better than the fundamentals and longer-term prospects described above. But unless the oil price declines go deeper still (not especially likely), much less if oil prices bounce back up (entirely possible given the volatility in the Middle East), the pace of consumption growth and overall growth in the new year should continue at a still substandard rate.</p> <p><span class="separator">&nbsp;</span></p> <p><span class="legal"><sup>1</sup> Employment data from the U.S. Department of Labor<br> <sup>2</sup> Data from the U.S. Department of Commerce</span></p> <p>&nbsp;</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 29 Dec 2014 09:23:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/setting-the-scene-for-2015.htmlSetting the Scene for 2015<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>What can investors expect from the Federal Reserve, the economy, and financial markets in the new year?</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Market prospects in the coming year would seem to hinge on four major considerations. One is geopolitics, inherently unpredictable but potentially disruptive, especially these days. Another is the Federal Reserve’s plan to raise interest rates along a gentle path beginning sometime in the middle of the year. Third is the perennial question of where value lies within and between markets. Fourth is the state of the U.S. economy. The balance of probabilities on these four fronts favors two broad investment positions. In fixed-income investing, it would seem best to lean away from longer-duration quality bonds in favor of shorter-duration instruments and more credit-sensitive issues, including municipals. Though equity valuations are not what they were, they remain attractive enough to sustain the rally, especially since the economy and, consequently, earnings are likely to continue growing.</p> <p><b>A Word on Geopolitics<br> </b>No investor can contemplate possibilities without acknowledging the risk of geopolitical disruptions. An advance by ISIS (Islamic State of Iraq and Syria) or increased Iranian tensions could easily reverse the oil price relief that most global economies presently enjoy. Korean tensions or a more assertive level of Chinese activity in the East or South China seas could, at the very least, shift Washington’s budget priorities and more seriously threaten a shooting war, either of which would change investment calculations. Another turn in what has been called the Arab Spring could impose vaguer risks on the investment horizon and certainly change relative pricing. More weakening in Japan’s or Europe’s economy or dangerous deflationary effects also could alter investment calculations, pricing, and impose the need for portfolio adjustments. And this is only a partial list.</p> <p>But investors cannot configure portfolios to guard against, much less take advantage of, all these factors. It is not even possible to assign probabilities to such risks. In this respect, the array of such possibilities, though easy to itemize and identify, are much like the almost equal possibility of disruption from entirely unforeseen events. Rather than twist portfolios within what is tantamount to a random range of possibilities, it would be better to remain alert and nimble to such concerns, while otherwise structure investments around the economic and financial fundamentals, where, however obscure the future, there is a greater ability to discern likelihoods and set probabilities.</p> <p><b>Fixed Income &nbsp;&nbsp;<br> </b>For the moment, extremely low interest rates and yields in Europe and Japan, along with the economic woes besetting these regions, are driving money into U.S. fixed-income markets. These flows have kept Treasury and agency yields low as well as yields on high-quality corporate bonds.<sup>1</sup> But unless the eurozone and Japan truly fall apart, these influences can only last so long. Looking out beyond the next few weeks and months, then, the big bond consideration is the Fed’s clear desire to raise interest rates—“normalize” them, in the words of Fed chairperson Janet Yellen.<sup>2</sup></p> <p>On one side, it would be easy to exaggerate the danger here. References frequently made to the financial havoc created by Fed rate hikes in 1994 are misplaced. Chairperson Yellen as well as various regional Fed presidents have made clear their intention to exercise caution and move rates up, once they start, along a very gradual path. Yellen has further stressed the Fed’s ongoing sensitivity to statistics—meaning that it has no desire to raise rates far enough or fast enough to jeopardize economic growth. Yellen also has indicated that the Fed will not even begin to raise rates until it is confident that the economic recovery can withstand such a move.<sup>3</sup>&nbsp;Taking the Fed at its word, then, investors have little or no reason to worry over an economic stall, much less a decline, over this time period. (More on the economy below.) &nbsp;&nbsp;</p> <p>Still, if the Fed will surely go gently, its direction is clear. Investors can then be reasonably sure that bond yields will follow short-term rates upward or even anticipate the Fed’s moves as the start date for such increases becomes more certain. This prospect threatens returns in intermediate- and longer-term fixed-income instruments, especially those in Treasuries, agencies, and high-grade corporate paper, which respond to little else but general rate movements. In longer maturities, there is a good prospect of capital losses here sometime during the course of 2015. Since in the interim such assets pay a relatively paltry yield, this class of investments hardly offers much appeal. There are, however, fixed-income avenues that offer better opportunities or at the very least better defense.&nbsp;</p> <p>One clear defense against rising yields is to shorten the average duration of a portfolio’s fixed-income holdings. Though a rise in short-term interest rates would hit the capital values of intermediate-term and even shorter-term instruments, longer-term instruments are much more vulnerable. Even if the basis-point change in longer yields is considerably lower than on shorter- and intermediate-term instruments, the price leverage on the longer-term instruments is disproportionally greater. &nbsp; &nbsp;</p> <p>A second option would be to reach for more credit-sensitive instruments, where yield spreads offer protection of a sort. Though corporate junk bonds, for instance, carry yield spreads over Treasuries that are slightly lower than they have averaged for the last 40 years or so, these spreads remain wide, considering how default rates among corporate bonds have declined. It seems likely, then, that shrinking spreads on credit-sensitive instruments will absorb much of the prospective rate increases, protecting those who hold such instruments from the capital losses more likely in higher-quality instruments. Adding to their appeal, credit-sensitive instruments also pay holders a much more generous yield. An especially cautious investor might combine these two defenses into a third that shortens duration with more credit-sensitive instruments.<sup>4</sup></p> <p>A fourth option is municipal bonds. These, of course, are suitable only for tax-paying investors; but even at low marginal tax rates, municipal bonds provide attractive aftertax yields, much more attractive than they have been historically. Indeed, even relatively high-grade municipals pay higher aftertax yields than do corporate junk bonds. The root of such value is clear in the headlines about Detroit and Puerto Rico. But despite such notoriety, default rates among municipal bonds are very low, less than one-tenth of one percent in fact, and, more important, lower than on corporate bonds. On this basis, such bonds hold out the promise of absorbing in shrinking spreads much of the yield increases likely in Treasuries, agencies, and high-grade corporate paper, while at the same time paying investors comparatively attractive aftertax yields.<sup>5</sup>&nbsp; &nbsp; &nbsp;&nbsp;</p> <p><b>Equities and Economics &nbsp;&nbsp;<br> </b>In contrast to the complexities facing fixed-income investing, the prospect for a continuation of the equity rally has two things going for it: 1) value remains, even if it is not as overpowering as it was one, two or three years ago, and 2) the economic recovery, though likely to remain substandard next to history, will continue to promote some earnings growth, if not the striking gains exhibited earlier in the recovery.</p> <p>The market still offers value. The S&amp;P 500<sup>®</sup> Index,<sup>6</sup> for instance, offers a price-to-earnings multiple about where it has averaged for the last 35–40 years. On that basis, even a cautious view of the market would label it fairly valued, able, at the very least, then, to follow earnings. With nominal domestic revenues likely to expand about 4.0% in the coming year, gross earnings, with modest help from continued operating leverage, look likely to come in at close to 5.0%. Net share buybacks should put the per-share earnings gain at 6.0%. Without any expansion in multiples, stock prices could track this earnings growth and so put in a similar 6.0% gain. Since on top of such price gains stocks also offer a dividend yield of about 2.0%, a conservative expectation would put equity gains at about 8.0%—not the impressive figures of past years, to be sure, but respectable nonetheless.<sup>7</sup></p> <p>Prospects improve when viewing equity valuations relative to bonds or cash. On these bases, stocks offer better than fair value; in fact, they look cheap. There are, of course, a host of metrics for such comparisons. There is no space here to go through all of them, but since they all agree, there is no need to do so either. The most straightforward comparison of dividend yields with rates on cash can illustrate. As already indicated, the S&amp;P 500 pays a dividend yield of about 2.0%. Deposit rates vary, but generally pay about 25 basis points (bps), some 175 bps <i>less </i>than stocks. Historically, cash pays 200 bps on average <i>more</i> than dividend yields, not less, as is the case now. Such measures, and others of greater complexity and greater obscurity, speak not just to still attractive equity valuations but also that such favorable value comparisons could easily survive both further stock price gains and the moderate rate increases contemplated by the Fed.<sup>8</sup></p> <p>Meanwhile, prospects for continued, albeit moderate economic growth should spare equities the threat of recession and declining earnings, thus allowing them to realize their value. To be sure, all the forces that have kept the recovery subpar to date remain in place. Both company managements and lenders remain inordinately cautious, as a legacy of the pain of the Great Recession and in response to the continuing ambiguities of Washington’s active regulatory policies as well as the remaining uncertainties left by ambitious past legislation. But neither is there anything pre-recessionary about this economy, and it would be an economic downturn, not slow growth, that would prevent markets from realizing their value.</p> <p>Three reference points at least direct clearly away from recession and toward continuing growth<sup>9</sup>:</p> <p>1) The housing market is improving, not rapidly, but durably. The statistics record growth in sales, construction, and real estate prices. These are a long way from where they were before the housing bust of the Great Recession, and at their slow pace of advance, they will take a long time indeed to recover those highs. But in this context, the important thing is that the economy has never fallen into recession when real estate is improving, even if only slowly.</p> <p>2) Corporate balance sheets are in great shape. There is, in fact, not a hint of excess. Nonfinancial corporations, according to Fed statistics, have checking account deposits equal to as much as 10% of their total liabilities, not even counting time deposits, money market accounts, and other cash equivalents. To be sure, managements are proceeding cautiously. They are neither hiring nor spending on expanded capacity nearly as aggressively as they once did. But recessions do not result from caution. They occur when companies are squeezed and have no option but to cut back, and with so much cash on its balance sheets, corporate America is far from squeezed.</p> <p>3) Households, too, have improved their finances. The burden of debt service on aftertax income has fallen in the past two to three years, from about 20% to just over 15%. Though incomes have grown more slowly than they might because hiring has proceeded at a slower pace than in past recoveries, overtime and upgrading have allowed greater gross income growth for those who have jobs. So, although payrolls have expanded at an annual rate of only 1.5–2.0% during the past couple of years, aftertax incomes from wages and salaries have expanded at closer to 4.5–5.0%—not enough to create a consumption boom, but certainly enough to sustain an economic recovery.</p> <p><b>Recap<br> </b>If the great geopolitical issues of the day impose more uncertainty than usual, two factors make the economic and financial fundamentals look remarkably clear: 1) the Fed intends to raise interest rates, slowly and cautiously, but upward nonetheless, and 2) equity markets still show value, and continued economic growth, even if slow, should enable them to realize it. The first of these two considerations makes longer-term, quality fixed-income instruments less than attractive, though credit spreads remain attractive enough for investors to find good protection with more credit-sensitive instruments, especially municipal bonds, particularly in shorter durations. The latter consideration indicates that the equity rally should carry on, although likely not at the impressive pace it has put in to date.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="legal"><sup>1</sup>&nbsp;Department of the Treasury.<br> <sup>2</sup>&nbsp;Federal Reserve.<br> <sup>3&nbsp;</sup>Ibid<br> <sup>4&nbsp;</sup>Data from Bloomberg.<br> <sup>5&nbsp;</sup>Ibid.<br> <sup>6&nbsp;</sup>The S&amp;P 500<sup>®</sup>&nbsp;Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries. An index is unmanaged, does not reflect the deduction of fees or expenses, and is not available for direct investment.<br> <sup>7&nbsp;</sup>Data from Standard &amp; Poor’s.<br> <sup>8&nbsp;</sup>Ibid.<br> <sup>9&nbsp;</sup>Data for point 1 come from the Department of Commerce and the National Association of Realtors; data for point 2 come from the Federal Reserve; and data for point 3 come from the Federal Reserve, the Department of Labor, and the Department of Commerce.</span></p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 22 Dec 2014 08:51:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-housing-still-room-to-grow.htmlU.S. Housing: Still Room to Grow?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Federal Reserve rate hikes or not, the fundamentals suggest the sector’s slow, steady recovery likely will continue.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The prospect of Federal Reserve rate hikes has brought out much concern about the durability of the housing recovery. That is understandable. Any increase in rates threatens to raise the cost of supporting a mortgage, and the housing recovery, though far from following a powerful trend, has added to the admittedly tepid general recovery. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;</p> <p>Still, it would be easy to exaggerate the impact of planned Fed actions. To begin with, policymakers intend to raise rates only slowly and cautiously. They will remain sensitive to the economy’s reaction, including housing. For another, housing remains historically affordable, so that any rate hikes, particularly the modest ones that this Fed contemplates, are not likely to shut down buying as dramatically as some seem to fear. Finally, other factors, most especially the willingness of banks to extend credit for real estate, likely will improve during the time before the Fed makes its rate moves. The housing recovery will, then, likely proceed, albeit slowly as it has to date, even after the Fed begins its promised rate increases.</p> <p><b>The Recovery So Far<br> </b>From its lows of 2009, the housing market has made an uneven, but on balance substantive recovery. It remains substandard, however, in two crucial respects, relative to past cyclical recoveries and especially compared to the precipitous drop that preceded it. Sales of new houses fell some 81% during the Great Recession, from a high of about 1.4 million units a year in 2005 to about 400,000 in spring 2009, when the general economic recovery began. The recessionary pressure in the sector was so powerful that even as the general recovery proceeded, sales of new homes actually fell an additional 32.5%, to lows of 270,000 in spring 2011. Only then, fully two years into the general economic recovery, did new homes begin their upturn. This growth proceeded in fits and starts, averaging about 17% a year, which is impressive in a vacuum, perhaps, but leaves housing nowhere near to recovering the ground it had lost. As of September this year (the most recent period for which data are available), sales of new homes stood at a yearly rate of 467,000, fully 66% below their former highs from before the bust of the Great Recession.<sup>1</sup>&nbsp; &nbsp; &nbsp;</p> <p>New construction has followed a similar pattern. Housing starts peaked at an annual rate of 2.2 million units in fall 2005 and fell almost 78% during the Great Recession, to a low of 478,000, at an annual pace. They began a modest recovery in spring 2009 along with the overall economic recovery. But two years later, in spring 2011, when new home sales at last began to grow again, starts were only some 25% above their recession lows, a minuscule recovery given the steepness of the previous slide. The pace of recovery has picked up since, but in October 2014 (the most recent period for which data are available), starts averaged barely above 1.0 million a year, still almost 55% below their pre-recession highs.<sup>2</sup>&nbsp;&nbsp;</p> <p>Though hardly impressive in light of the previous downturn, these gains have contributed to the economy’s overall growth path, though most of that help has emerged only recently. Early in the recovery, the housing growth was so slight that, according to the Bureau of Economic analysis at the Commerce Department, residential construction actually detracted from the pace of overall growth in 2010. Housing added a minuscule 0.02 percentage points a year to overall growth in the real gross domestic product (GDP) in 2011 and 2012. In 2013 and 2014 so far, it has added a still small 0.17 percentage points a year to overall growth.<sup>3</sup> Its contribution to employment gains has been only slightly better. Construction jobs accounted for only some 5.9% of total jobs created in the recovery since 2009, though during the past couple of years such jobs have averaged a modestly higher 8.5% of the total.<sup>4</sup></p> <p><b>Reasons<br> </b>The biggest help for housing so far has come from increased levels of affordability. The severe drop in real estate prices during the Great Recession and the even more precipitous drop in mortgage rates have lessened the burden of the average mortgage on the average family’s income. Here, the figures are striking. Between 2008 and 2011, when new home purchases finally turned up again, the median price of a single-family house in this country had fallen by more than 20%, according to the National Association of Realtors (NAR). The rate on the average fixed mortgage had dropped more than 200 basis points (bps), or by more than 30%, according to the Fed. The rate on a variable mortgage fell even more dramatically. Though the median family income actually fell during this time, these price and rate declines improved those families’ ability to support a mortgage. Affordability (to use the NAR’s term) improved more than 70%.</p> <p>Two impediments held back the pace of recovery, however. One was the loss of confidence in the household sector. Concerns and insecurities engendered by the pain of the Great Recession dissuaded many from stretching—as they might have previously—for the house of their dreams. The second impediment to recovery was the decline in confidence among lenders. The huge mistakes of the housing boom and the subsequent losses during the recession prompted banks and other mortgage lenders to tighten credit standards in general and especially where residential real estate was concerned. Even as the overall recovery progressed, bank lending for real estate fell 5.5% in 2010, 3.8% in 2011, 1.1% in 2012, and 1.0% in 2013. It only just began to turn up this year, and then only at an average annual rate of less than 3.0%. As affordable as housing had become, borrowers simply could not get the necessary credit.&nbsp; Anecdotal evidence suggests that a great many of the purchases that did occur were made for cash, and by business or well-heeled buyers who planned to rent the properties rather than live in them.<sup>5</sup>&nbsp;</p> <p><b>Prospects for the Future<br> </b>This balance of forces seems poised to change, though it should still support a modest recovery going forward. On the negative side, rising real estate prices already have begun to erode the superior affordability comparisons. The prospect of Fed rate hikes likely assures further erosion on this score. No doubt, actions on both fronts will tend to squeeze out the marginal buyer and so tend to slow the housing recovery. But that should not halt growth altogether. &nbsp; &nbsp;</p> <p>Even the prospective deterioration in affordability could hardly be described as intense. Housing, as mentioned, remains, in a historical context, affordable. Both real estate prices and mortgage rates are well below their former highs. Affordability, as calculated by the NAR, though down from its 2011 highs, remains 60% better than before the housing bust began and, remarkably, some 25% better than it averaged throughout the 1990s.<sup>6</sup>&nbsp;Even if mortgage rates were to rise by 100 bps and real estate prices were to accelerate their recent rising trend, it would still take until 2016 before affordability deteriorated to its state in the 1990s and early 2000, and much longer still to reach the kind of severe constraints that could create a downturn. And since the Fed has made clear its intentions to raise rates cautiously along a gentle path, it will no doubt take a good deal longer than this for it to add those 100 bps to mortgage rates.<sup>7</sup></p> <p>If a gradual deterioration in affordability will tend to slow but not stop the housing expansion, other impediments, those holding housing back thus far, likely will improve. Homebuyers’ confidence and aggressiveness are, admittedly, hard to quantify, but signs of improvement are evident in the 11.5% rise during the past year in the University of Michigan’s consumer sentiment index.<sup>8</sup> Mortgage lenders also have begun to ease their former reluctance to extend credit for real estate. The Fed’s survey of senior lending offices describes an easing in requirements generally, a change that no doubt explains the real estate lending growth described earlier. These positives will no doubt develop only gradually. But at the margin, their turn should relieve the former drag on home-buying and so promote the general recovery in the area.<sup>9</sup>&nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>The pace of housing sales and construction might even quicken slightly under the changing mix of influences. A more conservative expectation would look for this changing mix of influences to sustain the housing recovery on the moderate path it has already established. Whatever record the precise statistics eventually show, investors can rest secure that, barring some presently unforeseen shock, a recovery will continue in one form or another for quite some time to come, despite plans at the Fed.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="legal"><sup>1&nbsp;</sup>Data from the Department of Commerce.<br> <sup>2&nbsp;</sup>Ibid.<br> <sup>3&nbsp;</sup>Ibid.<br> <sup>4</sup>&nbsp;Data from the Department of Labor.<br> <sup>5</sup>&nbsp;Data from the Federal Reserve.<br> <sup>6</sup>&nbsp;Data from the National Association of Realtors.<br> <sup>7</sup>&nbsp;Data from the Federal Reserve.<br> <sup>8</sup>&nbsp;Data from the University of Michigan.<br> <sup>9</sup>&nbsp;Data from the Federal Reserve.</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 15 Dec 2014 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/stocks-going-with-the-flows.htmlStocks: Going with the Flows<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Mutual-fund data show that retail investors remain reluctant to commit money to equities. That actually could help extend the rally in the months ahead.&nbsp;</i><b></b></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>To judge from money flows into and out of mutual funds, the scars of 2008–09 run deep. Perhaps that could be better described as the scars of the first decade of this century. Investors, particularly retail investors, suffered such shocking setbacks in stocks during those years that even now, after a tremendous equity rally, they remain reluctant to commit to the asset class. No doubt this reticence has kept the stock rally less extensive than it otherwise would have been. It also suggests that there is support for an extension of the rally—ammunition, so to speak, for further buying—especially if investors turn to the more aggressive investment approaches of the past.</p> <p>Professional investors have talked of what they call “the great rotation” for some time now. They have anticipated that past gains in stocks would encourage retail investors to buy equities and prompt them to trade out of their fixed-income holdings or, at the very least, redirect their investment cash flows toward equities instead of bonds. According to mutual fund data collected by the Investment Company Institute (ICI), that rotation has yet to begin.</p> <p>A year ago, it looked, for a while at least, as though retail investors were beginning the rotation. During the first nine months of 2013, funds flows, which had favored bonds for years and had come out of equities, began to turn. Overall bond mutual funds saw net outflows of $27.3 billion during that time, about $3.0 billion a month on average, mostly from municipals, while money market funds suffered outflows of $21.7 billion, $2.4 billion a month. Equities and hybrid funds received all those monies plus net new flows as well. Hybrids during this time enjoyed $64.3 billion in new flows, an average of $7.1 billion a month, while equities saw net inflows of $116.8 billion, about $13 billion a month.<sup>1</sup></p> <p>But even as the stock market rally continued this year, the rotation hinted at in 2013 lost momentum. During the first nine months of this year, new fund flows into hybrids slowed by more than half to $31.9 billion, $3.5 billion a month. Net new flows into equities slowed by almost two-thirds, to $46.5 billion, which is only $5.2 billion a month. What is more, this gain was all in foreign equity investments, which enjoyed inflows of $80.3 billion, or $8.9 billion a month. Domestic equity funds actually saw a net outflow during this time of $33.8 billion, or $3.8 billion a month. Meanwhile, retail investors returned to bonds, which saw inflows of $45.4 billion during this nine-month stretch, or about $5.0 billion a month. The only trend of 2013 that saw an extension was the outflows from money market funds, which came in at $114.7 billion, almost $13.0 billion a month.</p> <p>From early October and early November (the most recent time for which data are available), these anti-equity trends persisted. Domestic equity funds saw outflows of $1.5 billion during that one-month span. Hybrid funds saw net outflows of about $1.6 billion. Bond funds also lost, however. More than $7.1 billion flowed out of them during this one-month span. Presumably, some of these monies found their way back to money market funds, but the ICI does not provide such data on a frequent enough basis to state for sure.</p> <p>The only way to explain such durable anti-equity biases is by reflecting back on the recent past. Bond investors since the turn of the century may not have done as well as in the prior 20 years, but have suffered less trauma than equity investors. They have seen the value of their assets cut by half or more for a time in two great market crashes. Over a 10-year period, for example, stocks, as measured by the S&amp;P 500<sup>®</sup> Index,<sup>2</sup> may have averaged annual returns well in excess of 8% a year and far better than bonds. But it is not the averages that stick in investors’ minds. It clearly is the shocks suffered between 2000 and 2002 and then again between 2007 and 2009.&nbsp;</p> <p>The cautions, engendered by this history and evident in those fund flows, have, however, created an opportunity. By holding back the pace of the equity advance, they have kept stocks from fully realizing their value as quickly as they might have. That likely effect helps explain why equity yields still, even after all the gains of the past five years, look attractive, historically, next to bond yields. This fact and the clear indication that investors remain less than fully exposed to equities argue for a continuation of this equity rally. Only after the much-looked-for rotation occurs and investors have accumulated stocks as fully as in the past will they reach full valuations. In the meantime, further gains look likely.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="legal"><sup>1&nbsp;</sup>All data herein from the Investment Company Institute (ICI).<br> <sup>2&nbsp;</sup>The S&amp;P 500<sup>®</sup>&nbsp;Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries. An index is unmanaged, does not reflect the deduction of fees or expenses, and is not available for direct investment.</span></p> <p><span class="separator">&nbsp;</span></p> <p>&nbsp;</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 8 Dec 2014 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-economy-animal-spirits-remain-caged.htmlU.S. Economy: "Animal Spirits" Remain Caged<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>If the financial health of U.S. companies is so strong, why aren’t managers stepping up the pace of hiring and capital spending?</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The market’s recent volatility has developed in response to at least one inscrutable fear and two fundamental matters. The inscrutable fear is Ebola. There is no way to forecast this sort of thing, no way carefully to weigh probabilities. Its impact emerges from periodic thinking about the worst. There is little that this column can offer here except to note that “the worst” seldom happens. One of the fundamentals is the mess in Europe. This space has offered a lot of commentary on this matter, little of it encouraging. (The latest piece, “<a href="/content/lordabbett/en/perspectives/economicinsights/europe-draghis-deflation-desperation.html">Europe: Draghi’s Deflation Desperation</a>,” appeared on October 13.)&nbsp; The other fundamental is the pace of this country’s economic recovery. Here, hopes of a durable acceleration alternate with the reality of disappointing results so far in this recovery. Other <i>Economic</i> <i>Insights</i> have dealt with this question, most recently the one on November 24 (“<a href="/content/lordabbett/en/perspectives/economicinsights/us-economy-getting-a-fix-on-growth.html">U.S. Economy: Getting a Fix on Growth</a>”). This column turns to evidence of the ongoing economic sluggishness and why, though recession is highly unlikely, the growth rate likely will remain disappointingly slow.</p> <p>At the root of much of the recovery’s substandard character is the extremely cautious behavior of corporate managements and small-business owners. Firms surely have the wherewithal to support more aggressive rates of expansion. Profits and margins are strong, as are business balance sheets, remarkably so in fact. Yet, managements seem to lack the confidence they need to hire and spend and so drive the economy forward. The great economist John Maynard Keynes referred to this quality as “animal spirits.” And so hiring has remained historically restrained and so also, accordingly, have household incomes and spending, at least relative to past recoveries. Spending by businesses on new facilities, equipment, systems, and intellectual capital also has remained historically restrained. Nor are their signs of a change in such patterns, at least not significant enough to alter the substandard character of this recovery.</p> <p><b>They Could Be Much Bolder<br> </b>Certainly, managements have the resources to be much bolder than they have been. Non-financial corporations, for example, have seen the value of their financial assets jump 4.7% a year since 2009 and 4.8% a year since 2012. Their cash on hand has increased during these two periods at annual rates of 3.3% since 2009 and a whopping 5.8% rate since 2012. Cash holdings now exceed 10% of total liabilities. The value of their real estate assets have increased at a 9.1% annual rate since 2009 and at a still stronger 12.5% rate since 2012. Total assets have jumped at annual rates of 5.6% and 5.4% during these two respective periods. Business caution has, however, so held down the growth of liabilities that their net worth has jumped 6.5% a year since 2009 and 6.6% since 2012.<sup>1</sup>&nbsp; &nbsp;&nbsp;</p> <p>This story of improvement and caution is much the same for smaller business. Nonfinancial, non-corporate firms in the United States have seen their total assets expand 9.5% a year since 2012. Their cash holdings have grown less impressively than those of larger companies, but like their larger brothers and sisters, caution in these smaller firms has held back increases in liabilities, which have expanded at only a 1.2% annual rate since 2009 and only a 1.9% rate since 2012. Their net worth, accordingly, has jumped at a 7.8% yearly rate since 2009 and a 6.6% rate since 2012. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>Despite the impressive improvement in business’s financial resources, two considerations in particular have fostered continued reluctance. First is the legacy of the Great Recession of 2008–09—perhaps “wounds” is a better word. During that difficult time, managements came up short on several counts. Many report that they had trouble making payroll. The financial crisis that accompanied the recession exaggerated such pressure. Many small and quite a few larger firms found lenders less than eager to honor lines of credit previously arranged. Little wonder, then, that managements remain reluctant to use their assets and their cash as fully and as aggressively as they once did. On top of these powerful influences, Washington, beginning in 2009, passed a great deal of complex legislation. The Affordable Care Act and the Dodd-Frank financial reform legislation stand as prominent. Whatever the merits of these laws, their complexity created considerable uncertainty among managements about the costs of hiring or credit and even the availability of credit in the future, a consideration that greatly exacerbated the reluctances engendered by the recessionary experience.</p> <p><b>The Evidence<br> </b>Business has, accordingly, hired at a slower pace than in the past. Even the 2014 pickup in the pace of payroll growth falls short of the historical standard. So far this year, according to the Department of Labor, payrolls have grown on average by 226,667 a month, up from 194,250 a month in 2013 and 186,333 in 2012.<sup>2 </sup>Though this is a welcome improvement, past recoveries in the 1980s, 1990s, and earlier in this century saw much stronger payroll gains, often in excess of 300,000 a month. Reflecting the slow pace of hiring, real incomes during this recovery have grown less robustly than in past cycles. The lavish use of overtime and an upgrading in the average skillset of new employees have helped overcome some of the effects of the hiring shortfall, but not enough to change the adverse comparison. So far this year, overall real personal income has accelerated to a 3.6% annual pace of increase, from negligible growth in 2013 and 2012. Though this too is a welcome improvement, the established trend nonetheless remains well below that of past cyclical recoveries.</p> <p>These increases are good enough to sustain consumer spending, and give some hope of an acceleration going forward, but nothing to match past cyclical recoveries. The strain is not just that households have seen their spendable resources grow along a shallow slope but also that their sense of the shortfall, and the still constrained jobs market, has kept them from extending themselves as they once would have. To be sure, this caution on the part of households does guard against an overextension that might, in time, lead to a bust, but it also blocks a rise to that happy medium between excess and greater levels of economic activity. &nbsp; &nbsp;</p> <p>Managements have remained reluctant to spend and expand in other ways as well. The most telling sign here is how little their capital spending exceeds ongoing rates of depreciation. In past recoveries, companies quickly increased spending on new equipment, premises, and intellectual capital, increasing it on average from barely over depreciation during the recession to almost 45% above rates of depreciation in the early stages of recovery and even higher later in the expansion. But this time their caution has held them back, so that new spending on equipment, premises, systems, and intellectual capital, even after years of albeit slow recovery, still barely exceeds depreciation rates by 20%, less than half the historical average. Apart from directly holding down spending flows into the economy, this relatively timid behavior also limits future potentials for productive capabilities, productivity, hiring, and upgrading.<sup>3</sup>&nbsp;&nbsp;</p> <p><b>If Not Now, When? &nbsp; &nbsp; &nbsp;&nbsp;<br> </b>Sadly, there is little sign that the old “animal spirits” are likely to return quickly. Time, no doubt, will erase the bad memories of 2008–09 and perhaps permit more aggressive behavior among business managers. But as the evidence just presented indicates, it likely will take considerably longer before behavior changes substantively, and then the turn likely will occur only slowly. Meanwhile, the uncertainties connected with Washington’s ambitious legislation linger. Regulators have yet to write, much less clarify, many of the rules connected with the Dodd-Frank financial legislation, leaving all in business and finance up in the air about costs, availability, even required procedures in getting credit. There was some hope as 2014 approached that a full implementation of the Affordable Care Act would clarify its costs, benefits, and burdens. But so much of the bill has been modified temporarily—some for indefinite periods—that the most oppressive uncertainties remain in place. And all this offers ample reason to expect that this recovery will continue to remain historically slow, if perhaps not quite as substandard as it has been this far.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 1 Dec 2014 14:00:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-economy-getting-a-fix-on-growth.htmlU.S. Economy: Getting a Fix on Growth<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>What do data on<b> </b>inventories and consumer spending suggest for the pace of recovery?</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>With economic indicators swinging widely from one month to the next, it is harder than ever to get a fix on the underlying trends. At least it looks that way in the headlines. Fortunately, a little detail makes patterns clearer. The most information comes from a look at two subcategories of the gross domestic product (GDP): inventories and consumer spending. The picture that emerges points to likelihoods of continued sluggish growth that is broadly consistent with the pace of the recovery so far.</p> <p><b>Inventories and Weather &nbsp;&nbsp;<br> </b>The broad GDP figures give a good idea of the statistical confusion and how that has created swings in consensus sentiment. The top line of Table 1 tells the story. When, in the last quarter of 2012, the Commerce Department reported almost no growth in real GDP,<sup>1</sup> concerns immediately arose that a recessionary dip was in prospect. A resumption in the expansion during the first quarter of 2013 dissipated some of that fear, but it returned as the pace of economic advance slowed again in the spring quarter. Stronger growth in the second half of the year entirely dispelled recession fears and drove consensus thinking to look for an economic acceleration in 2014. But then an unseasonably severe winter depressed the first quarter. Though the reasons for the decline were obvious and clearly temporary, consensus thinking about fundamentals dipped along with the headline figures. A spring and slightly less pronounced summer surge in growth, though a predictable one-time catch up from weather-induced setbacks, seems nonetheless to have brought back renewed expectations for a fundamentally stronger economy.</p> <p>If consensus thinking seems prone, as ever, to build on the most recent release, however obviously misleading, a look at some of the subcategories of the GDP can offer perspective, one that consensus thinkers might use, if, that is, they bothered to read more than headlines. The rest of Table 1 shows the relevant growth rates. Table 2 helps the analysis by showing the percentage-point contribution to overall real growth made within each major GDP subcategory.&nbsp;</p> <p>Inventory movements are especially revealing. In the first quarter of 2012, a temporary surge in housing and business spending caught suppliers off guard. The depletion of their inventories shaved 0.2 percentage points off the overall pace of real growth and moderated the overall impact of the surge.&nbsp; When, predictably, these suppliers rebuilt their inventory stocks in the spring quarter, they added some 0.3 percentage points to overall growth. Since, however, housing and capital spending returned to their slower trends during that quarter, business needed to adjust inventory levels again. In the third and especially fourth quarter, they trimmed the inventories that they had mistakenly built up in spring. In the fourth quarter, these efforts alone cut 1.8 percentage points of overall growth, which, combined with a short-lived drop in government spending, created what was clearly a temporary interruption in growth though consensus thinking took it as more fundamental. &nbsp;</p> <p><span class="separator">&nbsp;</span></p> <p><b><span class="rte_txt_green">Table 1. Quarter-to-Quarter Growth, Selected Measures</span><br> </b><i>Seasonally adjusted % change annualized rate</i><br> <table class=no_style border="0" cellspacing="0" cellpadding="0" width="570"> <tbody><tr><td width="112" valign="top"><p>&nbsp;</p> </td> <td width="173" colspan="4" valign="top"><p>&nbsp;</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="190" colspan="4" valign="top"><p>&nbsp;</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="133" colspan="3" valign="top"><p>&nbsp;</p> </td> </tr><tr><td width="112" valign="top"><p><b>&nbsp;</b></p> </td> <td width="173" colspan="4" valign="top"><p><b>2012</b></p> </td> <td width="16" valign="top"><p><b>&nbsp;</b></p> </td> <td width="190" colspan="4" valign="top"><p><b>2013</b></p> </td> <td width="16" valign="top"><p><b>&nbsp;</b></p> </td> <td width="133" colspan="3" valign="top"><p><b>2014</b></p> </td> </tr><tr><td width="112" valign="top"><p><b>&nbsp;</b></p> </td> <td width="42" valign="top"><p><b>1</b></p> </td> <td width="40" valign="top"><p><b>2</b></p> </td> <td width="45" valign="top"><p><b>3</b></p> </td> <td width="45" valign="top"><p><b>4</b></p> </td> <td width="16" valign="top"><p><b>&nbsp;</b></p> </td> <td width="54" valign="top"><p><b>1</b></p> </td> <td width="45" valign="top"><p><b>2</b></p> </td> <td width="45" valign="top"><p><b>3</b></p> </td> <td width="45" valign="top"><p><b>4</b></p> </td> <td width="16" valign="top"><p><b>&nbsp;</b></p> </td> <td width="58" valign="top"><p><b>1</b></p> </td> <td width="40" valign="top"><p><b>2</b></p> </td> <td width="34" valign="top"><p><b>3</b></p> </td> </tr><tr><td width="112" valign="top"><p>Real GDP</p> </td> <td width="42" valign="top"><p>2.3</p> </td> <td width="40" valign="top"><p>1.6</p> </td> <td width="45" valign="top"><p>2.5</p> </td> <td width="45" valign="top"><p>0.1</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p>2.7</p> </td> <td width="45" valign="top"><p>1.8</p> </td> <td width="45" valign="top"><p>4.5</p> </td> <td width="45" valign="top"><p>3.5</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="58" valign="top"><p>-2.1</p> </td> <td width="40" valign="top"><p>4.6</p> </td> <td width="34" valign="top"><p>3.5</p> </td> </tr><tr><td width="112" valign="top"><p>Consumer Spending</p> </td> <td width="42" valign="top"><p>2.8</p> </td> <td width="40" valign="top"><p>1.3</p> </td> <td width="45" valign="top"><p>1.9</p> </td> <td width="45" valign="top"><p>1.9</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p>3.6</p> </td> <td width="45" valign="top"><p>1.8</p> </td> <td width="45" valign="top"><p>2.0</p> </td> <td width="45" valign="top"><p>3.7</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="58" valign="top"><p>1.2</p> </td> <td width="40" valign="top"><p>2.5</p> </td> <td width="34" valign="top"><p>1.8</p> </td> </tr><tr><td width="112" valign="top"><p>Capital Spending</p> </td> <td width="42" valign="top"><p>5.8</p> </td> <td width="40" valign="top"><p>4.4</p> </td> <td width="45" valign="top"><p>0.8</p> </td> <td width="45" valign="top"><p>3.6</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p>1.5</p> </td> <td width="45" valign="top"><p>1.6</p> </td> <td width="45" valign="top"><p>5.5</p> </td> <td width="45" valign="top"><p>10.4</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="58" valign="top"><p>1.6</p> </td> <td width="40" valign="top"><p>9.7</p> </td> <td width="34" valign="top"><p>5.5</p> </td> </tr><tr><td width="112" valign="top"><p>Housing</p> </td> <td width="42" valign="top"><p>25.5</p> </td> <td width="40" valign="top"><p>4.3</p> </td> <td width="45" valign="top"><p>14.1</p> </td> <td width="45" valign="top"><p>20.4</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p>7.8</p> </td> <td width="45" valign="top"><p>19.0</p> </td> <td width="45" valign="top"><p>11.2</p> </td> <td width="45" valign="top"><p>-8.5</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="58" valign="top"><p>-5.3</p> </td> <td width="40" valign="top"><p>8.8</p> </td> <td width="34" valign="top"><p>1.8</p> </td> </tr><tr><td width="112" valign="top"><p>Government</p> </td> <td width="42" valign="top"><p>-2.7</p> </td> <td width="40" valign="top"><p>-0.4</p> </td> <td width="45" valign="top"><p>2.7</p> </td> <td width="45" valign="top"><p>-6.0</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p>-3.9</p> </td> <td width="45" valign="top"><p>0.2</p> </td> <td width="45" valign="top"><p>0.2</p> </td> <td width="45" valign="top"><p>-3.8</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="58" valign="top"><p>-0.8</p> </td> <td width="40" valign="top"><p>1.7</p> </td> <td width="34" valign="top"><p>4.6</p> </td> </tr><tr><td width="112" valign="top"><p>Final Sales</p> </td> <td width="42" valign="top"><p>2.5</p> </td> <td width="40" valign="top"><p>1.3</p> </td> <td width="45" valign="top"><p>2.7</p> </td> <td width="45" valign="top"><p>1.9</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p>2.0</p> </td> <td width="45" valign="top"><p>1.5</p> </td> <td width="45" valign="top"><p>3.0</p> </td> <td width="45" valign="top"><p>3.8</p> </td> <td width="16" valign="top"><p>&nbsp;</p> </td> <td width="58" valign="top"><p>-0.9</p> </td> <td width="40" valign="top"><p>3.2</p> </td> <td width="34" valign="top"><p>4.1</p> </td> </tr></tbody></table> </p> <p><span class="legal">Source:&nbsp; Department of Commerce.</span></p> <p><span class="separator">&nbsp;</span></p> <p><b><span class="rte_txt_green">Table 2. Contributions to Real GDP Growth</span><br> </b><i>Percentage points of the annualized figure</i></p> <table class=no_style border="0" cellspacing="0" cellpadding="0" width="570"> <tbody><tr><td width="115" valign="top"><p>&nbsp;</p> </td> <td width="174" colspan="4" valign="top"><p>&nbsp;</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="186" colspan="4" valign="top"><p>&nbsp;</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="126" colspan="3" valign="top"><p>&nbsp;</p> </td> </tr><tr><td width="115" valign="top"><p><b>&nbsp;</b></p> </td> <td width="174" colspan="4" valign="top"><p><b>2012</b></p> </td> <td width="18" valign="top"><p><b>&nbsp;</b></p> </td> <td width="186" colspan="4" valign="top"><p><b>2013</b></p> </td> <td width="18" valign="top"><p><b>&nbsp;</b></p> </td> <td width="126" colspan="3" valign="top"><p><b>2014</b></p> </td> </tr><tr><td width="115" valign="top"><p>&nbsp;</p> </td> <td width="42" valign="top"><p><b>1</b></p> </td> <td width="42" valign="top"><p><b>2</b></p> </td> <td width="42" valign="top"><p><b>3</b></p> </td> <td width="48" valign="top"><p><b>4</b></p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="48" valign="top"><p><b>1</b></p> </td> <td width="48" valign="top"><p><b>2</b></p> </td> <td width="42" valign="top"><p><b>3</b></p> </td> <td width="48" valign="top"><p><b>4</b></p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p><b>1</b></p> </td> <td width="36" valign="top"><p><b>2</b></p> </td> <td width="36" valign="top"><p><b>3</b></p> </td> </tr><tr><td width="115" valign="top"><p>Consumer</p> </td> <td width="42" valign="top"><p>1.9</p> </td> <td width="42" valign="top"><p>0.9</p> </td> <td width="42" valign="top"><p>1.3</p> </td> <td width="48" valign="top"><p>1.3</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="48" valign="top"><p>2.5</p> </td> <td width="48" valign="top"><p>1.2</p> </td> <td width="42" valign="top"><p>1.4</p> </td> <td width="48" valign="top"><p>2.5</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p>0.8</p> </td> <td width="36" valign="top"><p>1.8</p> </td> <td width="36" valign="top"><p>1.2</p> </td> </tr><tr><td width="115" valign="top"><p>Capital Spending</p> </td> <td width="42" valign="top"><p>0.7</p> </td> <td width="42" valign="top"><p>0.5</p> </td> <td width="42" valign="top"><p>0.1</p> </td> <td width="48" valign="top"><p>0.4</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="48" valign="top"><p>0.2</p> </td> <td width="48" valign="top"><p>0.2</p> </td> <td width="42" valign="top"><p>0.7</p> </td> <td width="48" valign="top"><p>1.2</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p>0.2</p> </td> <td width="36" valign="top"><p>1.2</p> </td> <td width="36" valign="top"><p>0.7</p> </td> </tr><tr><td width="115" valign="top"><p>Housing</p> </td> <td width="42" valign="top"><p>0.6</p> </td> <td width="42" valign="top"><p>0.1</p> </td> <td width="42" valign="top"><p>0.4</p> </td> <td width="48" valign="top"><p>0.5</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="48" valign="top"><p>0.2</p> </td> <td width="48" valign="top"><p>0.5</p> </td> <td width="42" valign="top"><p>0.3</p> </td> <td width="48" valign="top"><p>-0.3</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p>-0.2</p> </td> <td width="36" valign="top"><p>0.3</p> </td> <td width="36" valign="top"><p>0.1</p> </td> </tr><tr><td width="115" valign="top"><p>Government</p> </td> <td width="42" valign="top"><p>-0.6</p> </td> <td width="42" valign="top"><p>-0.1</p> </td> <td width="42" valign="top"><p>0.5</p> </td> <td width="48" valign="top"><p>-1.2</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="48" valign="top"><p>-0.8</p> </td> <td width="48" valign="top"><p>0</p> </td> <td width="42" valign="top"><p>0</p> </td> <td width="48" valign="top"><p>-0.7</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p>-0.2</p> </td> <td width="36" valign="top"><p>0.3</p> </td> <td width="36" valign="top"><p>0.8</p> </td> </tr><tr><td width="115" valign="top"><p>Inventories</p> </td> <td width="42" valign="top"><p>-0.2</p> </td> <td width="42" valign="top"><p>0.3</p> </td> <td width="42" valign="top"><p>-0.2</p> </td> <td width="48" valign="top"><p>-1.8</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="48" valign="top"><p>0.7</p> </td> <td width="48" valign="top"><p>0.3</p> </td> <td width="42" valign="top"><p>1.5</p> </td> <td width="48" valign="top"><p>-0.3</p> </td> <td width="18" valign="top"><p>&nbsp;</p> </td> <td width="54" valign="top"><p>-1.2</p> </td> <td width="36" valign="top"><p>1.4</p> </td> <td width="36" valign="top"><p>-.6</p> </td> </tr></tbody></table> <p><span class="legal">Source: Department of Commerce.</span></p> <p><span class="separator">&nbsp;</span></p> <p>Having gone too far with inventory reductions in 2012, business in 2013 returned to rebuilding. Their efforts added to overall growth, making the economy look much stronger than it in fact was. Final sales do a better job of capturing the fundamental, more moderate trend and show why, even as business added to inventories, the stage was set for a subsequent downward adjustment. Matters reached extremes during 2013’s third quarter. Then, inventory accumulations added 1.5 percentage points to the overall growth measure and made a slight uptick in final sales, to a 3.0% annualized rate of expansion, otherwise look like a boom. Then, in this year’s first quarter, unseasonably severe winter weather started the whipsaw again. It affected almost all sectors in the economy, but problems with shipping made for an especially sharp downward adjustment in inventories that turned a modest dip in final sales into a frighteningly sharp decline in overall GDP. The subsequent efforts of business to rebuild those inventories exaggerated an understandable, but relatively contained and short-lived, spring catch up from weather-related interruptions in construction and business spending. In the third quarter, an effort at moderation returned. Though seen this way, and it is clear that almost all was temporary, the economy, to those who just looked at the headlines, appeared to have surged.</p> <p>Behind all this confusion and the swings in consensus opinion, final sales offered a much less volatile and more reliable picture of still moderate growth. The final sales figures, to be sure, are still highly variable quarter to quarter, but, as is also evident, they are much less wild and misleading than the overall real growth measure on the top line. What these figures show, in fact, is an economy that has tracked a modest expansion path since this recovery began in 2009, growing steadily but slower than usually. All but one quarter recorded growth below the long-term 3.5% historical annual real pace. There is, of course, a chance of an acceleration going forward. It could come from many directions, but, with the consumer still amounting to 70% of the economy, much will depend on how willing he and she are to depart from the cautious pattern they have pretty consistently held throughout this recovery. &nbsp;&nbsp;&nbsp;&nbsp;</p> <p><b>The Consumer &nbsp; &nbsp; &nbsp;&nbsp;<br> </b>What this recovery has shown thus far is a consumer constrained by three factors. First, the slow rate of expansion in the jobs market has held back income growth and with it the wherewithal to spend. Second, the slow rate of jobs and income growth has made consumers shy of resuming past, more aggressive spending patterns. Historically, they have increased spending ahead of income growth on the assumption that an improving economy will catch them up to higher spending levels. Third, the scars left by the 2008–09 Great Recession and the attendant financial crisis have greatly exaggerated this caution.</p> <p>Substandard jobs growth constitutes one root of this atypical caution. To be sure, the jobs picture has brightened some this year. Payrolls in 2014 have increased on average by 218,000 a month, compared with 194,000 in 2013 and 186,000 in 2012. This pace, however, is still historically disappointing. Past recoveries have done much better. Still, the modest 2014 acceleration in payrolls growth and very modest wage increase, due mostly to a greater use of overtime, have accelerated income growth modestly. Total employee compensation is up in nominal terms at an annualized pace of 5.2% so far this year, faster than the 4.1% recorded last year. That pickup should allow some acceleration in consumer spending, but even if households follow the relative income gains in lock step, they would still pick up consumption to slightly more than a 3.0% real growth, enough to accelerate the overall economy slightly, but not enough to change its still sluggish underlying character.</p> <p>Then there is the added, critical question of caution. As already indicated, households have remained reluctant to follow their historical pattern of running ahead of income, foregoing saving and stepping up borrowing. Instead, they have saved more than in the past. Where once savings rates ran at 3.0–3.5% of aftertax income, they have in this recovery averaged 5.5–6.0%. During those few times when household spending has run ahead of income gains, such as the first and last quarters of 2013, and savings flows have fallen below 5.0% of aftertax income, households always have checked themselves in subsequent quarters, sharply slowed their rate of spending growth, and brought their savings flows back up toward 5.5%.</p> <p>The greatest chance of an economic acceleration would emerge if households were to break this pattern, shed some of this caution, and return to past patterns. Clear improvements in their balance sheets certainly could support such a change in sentiment. Household net worth has gained 8.3% a year during the past two years. The value of household financial assets has risen 7.4% a year. Real estate values have risen 7.5% a year during this time. Owner equity in homes has jumped from 45.7% in 2012 to 53.6% presently.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;</p> <p>But while this balance sheet improvement could foster more aggressive spending and certainly argues against the possibility of a downturn, households do not seem likely to shed their caution just yet. Not only does their unusual preference for savings speak to ongoing caution but also so does their evident reluctance to expand liabilities of any kind, which, despite gains in assets, have only grown 1.1% a year during these last two years. With memories of the last recession lingering and a still-sluggish jobs market constraining income growth, people likely will remain reluctant to get too far ahead of themselves, making it therefore less than likely that the economy will accelerate substantially from the slow pace already set in this recovery.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 24 Nov 2014 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-congress-10-post-election-moves-to-watch.htmlU.S. Congress: 10 Post-Election Moves to Watch<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Amid the big changes in the U.S. capital, here are the potential legislative actions that could influence financial markets.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>With the remarkable midterm election results, it is only natural to ask how Washington might change.&nbsp; Political forecasting, of course, makes market and economic forecasting look almost easy. Still, without any implication of what is good or bad or what should happen or not, the logic of the situation suggests a number of future congressional initiatives. Many likely will fail, vetoed by President Obama. But they will occupy the attention of financial markets and so affect pricing. Here are 10 of them to watch out for<sup>1</sup>:</p> <p>1) Though the Republicans seem to have moved away from the idea of repealing the Affordable Care Act, they may well advance legislation to repeal the unpopular medical device tax presently in the law.</p> <p>2) The Republican Congress also may look to remove the employer mandate from the law.</p> <p>3) Congress may ease some of the capital requirements presently built into the Dodd-Frank financial legislation, particularly those aimed at large insurance companies.</p> <p>4) There also is talk about imposing more governance and accountability on the Consumer Financial Protection Bureau created by Dodd-Frank, perhaps by creating an inspector general for it or a board of directors.</p> <p>5) Also on the financial side, there is discussion of streamlining the processes surrounding financial institutions deemed too big to fail, though little detail on this point has emerged.</p> <p>6) The Republican Congress also will likely strive to rein in President Obama’s regulatory agenda, especially the Environmental Protection Agency’s dealings with power utilities.</p> <p>7) Congress likely will push for the Keystone XL pipeline and perhaps also introduce measures to expand facilities for the export of natural gas.</p> <p>8) If anything, the Senate confirmation process for presidential appointees will become even tougher, most especially for any replacement of Attorney General Eric Holder, who is retiring.</p> <p>9) With Senator John McCain (R-AZ) now chairing the Senate Armed Services Committee, a review of the missteps in Benghazi will remain in the headlines, as will efforts to “do more” against ISIS (Islamic State of Iraq and Syria) and in the Middle East generally. So far, that “more” remains vague and seems to exclude “boots on the ground.”</p> <p>10) Debate will heat up on the expiring legislation that authorizes surveillance by the National Security Agency, though this would have been the case regardless of the election results.</p> <p>Besides these 10 points, there is a potential for welcome tax reform, either on the corporate side alone or more generally. Though the two parties remain far apart on many of the details, as do the president and Congress, all the proposals share a general desire to lower statutory rates and make up the revenue difference, to a degree or entirely, by ridding the tax code of deductions and other breaks. There is room here for compromise, if the parties involved are capable of it. Such moves, probably more than anything else, would help the economy and financial markets.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="legal"><sup>1</sup>&nbsp;See, Nick Timiraos and Colleen McCain Nelson, “Obama, GOP Begin Laying Out Road Map for Future,”<i>The Wall Street Journal</i>, November 5, 2014, and Vicki Needham, “Five Things That Would Change in a Republican-Led Senate,”&nbsp;<i>The Hill</i>, November 2, 2014.</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 17 Nov 2014 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/oil-prices-good-news-by-the-barrel.htmlOil Prices: Good News by the Barrel<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Ignore the pessimists. Declining petroleum prices likely will give an overall boost to the U.S. economy</i>.</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>A few months ago, when the rise of ISIS (Islamic State of Iraq and Syria) pushed up oil prices, articles abounded about the danger posed to the U.S. and the global economy. Now that oil prices are falling, articles abound about the dangers to the economy of lower prices, sometimes by the same people. Can pessimism really have it both ways? The answer is “no.” While there are economic positives and negatives to just about everything, declining energy prices are on balance favorable for the economy. If they persist, they will boost growth rates. They already have helped reverse the market correction of a few weeks ago.</p> <p><b>The Economic Effect<br> </b>A recent <i>Wall Street Journal</i> article<sup>1</sup> summarized the negative view of reduced oil prices. It centers on the threat to the fracking energy boom. Noting that fracking is a relatively expensive way to lift oil, this argument frets that low prices will render much existing American production unprofitable. It goes on to point out that oil and gas extractions have increased their importance to the U.S. economy in general and increased the worries, accordingly, over the ripple effect from layoffs in the country’s new oil fields on consumer spending and on housing. The concern focuses on the centers of the new boom: North Dakota, Oklahoma, and Texas. All three states are leading growth centers. North Dakota stands out.&nbsp; Rich in the Bakken Shale deposits, the state’s economy grew 9.7% in real terms last year. Since the general economy is already growing much slower than normal, and certainly slower than these boom states, the loss of their superior growth, these concerned analysts contend, could shut down the recovery.<sup>2</sup>&nbsp; &nbsp;</p> <p>While the logic here is not wrong, it certainly is incomplete. For one, the fracking revolution is not so fragile as implied by these pessimists. According to the International Energy Agency, only 4% of U.S. wells require oil above $80 a barrel for profitability. Other sources suggest that most of the shale oil production can remain profitable even if oil prices were to approach $50 a barrel. The same is true of the Canadian tar sands. Though the extraction industry has grown as a share of the economy, it still only accounts for 1.7% of the total. Even if it were to disappear altogether, though hardly likely, it would not take down the whole economy. Meanwhile, the Labor Department reports that oil and gas extractions, though booming, have accounted for only some 60,000 new jobs since 2010. Though a remarkable turn from past years, that entire amount equals less than a third of the average monthly jobs gain this year, and even if new exploration were to stop altogether, again hardly likely, the industry would not give up all these jobs.<sup>3</sup>&nbsp; &nbsp; &nbsp;&nbsp;</p> <p>Still more significant in this balance of good and bad is the positive impact of cheaper fuel on the American consumer and on most American industry. The Labor Department reports that the average family dedicates some 10% of its budget to fuels of all kinds. The 25% drop in oil prices since last June, then, amounts to what effectively is a spendable income gain of 2.5% and in just a few months, effectively a $373 billion addition to households’ gross spending power. Even if families spend a small portion of this freed-up money, it cannot help but boost the economy. Beyond this consumer effect, lower oil prices also benefit shipping, warehousing, manufacturing, and all the rest of American businesses that are net energy consumers. Taken together, these effects conservatively could add in excess of one percentage point to the economy’s annual pace of growth, more if prices fall further, less, obviously, if the relief proves short lived.<sup>4</sup>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;</p> <p><b>Relief for How Long?<br> </b>Barring new problems in the Middle East, there is every reason to expect low prices to persist. Increased sources of oil and gas production—from fracking in the United States, tar sands in Canada, and, broadly, from technologies that permit greater recoveries from existing conventional wells—has enabled global oil output to climb by amounts approaching some 50% since 2010, far faster than demand, especially since the world’s economies are expanding only slowly.<sup>5</sup>&nbsp;What is more, oil finds in the South Atlantic, in Australian shale, and promise in the Russian Arctic indicate still greater supplies going forward. As a recent piece in this space, “<a href="/content/lordabbett/en/perspectives/economicinsights/oil-prices-fracking.html">Oil Prices: Fracking to the Rescue</a>” (July 14), explained, a strict supply-demand consideration would set prices even lower than they are today, perhaps to $60 a barrel.&nbsp;</p> <p>But for all the favorable impact of new supplies, there is nonetheless still a meaningful chance of an upward price spike. The unstable Middle East remains, after all, an important source of oil. Some 35% of all the oil shipped in the world passes through the Persian Gulf. Any threat to that flow could force up oil prices, despite all the production gains made in the United States, Canada, Australia, and elsewhere. It was, after all, the threat ISIS leveled at Iraq’s oil fields that drove up prices from around $85 a barrel in late 2013 to more than $100 a barrel last spring, even with all the additional sources and production from elsewhere. No doubt prices have fallen recently because, contrary to earlier fears, Iraqi production has continued to reach markets. But the situation in Iraq is far from secure. A strong possibility of growing tension between the United States and Iran also remains. A reverse on any of these fronts could easily and quickly turn today’s favorable pricing picture on its head.<sup>6</sup></p> <p>Indeed, the pressure of low prices on producers, Russia and Iran in particular, has created a powerful incentive for producers to foment just such problems. Tehran, for example, already has accused the United States of fostering the price decline in order to destabilize Iran’s economy. Apart from that country’s adolescent sense of self-importance, the damage to Iran’s economy, from the oil price declines and the sanctions, already has had a destabilizing effect and weakened the position, according to some reports, of the so-called moderate President Hassan Rouhani. He then has ample reason to introduce an element of uncertainty into world oil markets. So does Russia, which also has been hit by sanctions as well as the oil-price drop. With oil accounting for some 80% of that country’s exports and 50% of the Kremlin’s revenues, Russia’s leadership may well calculate that it has more to gain by making trouble than it does by cooperating in Europe and elsewhere.<sup>7</sup>&nbsp; &nbsp;&nbsp;</p> <p><b>Pulling the Pieces Together<br> </b>It would be foolhardy in the extreme to forecast geopolitical trouble on the basis of such pressures, however real or plausible. At the same time, these risks recommend against a smug reliance on favorable supply-demand calculations. What circumstances do allow is a threefold conclusion: 1) Contrary to some media suggestions, the fracking revolution by and large is not threatened by today’s reduced prices; 2) though straight supply-demand calculations suggest continued low prices, that prospect is less secure than many imply; and 3), for as long as prices remain low, the economy on balance should benefit and gain cumulatively the longer prices remain low.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 10 Nov 2014 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-budget-who-pays-the-way.htmlU.S. Budget: Who Pays the Way?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Over time, how has the mix of U.S. government revenues shifted among individual, corporate, and payroll taxes? This is the second of two parts.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>This week’s discussion is the second half of a look at the federal budget. Together, both parts should give readers perspective on who supports the government and how the government disposes of that support. <a href="/content/lordabbett/en/perspectives/economicinsights/us-budget-how-is-spending-trending.html">Last week’s discussion</a> looked at outlays, showing that entitlements entirely dominate spending, and that unless there is reform, they could squeeze out most other government priorities. This week’s discussion looks at the revenues. It shows how Washington for some time now has shown a reluctance to increase its total tax take from the economy, relying on sometimes huge deficits to make up the shortfall from spending. The government has, however, shifted the incidence of tax burdens, a trend the president’s latest budget plans to halt in coming years.</p> <p><b>Revenues Overall &nbsp; &nbsp;<br> </b>The historical record is clear. For 35 years after World War II, Washington took revenues from the economy at a faster rate than the economy grew. Right after the war, the tax take did decline, falling from more than 20% of the gross domestic product (GDP) during the conflict to a low of 14.1% of GDP in 1950. It rose again with the Korean War and fell afterward, but never back to the 1950 rate. By 1960, total revenues had risen to 17.3% of GDP, and by 1969, they touched 19.0%, after which the relentless rise all but stopped.<sup>1</sup>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>It would seem from the record that a tax take approaching 20% of GDP is about as much as the American public will tolerate. Accordingly, the proportion of GDP taken in revenues ceased rising in the 1970s. The decade closed with the take still at about 19.0%. Ronald Reagan’s promised tax cuts took the total down to about 17.0% of GDP by the late 1980s, giving George H.W. Bush leeway to raise taxes to meet Washington’s ever growing demands for financial and economic resources, a step that Bill Clinton built on in the early 1990s. These increases brought revenues again up toward 20% of the economy in 2000, the last year of Clinton’s second term. Little wonder, then, that the budget showed a surplus. The market bust that followed, and then the Bush tax cuts, brought the tax take down again, to about 17.5%, during the last years of Bush’s time in office. Revenues fell further, to 14.6% of GDP in 2008–09, less because of policy then from the Great Recession’s impact on income and profits. But tax increases under President Obama and a modest cyclical recovery began to push the tax take up again.&nbsp; Still, the 2014 percentage of GDP, at 17.3%, remains below the practical ceiling of 20%. &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>The White House’s budget projections indicate plans to push toward this practical ceiling. Total revenues are expected to grow 7.1% a year over the next five years, far faster than the official 5.1% projection of nominal GDP growth. The difference should bring the revenues take up to 18.6% of the GDP by 2019. Whether that evokes another round of relief is up to the voters, and is anyone’s guess, especially now.</p> <p><b>The Mix &nbsp; &nbsp; &nbsp; &nbsp;<br> </b>Though Washington derives revenues from a broad array of taxes and fees, it has relied primarily on four sources: individual income taxes, corporate income taxes, payroll levies, and excise taxes. The mix has varied tremendously over time.&nbsp;</p> <p>Individual income tax burdens show the most steady pattern. They, like the total, rose as a proportion of both GDP through the 1950s and 1960s, and, unlike the total, continued to rise relatively through 1970s, going from 5.6% of GDP (about 40% of all revenues) in 1950 to a high of 9.0% in 1982 (48.2% of all revenues). The Reagan tax cuts offered a reprieve in the mid-1980s, but individual income taxes, like overall revenues, were again rising relatively later in that decade and in the 1990s, outpacing nominal GDP growth, so that by the end of the century, they were again above 9.0% of the economy (just less than 50% of all revenues). The Bush tax cuts created another pause, but individual income taxes have again risen relatively with the Obama rate increases and the economic recovery’s impact on the progressive code. They should reach 8.0% of GDP this year (and constitute 46.2% of all revenues). The White House budget plans to increase individual income taxes a rapid 8.1% a year for the next five years, fast enough to push them to 9.2% of GDP (some 48.4% of all revenues) by 2019. &nbsp; &nbsp;</p> <p>Corporate and payroll taxes, as well as excise taxes, have shown huge relative swings. In the 1950s, for instance, a legacy of heavy wartime taxes on profits, including what Washington called an “excess profits tax,” brought corporate income taxes to almost a third of total federal revenues and equal to almost 5% of the country’s GDP. During those years, payroll taxes for Social Security and what the Treasury calls “social insurance” constituted barely 10% to the government’s total revenue take and amounted to less than 2% of the total economy. Excise taxes, mostly tariffs, constituted almost 20% of Washington’s total tax take, more than 2.5% of GDP. These burdens switched dramatically in succeeding years. The growth in the welfare state made greater demands on payroll taxes, while tariff cuts drove down excise taxes and international competition did the same to corporate taxes. By 1992, as Bill Clinton took office, the switch was complete. Corporate taxes contributed less than 10% of the overall federal revenues take (1.6% of GDP), excise taxes constituted 4.2% (0.7% of GDP), and payroll taxes had risen to almost 38% of the total revenues take (6.4% of GDP).</p> <p>These trends have stabilized during the Obama administration, probably less from explicit policy than because they had proceeded about as far as they could go. Payroll taxes, for instance, after reaching 6.1% of GDP on average toward the end of the first decade of this century (roughly 35% of the total federal tax take), have ceased their relative rise, holding about steady at these relative levels. The White House’s plan calls for a very slight relative decline to 31.1% of total revenues (5.9% of GDP) by 2019.&nbsp; Excise taxes have all but ceased to matter in the equation. They remain in the plan at about 3% of the total federal take (0.6% of GDP), more from levies on tobacco and alcohol than tariffs. Proposed corporate tax reforms, in which the code lowers statutory rates while shredding tax breaks, turn out in the president’s plan to raise revenues on balance. According to the budget document, corporate taxes will rise from 11.1% of the total tax take this year (1.9% of GDP) to 12.2% in 2019 (2.3% of GDP). &nbsp; &nbsp;&nbsp;</p> <p><b>Takeaway &nbsp; &nbsp; &nbsp;<br> </b>Except in the unlikely event that Washington forswears its ever-growing economic and financial demands, this revenues picture makes a powerful case for major tax reform. The country could benefit from a reduction in payroll taxes. To be sure, they have increased because of their natural link to social spending. But these high rates nonetheless discourage job creation among employers and discourage paid work generally among the population. They are regressive, too, falling relatively hardest on poorer workers, who never reach the point where some payroll taxes top out and in any case pay at the same rate as high-income earners. Since excise taxes can in no way take up the slack and corporate tax hikes would impair international competitiveness, the only place to make up the difference would seem to lie with personal income taxes. It would, however, be less than productive simply to expand the existing structure. The economically efficient way to absorb the burden would involve a broadening of the tax base, a lowering the statutory rate, and simultaneously ending many of the long list of tax deductions that mostly benefit higher-income people. It is encouraging that both sides of the aisle in Washington are considering such reforms, but discouraging that the present rancor in the capital precludes any progress, probably until after the next presidential election.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 3 Nov 2014 10:01:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/quarterly-roundtable-us-economy-just-the-cleanest-dirty-shirt.htmlQuarterly Roundtable: U.S. Economy—Just the Cleanest Dirty Shirt<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The recent surge is not likely to continue, but obstacles to growth are even greater elsewhere.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p><span class="separator">&nbsp;</span></p> <p><b>In Brief</b></p> <ul> <li>The U.S. economy grew by an annualized rate of 4.6% in the second quarter of 2014, according to the Bureau of Economic Analysis, marking the third quarter in the last four in which real economic growth exceeded 3.5%.</li> <li>It appears unlikely, however, that the recovery will continue at this pace. Various structural factors and other longer-term impediments stand in the way of a stronger expansion.</li> <li>But it’s also unlikely that the U.S. economy is in a period of “secular stagnation,” as some economists have suggested. Secular stagnation suggests the economy’s performance would be impervious to policy improvements. In reality, although there are secular aspects to the current sluggishness, certain structural reforms would probably produce higher growth.</li> <li>The European Central Bank recently cut its benchmark interest rate and has begun to embark on a policy of quantitative easing. But monetary policy may have reached its limit, and may have already created other problems, including a credit bubble in emerging markets.</li> </ul> <p><span class="separator">&nbsp;</span></p> <p>The U.S. economy expanded by an annualized rate of 4.6% in the second quarter of 2014, rebounding sharply from the first quarter’s 2.1% contraction. In fact, gross domestic product (GDP) has risen by more than 3.5% annualized in three of the last four quarters. But a number of factors suggest the economy will soon return to its muddle-through pace of the past several years.</p> <p>Some economists have even raised the possibility of “secular stagnation,” given that the problem of tepid growth, even in a loose-money environment, predates the financial crisis of 2008–09. Nevertheless, for the time being, the pace of growth appears practically torrid when compared with rest of the developed world. The eurozone continues to slump, and now faces the possibility of deflation. The European Central Bank (ECB) recently cut its benchmark interest rate and will soon begin a type of quantitative easing, though it faces some resistance. These policies do not come without a price, however, and the Bank for International Settlements (BIS) has indicated that monetary policy in the developed world is too loose, resulting in asset bubbles and excessive levels of debt in emerging markets.</p> <p>Tackling these and other issues are <b>Lord Abbett Partners <a href="/content/lordabbett/en/global/biographies/milton-ezrati.html">Milton Ezrati</a>, Senior Economist and Market Strategist; <a href="/content/lordabbett/en/global/biographies/zane-brown.html">Zane Brown</a>, Fixed Income Strategist; </b>and<b> <a href="/content/lordabbett/en/global/biographies/harold-sharon.html">Harold Sharon</a>, International Strategist.</b></p> <p><b>Q. GDP has grown by 3.5% or more in three of the last four quarters, starting in third quarter 2013. Is the recovery finally kicking into high gear?</b></p> <p><b>Ezrati:</b>&nbsp;I’m skeptical that growth is going to continue at this level. What we’ve seen recently are surges that are not sustainable. We saw a surge in inventories in the third quarter of 2013, followed by a drop in the fourth. Housing was also weak in the fourth quarter, but the weakness in inventories and housing were more than covered by a surge in consumer spending. In the first quarter of this year, growth was -2.1%, in part due to the weather, but also because consumers pulled back after outspending their income growth in the previous quarter.</p> <p>In the second quarter of 2014, we saw a surge in housing, manufacturing orders, and construction activity, but these were all rebounds from the weather-related slowdowns in the first quarter. What we’ve seen so far in the third quarter is a response to these second-quarter surges—a decline in manufacturing orders and a decline in construction spending. So, I’m skeptical that GDP can continue at the 4.6% rate of the second quarter.&nbsp;</p> <p>Even with the strong performance recently, GDP growth has averaged only 2.6% over the past four quarters.</p> <p><b>Brown:</b>&nbsp;It’s hard to believe that we could be growing 3–4% a year, because job growth is only around 200,000–215,000 per month [according to the Bureau of Labor Statistics] and wage growth is barely keeping up with inflation. Also, in the second quarter of 2014, people began purchasing health insurance under the Affordable Care Act, and that could spill over into the third quarter as well. Although this contributed to GDP in the second quarter and will also contribute in the third quarter, it’s essentially a one-time increase; it won’t continue much after that.&nbsp;</p> <p>So, that’s another reason this pace of growth is probably sustainable.</p> <p><b>Ezrati:</b>&nbsp;If consumers start outspending their incomes on a regular basis, which they did in the fourth quarter of 2013, this surge will come to an end very quickly, because they’ll become stretched and will have to pull back. So, unless businesses start hiring and start investing the cash on their balance sheets, this won’t continue. So, I don’t think we’re off to the races yet.</p> <p><b>Q. If the recent surge in growth is not sustainable, is it possible that the U.S. economy has entered a period of “secular stagnation,” as some economists [such as Larry Summers, former director of the White House U.S. National Economic Council under President Obama; Minneapolis Fed president Narayana Kocherlakota; and Fed vice chairman Stanley Fischer] have suggested?</b></p> <p><b>Ezrati:</b>&nbsp;There are demographic reasons for the slow growth of the economy, but there are cyclical things going on as well. The recession was inordinately deep, for reasons we’ve discussed, and it’s left a legacy of caution that weighs on the growth rate. But that won’t last forever. So, Summers might be right about the demographics and other structural reasons for the economic sluggishness, but that doesn’t mean that the growth rate needs to be 2.0% or less forever.</p> <p><b>Brown:</b>&nbsp;I think there are structural aspects to the economy’s sluggishness. baby boomers are retiring, downsizing, and spending less. Also, the millennials are not that interested in household formation, and they’re more interested in renting than owning. These trends are present in other developed economies as well. That means that unlike in the past when we experienced a cyclical downturn, other economies won’t be able to help pull us out of it.</p> <p><b>Ezrati:</b>&nbsp;The mismatch in skills between what employers need and what the labor force has to offer may also be contributing to the downturn by keeping the unemployment rate high. And that won’t be solved overnight; as the economy continues to become more knowledge-based, workers who lack those skills are having a harder time finding work.</p> <p>There are two other factors hindering this economy. One is the legacy of the Great Recession. Business spending and hiring don’t occur unless management becomes more aggressive, but the experience of 2008–09 has scarred them. I think the amount of cash sitting on corporate balance sheets is evidence of that. Because of that experience, and because of the difficulty they may have had obtaining financing at that time, firms feel they must be self-financing.</p> <p>The other factor is the regulatory environment. The Affordable Care Act and the Dodd-Frank financial reform legislation created a lot of uncertainty. Congress is not passing much legislation now, but what they have passed remains ambiguous. The requirements of the Affordable Care Act, for example, are still unclear, and I don’t see that changing anytime soon.</p> <p>On the bright side, increased M&amp;A [mergers and acquisitions] activity is one sign of life in the economy. It means that businesses are again willing to take risks and is evidence of what [British economist John Maynard] Keynes called “animal spirits.”</p> <p><b>Brown:</b>&nbsp;It is positive in that sense, but M&amp;As contribute to the unemployment problem because they usually result in layoffs. They are also a reaction to the limited opportunities to invest in organic growth. Because the economy is growing so slowly, companies can’t justify investing in their own new growth, so instead they buy existing growth by acquiring a company. But that often means eliminating employees that are duplicative, such as a sales force, for example.</p> <p><b>Q. The U.S. Federal Reserve is ending its quantitative-easing program, and expects to raise the fed funds rate by mid-2015. In Europe, the ECB is facing resistance to its quantitative-easing program. Can the global economy grow without extraordinarily accommodative monetary policy? &nbsp;</b></p> <p><b>Brown:</b>&nbsp;Monetary policy has pretty much done all it can globally. Europe is taking a more targeted approach with its purchase of asset-backed securities, but in the grand scheme of things, that program won’t be enough to get those economies going. What is necessary is structural reforms that will make them more competitive.</p> <p><b>Ezrati:&nbsp;</b>Fiscal stimulus is out of the question. If the eurozone were to give up on its budget constraints, it could run out of room to borrow. With France, for example, there’s so much debt out there on the market already, that if France showed any sign of losing its commitment to fiscal austerity, the investment community would walk away from French debt.</p> <p><b>Sharon:</b>&nbsp;This does point out the pressure for government authorities to truly focus on growth-enhancing programs and policies. Policies on the fiscal side have just disappointed massively around the world. We’ve seen very few government privatizations or rollbacks of government interference in large economies. I would hope that as monetary policy stimulus fades, we’ll see more on the fiscal side everywhere.</p> <p><b>Brown:</b>&nbsp;Can the global economy grow without easy money? We’re going to find out. It’s not growing very rapidly even with easy money. The United States has been growing at around 2–2.6% in real terms, even with easy money, so the question becomes, what will happen when the Fed begins to raise rates? If the Fed does that aggressively, you would think it would have some impact on growth.</p> <p>But the Fed might not be as aggressive as its interest-rate projections imply. The Fed suggests that by the end of next year, the fed funds rate will be between 1.25% and 1.5%. What that implies is that it will make five or six consecutive quarter-point moves, starting in April 2015. I don’t think anybody is expecting a rate hike that soon. &nbsp;</p> <p>If the market is looking out that far, which I’m not sure is the case, it would be easy to come to the conclusion that the Fed cannot be as aggressive as it is suggesting. An aggressive stance by the Fed would hurt housing. So far, the housing recovery has been supported mostly by investors taking advantage of low prices and foreclosures. Prices have risen and foreclosures have slowed, so now would be the time that low interest rates would help homebuyers, those that want to buy the home to live in it. But now interest rates are probably going to rise. So, will rising rates affect the housing market? I think so.</p> <p>Also, at its meeting in June 2014, the Fed said it expected 3.1% growth in 2015. At this last meeting [in September 2014], it lowered its expectation to 2.8%. Also, in June, the midpoint of the Fed’s interest rate projections for year-end 2015 was 1.13%. But at the September meeting, the midpoint was 1.38%. That means that in a slower-growth environment, the Fed supposedly will be more aggressive in raising rates.</p> <p>So, I think their interest-rate projections are optimistic. The bottom line is that I don’t think growth will be strong enough to allow the Fed to be so aggressive. That doesn’t directly answer your question about whether the economy can grow without easy money, but I think the Fed will handle these rate increases delicately. But I don’t think the rest of the world is ready to abandon easy money policies.</p> <p><b>Q. The Bank for International Settlements [BIS] said in its annual report that monetary policy around the world is too loose, and that this is leading to bubbles in capital markets. Has the market priced in interest rate increases? Is the stock market, or parts of it, such as technology, in a bubble? Is the bond market?</b></p> <p><b>Ezrati:</b>&nbsp;As far as the U.S. stock market goes, it’s near new highs, but price-to-earnings [P/E] multiples are about where they’ve been over the past 35 years. Relative to cash and relative to bonds, the market looks cheap. So I don’t see where the BIS is getting the idea that the market is irrational, euphoric, or disconnected from fundamentals.</p> <p><b>Brown:</b>&nbsp;As for bonds, I think we’re far from a bubble in most categories, with the exception of Treasuries. Treasury securities really are priced too high. They’re artificially low in yields because of the Fed’s zero-interest rate policy and because of quantitative easing. So relative to inflation and relative to our economic growth, they are too low.</p> <p>But yield spreads on investment-grade bonds relative to Treasuries are wider than average. In the high-yield market, spreads are narrower than average, but at 500 basis points [bps] [as of September 30, 2014; all yield spread data is from Bloomberg, unless otherwise noted], they are a far cry from the previous low, which was 270 bps. So, are bonds in a bubble? No. The only category that appears to be overpriced is Treasuries, and the Fed is in the process of letting the air out of that market by ending its quantitative-easing program.</p> <p>As for stocks, Strategas Research has pointed out that profit margins are continuing to expand. This means that even in our current slow-growth economy, the market could produce a reasonable return. If nominal GDP grows by about 4%, if overseas earnings grow, and if companies continue to buy back shares, the market could produce a return in the mid to high single digits. That’s even if P/E multiples don’t rise. So even if we get that kind of return over the next 12 months, it would be hard to characterize a market like this—which continues to rise, but only enough to keep up with increased earnings—as being in a bubble.</p> <p>By the way, as Milton has pointed out in the past, corporate profit margins have been high because of operating leverage. In the wake of the financial crisis, businesses invested a lot in equipment and machinery, so they now have higher fixed costs than in the past. That means that once sales are high enough to cover those fixed costs, any additional sales that occur primarily have to cover variable costs, so the bulk of those revenues go to the bottom line.</p> <p>As for the BIS, it could be that its statements are being driven by an agenda. The BIS is an organization of central bankers, so they may be trying to send a message that fiscal policy needs to change and structural reforms are needed. In other words, monetary policy cannot solve the economic problems in developed markets.&nbsp;</p> <p><b>Ezrati:</b>&nbsp;The other thing to note is that the economy is still operating at less than 80% capacity, so that suggests there’s room for even more operating leverage.</p> <p><b>Brown:</b>&nbsp;The bond market in Europe, on the other hand, is another story. I think that’s pretty dangerous, given the possibility of negative economic growth. Yields in the high-yield market are almost 100 bps lower than they are here. That’s where there is really some risk. An economic slowdown could result in a lot of bankruptcies and a significant loss of principal.</p> <p><b>Ezrati:</b>&nbsp;Europe faces the possibility of deflation, so the low nominal yields may be sustainable, but in a deflationary economy the outstanding debt becomes larger and larger relative to the rest of the economy, so it becomes a greater burden for countries that are already overburdened with debt.</p> <p>The strategy that the ECB has been using to combat deflation is coming unwrapped. Although the bank has lowered interest rates, it has, in effect, raised real [inflation-adjusted] interest rates. Two years ago, the benchmark rate was 1.5% and inflation was 2.5%, so the real rate was -1% [1.5%-2.5%=-1.0%].&nbsp; Today, the benchmark interest rate is 0.15% and inflation is .30%, which means that the real rate is -0.15%. That means that the ECB has raised the real interest rate from -1.0% to -0.15%, or 85 bps [-1.00-(-0.15) =-0.85] over the past two years.</p> <p><b>Brown:</b> What is needed is some kind of policy to provoke growth or labor market reform to make the eurozone more competitive internationally. But there is no effort underway to make the necessary reforms, so the prospects of the eurozone turning around anytime soon are pretty minimal.</p> <p><b>Ezrati:</b>&nbsp;Italy was making an effort a few years ago under then-Prime Minister Mario Monti, and today Prime Minister Matteo Renzi is talking about reform, but nothing is happening. In France, it seems that whatever concessions the government gives with one hand, it takes away with the other. So it might provide relief for corporations by reducing employment-related taxes, but make that up by increasing the value-added tax. So, in effect, there’s no relief in taxes, just a shift.</p> <p>The other thing they do in Europe is subsidize inefficient factories in order to keep people working. According to <i>The Wall Street Journal</i>, there’s a refinery in Sicily that has lost €10 billion over the last five years. Demand for refined petroleum products is down 30% since 2006, but the company is not allowed to close the refinery. The article also mentioned that Italy also recently gave tax breaks to Electrolux, the appliance maker, to keep factories open that Electrolux wants to close. Last year, Bloomberg reported that if auto production capacity in Europe matched to demand, 18 auto plants would be closed. That’s one reason Europe has deflation—because they’ve got this glut of products.</p> <p><b>Q. Easy money has led to troubling debt levels, especially in emerging markets [EM], according to the BIS, and these markets are much bigger today than when the Asian crisis hit in the late 1990s. China, in particular, has had a boom in consumer lending for the past five years. How much of a threat is EM debt?</b></p> <p><b>Ezrati:</b>&nbsp;In the 1990s, one of the things that hurt emerging markets was that all their debt was in U.S. dollars. So, when their currencies depreciated, they couldn’t repay it. Today, much of the sovereign debt, at least, is in local currencies.</p> <p><b>Brown:</b>&nbsp;Corporate debt is still largely in dollars, however. In places like Brazil, which was growing very rapidly a few years ago, a lot of companies issued debt to finance huge expansions to expand their capacity and capitalize on the growth. But today, the Brazilian economy has slowed and the global economy has slowed. And, unfortunately, this debt is dollar-denominated, while their revenues are largely in Brazil’s currency, the real. At the time, issuing debt in dollars made sense because money could be raised quickly and at low rates.</p> <p>But now, with the dollar strengthening, the real is worth less and less, making debt payments for these companies more and more difficult. So there could be a rise in corporate defaults as a result.</p> <p><b>Ezrati:</b>&nbsp;They’re in the same boat that many Asian countries were in in the late 1990s.</p> <p><b>Brown:</b>&nbsp;The situation is China is different, but still pretty alarming. The property market accounts for between 20-30% of GDP, according to Bloomberg data, and sales and values have been falling. The <i>Wall Street Journal</i> reported that housing sales dropped nearly 11% in the first eight months of 2014, and prices fell more than 3% between April and September. The decline in prices may not sound like much, but the <i>Journal</i> said it’s about the same decline that occurred over a 10-month period in 2011-12. So, the decline this time has been more rapid.</p> <p>There’s not as much leverage in the housing market as we have here. Homebuyers will often make down payments of 30–50%, but this drop in home values means that consumers can’t act with the same level of confidence that they have in the past.</p> <p>Foreign direct investment has also declined for the first time in years. Manufacturing costs are higher now even relative to the United States. So, they don’t have the same cost advantage they had years ago. So, China may not achieve the 7.5% growth that they have targeted.</p> <p><b>Sharon:</b>&nbsp;There has been a large build-up of debt in many emerging economies since the financial crisis.&nbsp; In essence, as exports to the developed world slowed, many emerging economies, and China in particular, bridged the growth gap by substituting a credit-fueled economy for their export-led economies. As Milton said, at least this time the debt is mostly local, and with companies and individuals, not governments. But as we’ve seen in the past, these emerging market credit cycles always produced a bad-debt cycle at some point.</p> <p>China’s government has the wherewithal to take on the bad debt if necessary, but other emerging markets, such as South Africa, Indonesia, or Turkey, don’t have that luxury. We’ve already seen a few spectacular EM company debt blowups, and I suspect we’ll see more, especially in Eastern Europe, given the sanctions on Russia.</p> <p><b>Q. What are the investment implications of this slow-growth, loose money environment? &nbsp;</b></p> <p><b>Brown:</b>&nbsp;I think U.S. equities still have a reasonable chance to produce an 8–10% return over the next 12 months. And that probably will exceed any returns in any segment of the fixed-income market if the Fed is able to begin adjusting rates higher. Even high yield may not give you that kind of a return, because the coupon is around 625 bps [as of September 30, 2014], and with interest rates likely to rise, there will be some loss of principal.</p> <p><b>Ezrati:</b>&nbsp;On the equity side, among developed markets, I think the United States is preferable on a risk-adjusted basis, even though valuations are lower in Europe and Japan. On a risk-adjusted basis, I would still favor the United States because Japan has structural economic problems that they still have not dealt with. In Europe, they have the economic sluggishness that we’ve discussed here, and they’re not dealing with it. And I would add that Europe is closer to Ukraine and Japan is closer to North Korea.</p> <p><b>Brown:</b>&nbsp;So the threat of geopolitical risk is greater in those markets. But there are likely to be large exporting companies that are likely to get most of their revenues from outside Europe, and there may be opportunities among those companies.</p> <p><b>Ezrati: </b>From an asset allocation perspective, the U.S. stock market is more attractive, but from a stock-picking perspective, the more fertile fields may be in Europe and Japan.</p> <p><b>Sharon:</b>&nbsp;I agree with my colleagues, but I think the time to reenter the European markets may be early next year, when the ECB has given an “all-clear” signal as the new bank regulator in Europe. The nagging issue of European bank solvency will be, for all intents and purposes, closed; it won’t be viewed as a potentially systemic threat. By early next year, we’ll know what the level of liquidity and capital is in the system, and that will force the banks to get to the ECB’s desired level.&nbsp;</p> <p>The optimistic scenario would be that at the same time that we see more policies aimed at boosting economic growth and employment, and reducing austerity, that the depressing signals we now see in Europe will turn for the better. It will not be rapid, but the decline in the current market and in the currency could provide a nice entry point later for a potentially less bad 2015. That would surprise markets and make for reasonably good equity returns.</p> <p><b>Q. Thank you, gentlemen.</b></p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 27 Oct 2014 11:00:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-budget-how-is-spending-trending.htmlU.S. Budget: How Is Spending Trending?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>With the pivotal 2014 midterm election around the corner, here is the first of a two-part look at both sides of the U.S. budget. First up: Examining where U.S. taxpayers’ money actually goes—and whether current spending trends are sustainable.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>With the country set to elect a new Congress in just a few weeks and the 2016 presidential contest already in the news, this space aims, as a kind of public service, to look at who in the country pays for all Washington does and where Washington spends those funds. Perhaps the analysis will help readers, whether financial advisors or investors, pierce the fog and misinformation that inevitably accompanies election campaigns. To make what is a tsunami of data more digestible, this effort will come in two parts. This first number will take up spending, what Washington prefers to call outlays. It will show that without entitlements reform, virtually all the promises likely in the campaigns will be financially dubious. Next week’s discussion will look at the revenue side of the budget to see who supports the structure.</p> <p><b>Overview &nbsp;&nbsp;<br> </b>According to the president’s most recent budget,<sup>1</sup> overall federal spending is scheduled to rise 5.3% a year between fiscal 2014 and fiscal 2019. This is slightly faster than the 5.1% rate the White House expects for growth in the nominal gross domestic product (GDP). Accordingly, the White House estimates a modest rise in what the government takes from the economy. Federal spending, according to these estimates, will rise from 21.1% of GDP presently to 21.3% by the end of this period. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>Chances are that the government will end up taking a bigger share of the economy when all is said and done. There are at least two reasons. First, the White House’s economic growth projections lean toward the optimistic side. The administration expects real growth of 3.1% a year on average over these five years—a figure that exceeds the trends witnessed thus far in this recovery. Though an economic acceleration is possible, present signs hardly make it look likely. Nor do these projections admit to a recession, implying an unprecedented and unlikely recession-free 10-year stretch from 2009, when this recovery began, to 2019, the end date of the forecast period. Second, much of the projected budget savings comes out of defense (more on this below). With the fighting now in the Middle East as well as tensions with Russia, those cuts may not occur, and surely will fail to go as deep as the White House budget implies. &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>However much faster than GDP federal spending grows, the trend certainly fits with history. For more than 65 years now, government outlays have outpaced nominal GDP through both Republican and Democratic administrations and Congresses. They rose from 11.3% of GDP in 1948 to 20.6% in 1998, gaining on average slightly more than 0.2 percentage points of GDP a year throughout this time. The pattern broke briefly at the turn of the century, when the so-called “peace dividend” that came with the end of the Cold War slowed the pace of overall federal outlays below that of the overall economy and Washington’s spending fell three full percentage points of GDP, to 17.6% by 2001. Thereafter, the old pace of relative expansion resumed, in response to the continued expansion of the welfare state plus the Iraq and Afghan wars. Under both President Bush and President Obama, spending gained share of GDP by just about the historical pace of 0.2 percentage points a year. Applying this well-established trend to coming years would take federal spending up to a level more like 22.1% of GDP by 2019, well above the White House projection of 21.3%.</p> <p><b>The Big Pieces—Defense and Entitlements—Combined Are Almost 90% of All Outlays &nbsp; &nbsp; &nbsp; &nbsp;<br> </b>As already indicated, the White House expects savings from defense-spending cuts. It projects a 3.0% drop in Pentagon outlays each year between now and 2019. That would take the defense allocation from its current level of 3.6% of GDP (20.1% of the budget) to 2.6% of the GDP (16.2% of the budget) by 2019.&nbsp;</p> <p>Even before the recent trouble in the Middle East and Ukraine, this was an ambitious goal. To be sure, defense spending has trended down relatively for a long time. In the 1950s, even removing the effects of the Korean War, spending by the Pentagon averaged almost 10% of GDP and amounted to more than half of government spending. From the 1960s through the 1980s, it averaged more than 6.0% of GDP and about one-third of all federal spending. By the end of that decade, it was running about 4.5–5.0% of GDP. It did fall briefly below 3.0% of GDP between 1999 and 2001 because of the Cold War peace dividend, but picked right up again with the “War on Terror.” Even then, it came nowhere near earlier levels. For all the fuss made over the costs of war in Iraq and Afghanistan, defense outlays rose to a high of only 3.8% of GDP during that time and remained an historically small 20.1% of the budget. But even in the face of this gradual downtrend, it stretches credulity to expect the projected budgeted declines. Both past norms and geopolitical pressures conservatively point to spending about 0.5 percentage points of GDP higher than the White House projects in its budget, bringing it closer to 3.1% of GDP than the official 2.6% projection for 2019.</p> <p>White House expectations on entitlements spending are even less consistent with historical trends than are its expectations on defense. This broad category includes outlays on Social Security, Medicare, Medicaid, unemployment insurance, an array of smaller programs, and, looking forward, outlays required by the Affordable Care Act. Throughout this long history, spending on these items consistently has outpaced both the rest of the budget and the growth of GDP. At the end of World War II, for example, entitlements obligations about equaled defense spending, amounting to 3.4% of GDP and about 30.4% of the budget. By 1975, they had risen to almost 10.0% of GDP and almost half of all federal outlays—almost twice defense spending at the time. By the end of the century, such outlays were three times the size of the defense budget, amounting to about 60% of all federal spending and almost 11% of GDP. Even as the Iraq War shifted budget priorities, entitlements spending continued to rise faster than the economy, so that they now account for about 70% of all federal spending and just less than 15% of GDP—more than four times defense spending. In contradiction to these powerful trends, the White House projects little further relative growth to 2019—a dubiously optimistic outlook given this history and certainly anticipating the outlays connected to the Affordable Care Act.</p> <p><b>Interest &nbsp; &nbsp; &nbsp;<br> </b>On both these important counts, then, the White House spending estimates look low. Since combined defense and entitlements amount to almost 90% of all federal spending, their patterns effectively say it all for overall spending, which, given these observations, will likely end up absorbing two-plus percentage points more GDP than the White House suggests. On this basis, the economic burden of the federal government by 2019 would easily approach the high of 24.4% of GDP recorded during the 2009 economic emergency. But there is another element in the equation that might push up the figure even higher, and that is interest expense on the outstanding debt.</p> <p>In recent decades, interest expenses have tended to rise relentlessly because chronic deficits have added, equally relentlessly, to outstanding debt loads. Up until the late 1970s, however, manageable deficits and contained rises in interest rates kept these expenses from rising too much faster than GDP. In 1976, for instance, interest expenses amounted to only 1.5% of GDP and 7.2% of all federal spending. But by the early 1980s, expanding deficits and a spike in interest rates raised interest expenses briefly to more than 3.0% of GDP, and brought them up to fully 14.0% of all federal spending at the time. In the 1990s and earlier in this century, falling interest rates and more moderate deficits allowed this relative expense to fall toward 1.7% of GDP by 2007. Despite huge deficits since then, very low interest rates have actually pushed down this expense item. In 2014, outlays for interest will likely amount to only 0.8% of GDP (6.1% of all federal spending.) Looking forward, however, it is apparent that this relief cannot last. Deficits, though reduced from a few years ago, remain historically large, and rates, if the Federal Reserve is to be believed, are scheduled to rise.</p> <p>Anticipating this effect, the White House’s interest-rate projections are not unreasonable. The president’s budget assumes that 91-day Treasury bill rates will rise from about zero today to 1.2% on average in 2016 and 3.6% by 2019. It projects that 10-year Treasury note yields will rise 140 basis points from present levels, to 4.0% by 2016 and another 70 basis points to 4.7% in 2019. These increases push projected interest expenses from 1.7 percentage points of GDP to 2.5% by 2019 (11.6% of all federal outlays.) Of course, if other considerations—on defense and entitlements—turn out anywhere near accurate, deficits also will rise higher than the president’s budget projections, raising interest expenses more than expected in the budget, even if the White House has made an accurate interest rate forecast. On this basis, the expense from interest will likely rise to approach the 3.0% it averaged in the 1990s. Adding this difference into the mix should easily bring the overall economic burden of the federal government above the 2009 record of 24.4%.</p> <p><b>A Qualitative Conclusion<br> </b>For all the number crunching, either here or by the White House, it bears saying that such figuring is always slippery, especially five years out. But if the exercise cannot bear the precision people would like, there are at least three inescapable conclusions to draw from this work:</p> <p>&nbsp;&nbsp;&nbsp;&nbsp;1)&nbsp;&nbsp;Unless Washington turns away from more than 60 years of precedent and engages in entitlements reform, the relentless demands of these programs, already more than 70% of the entire budget, will burden the economy increasingly and dominate the budget still more going forward, squeezing out other government priorities.</p> <p>&nbsp;&nbsp;&nbsp;&nbsp;2)&nbsp;&nbsp;At one time, defense spending was large enough so that cuts there could offset the overall effect of the ever-growing entitlements expense. Because the Pentagon has fallen as a portion of the budget, savings there no longer offer the leverage on overall spending they once did, even if cuts were feasible, which, with the growth of global tensions, they are not.&nbsp;</p> <p>&nbsp;&nbsp;&nbsp;&nbsp;3) &nbsp;With the inevitable rise in interest expense on top of these effects, Washington will lose almost all flexibility with the rest of the budget. The programs that the election campaigns will describe and promise will be a chimera, in particular the plans for infrastructure refurbishing and research and development that make a regular return to prominence with each election cycle.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 27 Oct 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/life-cycle-or-lifestyle-fund-a-critical-investment-decision.htmlA Life-Cycle or Lifestyle Fund? A Critical Investment Decision<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Just because two people are the same age does not mean that they have the same investment needs or risk tolerances.&nbsp;&nbsp;</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The research is plain: Participants in 401(k) plans and retail investors generally seem determined to simplify their investment decision making. They have shown a preference for funds that diversify over a number of investment classes, managing, in a single purchase, to buy a mix of needed assets. There are a great variety of such funds, but they tend to come in two basic types: 1) those structured to the investors’ life cycle and 2) those structured to meet specific investor objectives and risk tolerances. The former, the life-cycle approach, is dominated by age-based funds. These combine assets—stocks, bonds, international investments, etc.—according to a set schedule based on the investor’s age and nearness to retirement. The latter, often called lifestyle or risk-based funds, aim to satisfy specific investment objectives and needs regardless of the investor’s age or nearness of retirement. While the life-cycle approach works for many, it carries certain rigidities that recommend the more flexible and individualized lifestyle approach.</p> <p><b>The Issue of Individuality<br> </b>Individuality is a critical consideration. Just because two people are the same age does not mean that they have the same investment needs or risk tolerances. A 38-year-old who has saved regularly for the prior 15 years has very different investment needs than another 38-year-old who has had some false starts in his career and has done very little saving. The late starter might want to make up for lost time and, accordingly, likely will seek a more aggressive investment portfolio than the first investor, who might well see a greater need to protect his nest egg and so prefer a more conservative approach. Despite such differences, life-cycle funds, guiding off age alone, treat these two investors in exactly the same way.&nbsp; Each might do better drawing in an array of lifestyle funds, with one opting for a more conservative and the other for a more aggressive asset mix.</p> <p><b>The Issue of Flexibility<br> </b>Yet life-cycle funds can rarely cope with life’s inevitable surprises. A divorce at 50, for example, might severely deplete what seemed like a secure investment nest egg, leaving its owner, despite his or her age, with a need to rebuild his or her asset base and, consequently, a concomitant need to take an aggressive investment posture. On the opposite side of the scale, a large inheritance at 40 might alter a person’s asset base sufficiently to turn all previous strategies on their head. An unexpected child or other dependant could similarly disrupt a person’s financial plans so that the prescribed age-based mix might not apply, might even suddenly seem counterproductive. Very unlike the life-cycle or age-based approach, an array of lifestyle funds would allow the investor to adjust strategy in response to such changes.</p> <p><b>Post-Retirement Issues<br> </b>Other problems with life-cycle funds can arise even after retirement. Unlike past generations, people retiring today plan to live for many years. At 65 years of age, for instance, the U.S. Census Bureau estimates in excess of 20 years of reasonable life expectancy. Over such an extended period, any investment should at least partially protect its owner from the ravages of inflation. Since many life-cycle funds roll assets into an annuity at the time of retirement, they may fail to offer such protections. A lifestyle approach, carefully selected, can, however, provide a measure of needed inflation protection over the years of retirement.</p> <p><b>A Coincidence of Interests<br> </b>In one other important respect, it is bewildering why any financial advisor would recommend a life-cycle or age-based investment. Because the approach effectively locks the investor into a preset schedule, the decision blocks any room for additional advice and so, in effect, puts the advisor out of a job. Beyond the selfish motives of an advisor, it also should be clear that there is good reason, from a client’s viewpoint, to pause before rolling into a life-cycle or age-based approach, with its lack of individuality and flexibility, and consider lifestyle funds in its place.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 20 Oct 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/europe-draghis-deflation-desperation.htmlEurope: Draghi's Deflation Desperation<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The specter of falling prices in the eurozone is making the ECB chief’s job even harder.</i><b></b></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The European Central Bank (ECB) faces a desperate situation. Remarkably low inflation is stealing its ability to ease the eurozone’s fiscal-financial strains and, consequently, its ability to buy time for the zone’s governments to implement desperately needed budgetary and economic reforms. If markets do not show it yet, the pressure of this crisis is intensifying on every front.</p> <p><b>The Problem and the Bank’s Response &nbsp; &nbsp;&nbsp;<br> </b>Economic reports from the eurozone are universally ugly. Germany’s economy, until now the major source of strength in the eurozone, declined during the second quarter. The Italian economy also declined. France, the zone’s second largest economy, has stagnated. Perhaps even more threatening than the prospect of a generalized recession are the inflation figures. Zone-wide prices have risen a mere 0.3% during the past 12 months, far below the 2.0% ideal identified by the ECB and perilously close to deflation, a frightening condition widely associated with Japan’s more than two decades of economic decline.<sup> 1</sup>&nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>Beyond such vague associations, deflation threatens a concrete policy problem. An element of inflation was always an essential part of the ECB’s efforts to resolve the crisis. Because rising price levels reduced the real value of outstanding debt, they put time on the side of relief. Outright deflation would actually make it an enemy by raising the real value of outstanding debt. Inflation also helped reduce real financing costs. Two years ago, for instance, zone-wide inflation of 2.5% cut that amount annually off the real burden of interest expenses. Combined with the then prevailing 1.5% benchmark short-term interest rate, this inflation effect actually took real financing costs into negative territory, to -1.0%, in fact. Now, though the ECB has decreased the benchmark interest rate to only 0.05%, inflation of only 0.3% does that much less to ease real financing costs, which, though still negative, have risen 0.75 percentage points to -0.25%. It is as if the ECB had tightened monetary policy.<sup>2</sup>&nbsp; &nbsp;&nbsp;</p> <p>Well aware of their predicament, policymakers at the ECB have turned to unconventional means in what looks like a desperate effort to continue some level of financial relief. Near zero-rate policies are themselves indicative, especially since the ECB until recently resisted such policies. The bank also has decided to stop paying commercial banks interest on reserves left idle with it and has begun to <i>charge</i> them, recently raising that cost to 0.2% a year. This novel, negative rate policy, they no doubt hope, will spur commercial banks to use their idle reserves for lending, stimulate economic activity, and help block any drift toward deflation. It might work, but it is hardly in the character of the old, conservative ECB. Still more, ECB president Mario Draghi announced that the bank would earmark close to €500 billion to buy asset-backed bonds in European financial markets and so channel funds directly to borrowers, again to stimulate economic activity and generate inflation instead of deflation. This quantitative easing, too, was something the bank had resisted. It speaks to how far the ECB has come, and to its desperation, that Germany’s Bundesbank has overtly criticized these policies.<sup>3</sup></p> <p><b>Deeper Problems</b>&nbsp;<br> Matters are that much more intense because few governments have used the past relief bought for them by the ECB to do much of anything to make their economies more dynamic, efficient, and competitive. It speaks to this problem that the deflationary threat itself has roots in the failure to reform. Had they proceeded with the kinds of changes pressed on them by the ECB and Germany, they would have long since dispensed with the subsidies they use to prop up inefficient and unprofitable operations and used the savings to offer tax relief to effective producers. But the taxes remain high, and these props remain in place. These unprofitable operations have, accordingly, glutted markets and driven down prices. Italy, for instance, has kept open a large Sicilian oil refinery even though it has accumulated €10 billion in operating losses during the last five years and the country uses 30% less gasoline than it did eight years ago. France and Italy have used subsidies to keep open 18 auto plants that also run losses. Italy still provides tax subsidies to keep open factories producing household appliance that the Swedish owner, Electrolux, has identified as unprofitable.<sup>4</sup>&nbsp; &nbsp; &nbsp;&nbsp;</p> <p>The picture looks bleak. Things seem poised to fly apart at any moment. They may well hold together for longer than seems possible, if only because people want them to do so. If Europe’s periphery now uses the remaining breathing room offered by the ECB’s redoubled efforts and implements needed reforms, this can yet work out. If, as it seems, these governments are determined to waste the opportunity, the eurozone looks scheduled for renewed upheaval.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 13 Oct 2014 09:55:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/stocks-priced-to-correction.htmlStocks: Priced to Correction?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Some market observers are worried that equities are overvalued and that a pullback is imminent. They shouldn’t be.&nbsp;</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>A short news item that reported marked improvement in retail investor sentiment seems to have created bearish feelings among several financial advisors. Helped by a pessimistic write-up in <i>Market Watch</i>’s<i> </i>“The Tell” column,<sup>1</sup> many took the news as a sign that stocks are overbought and so vulnerable to a correction. Equities, of course, are always vulnerable to correction, but a broader look, at the sentiment index<sup>2</sup> itself as well as most other indicators, belies this facile negative interpretation. On the contrary, equity valuations and prospects for continued, if slow, earnings growth suggest that the general equity rally should continue, albeit not at last year’s impressive pace.&nbsp;</p> <p>The reports that seem to have created this misplaced bearishness came out of the American Association of Individual Investors. Its sentiment index showed a nearly 40% jump in bullish feeling among retail investors as summer turned to fall. That has taken the index higher than it has averaged all year and higher than it averaged through much of 2013. Since enthusiasm about stocks tends to push up prices, often beyond the fundamentals, the concern, expressed in the column and by those financial advisors who have embraced its negative view, is entirely understandable. But before allowing a few data points to swing opinion, much less guide investment decisions, people, whether journalists or financial advisors, need to test such signals against other benchmarks. &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;</p> <p>Compared with its own recent past, this sentiment figure would hardly seem to signal danger. Though up, it is, after all, 10% below where it was briefly early in 2013.<sup>3</sup> Certainly, these higher figures hardly stopped equities from doing quite well. What is more, this recent sentiment figure is more than 13% below levels recorded late in 2010, and though equities have shown a lot of volatility since, they have risen impressively on balance. On these bases alone, investors have little reason to fear the recent uptick in bullish sentiment. On the contrary, it might actually help push up equities by freeing still substantial holdings of idle cash.&nbsp; &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;</p> <p>In the meantime, equity valuations still look attractive. Even with the upward price moves of recent years, earnings multiples today are hardly elevated from an historical perspective. They are, in fact, little different from their long-term averages, suggesting that even the most cautious investor would identify stocks as fairly valued, at worst, and so capable of at least tracking earnings, which are likely to rise even in this slow-growing economy. Relative to bonds and cash, stocks look better than fairly valued. This is no place to work through all the various metrics used in such comparisons, but they all tell pretty much the same story, one that is most easily outlined through a comparison of dividend yields and interest rates on cash. Today, cash pays little more than zero, while the S&amp;P 500<sup>®</sup> Index,<sup>4</sup> even after past gains, still pays a dividend yield of close to 2.0%. Historically, cash offers two percentage points <i>more</i> than the dividend yield on stocks, not the nearly 2.0% <i>less</i> it does now.<sup>5</sup>&nbsp;This tremendous difference from past patterns suggests not only that equities remain attractively valued but also that they can absorb a rise in interest rates before valuations even approach historical norms. &nbsp;&nbsp;&nbsp;&nbsp;</p> <p>On this basis, stocks would seem capable of increasing their multiples going forward and outpacing earnings. But even if multiples remain steady, this bearish worry is misplaced. To be sure, this slow recovery will keep earnings growth contained. Domestic revenues over the next 12 months, for instance, should about track the likely 4.5% rate of expansion in the nominal gross domestic product (GDP).<sup>6</sup>&nbsp;Since most of the corporations in the S&amp;P 500 earn a substantial amount overseas, many in emerging markets, overall revenues should outpace this figure slightly, bringing gross revenues up about 5–5.5%. With little pressure up or down on margins, gross earnings should rise at about this rate. Share buybacks, however, should push the per-share figure up faster. Presently, buybacks are running at a yearly rate of 2.5% of outstanding shares. Against that are exercised options and initial public offerings (IPOs). A reasonable net effect would likely reduce shares outstanding by some 0.5–1.0% over the next 12 months, bringing the per-share earnings growth to about 6.0%. With prices in a fairly valued market appreciating in tandem, investors, with the addition of the 2.0% dividend yield, could conservatively look for an 8.0% overall return from equities—not bad compared to investment alternatives and possibly better if still attractive valuations support a rise in multiples. &nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="legal"><sup>1</sup>&nbsp;William Watts, “Unloved No More?” Market Watch, August, 21, 2014.<br> <sup>2</sup>&nbsp;American Association of Individuals Investors Sentiment Survey, September 24, 2014<br> <sup>3</sup>&nbsp;Ibid.<br> <sup>4</sup>The S&amp;P 500<sup>®</sup>&nbsp;Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries. Indexes<b></b>are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.<b>&nbsp;</b><b>Past performance is no guarantee of future results.<br> </b><sup>5</sup>&nbsp;Data from Standard &amp; Poor’s.<br> <sup>6</sup>&nbsp;Data from Federal Reserve.</span></p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 6 Oct 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/how-might-stocks-take-a-hike.htmlHow Might Stocks Take a Hike?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Here's a look at what happened to equities during past periods when the Fed raised rates.&nbsp;</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Though the Federal Reserve continues to show extreme caution about rate increases, the expectation is that policy will move in that direction sometime next year. This prospect prompts a look here at how stocks have behaved during past such interest-rate moves and, by implication, how they might behave this next time. As is so often the case, the historical record is far from clear. Still, the patterns that do exist, amid other indicators, suggest little reason to abandon equities in anticipation of such a move, and within stocks, also suggest a bias toward growth and more economically sensitive sectors.</p> <p><b>When Rates Rose<br> </b>The available data permit a look at six times in the past when the Fed permitted a significant up move in short-term rates. Table 1 outlines these:</p> <p><span class="separator">&nbsp;</span></p> <p><b><span class="rte_txt_green">Table 1. Federal Reserve Rate Hikes</span></b></p> <table class=no_style border="1" cellspacing="0" cellpadding="2" width="570"> <tbody><tr><td width="186" valign="top"><p><b><br> <br> Periods of Increase</b></p> </td> <td width="84" valign="top"><p><b><br> <br> Low Rate</b></p> </td> <td width="90" valign="top"><p><b><br> <br> High Rate</b></p> </td> <td width="108" valign="top"><p><b><br> Total Move<br> (basis points)</b></p> </td> <td width="150" valign="top"><p><b>Monthly, <br> Rate of Increase<br> (basis points)</b></p> </td> </tr><tr><td width="186" valign="top"><p><b>1.&nbsp; Mar. 1972–Aug. 1974</b></p> </td> <td width="84" valign="top"><p>3.72%</p> </td> <td width="90" valign="top"><p>8.75%</p> </td> <td width="108" valign="top"><p>503bps</p> </td> <td width="150" valign="top"><p>21 bps</p> </td> </tr><tr><td width="186" valign="top"><p><b>2.&nbsp; April 1977–May 1981</b></p> </td> <td width="84" valign="top"><p>4.54</p> </td> <td width="90" valign="top"><p>16.29</p> </td> <td width="108" valign="top"><p>1075bps</p> </td> <td width="150" valign="top"><p>22 bps</p> </td> </tr><tr><td width="186" valign="top"><p><b>3.&nbsp; Oct. 1986–Mar. 1989</b></p> </td> <td width="84" valign="top"><p>5.18</p> </td> <td width="90" valign="top"><p>8.83</p> </td> <td width="108" valign="top"><p>365bps</p> </td> <td width="150" valign="top"><p>13 bps</p> </td> </tr><tr><td width="186" valign="top"><p><b>4.&nbsp; Sept. 1993–Jan. 1995</b></p> </td> <td width="84" valign="top"><p>2.96</p> </td> <td width="90" valign="top"><p>5.81</p> </td> <td width="108" valign="top"><p>285bps</p> </td> <td width="150" valign="top"><p>18 bps</p> </td> </tr><tr><td width="186" valign="top"><p><b>5.&nbsp; Oct. 1998–May 2000</b></p> </td> <td width="84" valign="top"><p>4.04</p> </td> <td width="90" valign="top"><p>5.92</p> </td> <td width="108" valign="top"><p>184bps</p> </td> <td width="150" valign="top"><p>10 bps</p> </td> </tr><tr><td width="186" valign="top"><p><b>6.&nbsp; Jan. 2004–Feb. 2007</b></p> </td> <td width="84" valign="top"><p>0.88</p> </td> <td width="90" valign="top"><p>5.03</p> </td> <td width="108" valign="top"><p>415bps</p> </td> <td width="150" valign="top"><p>11 bps</p> </td> </tr></tbody></table> <p><span class="legal">Source: Federal Reserve Board. A basis point is 1/100 of a percent.</span></p> <p><span class="separator">&nbsp;</span></p> <p><b>Overall Market &nbsp; &nbsp; &nbsp; &nbsp;<br> </b>If this history is any guide, the prospect of rising rates should hold no fear for equity investors, at least not initially. Though stocks (as measured by the S&amp;P 500<sup>®</sup> Index<sup>1</sup>) often suffer a sharp drop when rates first begin to rise, such setbacks usually dissipate quickly, no doubt because the Fed tends to push up rates when the economy and earnings are growing. The figures vary so much from one instance to the next that averages would be meaningless. But it is well documented that stocks in the past have provided positive total returns on balance for at least four quarters or more after rates begin to rise (other time periods may have been negative). The danger for equities emerges later in the Fed’s tightening phase, no doubt because economic weakness and often recession typically result from the <i>cumulative</i> effect of the increases. Two of these six instances offer an even more encouraging exception. In the late 1980s and early 1990s, the up moves in equities persisted on balance throughout the period of rising rates.<sup>2</sup>&nbsp; &nbsp; &nbsp;&nbsp;</p> <p>If this record applies to the future—and there is every reason to believe it may—equities still have room to advance even as the Fed enacts its policy change. Reinforcing this expectation are the still-attractive valuations offered by equities and the prospect that economic growth, and so too earnings growth, though slow, should continue. In contemplating this likelihood of stock gains even after the Fed begins to raise rates, investors also would do well to remember that, according to the Fed’s own statements, the policy change likely will not begin until next year, leaving potentially more room for gains in the interim. &nbsp; &nbsp;</p> <p><b>Allocation Among Equities<br> </b>When it comes to decisions on style, the historical picture offers little guidance, at least on the surface. Value stocks outperformed growth stocks in the first three of these periods of rate increases, while growth outperformed value during the two instances of rising rates in the 1990s. In the most recent period of rate increase, between 2004 and 2007, value again outperformed growth. While this seems like a truly mixed bag, a look at what else was happening during these periods can provide some sense of order and also a reason that growth has the potential to outperform during this next round of rate increases. <i>[Although due to market volatility, the market may not perform in a similar manner in the future.]</i>&nbsp; In the 1970s, for example, inflation was an overriding consideration and with it a concern over the quality of earnings that drove investors to favor value over growth. In the first decade of this century, memories of the great tech and dot-com crash created a clear preference for value. Since neither of these matters seems likely to prevail this next time, growth would seem to benefit, especially since valuations now actually favor growth stocks.</p> <p>This record is hardly conclusive on questions of whether to favor small cap or large cap stocks. In the early 1970s, large caps outperformed small caps as rates rose, but in the late 1970s and 1980s, it was the other way around. During the period of rate increase in the early 1990s, large took the lead, but small bested in the late 1990s—hardly a surprise in the tech and dot-com craze that dominated the time. During the one period of rate increase in this century so far, small outperformed large. Given this less than conclusive picture, it would seem, then, that the best way to proceed is to achieve a broad diversification across capitalization ranges. Fairly consistent valuations across classes argue the same way.&nbsp;</p> <p>Sector mix, too, presents a muddled historical picture, at least on the surface. In these past periods of increasing rates, no one major industry either leads or lags. That fact should hardly surprise, given how many other influences on relative sector performance operate, whether in periods of rate increase or decrease.&nbsp;</p> <p>So, for example, technology was the best performing sector during the two periods when rates rose in the 1990s. It also was the best performing sector during the periods of rate decline in the 1990s. Unsurprisingly, technology performed relatively poorly during the only period of rate increase so far in this century, no doubt as a reaction to the tech bust of 2000–02. While technology did its lead and lag, utilities, which would seem to be the anti-tech sector, did surprisingly well during the period of rate increase in the late 1990s, but fell, even as other stocks rose, during the time when rates rose in the early 1990s. Even financials, seemingly most closely associated with interest rates, have shown an inconsistent performance record. They were, for instance, the second worst performing major sector during the period of rate increase in the early 1990s, but were right in the middle of the pack during the period of the rate increase in the late 1990s and during the period of rate increase from 2004 to 2007.&nbsp;</p> <p>Extrapolating from such a muddle of specifics, it would seem that more economically sensitive sectors have done better in these past periods of rate increase than have other sectors. This stands to reason, since the Fed tends to raise rates when the economy is expanding. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;</p> <p><b>The Inevitable Bullet Points<br> </b>From this historical analysis, it would seem, then, that investors, contemplating the Fed’s decision to begin raising rates some months from now, should be guided by these evident patterns:</p> <p>&nbsp;&nbsp;&nbsp;&nbsp;1. Equities have potential room to move up well into the period of increasing rate hikes.<br> &nbsp;&nbsp;&nbsp;&nbsp;2. Chances are that growth stocks could lead value stocks into the period of rate increase.<br> &nbsp;&nbsp;&nbsp;&nbsp;3. Capitalization is such an open question that it calls for a broad diversification on this count.<br> &nbsp;&nbsp;&nbsp;&nbsp;4. If it is impossible to pinpoint sector winners and losers from past periods of rate increases, the record would seem to favor those that are economically sensitive.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 29 Sep 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-budget-the-good-the-bad-and-the-ugly.htmlU.S. Budget: The Good, the Bad, and the Ugly<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>A report from the Congressional Budget Office forecasts shrinking deficits through 2015. After that, fiscal strains begin to emerge.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The Congressional Budget Office (CBO) has had another look at federal finances. Its forecast, though mostly a technical exercise, has nonetheless made clear the underlying budget difficulties facing this country. It tells of some short-term good news, such as shrinking deficits into 2015. It also highlights that over the longer term the country will have to engage in major entitlements reform or else it will not be able to avoid counterproductive tax hikes, expanding deficits, a squeeze on other aspects of the budget, or some combination of these ugly alternatives.&nbsp;</p> <p><b>The Immediate Outlook Looks Fairly Good</b><br> It appears, however, that the next 18 months likely will enjoy financial improvement. The CBO, relying on reasonable economic projections, looks for the federal budget deficit to shrink, from $680 billion in 2013 to $506 billion this year, to $469 billion in 2015—for a net decline of 31% over the next two years. Relative to the gross domestic product (GDP), this anticipated flow of red ink constitutes a major decline in the deficit, from 10.0% of the overall economy in 2009 and the 4.1% in 2013 to only 2.6% in 2015—lower even than the 3.1% of GDP the deficit has averaged over the last 40 years.<sup>1</sup> It is indeed an impressive improvement. &nbsp;&nbsp;</p> <p>Part of this picture reflects the CBO’s expectation of an annualized growth of 8.7% in revenues over 2014 and 2015. Though the CBO forecasts only 2.4% real economic growth a year and 1.7% inflation, revenues tend to outpace the nominal economy. Aside from the tax hikes, there are two other reasons: 1) the progressive tax code takes on average proportionally more from each additional dollar of personal income and 2) the farther the economy gets from the recessionary years, the fewer firms have past losses to write against their tax obligations. Accordingly, the CBO projects individual income tax receipts to rise 7.7% a year over the two-year period and corporate tax receipts to increase at a 19.2% rate. Payroll taxes, which otherwise miss either of these leveraged effects, nonetheless show a relatively strong 6.0% annual growth rate largely because a partial payroll tax holiday ended at the start of this year. &nbsp; &nbsp; &nbsp;</p> <p>The expected deficit decline also emerges from slower growth in outlays. The CBO projects an expansion of only 4.2% a year for the two years.&nbsp; Much reflects an expected 2.3% drop in defense outlays. Mandatory programs (as the CBO calls social spending)—such as Social Security, Medicare, Medicaid, the Affordable Care Act—will, the CBO expects, expand at an annual rate of 4.0%.&nbsp; An 11.3% annualized expansion in Medicaid, itself driven by the implementation of the Affordable Care Act, and a 4.8% annualized advance in outlays for Social Security are offset by a slowdown in outlays for income security programs—food stamps, welfare, unemployment, and related activities—to 4.4% a year. Here, the biggest difference comes from declines in unemployment compensation (down at about a 27% annualized rate) due in part to declines in the number of unemployed, but mostly because of the expiration of extended benefits starting in 2014.&nbsp;</p> <p><b>The Bad News Comes after 2015 &nbsp;</b><br> In contrast to this rosy picture, the CBO sees things deteriorating after 2015. Flows of red ink, it forecasts, will expand to $560 billion by 2018 and then go to $960 billion by 2024, an increase of 8.2% a year after 2015. Even in an expanding economy, that deficit growth will take the budget shortfall from 2.6% of GDP in 2015 to 3.6% in 2024. Though this CBO estimate is reasonable, these figures actually lean toward the optimistic side in large part because the office’s analysts assume that the economy avoids recession over that entire long stretch of time. Still, the CBO’s forecast of 2.4% a year real growth is far from overly optimistic. It is, in fact, lower than the long-term historical trend of more than 3.0% real growth a year on average.&nbsp;</p> <p>On this economic base, the CBO’s forecasts moderate revenues growth of 4.4% a year on average. It projects individual income tax receipts will grow at a 5.6% yearly rate, payroll taxes at a 4.1% rate, and corporate taxes at a 2.6% rate. Tax reform could, of course, change these figures radically, but the CBO, as a matter of policy, works on the assumption that the law remains steady over the entire forecasting horizon. It is, admittedly, an unrealistic assumption, but probably the only practical way to proceed, since potential changes are impossible to predict and including possibilities multiplies the potential outcomes infinitely.</p> <p>However one might cavil over the revenues projections, it is the outlays projections that cause the underlying deficit problem. The CBO expects so-called mandatory programs to rise at an annual rate of 5.1%. A portion of this rapid growth reflects the reasonable expectation that healthcare costs will rise.&nbsp; The lion’s share reflects the growing average age of the population that will enlarge Social Security rolls and multiply spending for Medicare. This longer period will, the CBO expects, experience an acceleration of outlays growth due to the full implementation of the Affordable Care Act, or, in the report’s words, the “expansion in federal healthcare programs.”&nbsp;</p> <p>The other spending pressure comes from rising financing costs. The CBO expects these to rise 13.7% a year over this longer period. To some extent, this surge reflects the cumulative effect of ongoing deficits on federal debt outstanding, but mostly it reflects the expectation that interest rates will rise.&nbsp; Because the Fed has made it clear that it will begin to raise rates only in 2015, this financing cost consideration has little impact in the near term. The longer term, however, is a different matter. The CBO anticipates that three-month Treasury bill rates will rise from nearly zero now to about 1.1% in 2016, to 3.5% by 2019, and then stay at that level for the remainder of the forecast horizon. It assumes that the 10-year Treasury yield will rise to 3.8% by 2019, where it likely will stay thereafter.</p> <p><b>The Crux of the Problem</b><br> Because both these major spending streams—social programs and interest costs—grow faster than revenues, the longer-term financial picture is unavoidably strained. The country, then, will engage in major entitlements reform or it will accept more burdensome taxes or larger deficits or Washington will squeeze the rest of the budget unmercifully. Even with the CBO assumption that defense spending grows at only 2.2% a year after 2015 and non-defense discretionary spending grows at an even slower pace, the deficits increase as a percentage of GDP. If the country faces a war, even a contained one, or wants to upgrade its infrastructure, the pressure will be that much greater. Since neither higher taxes nor entitlements reform looks likely, the prospects outlined so well by the CBO would seem to describe an absolute best-case deficit picture.</p> <hr class="separator_grey"> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 22 Sep 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-housing-inspecting-the-recovery.htmlU.S. Housing: Inspecting the Recovery<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Recent data give the impression of a rapid rebound in the sector, but a deeper look at the numbers suggests a more modest upturn.</i><i></i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p style="font-size: 12px;">July brought signs of a surge in housing. There is a good chance now that Wall Street, and many official bodies in Washington, will run with the numbers and forecast a stronger recovery than previously. They frequently do run with the most recent set of data. But, as is the case almost as frequently, they would make a mistake to do so now. Apart from the tendency of the data to vary randomly from month to month, the underlying housing situation suggests that such strength will fade and will instead conform to the slower pace of recovery otherwise evident in the unfolding cyclical trends.</p> <p><b style="font-size: 12px;">Most of the Recent Releases Do Look Strong<br> </b><span style="font-size: 12px;">If the numbers were not universally strong, on balance they surely surprised on the high side. The Commerce Department reported that new housing starts jumped a remarkable 15.7% in July alone.</span>&nbsp;<span style="font-size: 12px;">That is 475.4% at an annual rate, clearly unsustainable. Permits issued for new houses rose 8.6% for the month. Sales of new homes fell 2.4% in July, but they had already seen a tremendous surge earlier in spring that had taken them up at a 20.2% annual rate. Meanwhile, the National Association of Realtors (NAR) indicated a 2.4% jump in the sales of existing homes in July, 32.9% at an annual rate. The popular Case-Shiller housing price index arrives with too much of a lag to have much relevance for such a current accounting, but the NAR, reporting on a more timely schedule, indicates that prices for existing homes rose at a 5.0% annual rate between June and July. This figure is also entirely consistent with the 5.0% home price advance over the past year. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;</span></p> <p style="font-size: 12px;">The detail in these reports was short of universally upbeat, but generally it, too, confirmed the picture of strength. Starts of new homes were particularly strong in multi-unit structures, rising 33.0% in July. Builders broke ground on 8.3% more single-family structures in the month, an impressive figure by itself.&nbsp; Permits issued in July for future construction were a bit less impressive, but still upbeat. Those for multi-family units rose 23.6%, and permits to build single-family units rose at an 11.3% annual rate. And the increases were pretty much across all regions of the country. The best showing was for starts of single-family structures in the Northeast. These rose an astounding 44.0% from one month to the next, also clearly unsustainable. Only the Midwest showed a decline, but that came after a surge in June that saw a 12.5% jump in starts and a 7.8% jump in permits. Sales of existing homes were equally widespread. &nbsp;</p> <p style="font-size: 12px;"><b>Not as Good as It Looks &nbsp;<br> </b>It would premise quite an acceleration in the recovery if such trends were to persist. It also would add an element of fear, since such a breakneck pace of construction would soon lead to excesses and then to a difficult correction. But neither the promise nor the fear is well placed. These recent figures have much that is transitory about them, and the fundamentals point to a much slower pace of advance.</p> <p style="font-size: 12px;">There are still elements, even in these July figures, of catch-up from the setbacks imposed by an inordinately severe winter weather earlier in the year. Because of the winter setback, housing starts in June were still almost 9% below their level of the previous December. It is only natural, then, that July would experience a surge as builders try to regain the lost ground. Similarly, sales of existing homes had fallen at an almost 12.5% annual rate between last December and last April, leaving ample room for an above-trend recovery into July. This pattern may well continue for another month or two, but once the down/up ride imposed by weather passes, the less impressive underlying trend should prevail. And here there is good reason to expect only a modest uptrend in sales and perhaps even a correction in starts.&nbsp;</p> <p style="font-size: 12px;"><b>Reason to Look for a More Modest Advance<br> </b>Crucial is the slow pace of family formation. Housing sales invariably and closely follow family formation. The problem today is the slow pace of jobs growth in this recovery. Though net payroll expansion has picked up late, to more than a 200,000 monthly rate, that figure still trails the standard of past recoveries, when net payrolls grew by more than 300,000 a month. With jobs relatively scarce, especially good-paying, full-time positions, people are delaying that crucial step to form a family that, historically, leads to home purchases. Of late, the Census Bureau estimates net household formation has averaged some 300,000 a year, a far cry from the 1.7 million averaged earlier in the century. With little room to expect a pickup in jobs growth (see <i>Economic Insights, </i>“<a href="/content/lordabbett/en/perspectives/economicinsights/jobs-recovery-half-speed-ahead.html">Jobs Recovery: Half Speed Ahead</a>,” July 28, 2014), it is unlikely that family formation will accelerate markedly and, so, also sales of either new or existing homes.</p> <p style="font-size: 12px;">Costs and credit also factor into the picture. With mortgage rates up, albeit marginally, and modest advances in real estate prices, home purchases are not as affordable as they once were. The NAR publishes an affordability index. It compares the average household incomes to the cost of supporting a mortgage on the average home. It shows an almost 9.0% drop in affordability from a year ago and an almost 22% drop from the best figures back in 2012. To be sure, housing is still more affordable than at almost any time in the early years of this century or the 1990s, but this recent deterioration should keep a lid on the pace of any future sales growth—so also will the continuing reluctance of lenders. They have of late become easier about lending for residential real estate. Up until this year, they were still cutting back on such loans. But even this year’s expansion shows only a 5.1% annual rate of increase. The ongoing, if slightly less intense caution exhibited by lenders should continue to make it difficult for many potential buyers to get mortgage loans. &nbsp; &nbsp; &nbsp;</p> <p style="font-size: 12px;">If home sales promise to advance along only a modestly rising path, construction looks primed for a correction. Housing starts rose some 22% during the past 12 months, including the July surge, but sales of new homes have risen only 12.3%, barely over half as fast, while sales of existing homes during the past year have actually fallen slightly. This kind of disparity between construction and sales is not likely to last. Builders are clearly banking on a sales acceleration, either explicitly and implicitly. The inventory of new homes speaks to this bet. As of July, six months’ supply of completed homes stood waiting for buyers, far less, of course, than during the dark days of the housing burst, but 22% more than existed late last year. This figure seems set to expand as builders complete all the starts recorded of late. At some future date, probably this fall or winter, builders may well pause, especially if, as is likely, the growth of sales holds to the expected slow pace. Then construction will likely first fall outright for a month or two and then fall into line with the modest pace of sales growth.</p> <p style="font-size: 12px;"><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 15 Sep 2014 09:45:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/the-feds-labor-pains.htmlThe Fed's Labor Pains<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The central bank’s tricky task is to identify the right labor-market signals on which to base its policy decisions.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Federal Reserve chairwoman Janet Yellen has made it clear in her testimony: monetary policy will respond to the state of labor markets. She also has made it clear that no single jobs measure will move the Fed.<sup>1 </sup>Policymakers will respond to an array of indicators to get a complete picture. Without access to the Fed’s closed meetings or Chairwoman Yellen’s private thoughts, it is impossible to know exactly what mix of indicators the Fed is using or how it is using them, but it is possible to offer perspective on the array of available measures.</p> <p><b>The Unemployment Rate<br> </b>The headline unemployment rate receives much attention. It is, however, often misleading, as Yellen pointed out in her recent congressional testimony, though using typically guarded language. The problem with the measure is that it counts only those looking for work as unemployed and then states that count as a percentage of the workforce, those at work plus those looking. If people get frustrated with the search and cease the effort, that hardly speaks well of the labor situation, but they do not count in the calculation. The rate, then, can give a false picture of reality. &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>That certainly is what has happened recently. This official gauge of unemployment has fallen, from 7.3% of the workforce a year ago to 6.2% recently.<sup>2</sup> In this calculation, however, the actual number of people at work or seeking work has barely increased. Since the nation’s working-age population has grown during this time, it seems clear that an increasing number of people have ceased looking for work or, perhaps, decided not to start. Put another way, participation of people in the workforce has dropped, from 63.4% of the civilian population, in fact, to 62.9%. Little wonder, then, that the very modest 1.4% increase in employment had such an outsized influence on the overall unemployment rate. Matters look much different when the Labor Department adds into the calculation those discouraged workers, those working part time for economic reasons, and, in the department’s words, those “marginally attached to the labor force.” After these adjustments, the combined measure of unemployment and underemployment comes to 12.2% of the workforce, down from 13.9% a year ago, but hardly the stuff that would get the Fed to cease worrying over the jobs situation and change policy.</p> <p><b>Payrolls &nbsp;<br> </b>This indicator is more stable than the unemployment rate. Aside from the perspective it offers, the Fed no doubt also values it because it is truly independent of the unemployment rate. Whereas the Labor Department develops the unemployment rate from a monthly survey of households, this figure comes from data provided by businesses. The payrolls data are, however, not without flaws. Because it is more difficult to get timely information from small businesses than large, the directions taken by those larger employers tend to dominate current payroll figures. The Labor Department uses estimates to bridge this gap, but these can either overstate or understate reality, especially when employment trends in large and small businesses diverge, which they frequently do. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>Payroll data do point to a marginally improved picture. During the past 12 months, net additions to payrolls have averaged 214,000 a month. That is up from 194,300 a month in 2013 and 186,300 in 2012. But such improvements, welcome as they are, are not likely on their own to move the Fed. Its policymakers are well aware how weak even these recent gains look compared with past cyclical recoveries, when payrolls grew typically by more than 300,000 a month, even decades ago when the economy and the labor force were smaller than they are today. The Fed also is well aware that total payroll employment only just recently surpassed its previous peak from six and a half years ago. The Fed knows that past recoveries have made much faster progress than this. Surely, the Fed wants further gains before it is willing to declare labor markets healthy and act on that judgment. No one at the Fed will, of course, say how much net gain will make policymakers comfortable, but it surely exceeds the 0.5% by which most recent total employment figure exceeds that distant past peak.</p> <p><b>Still More Data &nbsp; &nbsp; &nbsp;<br> </b>If past Fed commentary is any indicator, monetary policymakers also are concerned about the mix of employment, in particular how much is full time and secure. The Fed will, as a consequence, also likely include in its deliberations a consideration of Labor Department statistics on part-time employment. Here, too, the figures suggest a while before anyone would judge the jobs situation healthy. Part-time jobs today constitute almost 5.5% of all jobs, down from a whopping 6.9% at the depths of the Great Recession in 2008–09, but still a bigger portion of the whole than in any other recovery. Indeed, today’s improved figure is still worse than the worst recorded in most past recessions. In all likelihood, the Fed will want to see considerably more progress here before it moves decisively to change policy. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p>Other gauges that may well find their way into Fed deliberations include average weekly hours, particularly overtime, especially in concert with weekly earnings. Policymakers know that they must change policy before an inflationary wage momentum takes hold. If they do not, they will have to overcome, not just forestall, a difficult trend. But they also know that weekly wage figures reflect overtime, especially among hourly manufacturing workers who earn time and a half for weekly work above 40 hours. Policymakers will strive to distinguish such wage effects from anything more fundamental and so inflationary. In the past year, as overtime has increased 6.3% and the average workweek overall has increased 0.3%, weekly wages have increased 2.4%. Such a combination of events implies no underlying, inflationary wage pressure. If, however, overtime or the average workweek were to stabilize or drop and weekly wage gains were to accelerate, even modestly, it would signal the Fed that competition for workers was picking up and that policy should perhaps turn in a less supportive direction. &nbsp; &nbsp; &nbsp;</p> <p><b>A Final Word<br> </b>No doubt the Fed will rely on still other data points to form its picture of labor markets and determine when they warrant policy modification. This brief review of some likely influences should nonetheless give a sense of the more general picture the Fed has painted of its plans. Its policymakers will avoid a single gauge and instead will weigh one indicator against another, taking account of each measure’s inadequacies to form their picture of labor markets and, from that complex analysis, steer policy.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 8 Sep 2014 10:30:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/state-and-local-governments-outpace-the-feds.htmlState and Local Governments Outpace the Feds<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The fiscal health of state and local governments appears robust when compared with that of the federal government.</i><b></b></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>State and local government finances appear to have stabilized. No one could describe them as sound, in aggregate and certainly not in certain particulars, but they have stabilized in general. The sector as a whole continues to run deficits, of course, and there are many pressure points on the expenditures side of state and local government budgets. But these governments have kept spending growth in line with revenues growth and, so, have contained the flow of red ink. There also is the likelihood of such continued relative stability going forward, even in the country’s slow-growth economic environment. This is good news, even with all the caveats. There are, however, longer-term concerns.</p> <p><b>A Look at Where We Have Been<br> </b>State and local government finances have faced a tough pull back from the great recession of 2008–09. Quite apart from the pension issues that have garnered so much media attention, those economic hard times hit state and local budgets from both sides. Revenues fell as the economic downturn dragged down just about every tax line item. Between the fourth quarter of 2007 and the second quarter of 2009, personal income tax receipts fell 7.2%, sales tax receipts fell 7.7%, and corporate tax receipts fell 24.4%. Ironically, given the real estate roots of the recession, the only revenue item to rise was property taxes, which expanded 6.1%, largely because these flows reflected prior strength.<sup>1</sup>&nbsp; &nbsp; &nbsp;</p> <p>Against this difficult shortfall in receipts, the recession produced outsized demands for spending on social services. State and local outlays in this area jumped 13.8% between the fourth quarter of 2007 and the third quarter of 2009, when this particular pressure began to ease. As a consequence, overall state and local expenditures expanded 10.4% during that time. It is hardly surprising, then, that state and local budget deficits rose, from an annual rate of $205.2 billion in the fourth quarter of 2007 to $377 billion by the middle of 2009, an 83.9% increase that raised the deficit, from 9.4% of total expenditures to 16%.</p> <p>Following the devastating effects of the recession, the sluggish nature of this recovery has capped the growth of state and local receipts since. Between mid-2009 and the end of 2012, those receipts grew only 10.1%, or a mere 2.8% a year. Like incomes throughout the economy, this pace of expansion barely exceeded inflation. The recovery did, however, enable state and local governments as a whole to regain control of their outlays. Though substandard by historical standards, the pace of economic growth slowed demands for social benefits, keeping growth in this expenditure line item to 2.7% a year. This moderation, plus budget cuts elsewhere, enabled governors, mayors, and local managers to hold the pace of overall spending to a mere 0.8% a year, thereby stemming the tide of red ink, so that by the close of 2012, state and local deficits as a whole equaled $269.1 billion a year, about 10.0% of overall expenditures.</p> <p>Since then, these governments have eased off a bit on their austerity efforts. Their receipts have continued to grow at the slow 2.8% annual pace they set earlier in the expansion. Because outlays for social benefits have continued to rise faster than revenues—at a 5.9% annual rate in fact—these governments have had to continue squeezing the rest of their budgets to contain the growth in total outlays to 2.5% a year. That figure is faster than earlier in the recovery, but still slow and close enough to revenues growth to have held back the annual flow of red ink, which, as of the first half of 2014, stood at $259.7 billion a year, a touch over 10.0% of total expenditures.</p> <p><b>Looking Forward &nbsp;<br> </b>For the time being—a horizon of two to three years—likelihoods favor a continuation of this contained trend. A slow-growing economy should promote some growth in state and local revenues, but, as during the past few years of recovery, not much faster than the rate of inflation. With little sign of an acceleration in the economy, there is little chance of revenue growth exceeding 3.0% by much. At the same time, the limited chance of recession removes much risk of an outright decline in revenues, certainly not on the scale that occurred during 2008–09. Given political pressure to sustain some budget control and concern about how investors would react to widening deficits, governments should also continue to manage the pace of growth in outlays at about the rate of revenues growth, keeping a lid on the growth of red ink to about 10–10.5% of total expenditures. &nbsp;</p> <p>Though this pattern can last for a while, it is, however, unsustainable over the longer term. Except in the unlikely event that the economy gets a whole lot better quickly, the pace of growth in spending on social benefits will continue to outstrip revenues growth, as it has so far in this sluggish recovery. The recent growth rate of 5.9% is entirely plausible. An improvement in the jobs market, even a modest improvement, would tend to slow the pace, but against that, the further implementation of the Affordable Care Act threatens to add to the figure. The longer this goes on, the harder time state and local governments will have squeezing other parts of their budgets to keep the overall pace of outlays growth in line with revenues. Unless, then, there is some action to address this pressure, state and local finances over the longer term will again come under renewed, severe pressure. &nbsp;</p> <p>There is another risk for the longer-term outlook, and that is a rise in interest rates. The budget burden of financing has fallen as a part of total outlays, from 8.3% at the end of 2009 to 7.8% recently. Part of the decline reflects the success state and local governments have had keeping a lid on the flow of red ink. Part of it also reflects the remarkably low level of interest rates during this time. Over the long term, however, interest rates are very likely to come under upward pressure. Because municipal yields and rates at present (though low by historical standards) are high relative to Treasury and corporate yields and rates, they likely will resist any initial up move in yields and rates generally. Eventually, however, they will succumb to any general move upward. When that happens, state and local governments will have to pay more for financing, burdening their budgets further. So, unless they can indefinitely squeeze those other parts of their budgets they have shortchanged since this recovery began—a doubtful possibility—their deficits will tend to rise. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;</p> <p>These pressures seem unavoidable. An economic acceleration could, of course, relieve the strain by accelerating the growth of state and local receipts; but, as indicated, that looks unlikely right now. The budget pressure on this more distant horizon will, doubtlessly, create a concomitant political pressure for further reform in state and local financing. Should that reform prove effective, it could improve finances over the longer term and the security of municipal bond investments with it. A failure to reform over this longer time horizon or ineffective reforms would make matters less secure. Even in this case, however, the fears of investment loss, which surely would accompany such pressure, will almost surely overstate the risk. Since most of these governments know how much future financing depends on a reliable discharge of their debt obligations, they will squeeze a good deal else in their budgets, including social benefits, to avoid reneging on their bond obligations in any way. &nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Tue, 2 Sep 2014 13:35:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/stocks-eyeing-the-ipo-boom.htmlStocks: Eyeing the IPO Boom<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>What does the sharp increase in initial public offerings signal about the stock market's valuation?</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The powerful increase in initial public offerings (IPOs) signals investors in two ways. The most conventional reading is that equity markets are beginning to approach full value. After all, firms come to market when they can get better prices. But at the same time, the nature, size, and particular causes of recent IPOs raise questions about any such general interpretation. For the time being, then, the picture conforms to the judgment made by Lord Abbett in this space and elsewhere that the market, though not as drop-dead gorgeous as it once was, is, nonetheless, still attractive.</p> <p><b>Powerful Momentum<br> </b>IPOs have always closely followed market pricing, falling in market retreats and rising as valuations get richer. During the market crash of 2008, for example, private firms saw little return to a public offering.&nbsp; Only 27 companies went public in the United States that year, 95% less than in 2000, when more than 500 companies went public. The number has picked up with market gains. In 2010, after the economy began its admittedly substandard recovery, 136 companies went public. In the first half of this year alone, though, the figure has jumped to 165. If this pace holds for the rest of the year, 2014 will record 330 IPOs, a 100% increase over last year.<sup>1</sup></p> <p>If this jump clearly shows confidence among investment bankers and business managers that the market is more fully priced than previously, it would go too far to attach a word like “exuberance” to their attitudes. After all, today’s volumes, though smartly up from last year and certainly from 2008, remain well below levels of the late 1990s and 2000, when words such as exuberance and overvaluation did indeed apply to equity investors and prices. Even if the first half pace continues and 2014 does see 330 IPOs, volumes would remain only two-thirds of the 500 IPOs recorded in 2000 and less than half the 724 IPOs averaged in the United States in 1996 and 1997. The enthusiasm, though becoming more evident, is nowhere near where it was when the market was clearly approaching an overvalued state.<sup>2</sup></p> <p><b>Nature and Causes Diminish the Implicit Warning, Too &nbsp;<br> </b>The clustering of recent IPOs also warns against generalized interpretations. More than half the offerings recorded this year so far have been in technology and biotech. These are areas noted by investors—and no less a personage than Federal Reserve chairperson Janet Yellen—wherein pricing clearly has exceeded fundamentals. It stands to reason, then, that biotech and tech companies would rush to cash in, or rather out, when they could get outsized prices. This skewing, however, suggests that such urgent pricing considerations are not so prevalent elsewhere.</p> <p>The capitalization mix of IPOs also suggests that something other than generalized pricing gains are driving the aggregate activity. Of the 165 IPOs recorded during the first half of the year, most leaned toward larger deals. Less than 7% were valued below $50 million, and only 22% were valued below $1.0 billion. This is a very different picture from periods of generalized IPO enthusiasm over high stock prices.&nbsp; Between 1991 and 1997, for instance, some 80% of the 3,000 IPOs recorded during that time were valued at less than $50 million.<sup>3</sup>&nbsp; Commenting on this situation in testimony before Congress some months ago, David Weild, former vice chairperson of NASDAQ, noted how the United States led the world in small-capitalization IPOs in the 1990s but, despite still having the worlds’ largest gross domestic product (GDP), the United States ranked twelfth for such offerings more recently.<sup>4</sup></p> <p>This relative lack of smaller-capitalization IPOs is stranger still when considering the likely effect of the 2012 JOBS Act. Noting that smaller firms are the economy’s key source of new employment, Congress passed this piece of legislation, formally titled the Jumpstart Our Business Startups Act, to channel more capital to smaller firms.&nbsp;</p> <p>The bill offers five basic concessions to those the act refers to as emerging growth companies (EGCs), that is, firms with less than $1.0 billion in annual revenues: 1) the act smooths the IPO “on ramp” (to use Washington’s fun language) by gradually phasing in required compliance measures over time; 2) it allows confidential submissions of IPO registration statements with the Securities Exchange Commission (SEC), presumably to give managements more flexibility in timing their offering; 3) it exempts such firms from many of the usual disclosure statements or scales in such requirements; 4) it lifts restrictions on so-called “test the waters” communications among firms and qualified institutional buyers (QIBs) and institutional accredited investors; and 5) it relaxes restrictions on research at the time of the IPO, effectively reversing many rules adopted after the dot-com bubble burst in the early 2000s.<sup>5</sup>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp;</p> <p><b>Meanings?<br> </b>With such support, it is little wonder that IPO volume picked up in 2013 and 2014. The wonder is that it did not pick up more dramatically and that such a relatively small percentage of those coming to market were EGCs. The general impression, then, is that this IPO surge differs from the sort that would otherwise signal an overvalued market—a more fully valued market than previously, to be sure, and one with pockets of overpricing, but not a sign yet of general overvaluation. Stocks, then, would seem to offer more upside. Investors should nonetheless watch IPOs for signs when there is a truly full valuation.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 25 Aug 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/currencies-can-the-dollar-stifle-the-yuan.htmlCurrencies: Can the Dollar Stifle the Yuan?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The greenback is in danger of losing its global reserve status to China's currency, according to some observers. That, however, is not likely to happen soon.</i><i></i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Recent news about how U.S. companies have increased their use of Chinese yuan has engendered renewed fears of China. In particular, the announcement has raised concerns that the yuan might soon displace the U.S. dollar as the world’s premier currency for international trade and banking, what economists refer to as the global reserve currency. This is not the first time such anxieties have emerged. But as in previous instances, today’s fears are far from grounded in reality. Whatever Beijing implies in its public statements, it neither wants its yuan to replace the dollar nor could it, even if China’s leadership wanted it to.<b><i></i></b></p> <p>Beijing’s rhetoric would seem to claim special status for the yuan already. Government spokesmen have promoted trading arrangements that bypass the dollar. They have frequently criticized Washington’s budget deficits as inappropriate for the government that issues the world’s reserve currency. China’s leaders on more than one occasion have advocated diversification away from the dollar at international gatherings, such as the G-20, the group of the world’s 20 largest trading nations. But if such complaints and positions are sincere on an aspirational level, the elevation of the yuan now is not at all practical.</p> <p>For one, it would threaten China’s prosperity. For years, China has promoted exports as a means to growth by keeping the yuan cheap to the dollar and the euro and so giving its products attractive prices in global markets. Because international status for the yuan, much less reserve currency status, would prompt nations and businesses to hold it in amounts far beyond the needs for trade, such a role for the yuan would tend to push up its value and thwart this strategy. China cannot have it both ways. It will continue to opt for exports and growth.&nbsp;</p> <p>Beijing would, of course, like to reorient its economy away from exports. As far back as 2005, a government paper acknowledged the limits of export-led growth and advocated that China rely more on domestic sources, particularly consumer spending. But this sort of transformation is far from easy and can only go slowly. Even now, the scholarly research estimates that some 30% of the country’s jobs depend directly or indirectly on exports, which account for an even greater percentage of its jobs growth.<sup>1</sup> For the foreseeable future, then, China likely will remain export dependent and unable to tolerate the rise in the yuan associated with reserve status.</p> <p>If China’s ongoing export strategy alone stands in the way of the yuan’s internationalization, one other thing will make Beijing balk. For a currency to achieve such status, its home country must offer broad, liquid financial markets in which the whole world can trade freely, both the currency and an array of financial instruments where domestic and foreign holders can place their yuan. Presently, China offers none of this. Instead, China’s financial markets are thin, rudimentary, and far from open to the world. In part, Beijing has resisted making the adjustment because open, fluid markets interfere with government control of the foreign exchange value of the yuan. They also interfere with Beijing’s still strong desire to control the flow of financial capital in China, something it can do much more effectively now through the government's complete dominance of state-owned banks.&nbsp;</p> <p>There is every reason to expect that at some distant future date the yuan will challenge the dollar. But that time will wait until China has reoriented its economy and no longer needs exports as a primary engine of growth. It also will wait until Beijing feels confident enough to relinquish the control it currently seeks in closed, narrow financial markets. When that time arrives, the yuan and the dollar may share the reserve role for an extended time, as the dollar and Britain’s pound sterling did for decades in the middle of the twentieth century. But all this is a long way off. In the interim, concern about the yuan supplanting the dollar is a distraction from real life. To be sure, much about the U.S. economy raises questions about the dollar’s qualifications as the world’s reserve currency. But right now, not much else has the credentials to replace it, the yuan in particular.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 18 Aug 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-economy-a-token-of-our-depreciation.htmlU.S. Economy: A Token of Our Depreciation<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>In previous recoveries, capital spending exceeded depreciation by 30–50%. The current level of around 20% suggests more sluggishness ahead.</i><i></i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Much discussion in this space has delved into the substandard nature of this recovery, the reasons for it, and why the pattern will likely continue. The analysis has identified a number of causes, in particular: 1) the legacy of fear left by the Great Recession and financial collapse of 2008–09, and 2) the lingering uncertainties imposed by complex legislation coming out of Washington, primarily the Affordable Care Act and the Dodd-Frank financial reform. (See <i>Economic Insights</i> of July 7, 2014, for an <a href="/content/lordabbett/en/perspectives/economicinsights/can-the-us-economy-regain-its-old-glory.html">overview</a>, June 23 for a focus on <a href="/content/lordabbett/en/perspectives/economicinsights/us-housing-a-slow-building-recovery.html">housing</a>, May 12 for a focus on the <a href="/content/lordabbett/en/perspectives/economicinsights/consumers-why-the-united-states-isnt-the-land-of-the-spree.html">consumer</a>, May 5 for a focus on <a href="/content/lordabbett/en/perspectives/economicinsights/capital-spending-why-caution-still-rules.html">capital spending</a>, and April 28 for a focus on <a href="/content/lordabbett/en/perspectives/economicinsights/a-slow-motion-us-jobs-recovery.html">jobs</a>.) This week’s discussion returns to capital spending, easily the most affected by these concerns, and documents in a different way how these forces have subdued the pace of recovery.<b><i></i></b></p> <p>The capital spending figures reported by the government and commented on endlessly in financial newsletters and the media all focus on current spending flows. Anyone operating a business, however, knows that the real pace of expansion also must consider rates of depreciation—from daily wear and tear, from obsolescence due to technological advances, and because price charges sometimes destroy the profitability of equipment and procedures, as when fuel cost increases render inefficient vehicles useless for business. When current spending flows fail to cover such depreciation, the economy’s productive capacity can actually shrink, however impressive the new spending figures might otherwise look. When they rise above this depreciation by a reasonable margin, the economy’s overall productive capacity expands.&nbsp;</p> <p>Comprehensive depreciation data only go back to 1983, but still that is enough time to tease out the usual cyclical pattern. In expansions, current capital spending flows typically tend to exceed depreciation by 30% to 50%.<sup>1</sup> In recessions, that margin typically shrinks. Thus during the mid-1980s, as the economy emerged from the severe recession at the beginning of that decade, gross spending on new capital equipment, premises, and intellectual capital exceeded depreciation by an average of some 44.5%, promoting a healthy expansion in the economy’s overall productive capacity as well as an upgrade that added to the productivity of workers, who, consequently, had that much more space in which to work, more and better equipment, greater amounts of computing power, and more innovative techniques at their disposal. The recession in the early 1990s dramatically slowed this rate of improvement. Current spending flows in 1991 and 1992 still exceeded depreciation, but only by about 22%. After the economy picked up in 1993, however, the excess in capital spending over depreciation widened again, to 44.3%, for the rest of the decade, just about the amount averaged in the 1980s.&nbsp;&nbsp;</p> <p>The pattern changed slightly in the early part of this century. Though the 2001 recession was mild by any standard, business came out of it more cautious than in the prior two decades. No doubt, the cloud of terrorism that arose at the time colored managers’ thinking. In 2003, current capital spending flows barely exceeded depreciation by 3.0%. As that recovery proceeded, however, business shed much of its fear and, subsequently, spending margins over depreciation again rose significantly. They were, however, not quite as robust as they were during the 1980s and 1990s. Between 2004 and 2007, for example, current spending flows exceeded depreciation by just about 30%—still a handsome enhancement to the nation’s productive facilities, equipment, and computing power.</p> <p>But the Great Recession of 2008–09 and other weights or economic aggressiveness have changed things radically. In 2009, business was so traumatized that it failed to spend enough even to replace depreciated facilities. In that year’s third quarter, when the recovery was said to have begun, American firms spent 13% less for capital goods and technology than they depreciated. For the year as a whole, actual spending fell 8% short of depreciation. In 2010, such spending barely kept up. Even as the recovery became more secure in 2011, or seemingly did, business’ timidity was still apparent. That year, it spent on new capital barely 13% more than it depreciated, and in 2012 and 2013, it spent barely 20% more. What data exist for 2014 is little different. This is a very different and much less robust picture than in the economy’s past. &nbsp;&nbsp;&nbsp;&nbsp;</p> <p>These outlines are of a piece with the other cyclical comparisons done in this space. It tells of a traumatized economy, from the legacy of the Great Recession, as well as the associated financial failures, and from the confusion emanating out of Washington. It also reinforces the conclusion that these retarding forces will change only slowly at best. Though the economy seems set to continue its expansion, matters look slated to proceed at no faster a pace than the substandard one of recent years.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 11 Aug 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/fed-hawk-eyes-inflation-prospects-and-rates.htmlA Fed Hawk Eyes Inflation Prospects and Rates<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>The Federal Reserve is right on schedule by taking its time—not too fast, not too slow.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Philadelphia Federal Reserve Bank president Charles Plosser has, it seems, become the leading hawk on the Federal Reserve Open Market Committee (FOMC). Since the FOMC sets the nation’s monetary policy, people pay close attention. And he has frightened many of late, saying, according to some popular interpretations, that the Federal Reserve will have to get going with unwinding its extremely easy monetary policy and raise interest rates sooner and perhaps more dramatically than is generally expected. But these fears are largely misplaced. Plosser is neither as radical as he seems in some media reports nor is the inflation situation such that it will likely move him or the rest of the FOMC to shift policy dramatically.</p> <p><b>Plosser Ain’t That Far Out<br> </b>Plosser has been described as the “north pole of hawks on inflation.”<sup> </sup>At that, it is easy to see why traders fear his influence. But if his rhetoric has a hawkish tone, what he says is not all that different from Chairperson Janet Yellen or the rest of the FOMC for that matter. Nor has he ever advocated a sudden change in policy.</p> <p>To be sure, throughout the entire period of extreme monetary ease, he has consistently sounded a cautionary note on inflation potentials. He was issuing such warnings as far back in 2011. But alerting his fellow policymakers and the investment community to longer-term risks is entirely different from advocating an immediate, radical policy change. Indeed, at no point did he say that the Fed should tighten immediately. He objected to the second and third phases of quantitative easing because he worried over the long-term consequences of enlarging the Fed’s balance sheet and the difficulties that would impose when it came time for the Fed to change course. But his was a dispute over technique, not the immediate direction of policy.</p> <p>Even his most recent statements suggest nothing about a sudden shift at the Fed. In, for instance, his June 24th talk to the Economic Club of New York, he mentioned the risk of inflation, but he couched it as a risk not a likelihood. He spoke less of the immediate future than in terms of “three to four years.”<sup>1</sup> That hardly contradicts Yellen’s indication of no rate increase until 2015. Also like Yellen and many others at the Fed, Plosser insists that any change in monetary policy will hinge on unfolding economic events. As he has made clear, he would wait to raise rates above today’s near-zero levels until unemployment drops considerably more <i>and</i> fundamental inflation trends run at or above 2% a year. This is little different than the general Fed line. He has said that the Fed will probably move on rates “sooner than people think,”<sup>2</sup> but that is more a response to his reading of market expectations than a statement that things will change tomorrow. Plosser senses that traders expect rates to stay low indefinitely. He wants them to know this expectation is misplaced. In this regard, too, he is little different from Yellen or former Fed chairman Ben Bernanke before her, both of whom have issued the same message through in slightly less strident language. As with them, it also is worth noting that Plosser’s warning says nothing about a rate increase tomorrow or even before 2015 for that matter.<sup>3</sup></p> <p><b>Inflation Aggregates Hardly Flash Danger Signals<br> </b>Recent readings of the Consumer Price Index (CPI) might raise inflation concerns. So far this year, the overall measure, which includes food and fuel, has risen at a 2.7% annual rate. If there were reason to expect such a pace to last, it would indeed be worrisome and would also challenge the Fed to alter policy soon. But that is hardly the case. The spring acceleration in overall inflation had its roots in clearly temporary surges on fuel and food prices. None of these are likely to continue at their recent pace. Both sorts of prices have, in fact, already begun to moderate. Still, more compelling is the moderate underlying trend. The Labor Department reports that the overall CPI rose 2.0% over the past 12 months, right at the Fed’s preferred level and slightly lower than the previous 12 months.<sup>4</sup>&nbsp; &nbsp; &nbsp;</p> <p>The Fed’s preferred inflation measure, the personal consumption deflator, offers an even less worrisome picture than that painted by the CPI. According to the Commerce Department, which collects and records the data, this index has increased so far this year at a slightly slower rate than the CPI, advancing at a 1.9% annual rate, pushed up, like the CPI, by temporary surges in food and fuel prices. A measure that excludes the effects of food and fuel pricing showed a more modest rate of increase during the two months. Longer-term trends leave even less sign of the kind of inflationary pressure Plosser and other Fed policy hawks fear. Over the past 12 months, the overall consumer price deflator increased only 1.7%, well under the Fed’s 2.0% preferred rate, and a measure that excludes the effect of food and fuel increased only 1.4%.<sup>5 </sup>Neither is a cause for concern.</p> <p><b>Nor Do Commodity Prices Give Much Cause for Concern<br> </b>Commodity prices, often identified as an early warning of a generalized inflation, give a mixed picture. They always do. On balance, they, too, hardly point to an imminent takeoff in inflation.</p> <p>Most concerning when it comes to inflation are oil prices. According to the New York Mercantile Exchange, the price of a barrel rose from about $92 at the start of the year to a high of $107 earlier in July, a 16% increase.<sup>6</sup> The jump reflected the basics of supply and demand less than the fears engendered by geopolitical tensions in Ukraine and in Iraq (See <i>Economic Insights, </i>July 21.) If these matters get out of hand, oil prices could rise higher, but if supplies from Russia and the Persian Gulf continue to flow, as they have, then prices could easily fall back to where they started this year or even lower. Indeed, largely because these situations seemed to have stabilized or, at the very least, not deteriorated any further, oil prices during the past few weeks have dropped back down below $102 a barrel, a 13% drop from their highs. An inflationary momentum from this source depends on a serious deterioration in the geopolitical situation, which, though possible, is hardly a basis on which to change monetary policy, certainly not preemptively.</p> <p>The other source of inflationary concern is meat prices. So far this year, they have risen at an astronomical rate.&nbsp; According to the Chicago Merchantile Exchange, feeder cattle, for instance, jumped almost 28% from year-end 2013 to highs earlier this spring. Lean hog prices rose more than 30% during this time. But promising future relief, wheat prices (after rising some 23% from the start of the year to April) have fallen steeply since then, so that prices year to date are actually down more than 7%. Corn prices have followed a still more dramatic pattern, shooting up and then turning down, falling year to date on balance by just less than 17%. And, indeed, meat prices already have begun to moderate. Feeder cattle and lean hog prices have each dropped about 3% during the last couple of weeks.<sup>7</sup></p> <p>Meanwhile, other commodity prices look reasonably moderate. Gold prices, often seen as a proxy for general expectations on inflation, have risen so far this year, gaining about 12%. But they remain more than 25% below their highs of late 2012. And gold is already off 2.0% since hitting recent highs earlier this spring. Industrial price indicators also offer a moderate picture. Copper prices, for instance, after falling with the weather-induced economic slowdown earlier in the year, have risen again more recently. They nonetheless remain below the levels at which they began the year. Lumber prices have followed a similar down and up pattern, but at present they remain more than 8.0% below the levels at which they began the year. The Dow Jones-UBS Overall Commodity Index, though up about 5.0% so far this year, has already dropped from its recent highs.<sup>8</sup></p> <p><b>Nor Do Wage Patterns Raise Any Inflationary Flags<br> </b>Wages, as Plosser is often at pains to explain, tend to lag. Still, they remain a crucial indicator of whether the Fed needs to worry about what economists call a wage-price spiral. This pattern, usually identified as the main source of any sustained inflationary momentum, is when wages rise to keep pace with expected inflation, forcing managements to pass through the costs in higher prices, causing those expectations to be realized, and, in the process, sustaining a general price advance. Here, too, there is little to no sign a dangerous inflationary pressure that might warrant an abrupt shift in monetary policy, including premature rate increases.</p> <p>So for this year, the Labor Department reports, hourly earnings of all employees have risen 1.2%, or 2.5% at an annual rate. Weekly earnings have increased 1.7%, or 3.4% at an annual rate. In itself, these figures would hardly send up an inflationary flag. After all, productivity has grown about 1.0% during the past year and has trended up at an even faster rate, suggesting little cost pressure in these wage gains, certainly none in excess of the Fed’s inflation preference. What is more, these earnings gains would have come in even lower were it not for the relatively heavy use of overtime. There is no sign here of even the beginnings of a wage-price spiral that might force the Fed’s hand on policy. Nor is this year very different from the recent past. Over the last two years, hourly earnings have risen at a 2.1% annual rate and weekly earnings have increased at a 2.2% annual rate. After accounting for productivity advances, costs are rising at a pace well below the 2.0% informally targeted by the Fed.<sup>9</sup></p> <p>Different industries exhibit considerable variation in wage gains. That, of course, is always the case. But there is no sign of a widespread acceleration that might create concern about a wage price spiral. Just using broad measures can give an indication. Weekly earnings in goods producing industries have risen at a 2.6% annual rate during the past two years and at a 3.3% annual rate so far this year, a slight acceleration but hardly enough to warrant a policy shift, especially because manufacturing productivity increased 2.3% during the past year, taking most of the cost sting out of such earnings increases. In services, weekly earnings have risen at a 2.0% annual rate in the past two years and at a 3.5% annual rate so far this year. This acceleration, too, implies only modest cost pressures and no hint of a wage-price spiral. A further acceleration could raise legitimate concerns in this regard, but that is nowhere in the data, certainly not yet.<sup>10</sup></p> <p><b>Pulling the Pieces Together &nbsp; &nbsp;&nbsp;<br> </b>To be sure, past extreme monetary ease engenders concern of ultimate inflationary pressure. It is why Plosser attracts so much attention in the financial community. Many there share his fears. But for all the reasonableness of such thinking, clearly little or nothing in today’s statistics point to an immediate realization of such concerns, certainly not enough to justify a sudden change in monetary policy. But if there is no pressing need for the Fed to deviate from plan, Plosser’s policy warnings are right in principle. Ultimately, the Fed will need to move away from its policies of extreme ease. It will have to do so before the inflationary momentum builds. The decision to taper quantitative easing and to end the program this fall is a part of this plan. So, too, is the Fed’s decision to begin to raise interest rates gradually next year and then go on overtime to normalize the Fed’s posture and its balance sheet. But all of this, whether described by Plosser, Yellen, or even the monetary doves on the FOMC, should unfold very gradually and, as the economic situation seems to demand, no sooner than scheduled.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 4 Aug 2014 09:40:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/jobs-recovery-half-speed-ahead.htmlJobs Recovery: Half-Speed Ahead<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>While nonfarm payrolls growth is improving, the pace still lags previous rebounds.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The jobs figures for June looked fairly good. The unemployment rate fell to 6.1% of the workforce, and non-farm payrolls expanded by 288,000 and across a broad front of industries and occupations. So far this year, the economy has created 1,385,000 new jobs.<sup>1</sup>&nbsp;President Obama was at particular pains to point out that payrolls have at last topped their former high from before the Great Recession. This is all welcome news, but it looks good only when set against subpar patterns made familiar in this otherwise substandard recovery. Perhaps the acceleration of the last few months signals a positive change. Yet it is hardly impressive by the standards of other recoveries, and nothing in the data suggests much better anytime soon. &nbsp;&nbsp;</p> <p><b>Overall Employment Picture<br> </b>Even on the surface, overall payroll growth tells this disappointing story. It has, after all, taken almost six and a half years for payrolls to recapture their former high. Table 1 reveals how painfully protracted this has been. The second column shows the time in each cycle required for payrolls to top their former employment highs. Of the 10 previous cyclical expansions since the end of the Second World War, the average comes to one year and 10 months. The worst performance other than the present recovery was earlier in this century, when it took the economy three years and 10 months to get back to the old highs, a wait that prompted the media to term that period as a “jobless recovery.” &nbsp; &nbsp;&nbsp;</p> <p><span class="separator">&nbsp;</span></p> <p><b><span class="rte_txt_green">Table 1. Total Payroll Gains in Past Cycles</span></b></p> <p><img src="/content/dam/lordabbett/en/images/articles/charts/JobsRecoveryTables%23114D82.png"></p> <p><span class="legal">Source: National Bureau of Economic Research and the Department of Labor.<br> *Annualized percent growth rate in payroll employment for the five years following the initial downturn or to the next cyclical peak, if it came within that five-year stretch.<br> <sup>+</sup>Because these cycles came one right after the other, the calculation on employment’s growth pace was made as if they were a single cycle, starting the calculation at the beginning of the first cycle.</span></p> <p><span class="separator">&nbsp;</span></p> <p>If this is an unpleasant picture, there is one piece of good news embedded in these current figures. During the last year and a half, payroll employment growth has proceeded at an annualized pace of 1.7%. That figure is about the average recorded during all the other cycles. It is encouraging to believe things are back on trend, even if such a pattern would promise no catch-up for the relative ground lost during the majority of this expansion. The last column in the table puts into even sharper relief the inadequacies of this recovery so far. It shows the annualized pace of employment growth in the first five years after the initial downturn (or until the next peak, if the entire recovery was shorter than five years). There is quite a bit of variation from one cycle to another. The average rate of jobs growth, for what it is worth in such a varied sample, equals about 1.6% a year. The worst performance before this recovery occurred in the first few years of this century, when jobs growth averaged only 0.5% a year for the five years of the calculation. But by today’s standards, that looks fairly good. This recovery is the only one that saw a drop in net employment growth over such a long stretch of time. Of course, the five-year measure only goes to January 2013. Since then, the economy has created more jobs, so that finally this June payrolls exceeded that past peak.</p> <p><b>Participation and Part Time<br> </b>The media and many market commentators have used other measures to characterize this recovery. In particular, they have made much about the extent of long-term unemployment as a sign of economic ill health. They have drawn a similar conclusion from the drop in the general participation in the workforce. This consensus would seem to be on the mark with its selection of unemployment duration, but when it comes to workforce participation, the population’s aging trend muddies the analysis and so, also, such simple conclusions.</p> <p>Long-term unemployment in this recovery is quite simply unprecedented. And the appropriate word is <i>recovery</i> not recession, because the troubling trend actually developed after the economy turned upward. Until this cycle, the highest the long-term unemployment (27 or more weeks) rate ever became as a percentage of total unemployment was 26.0%. That figure was recorded in June 1983, just after the economy’s late-1982 trough.&nbsp; Typically, the economy suffers this debilitating unemployment most in the early months of recovery, before the pickup in economic activity can have its effect on labor markets. But in this cycle, the figure reached new highs even before the downturn ended, when long-term unemployment rose to 23.1% of total unemployment in late 2008. The percentage touched 34.0% at the economic trough in June 2009, the month that the economy began its upturn, and then it continued to rise for <i>two years more</i>, far longer than in any past recovery. Ultimately, in September 2011, it reached levels of 45.0%, almost double the former high. It has edged down since, but even in the most recent report for June, long-term unemployment still averaged 32.9%, far higher than the worst ever reached previously. The decision to increase the duration of unemployment benefits clearly factored in here, but this pattern also testifies to the remarkable weakness of this recovery generally. &nbsp;</p> <p>The participation of people in the workforce has fallen off during this recovery, too. Labor Department figures put participation in the workforce of all those over 16 years of age at almost 66.4% in 2007 just before the Great Recession began. By the cyclical trough of June 2009, the figure had dropped to 65.7%, and has since fallen to 62.8%. Many point to this trend and describe armies of discouraged people who have given up the job search. There is no denying the large numbers of discouraged workers, but there is more at work here than just discouragement. Because the participation statistics count all those above the age of 16, the data are susceptible to distortion by the growing numbers of retirees in the population. This is no small effect. Since 2005, the proportion of the population over 65 years of age has increased by about a full percentage point, to more than 13%. That proportion is expected to continue to rise, according to the Census Bureau, toward 20% of the population in the next seven to 10 years. Though these trends have many economic implications, the participation figures reflect more than just the relative strength or weakness of the recovery. &nbsp;&nbsp;</p> <p><b>Part Time and Prospects<br> </b>The last major &quot;tell&quot; on this recovery’s substandard nature emerges from the relative growth of part-time employment. Here, the figures cannot be described as unprecedented, but they are nonetheless striking. Table 2 tells the story. It tracks temporary employment as a percentage of total employment in past economic cycles as well as in this one. There clearly is a lot of variation, but still a clear pattern. Part-time work rises as a percentage of all work in economic hard times and falls as the recovery gains momentum. This measure became particularly high in this recent recession, hitting 6.9% of all employment. But that was not a record. The all-time high of 7.6% was set during the 1982 recession. Matters have improved in this recovery, as they did in every other recovery, but they remain high. In the most recent accounting for June, the percentage of jobs that are part time stood at 5.4%, just equal to the record set during the recovery in the mid-1980s. &nbsp;</p> <p><span class="separator">&nbsp;</span></p> <p><b><span class="rte_txt_green">Table 2. Part-Time Workers as a Percent of All Workers</span></b></p> <p><img src="/content/dam/lordabbett/en/images/articles/charts/JobsRecoveryTables%23114D83.png"></p> <p><span class="legal">Source: National Bureau of Economic Research and the Department of Labor.<br> *Or at the next cyclical peak if it occurred sooner.<br> <sup>+</sup>Because the 1980 recession bled into the recession of 1981–82 recovery, this accounting ignores the 1980 trough and makes its calculations based on the 1982 trough.</span></p> <p><span class="separator">&nbsp;</span></p> <p>Prospects now, after so much disappointment, seem to offer little better than this substandard past. The influences that have kept this recovery slow remain largely in place. The detailed review in the July 7th <i>Economic Insights</i>, “<a href="/content/lordabbett/en/perspectives/economicinsights/can-the-us-economy-regain-its-old-glory.html" target="_blank">Can the U.S. Economy Regain Its Old Glory?</a>” revealed two basic considerations. One is the lasting effects of the Great Recession, which generally has dampened appetites for risk among business managers, bringing great caution in its train, especially regarding full-time staffing decisions. The other is the continued weight of the complex legislation that came out of Washington in 2010, most notably the Affordable Care Act and the Dodd-Frank financial reform law. Aside from whether these are good policies or bad, they introduced great uncertainty into business planning by obscuring future staffing and credit costs—a state that could not help but also subdue business’s willingness to hire, expand, or take risk generally. Since so much remains to be clarified about the legislation, it would seem that its ill effects on hiring will likely linger for some time yet to come. Time will heal the scarring from the Great Recession, but that, too, seems likely to occur only very gradually.&nbsp; Perhaps the return of payroll growth to trend betokens relief on this front, but it is too soon to declare an end to the disappointing patterns exhibited so far in this recovery.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 28 Jul 2014 08:55:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/the-euro-why-the-low-spirits.htmlThe Euro: Why the Low Spirits?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Here’s a look at the factors behind the common currency’s slump versus the U.S. dollar—and its prospects in the months to come. &nbsp;</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The euro has lost considerably to the dollar since spring. Most recently, the drop reflects the deep trouble at Portugal’s biggest bank, the Espirito Santo Group. But apart from this reminder of how tenuous the Continent’s financial balance is, the euro’s decline against the dollar has two, probably fundamental causes. One is the drop in rates and yields in Europe, by both market action and European Central Bank (ECB) policy. The other is the geopolitical risk generated by circumstances in Ukraine and Iraq, both of which have, at the margin, produced a preference for American assets rather than European assets. Since all these differences are likely to persist, the euro should continue to lose ground to the dollar for some time, though at a more subdued pace than recently.&nbsp;</p> <p><b>The Influence of Rates<br> </b>No doubt ECB rate policy has factored into the currency equation.<sup>1</sup>&nbsp; In just the last few weeks, the ECB has: 1) cut its main policy rate (the equivalent of the fed funds rate in the United States), from 0.25% to 0.15%; 2) cut the rate it charges on direct lending to banks (the equivalent of the discount rate in the United States), from 0.75% to 0.40%; and 3) for the first time ever brought its deposit rate—what it pays banks on reserves they leave at the ECB—into negative territory, a charge of 0.10% a year. Since this country’s dollar-based rates have stayed more or less steady through this time, these ECB moves have marginally increased the attractions of dollar-dominated paper, affecting flows and altering currency values accordingly. To be sure, the euro began to slide against the dollar before the ECB altered policy, but these moves were telegraphed by policymakers, including ECB president Mario Draghi, weeks before they were actually put in place, no doubt affecting decisions on the placement of even very short-term money flows.</p> <p>Movements at the longer end of the yield curve have had their independent effect. German government 10-year yields, for example, have dropped by almost 40 basis points (bps) during the past year, to about 1.3%, while yields on comparable bonds in the United States have risen slightly, to more than 2.6%. Yield spreads accordingly have widened by 50 bps in the dollar’s favor, to 130 bps. Perhaps even more significantly, investors, convinced it seems that Germany and the ECB would back bonds issued by Europe’s troubled periphery, have moved into Greek, Spanish, Italian, and Portuguese bonds, bringing down their yields, respectively, by 562 bps, 209 bps, 166 bps, and 388 bps. Some of these otherwise risky bonds now offer barely any premium over U.S. Treasury issues. Even the yield premium on Greek bonds, where fears of default and rescheduling were actively considered not too long ago, is comparable to junk corporates in the United States. It is then little wonder that investors have turned increasingly toward U.S. markets with a commensurately positive effect on the dollar relative to the euro.<sup>2</sup></p> <p><b>Geopolitics, Oil, and Bet Hedging &nbsp; &nbsp; &nbsp;<br> </b>The dangers implicit in Ukraine and Iraq have also factored into the pro-dollar equation. It is no coincidence that the latest slide in the euro began with Russian intervention, first in the Crimea and then in Ukraine’s eastern and southern provinces. On the simplest level, the dollar’s appeal rests on geography. The euro has suffered because the currency zone is closer to both Ukraine and Iraq than is the United States. But the matter is more complex than just geography. Both geopolitical touch points have much to do with oil, and there the dollar has the fracking revolution on its side.<sup>3</sup>&nbsp; &nbsp;</p> <p>The most immediate pressure, and no small consideration in currency moves, is Europe’s clear and direct dependence on Russian energy supplies, most of which pass through Ukraine. Estimates vary in aggregate, and certainly country by country, but a fair bet is that Europe as a whole depends on Russia for more than 30% of its oil and gas. That makes European economies and markets highly valuable to an interruption, whether because the Russians use oil as a weapon or because an enlarged civil war in Ukraine stops shipments. To be sure, oil is a global commodity. Troubles in Ukraine would force the Russians to find other buyers. The energy supplies immediately denied Europe would flow elsewhere into world markets. Ultimately, Europe could tap other sources freed up by this diverted Russian flow or tap the Russian flow indirectly. Such an ultimate remedy, however, would take a long while, quarters, maybe years. In that long hiatus, Europe’s economies and markets would suffer disproportionately, making the dollar preferable to the euro, certainly at the margin.<sup>4</sup>&nbsp;&nbsp;</p> <p>Iraq is a bigger threat. Though to date oil continues to flow despite all the fighting, the chaotic and highly uncertain situation in that country, and in the region generally, threatens to cut off substantial energy flows from a part of the world. In this case, the threat is not, as in the case of Ukraine, of an interruption in flows or a redirection. Rather, it is one of lost supplies, some 30% of world flows, according to the Energy Information Administration. Of course, that danger exists for the world’s economy, not just Europe’s. But in assessing relative vulnerabilities, investors and market participants in general cannot help but take account of the new supplies made available by the fracking revolution in the United States and the new technologies freeing oil from Canada’s tar sands. In the past five years, these have increased North American production from just over 10% of global supplies to more than 15%. Meanwhile, European production, mostly from the North Sea, has dropped from almost 5% of global output to less than 3%.<sup>5</sup></p> <p>While such risk considerations no doubt color investor preferences and, hence, relative currency movements, the fracking revolution also has had an impact on currency suppliers. Because of the growth of domestic energy sources, the United States imports considerably less oil than it once did, and so supplies commensurately fewer dollars to global markets. According to the Commerce Department, the U.S. international balance on petroleum products has improved by some 8.5% just since this time last year, or by some $20 billion—a supply of dollars that otherwise would have entered global currency markets. Of course, oil flows are not the only factor even in this immediate supply-demand equation. This country’s overall international balance has deteriorated by some 5%, or $12 billion, indicating that other aspects of this country’s international account more than offset the energy improvement. Still, pricing accounts for trends as well as outstanding supplies at each moment, leaving room for markets to price in an impact from this tendency from fracking to stem the net supply of dollars into world markets.&nbsp;</p> <p><b>Prospects<br> </b>Neither of these influences promises to go away any time soon. The ECB, worried about extremely low inflation and the threat of deflation, has all but promised future rate cuts and other forms of monetary support, such as quantitative easing. Against this picture, the Federal Reserve is tapering its own quantitative easing program. If it is unlikely to raise short-term rates anytime soon, all its rhetoric emphasizes a future need to do so.&nbsp; In such a milieu, short rates and long yields in the United States are hardly likely to fall. Risk-adjusted rates and yield differences seem set to continue to favor the dollar.</p> <p>To be sure, this rate equation would change if the eurozone were to experience deflation. Then the real value of the currency would rise as a matter of course, raising its attractiveness, much as Japan’s deflation raised international interest in the yen, at least for some purposes. But Europe has not yet experienced broad-based deflation. Even if it were to experience some deflation, it would take a while before market perceptions changed. In the meantime, these rate differences would hold sway and in the dollar’s favor.</p> <p>No doubt the euro would gain relatively were the world to enjoy a happy resolution of tensions in Ukraine or the Middle East. Though anything can happen, and such things are harder to predict than currency shifts, which are none too easy themselves, these problems seem very far from resolution. Instead, they show every sign of becoming still more complex and less tractable. Still, the initial impact has passed. Currency (and other) markets will almost certainly continue to weigh them in favor of dollar assets, as described. The marginal influence over time will, however, impel a more gradual price impact than during recent weeks and months, during which time markets have had to deal with the dawning fact of such problems.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="legal"><sup>1</sup> All data in this paragraph from the European Central Bank website, <a href="http://www.ecb.eu/">www.ecb.eu</a>.<br> <sup>2</sup> Data from the statistics pages of <i>The Wall Street Journal</i>, July 11, 2014.<br> <sup>3</sup> Data from the Energy Information Administration.<br> <sup>4</sup> Ibid.<br> <sup>5</sup> Data from the Department of Commerce.</span></p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 21 Jul 2014 09:17:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/oil-prices-fracking.htmlOil Prices: Fracking to the Rescue?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Rising domestic oil and gas production has held energy prices in check. But it could be a different story if Middle East supplies are severely disrupted.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>For now, it looks as though fracking has saved the U.S. economy’s recovery.&nbsp; Were it not for the impressive increase in North American oil and gas production, the current hostilities in Iraq would have driven up global oil prices to $130–140 a barrel,<sup>1</sup> a level that could easily have stopped &nbsp;the United States’ already inadequate economic recovery, driven Europe back deeper into recession, and slowed growth elsewhere in the world, if not thwarted it altogether.&nbsp; This, however, is only the beginning.&nbsp; If North American energy sources have quelled fears about shortages and kept down prices, Iraq’s troubles could become much worse.&nbsp; They have as yet, however, had little effect on oil flows throughout the Persian Gulf.&nbsp; Should they, North American production would not be able to fill the gap, the price of a barrel would rise, and those higher prices would have their ill effects on economies worldwide.&nbsp;</p> <p><b>It’s Not about Energy Independence<br> </b>Contrary to much comment in the media, the relief from fracking in the United States has little to do with energy independence.&nbsp; Perhaps this concept would have meaning if the United States were involved in a global war, as it was twice during the twentieth century.&nbsp; But short of such an all-consuming conflagration, whether this country can produce enough for its own needs or not means less than how much it is adding to or drawing on the world’s precious supply of energy.&nbsp; Oil’s price is set on a global market, and all players, however much they produce, pay the global prices.&nbsp; Some years ago, for example, when North Sea oil made the United Kingdom a net oil exporter, people there still paid global price, and when there were disruptions of supplies from the Middle East, the United Kingdom paid the higher global price, as did all other countries. &nbsp;</p> <p>Rather than address questions of energy independence, what U.S. and Canadian oil production have done to blunt the immediate impact of this horrible situation is to make a significant difference in <i>global</i> supplies.&nbsp; More specifically, they have more than offset declines in Mexican and the North Sea production.&nbsp; Table 1 makes this relationship clear.&nbsp; Flows from Norwegian, U.K., and Mexican sources fell by some 1.002 million barrels a day, from the beginning to the present recovery in 2009, while U.S. and Canadian production rose by 3.548 million barrels a day.&nbsp; They constitute 81.2% of the entire 4.382 million-barrel a day increase in global supplies during this time.</p> <hr class="separator_grey"> <p><b><span class="rte_txt_green">Table 1. Oil Production in Recent Years, Selected Sources</span><br> </b><i>(000s of barrels per day)</i></p> <table class=no_style border="0" cellspacing="0" cellpadding="0" width="570"> <tbody><tr><td width="96" valign="top"><p>&nbsp;</p> </td> <td width="72" valign="top"><p><b>World</b></p> </td> <td width="102" valign="top"><p><b>Persian Gulf</b></p> </td> <td width="69" valign="top"><p><b>Russia</b></p> </td> <td width="75" valign="top"><p><b>U.K.</b></p> </td> <td width="77" valign="top"><p><b>Norway</b></p> </td> <td width="77" valign="top"><p><b>Mexico</b></p> </td> <td width="77" valign="top"><p><b>Canada</b></p> </td> <td width="75" valign="top"><p><b>U.S.</b></p> </td> </tr><tr><td width="96" valign="top"><p>2009</p> </td> <td width="72" valign="top"><p>72,609</p> </td> <td width="102" valign="top"><p>20,754</p> </td> <td width="69" valign="top"><p>9,495</p> </td> <td width="75" valign="top"><p>1,328</p> </td> <td width="77" valign="top"><p>2,067</p> </td> <td width="77" valign="top"><p>2,646</p> </td> <td width="77" valign="top"><p>2,579</p> </td> <td width="75" valign="top"><p>5,353</p> </td> </tr><tr><td width="96" valign="top"><p>2010</p> </td> <td width="72" valign="top"><p>74,378</p> </td> <td width="102" valign="top"><p>21,589</p> </td> <td width="69" valign="top"><p>9,694</p> </td> <td width="75" valign="top"><p>1,233</p> </td> <td width="77" valign="top"><p>1,869</p> </td> <td width="77" valign="top"><p>2,621</p> </td> <td width="77" valign="top"><p>2,741</p> </td> <td width="75" valign="top"><p>5,471</p> </td> </tr><tr><td width="96" valign="top"><p>2011</p> </td> <td width="72" valign="top"><p>74,489</p> </td> <td width="102" valign="top"><p>22,953</p> </td> <td width="69" valign="top"><p>9,774</p> </td> <td width="75" valign="top"><p>1,026</p> </td> <td width="77" valign="top"><p>1,752</p> </td> <td width="77" valign="top"><p>2,600</p> </td> <td width="77" valign="top"><p>2,901</p> </td> <td width="75" valign="top"><p>5,652</p> </td> </tr><tr><td width="96" valign="top"><p>2012</p> </td> <td width="72" valign="top"><p>75,868</p> </td> <td width="102" valign="top"><p>23,214</p> </td> <td width="69" valign="top"><p>9,922</p> </td> <td width="75" valign="top"><p>888</p> </td> <td width="77" valign="top"><p>1,607</p> </td> <td width="77" valign="top"><p>2,593</p> </td> <td width="77" valign="top"><p>3,108</p> </td> <td width="75" valign="top"><p>6,484</p> </td> </tr><tr><td width="96" valign="top"><p>2013</p> </td> <td width="72" valign="top"><p>76,039</p> </td> <td width="102" valign="top"><p>23,010</p> </td> <td width="69" valign="top"><p>10,049</p> </td> <td width="75" valign="top"><p>810</p> </td> <td width="77" valign="top"><p>1,530</p> </td> <td width="77" valign="top"><p>2,562</p> </td> <td width="77" valign="top"><p>3,324</p> </td> <td width="75" valign="top"><p>7,447</p> </td> </tr><tr><td width="96" valign="top"><p>2014 (YTD)</p> </td> <td width="72" valign="top"><p>76,981</p> </td> <td width="102" valign="top"><p>23,465</p> </td> <td width="69" valign="top"><p>10,147</p> </td> <td width="75" valign="top"><p>869</p> </td> <td width="77" valign="top"><p>1,627</p> </td> <td width="77" valign="top"><p>2,543</p> </td> <td width="77" valign="top"><p>3,492</p> </td> <td width="75" valign="top"><p>8,018</p> </td> </tr></tbody></table> <p><span class="legal">Source: Energy Information Administration (EIA).</span></p> <hr class="separator_grey"> <p><b>More Reliable Supplies, Plus Hope &nbsp; &nbsp; &nbsp;&nbsp;<br> </b>Perhaps even more significant in the current context than the straightforward impact on supply is the hope for more reliable energy sources engendered by this surge in North American production.&nbsp; The basis for such hope is apparent in Table 2, which shows the percent of world production accounted for by each significant producer.&nbsp; The Persian Gulf as an oil source actually has become slightly more important.&nbsp; That hardly speaks to reliability.&nbsp; But Canada has gained dramatically as a global supplier, while the United States has soared.&nbsp; The headlines boast that this country is now a bigger producer than Saudi Arabia, but more significant is that it is now more than one-third the size, in terms of production, of the entire Persian Gulf region, which includes Saudi Arabia, Kuwaiti, Iraq, Iran, the United Arab Emirates, and lesser suppliers, such as Bahrain and Qatar.&nbsp; These relative gains do show a shift in world production toward more reliable sources.&nbsp; To be sure, the United Kingdom, Norway, and even Mexico were reliable as their importance has declined, but with the rise of Canada and the United States, the more reliable sources as a group have risen to more than one-fifth of the world’s supply and more than half the size of the Persian Gulf. &nbsp;</p> <hr class="separator_grey"> <p><b><span class="rte_txt_green">Table 2. Percent Distribution of World Oil Production, Selected Sources</span></b></p> <table class=no_style border="0" cellspacing="0" cellpadding="0" width="645"> <tbody><tr><td width="91" valign="top"><p><b>&nbsp;</b></p> </td> <td width="102" valign="top"><p><b>Persian Gulf</b></p> </td> <td width="72" valign="top"><p><b>Russia</b></p> </td> <td width="75" valign="top"><p><b>U.K.</b></p> </td> <td width="77" valign="top"><p><b>Norway</b></p> </td> <td width="77" valign="top"><p><b>Mexico</b></p> </td> <td width="75" valign="top"><p><b>Canada</b></p> </td> <td width="75" valign="top"><p><b>U.S.</b></p> </td> </tr><tr><td width="91" valign="top"><p>2009</p> </td> <td width="102" valign="top"><p>28.5%</p> </td> <td width="72" valign="top"><p>13.2%</p> </td> <td width="75" valign="top"><p>1.8%</p> </td> <td width="77" valign="top"><p>2.8%</p> </td> <td width="77" valign="top"><p>3.6%</p> </td> <td width="75" valign="top"><p>3.6%</p> </td> <td width="75" valign="top"><p>7.3%</p> </td> </tr><tr><td width="91" valign="top"><p>2010</p> </td> <td width="102" valign="top"><p>29.0</p> </td> <td width="72" valign="top"><p>13.0</p> </td> <td width="75" valign="top"><p>1.7</p> </td> <td width="77" valign="top"><p>2.5</p> </td> <td width="77" valign="top"><p>3.5</p> </td> <td width="75" valign="top"><p>3.7</p> </td> <td width="75" valign="top"><p>7.3</p> </td> </tr><tr><td width="91" valign="top"><p>2011</p> </td> <td width="102" valign="top"><p>30.8</p> </td> <td width="72" valign="top"><p>13.1</p> </td> <td width="75" valign="top"><p>1.4</p> </td> <td width="77" valign="top"><p>2.4</p> </td> <td width="77" valign="top"><p>3.5</p> </td> <td width="75" valign="top"><p>3.9</p> </td> <td width="75" valign="top"><p>7.6</p> </td> </tr><tr><td width="91" valign="top"><p>2012</p> </td> <td width="102" valign="top"><p>30.6</p> </td> <td width="72" valign="top"><p>13.1</p> </td> <td width="75" valign="top"><p>1.2</p> </td> <td width="77" valign="top"><p>2.1</p> </td> <td width="77" valign="top"><p>3.4</p> </td> <td width="75" valign="top"><p>4.1</p> </td> <td width="75" valign="top"><p>8.5</p> </td> </tr><tr><td width="91" valign="top"><p>2013</p> </td> <td width="102" valign="top"><p>30.2</p> </td> <td width="72" valign="top"><p>13.2</p> </td> <td width="75" valign="top"><p>0.7</p> </td> <td width="77" valign="top"><p>2.0</p> </td> <td width="77" valign="top"><p>3.4</p> </td> <td width="75" valign="top"><p>4.4</p> </td> <td width="75" valign="top"><p>9.8</p> </td> </tr><tr><td width="91" valign="top"><p>2014(YTD)</p> </td> <td width="102" valign="top"><p>30.5</p> </td> <td width="72" valign="top"><p>13.2</p> </td> <td width="75" valign="top"><p>0.7</p> </td> <td width="77" valign="top"><p>2.1</p> </td> <td width="77" valign="top"><p>3.3</p> </td> <td width="75" valign="top"><p>4.5</p> </td> <td width="75" valign="top"><p>10.4</p> </td> </tr></tbody></table> <p><span class="legal">Source: Energy Information Administration (EIA). </span>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <hr class="separator_grey"> <p>There is something else that is moderating the price effect during this latest trouble in the Middle East.&nbsp; Unlike past times of supply interruptions or threatened interruptions, market participants this time have reason to hope, even expect, not just an increase in future global supply but also a continued shift in the direction of more reliable sources.&nbsp; The impressive growth of production in Canada (35%, between 2009 and the present) and the United States (nearly 50%) is a significant part of that expectation, especially since indicators point to continued growth at such remarkable paces.&nbsp; By contrast, Persian Gulf output has increased only 13% during this time, largely because of the development of Iraqi oil after the last bout of fighting and modernization of some Saudi production facilities.&nbsp; Neither of these, however, are likely to be repeated going forward.&nbsp; Though that prospect suggests slower growth in global supplies than otherwise, it does suggest a decrease in the significance in this volatile and unreliable region.</p> <p>Giving hope especially is that there is a greater such shift in prospect.&nbsp; Because fracking enables drillers to extract oil and gas from shale, all the world’s shale deposits now offer promise, when only a few years ago they hardly factored into the global supply equation at all.&nbsp; Some nations, such as France, resist the drilling, as do some individual states in the United States, but market participants account for the promise anyway, and do so on the assumption that an energy shortage would change such attitudes.&nbsp; Meanwhile, Australia, which has no such reluctance about drilling, recently announced a huge shale find that, if preliminary reports are to be believed, could increase global oil and gas supplies by some 13%.&nbsp; Coming years also should see production from Brazil’s large, conventional oil find in the South Atlantic and the promising exploration Exxon is now doing in the Russian Arctic.&nbsp; Russia, to be sure, hardly counts as a reliable source (with its temperamental, nearly autocratic government), but the increased supply will come to market nevertheless.&nbsp; Of course, these future sources are not available now, but oil prices, just like those in every financial and commodity market, reflect prospects and risks as much as basic current supply and demand, and these positive developments weigh in market calculations against the risk that turmoil in Iraq could cut off other supplies in the future. &nbsp; &nbsp;&nbsp;</p> <p><b>The Danger Cannot Be Easily Written Off &nbsp;&nbsp;<br> </b>Still, there is no mistaking the huge importance of Persian Gulf supplies.&nbsp; If the turmoil there were suddenly to take those supplies, or a significant portion of them, off line, the world would be hard pressed to replace those sources, and prices would rise with all their ill effects.&nbsp; What is more, the Persian Gulf itself is also a choke point of no small significance in oil transport.&nbsp; If production is a significant 30.5% of world output, upwards of 35% of seagoing oil and gas transport passes through the Gulf and the narrow Strait of Hormuz at its head.&nbsp; If Iran were to become further embroiled in Iraq’s problems, or otherwise come to a confrontation with Western powers, the strait would close and the world would find itself without any of this still crucial supply.&nbsp; To be sure, the U.S. Navy has a major presence in the Gulf, and it claims that it could prevent any such closure of the strait.&nbsp; But even if the navy could hold Iran’s forces at bay, the strait would close anyway, for the still significant threat to shipping would prompt insurers either to refuse to cover cargos in the Gulf or raise premiums to unsupportable levels.</p> <p>For the time being, though, markets have stood up well in the situation.&nbsp; Shipments continue even from Iraq—and certainly from Kuwaiti, Saudi Arabia, Iran, the Emirates, and other sources—and even as the rise of reliable sources outside the region disarms fears of any additional disruption.&nbsp; But given the continued importance of Gulf oil supplies in general and of the Gulf as a shipping lane, an expansion of this turmoil still threatens to overwhelm the confidence built on Canadian and U.S. supplies, and to raise oil prices, and, accordingly, to impede economic growth in general.&nbsp; &nbsp;</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 14 Jul 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/what-merger-mania-means-for-the-market.htmlWhat Merger Mania Means for the Market<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>A surge in prospective acquisitions could have positive implications for equities—and the broader economy.</i><b></b></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>A recent piece in this space talked about the movement of money. It investigated recent signs that reserves, long-provided by the Federal Reserve, seemed at last to have begun flowing into the general economy. This discussion takes up money flows of a different kind, those implicit in the recent, dramatic pickup in mergers and acquisitions (M&amp;A). As with those signs that banks are at last beginning to use their excess reserves, this surge suggests that companies finally seem willing to use the cash hoards they have built up and guarded throughout this recovery. At once, these actions show a renewed willingness to take risk, something that should promote more economic growth, and a durable direct support for equities.&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;</p> <p>For quite some time, analysts, including those at Lord Abbett, have looked for a surge in M&amp;A activity. After all, cash at nonfinancial corporations had risen for years. At 15% of total liabilities recently,<sup>1</sup> such relative holdings of cash and cash equivalents would look outsized in any environment but especially one in which they earn so little. But firms remained extremely cautious and added to rather than used their cash hoards. That behavior seems to be changing. So far this year, according to the company Dealogic, U.S.-based companies have agreed to a bit less than $640 billion in mergers and acquisitions. That is the highest amount recorded since 1995, when the firm began compiling such statistics. Deals in the healthcare area have received the greatest attention, but the activity is more widespread. Year to date, M&amp;A activity in telecommunications has topped $80 billion, and in technology, $60 billion. Deals in energy, food, utilities, and finance totaled more than $80 billion. Activity in every major sector, except real estate, picked up markedly from the year-ago period. &nbsp;&nbsp;&nbsp;&nbsp;</p> <p>For the economy, the crucial encouragement here is the more positive attitude toward risk implicit in such money flows. Until now, the lack of willingness among companies to extend their balance sheets in any way has contributed mightily to this recovery’s disappointing progress. It has held back not just M&amp;A activity but, significantly, also hiring and capital spending. But the new M&amp;A surge offers a welcome sign that perhaps such restrictive attitudes are beginning to change, that down the road managements might also step up their hiring and their capital spending. Also encouraging is how this M&amp;A pickup tells of a more aggressive attitude among lenders. Much of the recent activity has depended on bank financing of a sort that banks have assiduously avoided since 2007. Too much, of course, is dangerous, but the former extreme risk avoidance had also held back the pace of growth.&nbsp; &nbsp;&nbsp;</p> <p>The M&amp;A activity also brightens the prospects of the equity market. At the very least, it provides direct buying support to pricing. To be sure, many recent deals include stock swaps, but to the extent that they also include a significant proportion of existing cash and borrowed money, they redirect new monies into equities. In addition, these deals speak to still-attractive market valuations. Each time management chooses to acquire rather than build for itself, it announces that equities remain attractively priced, that even after all the stock gains of past years, it is still cheaper to buy than to build. Price movements around these deals speak to both points.&nbsp; According to Dealogic, shares of acquired companies in these recent deals have risen 18% on average the day after the deal is announced, more than historically. What is more remarkable, the shares of the acquirer also have risen, on average, by 4.6%. Historically, the shares of the acquirer have typically fallen on average 1.4% the day after the announcement. That they have risen implicitly reflects the market’s judgment that the acquirer received a good price. &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;</p> <p>There will no doubt come a time when M&amp;A activity will reflect a dangerous exuberance. That will signal danger for the market and the economy. This recent surge is far from that point. It suggests instead that equity prices have room to rise higher. It also implies that management, now willing to take risk, will help the economy accelerate. Much still suggests continued slow economic growth, as several pieces in this space have argued, and that is still the most likely prospect. But this possibility of a pickup in the pace of economic growth is nonetheless not to be ignored.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Tue, 27 May 2014 12:00:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/global-economy-a-chinese-checkup.htmlGlobal Economy: A Chinese Checkup<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Should investors worry about China’s economic health? Here’s a prognosis.</i><i></i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>If one were to believe the media, China is on the verge of collapse. But then again, the media has worried over that nation’s collapse since at least 2011; and yet throughout the intervening years, the Chinese economy has managed to keep up its expansion and at a real growth rate north of 7.0% a year. Still, it would be a mistake to dismiss such talk out of hand. China’s growth pace has slowed, the economy clearly needs structural reform, and financial excess has caused much damage. The balance of evidence and probabilities suggests that China will continue to muddle through, as it has, not, however, without rough patches connected to such concerns.&nbsp;</p> <p><b>A Mixed Economic Picture<br> </b>Though the news has dwelt on the negative, the economic indicators can best be described as mixed. Real gross domestic product (GDP) grew in the first quarter 7.4% from the same period last year. That is close to the government’s target and actually a touch above consensus. Still, those who lean toward pessimism point out that this growth rate, though many multiples of the pace recorded for the United States, is nonetheless a troubling shortfall compared with China’s 10–12% pace of real growth averaged not too long ago. What is more, some, questioning the reliability of Beijing’s economic statistics, suggest that reality is far less robust than the official figures suggest. Reinforcing such feelings is the HSBC purchasing managers’ survey, which recently recorded a figure of 48.0%, well below the 50% demarcation between growth and decline. Still, against this, factory output has increased 8.8% over the past year, retail sales have grown at double-digit rates, worker incomes are growing faster than previously as is the overall economy, and wages in China’s interior are at last beginning to catch up with coastal and urban wages, though they still have a ways to go.<sup>1</sup>&nbsp; &nbsp;&nbsp;</p> <p>The weak HSBC figures no doubt trouble Beijing, but otherwise, this mix should be far from upsetting. The Chinese leadership expects slow growth as part of its stated desire to shift the engine of growth from exports toward domestic consumption and development. The authorities had noted, some years ago actually, that China’s economy had risen from a negligible part of global exports in the 1980s to nearly 12% more recently.<sup>2</sup> With the best of will, they acknowledged that that percentage cannot rise indefinitely. This is one reason why they decided to reorient the economy’s focus. In this context, the slowdown may actually come as a welcome sign of success for this long-term plan, as, no doubt, does the news on retail sales, wage growth in general, and relative wage growth in the country’s interior.</p> <p>Nonetheless, the slowdown still threatens Beijing’s immediate need to produce jobs. Worried, but hardly panicked, Beijing has responded with a two-pronged approach. One part involves a kind of mini-stimulus, including an extension of the tax breaks for small business; additional spending of some 150 billion yuan ($24.6 billion) on infrastructure, mostly on railroads; and an effort to capture flows of foreign capital by allowing cross-border stock purchases with Hong Kong. The other part of the response involves steps to bolster exports by holding down the foreign exchange value of the yuan until the longer-term economic reorientation gains a firmer footing. China also has eased its one-child policy somewhat, but this clearly has a much longer-term objective in mind than any near-term stimulus.<sup>3</sup>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;</p> <p><b>The Threat from Debt<br> </b>If the economic picture is, at worst, only mildly troubling, financial matters offer more reason for concern. China has in recent years run up a huge debt overhang, much of it connected to real estate. Private sector financing grew 20% last year, far faster than the economy, much from lending by the shadow banking system. Meanwhile, local governments remain deeply in debt because of failed investments in upscale residential construction and over-ambitious infrastructure development, the by-now famous empty buildings reported breathlessly on <i>60 Minutes </i>and elsewhere. Many of these loans are going bad. When Shanghai Chaori Solar Energy defaulted earlier this year, Premier Li Keqiang warned of other defaults to come. In part, he was acknowledging the existence of the financial overreach, but he also was indicating that, contrary to the past, the government would allow defaults, presumably in order to force a more disciplined approach on lenders.<sup>4</sup></p> <p>The fear, of course, is that the bad loans will bring down the financial system and so the economy, much as occurred in the West in 2008–09. It is a serious enough concern to have elicited a response from Beijing beyond the embrace of the discipline of default. To exercise control and stem the outsized debt growth, the authorities have all but shut down the shadow banking system. They also have begun to direct lending by the largely state-run banking system. The object is to cut back the flow of credit to extravagant real estate development and the other dubious investment projects typical of the past. There is even talk of bringing in foreign financial firms to discipline lending further in order to avoid such wasteful uses of financial capital, though so far, this is mostly talk. In place of such misdirected uses of funds, there is a push to build needed lower-cost housing, of which, according to government statistics, the country needs more than 75 million units.<sup>5</sup></p> <p><b>Probabilities<br> </b>There are risks to be sure. Today’s fears are far from unfounded. But the probabilities suggest that China will contain the financial damage and also, in time, manage the shift from the purely export-led economy to one with a domestic growth engine as well. After all, the track record since such fears have gained currency suggests that the Chinese economy is less fragile than many seem to believe. What is more, Beijing has an urgent need to make it work. The country’s leadership is well aware that economic hardship in China quickly turns to social unrest, even rioting, making failure a much less palatable alternative than it might be elsewhere. For the investor, then, it is reasonable to expect a muddle through, at the very least, during the months and quarters immediately ahead. For the longer term, a successful reorientation of China’s economy in the direction of domestic growth engines promises a raft of new investment opportunities.&nbsp;</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 19 May 2014 09:35:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/consumers-why-the-united-states-isnt-the-land-of-the-spree.htmlConsumers: Why the United States Isn't the "Land of the Spree"<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Slow income growth and higher tax burdens for U.S. consumers likely will continue to restrain spending in the largest sector of the economy.</i><b></b></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The past two discussions in this space argued that the economic recovery, though it will almost certainly continue, will not likely deliver the acceleration of which the media has enthused of late. One examined the employment picture, the other patterns in capital spending. This week’s discussion looks at the consumer sector. At some 70% of the economy, the consumer just about determines the overall pace and direction of any recovery. This analysis, too, confirms that slow growth patterns will likely prevail going forward. &nbsp; &nbsp; &nbsp;</p> <p>Table 1 lays out the statistical essentials. It shows the major elements of household income, taxes, saving, and spending during the second half of 2013 and so far this year. For perspective, it includes a column (at the far right) showing the proportion of overall personal income reflected in each item on the table.</p> <p><b>Income &nbsp;&nbsp;<br> </b>The first block of figures in particular explains why a lasting acceleration is less than likely. Apart from the normal statistical noise, the growth of overall personal income so far this year differs little from the pattern set in the second half of 2013. This aggregate averaged a 3.1% annual rate of expansion during last year’s second half and though it has picked up to a 3.6% rate, so far this year, the difference is hardly significant. Important subcategories show even less difference. Total employee compensation has grown at a 3.0% annualized rate so far this year, slightly less than the 3.1% averaged during 2013’s second half. Wage and salary income, growing at a 3.0% annualized rate so far this year, has actually decelerated from the 3.3% rate of expansion averaged during last year’s second half. Proprietors’ income, too, has decelerated, growing so far this year at an annual rate of 2.4%, slightly below the 2.6% rate of advance averaged during the last six months of 2013. Income from assets (dividends, interest, and net capital gains) actually suggests a loss of growth momentum altogether.<sup>1</sup></p> <p><b>Tax Effects &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;<br> </b>Nor does the influence from Washington suggest an acceleration. Tax burdens so far this year have grown at a 2.4% annualized rate, faster than the 1.3% annual rate registered during last year’s second half. To be sure, this comparison may be misleading. The tax picture last year was remarkably uneven because so many managements, worried about tax hikes in 2013, paid huge bonuses and special dividends during 2012’s fourth quarter, and this caused a surge in tax payments during the spring tax season in 2013, when flows of tax money actually expanded at more than a 10% annual rate. Little wonder, then, that in the summer quarter, after this effect had run its course, the flow of tax payments dropped. For all these gyrations, however, aftertax income, what the Commerce Department calls “disposable income,” has averaged fairly steady but slow growth, expanding at a 3.4% annualized rate during last year’s second half and 3.6% so far this year.&nbsp;</p> <p>This picture says fairly definitively that matters going forward should remain pretty much as sluggish as they have throughout this recovery. Certainly, the pattern of hiring, discussed here two weeks ago, confirms that there is little likelihood of a surge in income that might alter established, slow-growth income patterns. To be sure, Washington this year will offer less of a drag on the growth of aftertax income than it did in 2013. For the whole of last year, increased tax rates, plus the effect of the sudden spring gain, pushed up tax burdens by more than 8%. The additional take from the consumer’s pocket amounted to $101.4 billion more than if taxes had just tracked income. It was, incidentally, more than the whole spending sequester over which so much ink was spilled and Washington expressed so much anxiety. With no new taxes or special payouts this year, the consumer at least will avoid a shock.</p> <p><b>Savings<br> </b>Even this, however, is unlikely to produce the acceleration of which so many are talking. As is only partially evident in Table 1, consumers shouldered last year’s additional tax burden by reducing their flows into savings. These fell at more than a 5% annual rate on average during last year’s second half. Though taxes have stabilized, albeit at higher rates, consumers seem disinclined to spend and more inclined to reestablish their savings flows. So far this year, as the table shows, their savings flows have jumped at a 33.2% annual rate. This may not last. They may turn to spending, but so far, the picture suggests that even this relief offers little reason to look for the talked-about acceleration in consumer spending or the economy in general. &nbsp;</p> <p><span class="separator">&nbsp;</span></p> <p><b><span class="rte_txt_green">Table 1. Consumer Sector Statistical Essentials</span><br> </b><i>Consecutive growth, seasonally adjusted, annualized</i></p> <table class=no_style border="0" cellspacing="0" cellpadding="0"> <tbody><tr><td width="235" valign="top"><p><b>&nbsp;</b></p> </td> <td width="78" valign="top"><b><br> 3Q</b></td> <td width="90" valign="top"><b><br> 4Q</b></td> <td width="107" valign="top"><b><br> 2014 YTD</b></td> <td width="128" valign="top"><b>Pct. of Total <br> Year-end 2013</b></td> </tr><tr><td width="235" valign="top"><p>Personal Income</p> </td> <td width="78" valign="top"><p>4.0%</p> </td> <td width="90" valign="top"><p>2.2%</p> </td> <td width="107" valign="top"><p>3.6%</p> </td> <td width="128" valign="top"><p>100.0%</p> </td> </tr><tr><td width="235" valign="top"><p>Compensation of<br> Employees</p> </td> <td width="78" valign="top"><p>2.4</p> </td> <td width="90" valign="top"><p>3.7</p> </td> <td width="107" valign="top"><p>3.0</p> </td> <td width="128" valign="top"><p>62.7</p> </td> </tr><tr><td width="235" valign="top"><p>Wages and Salaries</p> </td> <td width="78" valign="top"><p>2.6</p> </td> <td width="90" valign="top"><p>3.9</p> </td> <td width="107" valign="top"><p>3.0</p> </td> <td width="128" valign="top"><p>50.6</p> </td> </tr><tr><td width="235" valign="top"><p>Proprietor’s Income</p> </td> <td width="78" valign="top"><p>5.9</p> </td> <td width="90" valign="top"><p>-0.7</p> </td> <td width="107" valign="top"><p>2.4</p> </td> <td width="128" valign="top"><p>9.5</p> </td> </tr><tr><td width="235" valign="top"><p>Income on Assets</p> </td> <td width="78" valign="top"><p>7.6</p> </td> <td width="90" valign="top"><p>-0.1</p> </td> <td width="107" valign="top"><p>-3.0</p> </td> <td width="128" valign="top"><p>14.2</p> </td> </tr><tr><td width="235" valign="top"><p>Tax liability</p> </td> <td width="78" valign="top"><p>-2.7</p> </td> <td width="90" valign="top"><p>5.3</p> </td> <td width="107" valign="top"><p>2.4</p> </td> <td width="128" valign="top"><p>11.8</p> </td> </tr><tr><td width="235" valign="top"><p>Disposable Personal<br> Income</p> </td> <td width="78" valign="top"><p>4.9</p> </td> <td width="90" valign="top"><p>1.8</p> </td> <td width="107" valign="top"><p>3.6</p> </td> <td width="128" valign="top"><p>88.2</p> </td> </tr><tr><td width="235" valign="top"><p>Personal Outlays</p> </td> <td width="78" valign="top"><p>3.9</p> </td> <td width="90" valign="top"><p>4.3</p> </td> <td width="107" valign="top"><p>3.0</p> </td> <td width="128" valign="top"><p>84.6</p> </td> </tr><tr><td width="235" valign="top"><p>Savings Flows</p> </td> <td width="78" valign="top"><p>28.0</p> </td> <td width="90" valign="top"><p>-38.2</p> </td> <td width="107" valign="top"><p>33.2</p> </td> <td width="128" valign="top"><p>3.6</p> </td> </tr></tbody></table> <p><span class="legal">Source: Department of Commerce.</span><br> <span class="separator"><br> </span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 12 May 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/capital-spending-why-caution-still-rules.htmlCapital Spending: Why Caution Still Rules<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>Growing cash hoards underscore companies’ ongoing reluctance to spring for new equipment.</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Corporate spending behavior provides a key sign as to why this recovery will almost surely remain slow. Companies large and small show a distinct lack of expansionary enthusiasm. The last commentary in this spot examined the slow pace of hiring. This one looks at the reluctance of firms to spend for capital investments. They are spending some, of course. But mostly they continue to harbor huge cash balances and hold back, at all levels of such spending, on new equipment, software, and premises. Nor do orders patterns offer any reason to expect an acceleration anytime soon. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p><b>Corporate Finance<br> </b>Corporate balance sheets provide some of the most compelling evidence in this picture. According to the Federal Reserve, nonfinancial corporations hold almost $1.7 trillion in cash and cash equivalents, a huge sum even by today’s standards. It amounts to more than 11% of their total liabilities, a remarkably high number that is much more impressive given that these monies earn next to nothing and actually lose purchasing power after inflation. It speaks even louder to corporate caution that rather than spend this cash, companies actually have expanded such balances over the past year, in absolute and relative terms, growing them by 13.5%, far faster than the 7.8% growth in total nonfinancial corporate assets.</p> <p><b>Actual Spending &nbsp; &nbsp;<br> </b>The same sort of picture emerges from statistics on actual real capital spending. Last year, spending by all American business on new equipment increased at a real rate of only 3.9%, faster than the overall economy, but hardly indicative of a major corporate bet on the future. Real spending on premises actually fell by 2.7%. Outlays on software, what the Bureau of Economic Analysis calls “intellectual property products,” is the strongest major category, but even it has grown only at a 6.9% annual rate in real terms. More telling, perhaps, is that it is the only major category to accelerate from 2012, when it advanced only 2.9% in real terms. For the other aspects of capital spending, 2013 actually decelerated from 2012. The growth in real spending on equipment last year was 0.6 percentage points slower than the 4.5% recorded in 2012, while last year’s decline in real spending on premises was a major shift from 2012’s 9.2% growth.<sup>1</sup>&nbsp;</p> <p><b>Orders and Prospects<br> </b>Orders numbers suggest that things will stay lackluster going forward. Though highly volatile from one month to the next, trends in orders for capital goods are otherwise an excellent indicator of corporate intensions. And over the last four months, these figures have declined on balance at a 3.8% annual rate. Removing the especially volatile defense sector makes the message even more grim. In that case, orders registered an annualized decline of 20.3% during this time. To be sure, March was up strongly, but it should be given earlier losses, and it is the cumulative effect that counts. The volatility recommends against any extrapolation of these moves, positive or negative, but at the same time the picture here—in actual spending, corporate finances, and orders—argues forcefully against any expectation of an acceleration in capital spending anytime soon, much less something sufficient to drive an acceleration in the overall economy.<br> </p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 5 May 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/a-slow-motion-us-jobs-recovery.htmlA Slow-Motion U.S. Jobs Recovery<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><i>What could lift the U.S. jobs market out of its torpor?</i></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>While the jobs market stumbles along, as it has for some time, there is much talk about change. The Congressional Budget Office (CBO) worries about the ill effects of the Affordable Care Act (ACA). The White House, not surprisingly, takes a more upbeat view. Some commentators, seemingly simply bored of well-established slow-growth patterns, talk about a pickup, perhaps only for something new to say. But the fact is that little has changed. The same forces that have kept jobs growth slow remain in place and likely will continue in place for the foreseeable future. The statistics released regularly by the Labor Department confirm the fact. &nbsp;&nbsp;</p> <p><b>The Statistical Landscape<br> </b>Right up through the latest releases, the data tell a consistent story, one of progress, but at a depressingly slow pace. In the latest figures for March, for instance, payrolls grew by 192,000. That was a welcome improvement over the weather-depressed monthly hiring rate of 114,000 recorded for December and January.<sup>1</sup>&nbsp;But considering that the earlier, extremely slow rate called for a bounce as the weather improved in March, the figure was actually disappointing, slower, in fact, than the 203,000 a month averaged in 2013. Had it not been for that weather-based bounce, the March report would have been still less encouraging. It is noteworthy in this regard that manufacturing actually shed 1,000 jobs during that month, and almost half the jobs gains occurred in only four sectors: construction, transport and warehousing, retail trade, and health services. All but the last are extremely weather sensitive. It also is noteworthy that an additional one-fifth of the jobs growth recorded for March occurred in temporary employment—hardly a sign of a turn to robust hiring. &nbsp;&nbsp;</p> <p>There is no implication here of another decline. That is not at all likely. Rather, the point is to question recent talk of acceleration. Each month, of course, will continue to have its own ups and downs. Behind such statistical noise, however, nothing different is happening than has prevailed throughout this recovery. In 2013, for instance, the best month for new job creation, February, showed 280,000 net new hiring; the worst, December, saw only 84,000. In 2012, the best month, January, saw net hiring of 360,000, while the worst, June, saw only 88,000. In 2011, the best month, April, saw net hiring of 322,000, while the worst, January, saw only 70,000. This year has run true to this form.&nbsp; Some optimists have pointed to declines in weekly claims for unemployment insurance. But these only reflect those let go from their job. It is only reasonable that firing would slow in the fifth year of recovery. Relief on this front does not necessarily mean firms have become more enthusiastic about new hiring, as the above comparison shows.</p> <p><b>The Whys<br> </b>This recovery’s pattern is distinctly different from past benchmarks. On average, during the four previous recoveries—in the early 2000s, in the mid-1990s, in the mid-1980s, and in the mid-1970s—payrolls grew an average of 250,000 a month. This recovery so far has averaged a monthly gain of 137,000. Economic historians will surely devote much time to explaining this recovery’s atypically sluggish nature. No doubt the aging of the American workforce has something to do with it. But until detailed analysis uncovers all the influences, two factors present themselves as reasons: 1) the lingering legacy of the great recession of 2008–09 and 2) the uncertainties brought by the ambitious legislation produced in Washington in 2009 and 2010.</p> <p>Much commentary has dwelt on the effect of legislation, but it would be a mistake to underestimate the recession’s continuing impact. Especially because the downturn had its roots in a financial collapse, it has left lasting scars on many managements and colored their decision making accordingly. The signs are evident in the huge cash reserves companies continue to carry, much larger, absolutely and relatively, than in past recoveries.&nbsp; Even now, five years after the upturn began, nonfinancial firms hold cash and cash equivalents on their balance sheets equal to a whopping 11.3% of total liabilities. No doubt this preference for cash stems in no small part to the failure of banks during the financial crisis to honor previously arranged lines of credit. But whatever its specific cause, it speaks to a continuing caution that has held back capital spending, certainly compared with past recoveries, and even the mergers and acquisitions that would normally occur with so much available cash, though these just recently have begun to accelerate. This abiding reluctance to spend for expansion and expend these reserves has surely held back hiring.</p> <p>The Dodd-Frank financial reform legislation has compounded these effects. Setting aside whether this legislation is good or bad, effective or not, it is comprehensive enough to sow much doubt about the nature of future financial arrangements, the availability of credit going forward, possible covenants-attached loans, the nature of the credit available to firms, and the cost of that credit, both the rate and any fees that may arise. Though the law passed some years ago, little clarity has emerged, for the legislation left much implementation at the discretion of regulators who have hardly made their positions definite. Indeed, they have yet to write many of the rules required of them by the law. The “Volcker rule,” for example, to prevent banks from proprietary trading, took two years to evolve and still remains ambiguous.</p> <p>The ACA has had its retarding effects on jobs growth from both the demand and the supply side. Again, setting aside whether the legislation is good or bad, effective or not, its breadth could not help but affect hiring decisions. Managements in small, medium, and large firms have commented for years now that they cannot calculate the cost of a new employee. It is not, they insist, that the legislation would raise the cost of hiring.&nbsp; Rather, it is that the ambiguity leaves them in doubt where to bring the size of their workforce. They have, accordingly, postponed hiring decisions. Many had hoped, as 2014 approached, that the law’s implementation would bring clarity. But so much has been postponed and modified, uncertainties have remained.&nbsp;</p> <p>Meanwhile, recent CBO work suggests that on the supply side of the labor market the law has discouraged job seekers. The problem, according to these non-partisan analysts, is the government insurance subsidy for low-income people. Because that subsidy goes away as incomes rise, it acts like a tax on additional earned income, up to 85% in some cases, according to the CBO analysis. Many, the CBO concludes, will, as a consequence, decide against work.</p> <p><b>And Looking Forward<br> </b>Some of this burden surely will lift over time. The worst memories of the great recession will fade and with them the fears they have engendered. The provisions of Dodd-Frank and the ACA will become clearer, allowing managements to make definite calculations about the cost of hiring, borrowing, and expansion generally. Any ill effects of the ACA on labor supply will stabilize, too. If, as now seems likely, they enlarge the ranks of the permanently unemployed and underemployed, wages will adjust so that job seeking should resume for others. But as the patterns of the last few years make clear, this relief will likely arrive only very gradually. The rollout of the ACA certainly makes clear that ambiguity will hang over this important law for a long time to come. For the jobs market, then, progress will continue, as it has to date, but at the plodding pace to which all have grown accustomed. &nbsp; &nbsp;<br> </p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 28 Apr 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/will-baby-boomers-bust-the-markets.htmlWill Baby Boomers Bust the Markets?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>Worries that large-scale liquidation of investments by retiring baby boomers will pressure financial markets are overstated. Here’s why.</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The usual suspects have issued a dire warning: the baby-boom generation is retiring; markets are vulnerable. It sounds plausible. Financial advisors can see their older clients liquidating investments to support their retirement needs. The expectation of such events on a larger scale leads many to feel this fear. But if this story, like so many other scare stories, harbors a kernel of truth, this heavily publicized worry is vastly overstated. &nbsp;</p> <p><b>The Basis for Fear<br> </b>The broad demographic picture certainly is capable of raising anxiety. According to the Bureau of the Census, low birth rates will continue to slow the flow of young people into the workforce, while increasing longevity will enlarge the proportion of dependent retirees. The number of working-age people will fall, from an already low 5.2 for each retiree today to barely 3.3 by 2030.<sup>1</sup>&nbsp;Since retirees tend to draw on pensions and their own savings to support themselves after they have left off active production, these demographic patterns naturally raise fears of net liquidations in financial markets and so, consequently, downward price pressure, especially since the relative shortfall of the working-age in the population means that the nation will also have proportionally fewer people saving, contributing to pension plans, and generally replenishing the pool of investable assets. But while this demographic picture leaves reason for many longer-term economic and financial concerns and will force many changes in this economy and its markets, at least four points raise doubts about these particular, immediate, market concerns.&nbsp;</p> <p><b>No Reason for Panic about the Pace of the Drawdown<br> </b>First, the changing demographics will alter retirees’ investment strategies. Decades ago, people had to support five, maybe 10 years of retirement. All but the wealthiest converted assets, largely to bonds, as the retirement date approached and then drew down a significant part of that asset base each year. But today, when people can contemplate 20 or more years of retirement, such past practices no longer seem so wise. Retirees will draw down on their asset base much more slowly than their fathers and mothers did in retirement. The newer retirees will strive to protect the principal of their investment base much more carefully. Indeed, their planning horizon is so long that they will tend to keep much more of their portfolio in equities for longer than once was the case.</p> <p>Second, the changing nature of the investment industry further suggests that funds will move much less dramatically than is generally expected. As financial advisors shift increasingly toward a fee-based instead of a transaction-based business model, they will become less eager certainly than they once were to move assets about. Registered investment advisors, already 25% of the nation’s wealth-management business and growing fast, are almost all fee-based. Even the wire houses, once the center of transaction-based brokerage, are moving toward the fee-based model. Morgan Stanley Wealth Management, the nation’s largest, reports 37% of its assets are fee-based. Bank of America’s Merrill Lynch reports 44% and Wells-Fargo 27%. The proportions are growing, too, even as the overall dollar amounts rise.&nbsp;</p> <p>Third, pension funds are less likely to liquidate, too. Indeed, they face legal restraints that should prevent much of a drawdown in assets. All pension funds (Social Security excepted), even those run by state and local governments, must by regulation maintain an acceptable level of funding. If contributions from the existing workforce cannot support that level, then the sponsor of the fund must direct other revenues toward it. Corporations will have to channel revenues toward pension investments, and public authorities will have to direct tax monies to their funds, effectively putting funds into financial markets to supplement any shortfall.<sup>2</sup>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;&nbsp;</p> <p><b>Still Less Reason to Panic Now<br> </b>Fourth, any impact will face delay. Although the long post–World War II baby boom is indeed beginning to retire, the biggest birth years of that boom came toward its end, between 1958 and 1961. The birth rate figures of the time tell the story. At the beginning of the baby boom in the late 1940s, the birth rate was just over three children in the average woman’s lifetime. That figure rose throughout much of the 1950s, and by 1957 it had reached 3.7, a gain of about 20%. The rate stayed at that high level until 1961, when it began its long decline. As a consequence, the bulk of the baby boom is not retiring now or anytime soon. Rather, it has enlarged the part of the population in its fifties, an age well recognized as the highest earning and highest saving period in a person’s lifetime. Even as the beginning of the baby boom is retiring, then, the bulk of it is earning, saving, building up pension assets, and more than offsetting any drawdown from the older, smaller, retiring part. These people will not reach normal retirement age until 2022–23, and they will not likely begin their drawdown until later, suggesting that any real problems are eight to 10 years off, at least—time enough for advisors to shift portfolio strategy, if necessary, and time enough for many other things to change.<sup>3</sup>&nbsp;&nbsp;</p> <p><b>A Last Word<br> </b>This less frightening picture does not ignore the ill effects of the demographic trends. It recognizes the very real and detrimental financial and economic impact from the growing mismatch between dependent retirees on the one hand and taxpaying, saving, pension-contributing producers on the other. This fact of life in the United States will weigh heavily in coming years and force dramatic change in business practice, production emphasis, and public policy, as an earlier series in this space described. But the panic over the immediate market impact is misplaced and sadly typical of those who prefer drama to probability.<br> <span class="separator"><br> </span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="legal"><sup>1 </sup>Milton Ezrati, <i>Thirty Tomorrows </i>(Thomas Dunne Books/St. Martin’s Press, 2014).<br> <sup>2</sup> Joshua Brown, “The Quiet Takeover that Keeps Stocks Moving Up No Matter What,” <i>Business Insider, </i>March 5, 2014.<br> <sup>3</sup> Data from the Department of Commerce.</span></p> <p>&nbsp;</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 21 Apr 2014 10:01:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-economy-the-mild-kingdom.htmlU.S. Economy: The Mild Kingdom<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>&quot;Animal spirits&quot; remain caged as business spending lags. What will it take to unleash them?&nbsp;</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The great economist John Maynard Keynes wisely noted that no economic stimulus could work unless it inspired the &quot;animal spirits&quot; of business. With this two-word phrase, he tried to sum up the optimism, the drive for expansion, the outright greed that prompts business managers, despite myriad unknowns, to hire, spend on new equipment and facilities, and engage in a host of expansion activities. Only when this happens can government stimulus spending or monetary ease prompt a generalized, self-sustaining expansion.</p> <p>Cleary, the present recovery lacks for such &quot;spirits.&quot; Hiring remains less than lackluster by historical or just about any other standard. Spending on new structures by business has followed an uneven path at best. Spending on new equipment and systems offers a modestly brighter picture, but nothing like past recoveries. The word <i>spirited</i> hardly applies. What exactly has dampened the appetite for risk will, no doubt, offer much material for economic historians for many years to come. Surely part of the problem lies with the legacy of the financial crisis and the great recession. If anything can instill an excess of caution, an experience like that one can. Massive pieces of sweeping legislation, such as the Affordable Care Act and Dodd-Frank, whether good, bad, or indifferent as law, cannot help but engender uncertainty and further inspire excessive caution. Surely other, less prominent, influences have come into play.</p> <p>This discussion leaves the post mortem to the historians. It aims instead to examine capital spending data in an effort to ascertain how this failure of spirit has manifested itself and whether there are signs of change. It arrives at two broad conclusions: 1) The contours of capital spending are generally much like other recoveries, just much more muted, a condition that looks likely to persist and 2) the industry-by-industry detail shows significant change in who is spending and on what—something that may require more of a policy response to remedy than Washington is capable of at the moment.</p> <p><b>The Thirty Thousand-Foot View</b><br> In this recovery, the broad aggregates have proceeded with much the same contours as in past recoveries. Typically, capital spending surges in the initial quarters of a cyclical rebound. Such surges have nothing to do with a need for new capacity. Coming off an economic trough, business and industry usually have ample spare capacity. Rather, these initial surges stem from the jump in profits that always accompanies the initial stages of recovery and that allows business to gratify the pent-up demand it postponed during the recession, usually for modernization, upgrading, and efficiency-enhancing equipment. Once this pent-up demand is gratified, such surges typically give away to a slower pace of expansion, as the pace of profits growth typically also slows from its own initial recovery surge. That period of slower expansion usually persists until later in the cycle, when increases in activity have finally employed existing productive capacities, at which time business again ramps up spending, this time on a broader basis to add to productive capacity generally.</p> <p>This recovery has so far followed these general contours. In 2010 (the first full year of growth), for example, overall capital spending grew 8.1% in real terms, a little slower than the 9.0% average in comparable times in the previous five recoveries. The mix was true to historical form, too. Spending on equipment, innovation, and systems—what the Commerce Department refers to in part as &quot;intellectual property products&quot;—drove the bulk of this growth, expanding at almost a 9% rate in real terms. Spending on structures, not surprisingly after a generalized real estate collapse, continued to decline, by 2.9%, in real terms. In 2011–12, the declines in spending on structures turned into a modest expansion, but true to past cyclical patterns, spending on equipment and intellectual property slowed, growing at a much lower 6.3% annual pace, also slower than in past recoveries.<sup>1</sup></p> <p>The pattern in 2013 also held true to this form. With business utilizing a still low 78.5% of existing capacity, the growth in outlays for capital equipment, intellectual products, and new structures continued to slow. Spending on structures grew barely over 1.0% in real terms, while spending on equipment and intellectual products expanded only 3.0% in real terms.<sup>2</sup> And because of the spirit-dampening weight on this recovery, this continued slowdown, though true to the general contours of past cyclical patterns, was considerably slower than the averages from those past cycles.</p> <p>This pace will not likely pick up anytime soon. Perhaps distance from the pain of 2008–09 will allow the &quot;animal spirits&quot; of business to rise a bit, but otherwise all that has dampened that appetite for risk and expansion to date remains in place. More significantly, perhaps, rates of capacity utilization across industry will remain too low to spur a desire to increase productive capacity. Typically, this rate needs to climb above 82–83% to spur the second, later-cycle phase of rapid capital spending growth, and at likely rates of overall expansion, that point is still a long way off. Even in the unlikely event that the overall annual pace of real economic growth were to remain above 3.0% a year,<sup>3</sup> it would take until 2016 before capacity utilization would reach a point sufficient to prompt an acceleration in capital spending, and that is pushing the likelihoods on growth.</p> <p><b>A Littler Closer to the Deck</b><br> Taking the analysis down to a slightly lower elevation that can reveal greater detail, a marked difference from the past emerges, not only from past cycles but, pointedly, also from the trends that existed just before the financial crisis and the change in administrations in Washington. (Given common usage these days, the metaphor here should talk about &quot;drilling down&quot; instead of less elevation; but having started with an airplane metaphor, it seems only right to stick with it. Besides, the introduction of the word &quot;drilling&quot; immediately focuses minds on fracking, but that is only a part of this picture.)</p> <p>The only industries that have accelerated their spending on structures from before the crisis are restaurants and bars, air transportation, special care medical facilities, and petroleum and gas drilling. The last, of course, reflects the fracking revolution, and will likely persist for some time. Spending by air transportation, no doubt, reflects the long neglected need to upgrade airport facilities and will run its course. The sudden spending on restaurants and bars inspires the imagination as to the whys, but without evidence, such speculation has no place here. The spending on special medical facilities, such as nursing homes, is no doubt an aspect of the well-established aging trend in the population and will likely also persist for some time. More interesting, and perhaps troubling, are the sectors that have shown dramatic spending decelerations. These include building for hospitals and most aspects of manufacturing. The former almost surely reflects a response to the constraints and uncertainties imposed by the Affordable Care Act. The latter reflects the caution implicit throughout this recovery. Neither looks likely to change anytime soon.</p> <p>Where equipment and intellectual products are concerned, the picture hardly speaks to &quot;animal spirits&quot; either, and is even more problematic for the future. There, almost everything has slowed from before the crisis, even though this area has seen the fastest pace of growth so far in this recovery. The only exceptions are spending on cars, trucks of all kinds, and railroad equipment. The spending on railroad equipment may well have a connection to the fracking revolution, especially since regulatory considerations have impeded pipeline construction. For the rest, the problem is that much of this spending reflects a catch-up in areas long neglected. It will run its course, probably quite soon, and then no area of size will exhibit an acceleration from pre-crisis rates of expansion. It is particularly disappointing in this detail, especially in the quest for &quot;animal spirits,&quot; that real spending on custom software, research and development, and scientific effort in general have all shown a particularly marked slowdown, growing at a 5.8% annual rate so far in this recovery, compared with a 9.2% annual rate of advance during the three years prior to the crisis.<sup>4</sup></p> <p><b>Prospects</b><br> Combined, the picture suggests continued growth, but at a comparatively slow pace, as it has shown throughout this recovery. Especially from the configuration of detailed spending, it seems that the cautions and concerns that have weighed on this recovery will continue to do so. Sluggish hiring and restrained spending across the board indicate continued lingering fears from the financial crisis and great recession, while policy in Washington is hardly poised to lift the uncertainties that have dampened the verve of business for some time now. In the meantime, capacity utilization remains low enough to allow business to postpone any need for capacity expansion for a year more or longer. The &quot;animal spirits&quot; that Mr. Keynes identified as essential should remain subdued for the foreseeable future.</p> <p><span class="separator">&nbsp;</span></p> <p>&nbsp;</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="legal">* I would like to thank Steve Lipper, Lord Abbett Investment Strategist, for suggesting this line of analysis<br> <sup>1</sup> All data from the Department of Commerce.<br> <sup>2</sup> Ibid.<br> <sup>3</sup> Ibid.<br> <sup>4</sup> Ibid.</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 10 Mar 2014 16:47:00 -0400http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/what-is-the-fed-thinking.htmlWhat Is the Fed Thinking?<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>The central bank's decision to taper, despite its earlier caution on the economy, has puzzled many observers. New research from the Fed's own staff may provide some clues to its current mindset.&nbsp;</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>It is becoming harder to divine the thinking of the Federal Reserve. Recent behavior—particularly the two moves to taper the amount of quantitative easing—seem out of character with the Fed's earlier, much more tentative tone, especially since little in the economy has changed, certainly not enough to explain or even warrant this this more aggressive turn. Meanwhile, Janet Yellen, the new Fed chairwoman, would seem likely to lean toward more caution, not less. While a definitive reason for the change in thinking will not likely emerge anytime soon, a piece of research from the Fed's own staff may provide a hint, for it calls into question the whole rationale for quantitative easing in the first place.&nbsp;</p> <p><b>Seeming Change at the Fed</b><br> There can be little doubt that the Fed’s tone has changed. Last spring, for example, then-Chairman Ben Bernanke announced that the Fed might begin cautiously to slow the flow of quantitative easing—&quot;taper,&quot; in his words. His language was very tentative, and he qualified the plan by saying that the economic circumstances had to be just-so for the Fed to go ahead. Markets reacted poorly, anyway. During June and July 2013, the yield on 10-year Treasury bonds jumped by almost 100 basis points (bps).<sup>1</sup> Stock indexes fell. But by August, markets had stabilized, and were ready for the Fed's active policy arm, the Federal Open Market Committee (FOMC), to start its taper when it met in September. But when the FOMC met, it decided to forgo even the first tentative steps toward the tapering. Consensus wisdom explained the caution in terms of Fed fears of renewed market turmoil or some underlying economic weakness about which only the Fed was aware, or a combination of the two.</p> <p>Then, three months after this remarkable display of caution, the taper started. The FOMC announced in December 2013 its decision to buy $10 billion a month fewer Treasury and mortgage bonds than it had previously. Yet too little had changed in the economy to explain the move. There might have been slightly more optimism, but not the change for which the Fed said it was looking. The unemployment rate, for instance, had fallen slightly, but not because of new hiring; and anyway, it was still above the Fed's benchmark 6.5% of the workforce.<sup>2</sup> There was some uncertainty surrounding the change in leadership from Bernanke to Yellen, but in December, he still sat at the head of the table. Then in January 2014, barely four weeks from the first taper move, the FOMC announced another step to slow monthly bond purchases, again by another $10 billion. Not only was there no change in the underlying environment between December and January but also there was not even enough time to weigh the impact of the first taper.</p> <p><b>New Research</b><br> Only those on the FOMC, of course, can truly know the thought process behind this new eagerness to taper. But if the economic facts on the ground offer an insufficient explanation, a piece of Fed research might. Early last December, the FOMC received a remarkable study by two Fed economists, Steve A. Sharpe and Gustavo A. Suarez, titled, &quot;The Insensitivity of Investment to Interest Rates: Evidence from a Survey of CFOs.&quot; It concludes that companies are unlikely to cut back much on capital spending if interest rates rise, even by as much as 100 bps, and they are even less likely to expand such spending if interest rates were to fall, even by as much as 100 bps.<sup>3</sup> Since the whole point of quantitative easing was to stimulate business spending, and hence the economy, by reducing the cost of funds, the report must have given members of the FOMC pause. Certainly, it should have.</p> <p>Of course, no single piece of research is ever conclusive. Still, this one is compelling, especially because it focuses on the period since the financial crisis and recession of 2008–09. Like all good scholars, Sharpe and Suarez's paper reviews earlier work in the field. It notes that these studies, which rely on time series data on interest rates and capital spending, find only a slight change in business behavior in response to interest rate moves. Other studies, which drill down to specific firms, find a slightly stronger relationship, but only slightly. Sharpe and Suarez's study approaches the matter differently from this earlier research. It relies on surveys, compiled by Duke University, of hundreds of CFOs in companies large and small across the country. These polls were made both before and after the rate increases in 2013.</p> <p>If anything, Sharpe and Suarez find even less sensitivity to changes in yields and rates than did the earlier work. Only 8% of the respondents said they would increase this spending if the rates they face were to fall more by 100 bps and only 8% more said they would increase their spending if the rates were to fall in excess of 200 bps. Fully 68% said that they would not change the spending plans at all in response to interest rate moves, citing other factors, such as revenues growth and cash on hand, as more important. Rate increases drew only a slightly stronger response. Some 16% of the respondents said that they would reduce investment spending in response to a 100 basis-point rise in the rates they face, and another 15% said they would cut their spending for a rise of more than 200 bps—more sensitivity than they showed to rate declines, but still, hardly a powerful response.<sup>4</sup></p> <p><b>Impact</b><br> Since the main purpose of quantitative easing was to use rate and yield reductions to induce businesses to spend, and hence propel economic growth, these findings raise two significant policy doubts: 1) whether the Fed was right to initiate quantitative easing in the first place, and 2) whether a continuation of the program has promise of a favorable impact down the road. These results certainly strengthen the position of those on the FOMC who have doubted the program throughout. The Fed may be especially sensitive to these conclusions and the doubts they raise because it also is well aware that quantitative easing, whatever else it might do, carries considerable risk. Several members at the Fed, including Bernanke, have noted the possibility that quantitative easing could breed asset bubbles, such as developed from past, and less radical, easy monetary policies in the late 1990s and during the years 2005–07. Others have noted how excess flows of liquidity also led to generalized inflationary pressures, something the Fed definitely wants to avoid. Against such concerns, the research effectively warned the FOMC that its quantitative easing program was incurring risk with little or no chance of the reward policymakers sought.</p> <p>No doubt, the report could not sway policy on its own. But given the tension over quantitative easing already in the FOMC and the clear longer-term risks of which all at the Fed are well aware, it may well have had an outsized impact and, so, go a long way to explaining the Fed's new eagerness to taper, even though little in the underlying economic fundamentals has changed since last year. It points, all else equal, to a measure of tapering at each FOMC meeting going forward.</p> <p><span class="separator">&nbsp;</span></p> <p>&nbsp;</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><sup>1</sup> Data from Bloomberg.<br> <sup>2</sup> Data from the Department of Labor.<br> <sup>3</sup> Steve A. Sharpe and Gustavo A. Suarez, &quot;The Insensitivity of Investment to Interest Rates: Evidence from a Survey of CFOs,&quot; Federal Reserve, December 2013.<br> <sup>4</sup> Ibid.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 3 Mar 2014 21:52:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/us-economy-curb-your-enthusiasm.htmlU.S. Economy: Curb Your Enthusiasm<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>Amid optimistic projections of an acceleration in growth, the factors that have restrained GDP remain firmly in place.&nbsp;</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>A relatively strong end to 2013 seems to have generated talk of a generalized and sustained economic acceleration going forward. Journalists, tired of writing about slow growth, have embraced the new story line. The Federal Reserve and the International Monetary Fund (IMF) have raised their growth estimates for the U.S. economy in 2014 and 2015. Though a recovery doubtless will continue, the acceleration of which so many discuss will likely remain elusive. Never mind that these organizations have persistently shown overly optimistic projections—all that has kept growth slow to date remains in place.</p> <p>No doubt the flow of statistics as the year progresses will change consensus opinion. It always does. In the final tally, a technical debate will ensue as to whether the forecasted acceleration was right or wrong. The pro and con of that dispute will, as always with economists, resemble the modern equivalent of medieval concerns over how many angels can dance on the head of a pin. To render the argument even sillier, it will revolve around statistics that will remain subject to revision for a long time to come. But as the following discussion of recent trends and their sustainability will show, the underlying picture, whatever the precise statistics that debaters reference, will remain one of continued, subpar economic recovery.</p> <p>The root of all this recent enthusiasm is evident in the overall real gross domestic product (GDP) figures for the past year. The opening quarter of 2013 came in at a disappointing 1.1% real annualized growth rate, slow even by the standards of this disappointing recovery. At the time, the usual threats about a second recessionary dip gained currency and began to take over consensus thinking. The second quarter blunted some of this pessimism. It showed real growth up at a 2.5% annualized real rate, hardly good by the standards of past cyclical recoveries, but at least back on track with the rest of this disappointing recovery and enough to scotch talk of recession. The third quarter showed more strength, a 4.1% annualized rate of real growth. The preliminary 3.2% real growth figure for the fourth quarter seemed to confirm, at least for some, that something good was happening.<sup>1</sup> Though even these figures look slow by the standards of past recoveries, they were enough to change the tone of consensus chatter. Recent weaker numbers already have taken some of the bloom of the rose of growth enthusiasm.</p> <p><b>A Question of Inventories</b><br> Inventory patterns always presented a reason to doubt expectations of robust growth. A remarkable amount of the second half acceleration reflected an accumulation of goods on shop shelves and in warehouses across the country. According to the current state of statistics offered by the Commerce Department, this accumulation alone accounted for a little less than a third of the second half growth and almost two-thirds of the acceleration over the first half of the year. But though the Commerce Department reasonably counts inventories in the GDP because the economy produced them, they remain unsold. Actual final sales to final users in the second half grew much less robustly, at a 2.6% average annualized rate, up, admittedly, from the 2.3% annualized rate of the first half, but hardly the picture of a marked pick up that emerges when inventory accumulations are included, as they are in the headline figures.<sup>2</sup></p> <p>There is something else about this inventory buildup. Going forward, business is likely to meet future sales with these accumulated stocks of goods instead of with new production, or at least it will meet some of those sales in this way. Because a depletion of inventories would count against the gross growth figure, that measure would then trail the pace of final sales. To be sure, inventory sales ratios are up only slightly, and so invite only a small adjustment. Auto inventories today, for instance, stand at almost 2.2 months' sales, up from just over 2.0 a year ago. Overall retail inventories, presently at almost 1.5 months of sales, are less than 3.0% higher than they were a year ago. It is, however, far from a huge overhang. But it could convince management to trim inventory stocks a bit and certainly not to add much more to them. Either way, the figures going forward would miss the inventory fillip they got during 2013's second half. At best, the overall real GDP record would just about track the ongoing slow pace of final sales, at about a 2.5% annualized rate.<sup>3</sup></p> <p><b>The Household Sector</b><br> Consumer spending did accelerate in the fourth quarter, at least according to the Commerce Department's preliminary figures. Its overall annual rate of real growth registered 3.3%, compared with an average annual growth rate of 2.0% for the first three quarters of the year. Spending on housing buoyed the third quarter especially, expanding in real terms at a 10.3% annualized growth rate.<sup>4</sup> But three factors call into question the sustainability of both those contributions to overall real GDP growth, at least at the pace of last year's second half. One is still weak labor markets and the implications that they have for income growth. The second is the already evident slowdown in home sales and construction. And the third is the mix of the recent spending surge.</p> <p>Hiring remains lackluster. Some months show better payroll growth than others, contributing to alternating bouts of optimism and pessimism, but the underlying trend can at best be described as sluggish. During the past 18 months, payrolls averaged a monthly rise of 181,000, far slower than in past recoveries. During the last six months, the average actually slowed to 170,000 a month. At the same time, the average weekly wage has increased at a paltry 1.5% annual rate. This wage figure would have shown even slower growth were it not that industry turned to overtime in place of hiring. The resulting combination of employment and wage growth is sufficient to propel modest growth in consumption, but not enough to sustain the strong pace registered during fourth quarter 2013 especially. As it is, households, to support that expansion in consumption, had to slow their pace of savings, from 4.9% of their aftertax income last summer to 4.3%.<sup>5</sup> Even if households are willing to renounce the embrace of thrift they made after the 2008–09 recession and financial crisis, there are limits to how far this can go.</p> <p>Meanwhile, the housing recovery, which had gained such striking momentum earlier in 2013, has begun to slow. Its earlier powerful pace was never sustainable. Lenders have remained reluctant to extend credit, and besides, the recorded surge was more a typical statistical bounce from a very low trough than anything fundamental. It is noteworthy in this regard that the power of the initial surge occurred almost exclusively in those regions of the country where the previous downdrafts were most severe—Southern California, Nevada, Arizona, and Florida. The rise in mortgage rates during summer, after the Fed announced its decision to taper its rate of quantitative easing, reinforced a slowdown that was otherwise built into the fundamentals. Actually, sales and construction fell some during the later months of 2013. The sector will likely return to growth. Residential real estate remains historically affordable, even with the rise in home prices earlier in the year and the more recent rise in mortgage rates. And lenders are becoming a little easier about extending credit for home purchases. But the sector will not likely return to the rapid growth pace of earlier in 2013.<sup>6</sup></p> <p>And then there is the mix of spending during the surge. Three areas showed the greatest sales growth—autos, home furnishings and appliances, and recreational goods and vehicles, each expanding in real terms at annualized rates of, respectively, 3.0%, 9.6%, and 10%. Certainly, the slowdown in housing sales and construction should slow the pace of spending on home furnishings and appliances going forward. But more than that, all these sorts of purchases are durable goods. For most people, they constitute a one-time purchase that is not repeated for years. This recent surge reflected a measure of confidence that allowed consumers to catch up with long-deferred purchases. The average age of the country's auto fleet had reached the point where some large measure of replacement was all but inevitable. Perhaps that effect will carry on a little longer, but, by its nature, it cannot persist for long. As with other sources of this surge, its strength will likely fade, even as some moderate growth continues. The seemingly sudden 0.4% decline in retail sales recorded for January<sup>7</sup> would seem to confirm this slowing picture, but, of course, the weather-induced severity of the adjustment overstates the degree of weakness.</p> <p><b>Capital Investment and Trade</b><br> Capital investment by business and industry was only a small part of the second half GDP surge. There was only a slight acceleration in real spending on equipment, from a 2.5% real annualized rate of gain in the first half to a 3.1% rate in the second half. Real spending on what the Commerce Department calls &quot;intellectual property&quot; accelerated more, from a real 1.1% annualized rate of advance in the first half to a 4.5% rate in the second half. Meanwhile, real spending on structures and other fixed facilities followed its typical lumpy pattern, falling in real terms at a 25.7% annual rate in the first quarter, rising at a 17.6% rate in the second and at a 13.4% rate in the third, only to fall at almost a 10.0% annualized rate in the last quarter, at least according to preliminary figures. All this spending on average contributed a bit over half a percentage point to overall real GDP growth.<sup>8</sup> Though there is every reason to expect this to continue, the caution continuously shown by business for years now, in its expansion plans, its hiring, even in its acquisitions, makes it doubtful that such spending will surge at all, much less enough to change the overall economic picture.</p> <p>Trade is very different. Both a rise in exports and a fall in imports contributed greatly to the GDP acceleration during 2013's second half. Real exports accelerated from a 3.4% real annualized rate of growth during the year's first half to a 7.6% rate during the second half. Real imports, which count as a negative in the Commerce Department's GDP calculation, slowed from a 3.8% annualized rate of real growth in the first half to only a 1.7% rate in the second half. Combined, the contribution of net trade to real GDP growth swung from a 0.2 percentage-point <i>detraction</i> in the first half to more than a 0.7 percentage-point <i>contribution</i> in the second, a swing of almost a full percentage point.<sup>9</sup> Because so much of this improvement reflects the fracking revolution in the energy industry, which is still gaining momentum, there is reason to expect the positive effects to persist into 2014 and 2015 and beyond, if not quite at the recent pace, at a significant pace nonetheless.</p> <p><b>Government</b><br> This area, which detracted from growth all last year, should offer a modest contribution over the next 12–24 months. Actually, state and local government spending had begun to pick up a small measure of momentum last spring. Tax revenues have at last begun to pick up—not enough, of course, to put state and local government finances in good shape, but enough to turn the picture from one of cutbacks to one of modest re-hiring and modest increases in spending on other obligations. It was not a big deal. Such outlays in real terms went from declines of about 1.0% at an annual rate in 2012's last quarter and 1.3% in 2013's first quarter to a growth of about 1.3% in 2013's second half.<sup>10</sup> Hardly the stuff of a boom, but an improvement nonetheless and one that shows every indication of persisting.</p> <p>The federal picture should turn around more dramatically. Spending on goods and services, for defense and non-defense purposes, the only part that counts in the GDP, fell consistently throughout 2013, at a 5.0% annual rate in real terms during the first half of the year and at a 7.1% rate on the second half. But as the recent budget deal has postponed any sequester effects for a couple of years, the declines of last year should turn to modest increases this year, perhaps as much as 2.0–2.5% in real terms. So whereas federal cutbacks detracted some 0.4 percentage points from overall real GDP growth last year, they may add slightly, perhaps 0.2 percentage points, to growth during 2014.<sup>11</sup> That change constitutes a swing of more than half a percentage point—not enough to drive a substantive acceleration, but a contribution to the overall growth picture, nonetheless.</p> <p><b>Pulling the Threads Together</b><br> Though the picture in trade and government would suggest some real growth acceleration, these are hardly enough to overwhelm the larger areas expected to slow. Capital spending, after all, will likely track a still modest growth path and consumer spending going forward will, as explained, likely grow at a slower pace than in last year's second half. Since the consumer constitutes some 70% of the economy, even a modest slowdown in the sector can offset the aggregate effect of modest accelerations elsewhere. Meanwhile, housing, though it will likely resume its recovery in 2014, will expand at nowhere near the speed of 2013. The inventory effect will almost surely slow the aggregate growth pace. The balance is a continued slow recovery along the lines to which all have grown accustomed over these last few years, even if the exact contours of the mix clearly will change.</p> <p><span class="separator">&nbsp;</span></p> <p>&nbsp;</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><span class="legal"><sup>1</sup> All data from the Department of Commerce.<br> <sup>2</sup> Ibid.<br> <sup>3</sup> Ibid.<br> <sup>4</sup> Ibid.<br> <sup>5</sup> Ibid.<br> <sup>6</sup> S&amp;P/Case-Shiller data.<br> <sup>7</sup> All data from the Department of Commerce.<br> <sup>8</sup> Ibid.<br> <sup>9</sup> Ibid.<br> <sup>10</sup> Ibid.<br> <sup>11</sup> Ibid.</span><br> </p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 24 Feb 2014 16:33:08 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/the-fed-yellen-staperingtightrope.htmlThe Fed: Yellen's Tapering Tightrope<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>In reducing quantitative easing, the Federal Reserve chairwoman faces a big challenge: preventing asset bubbles at home without pressuring developing economies.&nbsp;</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Like a tightrope walker, Federal Reserve chairwoman Janet Yellen and her colleagues at the Fed dare not lean too far in one direction of monetary policy or another. On the one side, they know that they have to taper their quantitative easing program and generally rein in the Fed's present, extremely easy monetary posture. As former chairman Ben Bernanke has repeatedly made clear, a failure to do so risks financial bubbles and, worse, a generalized inflation. But on the other side, the still fragile state of global finance and economics creates a vulnerability to even minor policy adjustments. The recent turmoil in emerging markets testifies to this risk. It is surely too early to judge whether either danger will become a reality or, if so, which one, but investors, nonetheless, need to keep a weather eye on both sides of this risk equation.</p> <p><b>Ominous Precedents</b><br> Recent history speaks loudly to these risks, the second one in particular. The last two collapses in markets and the economy—2000–01 and 2008–09—resulted from Fed tightening that otherwise seemed minor, but nonetheless had an outsized impact on markets and through them on economic activity.</p> <p>The first of these developed less from active Fed policy than from Fed neglect, but ultimately owed much to this kind of a policy error. The problem began in China. Because this country had set out to promote its exports by keeping down the foreign exchange value of its currency, the yuan, the People's Bank of China had to buy dollars almost continually, which it then invested largely in U.S. government securities. This flood of liquidity into U.S. financial markets helped inflate the dot-com and technology bubble that expanded throughout much of the 1990s. The Fed could have neutralized, that is &quot;sterilized,&quot; the effect of these Chinese flows, but for reasons of its own, the Fed chose not to do so. It burst the bubble it had allowed Chinese liquidity to create, on its own. And it did so inadvertently. Worried in 1999 about a modest uptick in inflation, policymakers engineered what must have seemed to the Fed very moderate restraint. Short-term interest rates rose by a mere 80 basis points over the course of that year, not even back to the levels that had prevailed earlier in 1998. But markets, already bloated with excess liquidity, had an outsized reaction. The technology and dot-com collapse of 2000–01 followed.<sup>1</sup></p> <p>The second bubble and bust was even more closely related to Fed policy. Of course, Chinese liquidity continued to flow into the United States during the early years of this century, as it still does. This time, the Fed's easing efforts to promote recovery after the technology/dot-com bust actually added to the flood. The investment focus settled on real estate instead of a particular sector of the stock market, but, as previously, the country was experiencing a liquidity-driven rise in asset prices beyond what any economic fundamentals warranted. When the Fed, mildly worried in 2006 and 2007 over economic overheating and a slight acceleration in the pace of inflation, decided to drain a small measure of liquidity from markets again accustomed to a flood of liquidity, the markets reacted radically, even more violently than in 2000. The resulting economic and financial carnage is familiar to all.<sup>2</sup></p> <p><b>Risk of a Repeat?</b><br> Now, as the Fed continues to taper its quantitative easing, the obvious question to ask is whether there is a risk that this pattern of bubble and burst will repeat. The short answer is, yes, the risk exists. Markets for years now, since 2008 in fact, have seen a flood of Fed-provided liquidity, and asset prices have risen in part because of it. What in any other circumstance would look like the most modest of policy adjustments could create an outsized reaction. But if the risk of a repeat exists, much evidence suggests that it is not a probability.</p> <p>On the worrisome side is the recent behavior of risk assets, particularly in emerging markets. From the moment last spring that the Fed first began to talk about tapering, emerging market currencies, bonds, and equities have all suffered and in much the same way as when past bubbles have burst. Between June and September last year, emerging market equities, as a group, lost about 13% of their value,<sup>3</sup> even as many of their currencies also suffered setbacks and the rates they had to pay to borrow rose. When the Fed forewent a tapering move last September, these equity markets recovered some of the ground they had lost, but they gave it all back and more when the Fed actually began to taper in December 2013 and January 2014. Meanwhile, currency pressure in several of those countries reached crisis levels, and the rates markets charged them to borrow rose still more, whether the debt was denominated in dollars or in their own currencies.</p> <p>As familiar as the pattern looks on the surface, however, several differences from the past push the probabilities away from a repeat of such disasters. For one, the Fed's actions to date hardly constitute even modest monetary restraint. Policymakers, after all, have only slowed the pace at which they are pouring new liquidity into markets. Up until last December, the Fed was buying $85 billion a month of Treasury and mortgage-backed bonds. The Fed has slowed down the flow to $65 billion a month.<sup>4</sup> This is hardly a withdrawal of liquidity. Indeed, it still constitutes a torrent of monetary support. Meanwhile, the Fed has kept short-term interest rates near zero, another major support to the markets. Nor are markets as overpriced as they were in 2000 or 2008. The rallies of the past few years have realized much of the superb valuations that had existed, but in no way are either equity or real estate prices as far from the economic fundamentals as they were in past bubbles.</p> <p><b>The Balance of Evidence</b><br> To be sure, people in the past seemed unaware of how out of line prices had become, and the Fed thought it was following a moderate path. It also is true that emerging markets concerns today go beyond liquidity. Argentina, for example, suffers from an unsupportable debt overhang and Turkey from political discord troubles. Questions have arisen about the sustainability of China’s growth rate and its debt overhang. But if this emerging market response is not quite yet the proverbial canary in the coal mine alerting to a danger, it is reminiscent of past blunders and it is a cautionary flag that investors need to acknowledge, even if the entire economic picture still says they may never have to heed it.</p> <p><span class="separator">&nbsp;</span></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <p><sup>1</sup> For more detail, see, Milton Ezrati, <i>Thirty Tomorrows</i> (New York: Thomas Dunn Books/St. Martin's Press; forthcoming April 2014), especially chapter 13.<br> <sup>2</sup> Ibid.<br> <sup>3</sup> Data from Bloomberg.<br> <sup>4</sup> Data from the Federal Reserve.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Tue, 18 Feb 2014 09:28:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/labor-do-the-jobless-lack-the-skills.htmlLabor: Do the Jobless Lack the Skills? <div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>Many commentators worry that a skills mismatch is weighing on the U.S. labor market. But the elevated unemployment rate stems from a variety of other factors</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>The answer to the title question is: No, probably not. It is, of course, very popular to explain the nation's stubbornly high unemployment in terms of a mismatch between the skills the economy needs and those that exist in the workforce. People of all political stripes—in Washington, in business, academia, think tanks, even organized labor—have done so and have proposed solutions, usually, and not coincidentally, furthering their partisan agendas. To be sure, this consensus is broadly correct. The modern developed economy will need ever better educated, better trained workers. But though an important longer-term issue, today's stubbornly high rate of unemployment seems to result from more cyclical and immediate policy considerations, such as extreme caution in corporate America, skewed wage expectations, and the extension of unemployment benefits. The skills mismatch may in time create chronically higher unemployment, but that is not what is happening now.</p> <p><b>A Popular Argument Indeed</b><br> The popularity of the skills mismatch argument is evident. President Obama noted the issue in the last three State of the Union addresses, and in his latest budget asked for $8 billion in new monies for training to address it. His opponent in the 2012 election, Mitt Romney, while disagreeing on almost every other point with the president, asserted that a skills mismatch &quot;lies at the heart of our job crisis.&quot; The president of the Minneapolis Federal Reserve has pointed to the skills gap as the root of the nation's unemployment problem,<sup>1</sup> as has the U.S. Chamber of Commerce. The International Labor Organization, in its publication <i>Global Employment Trend 2013</i>, features the mismatch as the cause of &quot;long-term unemployment,&quot;<sup>2</sup> while the prestigious Organization for Economic Cooperation and Development (OECD) has produced book-length studies documenting the mismatch in the United States and across its global membership. And those are only some of the most prominent sources of such commentary.</p> <p>It is easy enough to understand why so many people and interests seek an explanation. The nation's labor market has behaved in an atypical way. Usually, unemployment rises when there is a shortage of jobs on offer and falls when business and government put more jobs on the market. But since this recovery began in 2009, the United States, and many other developed countries as well, have suffered abnormally high rates of unemployment even as the number of available job openings has increased. It is unusual and disturbing that people go wanting for jobs at the same time as jobs go begging people to fill them. Yet as millions have failed to find work, so much so, in fact, that millions have even given up trying: the number of unfilled positions offered by business and industry has risen by almost 1.5 million, from about 1.4% of the total to about 2.4%, some 600,000 of these positions in manufacturing.<sup>3</sup> This strange twist in the Beveridge curve (what economists call the graphic presentation of this relationship) naturally makes all concerned look to explanations outside the normal business cycle, and the existence of a skills mismatch naturally attracts.</p> <p><b>Reason to Look Elsewhere</b><br> Aside from such atypical statistical relationships, the main support for the skills mismatch explanation comes from research that found rapid wage increases in some skills and stagnation in others. Those conducting the research allow that the situation could reflect a particular need rather than the general skills mismatch of which most commentary speak. But it does point in that direction.</p> <p>Other than this, however, most other investigations raise a measure of skepticism about the skills mismatch explanation, and point to other causes. Studies that examine specific jobs and the men and women who hold them find no evidence of a skills mismatch at all, except perhaps for high school dropouts. The Chicago Federal Reserve Bank, in its review of work done elsewhere as well as its own original research, offers more reason to doubt the skills mismatch. The bank points to the considerable evidence that firms have approached recruiting less aggressively than they have in the past. It reviews other research questioning the skills mismatch explanation by pointing out how little variation there is from one industry to another. All show employment below past peaks, high- and low-skill industries and positions alike. The Chicago Fed's own work raises a similar point. If the problem were a general skills shortfall, one would think the mismatch would occur in particular sectors, levels of skill, and industries.</p> <p>Some of the most interesting work on this question comes out of Northeastern University. There, Professor William Dickens compared job openings statistics to unemployment data disaggregated according to the duration of unemployment.<sup>4</sup> In this way, he composed a series of what could be described as specialized Beveridge curves for each subgroup. Dickens discovered no relationship at all between short-term unemployment (five weeks or less) and job vacancies. The implication is that such unemployment, as in the past, simply reflects the normal hiatus people face when they change jobs, even when the move is planned, what economists call frictional unemployment. When he did a similar analysis for those unemployed for five to 14 weeks and 15–26 weeks, he discovered that in the conventional relationship between jobs on offer and unemployment, the more jobs there are available, the less unemployment there is. Only for the very long-term unemployed (27 weeks or more) did he observe the strange result in which the number of jobs on offer and unemployment rose in tandem. It seems, then, that the entire departure from past cycles is concentrated in this group of long-term unemployed.</p> <p><b>Drawing the Pieces Together</b><br> It is possible, of course, that a skills mismatch creates the long-term unemployment. No doubt, there is something to this. But in light of all this research, it would seem that other causes lie at the root of this stubbornly high long-term unemployment. Extreme caution among managements is entirely plausible given the severity of the past recession and the uncertainties imposed by the Affordable Care Act and other massive pieces of legislation. In addition, the 2008–09 recession created layoffs in areas where pay was high relative to skill levels, finance, construction, real estate sales, and media, in particular. As these people have sought alternative employment, they have no doubt balked at the lower salaries they have been offered and, quite naturally, have held back in the hopes of finding jobs in which they could recover a greater share of their former wage or salary. At the same time, such behavior has received encouragement from a third factor, the government's decision to greatly elongate the period over which people could collect unemployment.<sup>5</sup></p> <p>If this analysis is correct, and it seems likely, this strong relationship will break down in time, quite aside from any efforts to erase a skills mismatch. Time, of course, will clarify the uncertainties still surrounding the ambitious legislation of the past few years. It also will heal the wounds left on management by the last severe downturn in 2008–09. Time also will convince many that their former wages and salaries cannot in fact be reproduced, forcing the unemployed to accept less than they commanded during the artificial environment of the last boom. The recent decision to remove the prop of exceptionally long-term unemployment benefits should accelerate this process. It will impose hardship, to be sure, and no one wants to see that. But it also will spur these long-term unemployed to accept positions, disappointing as the wages are, even if only as an interim solution, and, accordingly, reduce the number of the long-term unemployed.</p> <p>Over the longer term, perhaps, a skills mismatch, and an education mismatch, which is different, could cause a chronically elevated unemployment rate. Indeed, such a prospect would be likely, if the nation fails to give greater attention to training, education, and also immigration reform. But it would be premature to look for such a result until—or if—the economy fails to step up to the needs of the more demanding future economy. For now, the data cannot support the skills mismatch argument as a cause of stubbornly high unemployment, no matter how popular it is.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:15px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <hr class="separator_grey"> <p><sup>1</sup> Federal Reserve.<br> <sup>2</sup> International Labor Organization, February 4, 2013, and Barbara Kiviat, &quot;The Big Jobs Myth,&quot; <i>The Atlantic</i>, July 2012.<br> <sup>3</sup> All data from the Department of Labor.<br> <sup>4</sup> Jason Faberman and Bhashkar Mazumder, &quot;Is There a Skills Mismatch in the Labor Market?&quot; <i>Chicago Fed Letter</i>, July 2012.<br> <sup>5</sup> For more detail, see Rand Ghayad and William Dickens, &quot;It's Not a Skill Mismatch,&quot; <i>VOX Policy Analysis</i>, January 5, 2013.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 10 Feb 2014 11:31:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/hows-housing-doing.htmlHow's Housing Doing? <div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3>The residential real estate market should continue its modest improvement in 2014-15—with positive implications for the U.S. economic recovery.</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>Beneath its typically erratic month-to-month pattern, the housing recovery has slowed. Some of this was bound to happen. The sharp rebound registered earlier last year was hardly sustainable. Because the Federal Reserve's talk of tapering raised mortgage rates last summer, the inevitable slowdown in the pace of recovery turned to a modest decline. But for all this, moderate continued improvements in residential real estate look reasonably secure in 2014-15, and with it greater security for a continuation of the admittedly slow economic recovery overall.</p> <p><b>The Picture So Far</b><br> During the first half of 2013, housing appeared to be roaring back. Sales of existing homes—all those properties that had been languishing behind the for-sale signs for years—jumped at a 17.7 % annual rate between January and July. Sales of new homes followed a more erratic pattern, but rose at a 29% annual rate on balance during the first six months of the year.<sup>1</sup> Real estate prices increased in response to the renewed demand. According to the National Association of Realtors, the median sales price of a home rose nationally at a 41% annual rate between January and June.<sup>2</sup> A different price measure, the S&amp;P/Case-Shiller Home Price Index,<sup>3</sup> rose at a 19.1% annual rate during this same time.<sup>4</sup></p> <p>This kind of a surge was unsurprising, but always unsustainable. Given the depths to which residential real estate had sunk, a strong initial bounce was typical. But such surges also typically tend to run their course quickly. The signs were all there. The greatest gains occurred in Florida, Nevada, Arizona, and California—the states that had seen the worst downdrafts. Elsewhere in the country, the gains were much more moderate. Meanwhile in June and July, bond yields and mortgage rates jumped in response to talk from the Fed about tapering the flow of new liquidity in its quantitative easing program. The average mortgage rate offered by lenders rose more than 100 basis points (bps) between June and September, all but ensuring a more pronounced slowdown in the pace of recovery, more, in fact, than was already built into the market dynamic.</p> <p>Accordingly, between July and year-end, it began to look as though the housing market had relapsed into decline. Sales of existing homes fell at a 15.1% annual rate from July through November (the most recent month for which data) fell at a 15.4% annual rate between June and December.<sup>5</sup> Median sales prices for existing homes, as tracked by the National Association of Realtors, slipped at a 15.9% annual rate during this time,<sup>6</sup> while the S&amp;P/Case-Shiller Price Index showed gains at an 8.1% annual rate between June and November (the most recent period for which these data are available),<sup>7</sup> still strongly positive, but slower than earlier in the year.</p> <p><b>Now What?</b><br> The natural question now is to ask whether the housing recovery can regain traction in 2014 and 2015. The probabilities indicate that, yes it can and will, but at a much slower pace than averaged early last year. Though Fed policy will edge up mortgage rates, affordability remains high, and lenders will likely become less reluctant to extend credit to residential real estate.</p> <p>Housing remains remarkably affordable, at least by historical standards. To be sure, it is down from where it was between 2009 and 2012, or earlier in 2013. Real estate prices, up on balance nearly 10% during the last 12 months, have outpaced the growth of median household income, up only 2.1% during this time, and mortgage rates have gone up by 125 bps. The burden of servicing a mortgage on the median property has gone from 12.3% of median family incomes a year ago to 14.7% last November (the most recent period for which data are available). Taking all this into consideration, the National Association of Realtors estimates that, nationally, a home is 16.1% less affordable than it was a year ago. On this basis, it would be reasonable to look for a slowdown in the pace of recovery, but since even today’s reduced affordability is better than any time in the past 40 years (except for the past four years), it also is reasonable to expect a recovery to continue.<sup>8</sup></p> <p>Affordability will probably lose still more ground over the course of the next 12–18 months. Though household incomes will undoubtedly rise, any gains will run only slightly faster than last year at best. Constrained employment growth will hold back the pace of any gains, as will the retarding effect on wages of still-high rates of unemployment. Though housing price gains also should slow, they nonetheless will likely outpace income growth. And, of course, continued Fed tapering will raise mortgage rates, perhaps by another 100 bps over the next 12 months. On this basis, affordability may well deteriorate by another 10–15%. But even with such further deterioration, affordability will remain almost 30% better than its best levels of the 1980s, 1990s, and earlier years of this century, again excluding the last four years.</p> <p>The recovery could get some small extra momentum in 2014–15 as lending institutions become modestly easier about extending credit in real estate. After the 2008–09 financial crisis, most lenders, understandably, wanted nothing to do with real estate. According to the Fed, they cut back on their lending in the area by 5–6% a year in 2009 and 2010, and by about 2.4% a year on average in 2011 and 2012. Even early last year, as the housing recovery gained momentum, banks cut their mortgage exposure by 1.2%. This reluctance to lend has kept many buyers from taking advantage of the historical affordability that developed during this time. But December showed the first modest rise in real estate lending, albeit only at a 2.4% annual rate. This new willingness to extend credit to the area seems to have extended into January, on admittedly very preliminary data. If the availability of credit continues to improve, the recovery will receive help, especially since housing will remain historically affordable, if not quite as affordable as it was last year. Still, given the remembered pain of 2008-09, it is unlikely that lenders will change their attitudes fast enough or far enough to change the expected slow recovery into something substantively more robust.<sup>9</sup></p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:15px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <hr class="separator_grey"> <p><sup>1</sup> Data from the Department of Commerce.<br> <sup>2</sup> Data from the National Association of Realtors.<br> <sup>3</sup> The S&amp;P/Case-Shiller 20-City Home Price Index measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States.<br> <sup>4</sup> Data from Standard &amp; Poor's.<br> <sup>5</sup> Data from the Department of Commerce.<br> <sup>6</sup> Data from the National Association of Realtors.<br> <sup>7</sup> Data from Standard &amp; Poor's.<br> <sup>8</sup> All data from the National Association of Realtors.<br> <sup>9</sup> All data from the Federal Reserve.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 3 Feb 2014 10:26:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/the-secret-of-the-euros-survival.htmlThe Secret of the Euro's Survival<div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <h3><span class="articlePhrase">Despite fiscal strains and political controversy, the common currency still enjoys broad support among member nations. Here's why.</span></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <p>It appears that the euro and the eurozone will survive without expulsions, secessions, or, critically, defaults. The Continent's fiscal-financial crisis will almost surely go on, indefinitely it seems. The debt burdens are high, many of the zone's members have broken political-economic models, and the ongoing recessions and near recessions in many member countries will compound the financial strains for some time to come. But set against these difficulties, unity in the zone enjoys three broad supports: 1) a tremendous political will to continue the eurozone experiment; 2) continued support by the European Central Bank (ECB); and 3) tremendous pressures on Germany, Europe's paymaster, to sustain the euro and the eurozone as it is presently constituted.</p> <p><p>It may seem counterintuitive, but all the debate, compromise, even the tensions that have overtaken Europe since the crisis broke in 2010 speak to a tremendous will among its members to make the currency union work. Each nation has maneuvered for the best deal it can get. The French and others have argued for zone-wide bonds to cover budget shortfalls, while the Germans, who know they will have the ultimate responsibility to meet such obligations, have refused. While some, particularly the Spanish, have looked for zone-wide funding of bank capital needs, Berlin has demurred until there is also effective zone-wide bank supervision. But in all these and other disputes, never once has a nation threatened to break off negotiations, much less withdraw from the common currency or the institutions that support it.<sup>1</sup></p> <p>The commitment of the ECB in part reflects this impressive political will. It is, after all, an institution established by the same parties negotiating the ins and outs of the crisis. To be sure, the bank has at times talked out of both sides of its mouth. It has on occasion dragged its feet about providing liquidity to troubled financial markets, worrying over non-existent inflationary pressures instead of more immediate needs. The bank has, at various stages of this crisis, refused to help because of legal niceties that at other times it willingly ignored. But in the teeth of the worst trouble, it always moved to relieve the crisis. In the summer of 2011, for instance, when tensions came to a head over Spain's budget and banking shortfalls, the ECB set aside its past reluctance to buy the debt of these troubled countries, at once easing their and the market's acute liquidity shortages and concerns. It has followed that policy since—and it will likely continue to do so. ECB president Mario Draghi has said that the bank will do whatever it takes to secure the currency and its zone. He and everyone else at the ECB have a powerful personal motivation to do so, too, since without a euro, they know that there would be no need for a European Central Bank—or their jobs.<sup>2</sup></p> <p>Berlin, as leader of Europe's most significant and viable economy, seems entirely committed to protecting the euro and its zone from any dissolution or dismemberment. It is noteworthy in this regard that for all the strains and debate in Germany's September election, the voters overwhelmingly returned the pro-Europe Angela Merkel to the chancellor's office. Similarly, the voters refused to give significant votes to any party that advocated German withdrawal. But more than personal and party commitments, Germany has little option but to support the euro and work to preserve the eurozone as it is presently constituted. Economic and financial imperatives compel it. Even if the vote this past September had gone less well than it did, the country simply is too tied to the euro and the union to turn away. Berlin may negotiate its best deal, but it knows that if it were to let the common currency fail, even in the part, it would do itself great economic and financial harm.</p> <p>The vulnerability of German banking alone is impressive. By their own accounting, German banks and other financial institutions hold some €400 billion in Spanish, Greek, Portuguese, and Irish obligations alone. This exposure amounts to about 270% of the German banking system's tier 1 capital and 17% of Germany's gross domestic product (GDP). No doubt, exposure to Italian debt only pushes this vulnerability to greater extremes. Dissolution of the eurozone, the expulsion of some current members, and the unavoidable defaults such events would produce would consequently threaten Germany with such severe credit constraints that the economy would surely tip into a deep recession. The only way Berlin could avoid such an outcome would be to support the banks directly. There are, then, only three options: recession, direct support for the banks, or support for the periphery. Politically and financially, it is easier to marshal Europe to do the last than to face the others.<sup>3</sup></p> <p>German industry has almost as much at stake in the euro and in the survival of the zone. To be sure, German business went into the currency union with great skepticism. But since, it has learned to love the euro. To see why, all one need do is consider what German industry would face in the absence of the common currency. Money now is pouring into Germany. It is, after all, the only viable large economy on the Continent. A separate deutschemark would by now have risen into the stratosphere. German business would have lost any pricing edge on global markets. Its exports would have suffered horribly. But because the euro encompasses weaker economies, it has not risen as high as an individual German deutschmark surely would have. The common currency has effectively saved German producers, and they know it. No doubt business leaders frequently brief Berlin on this economic fact of life.<sup>4</sup></p> <p>Berlin also knows that a dissolution of the euro would steal the special trade advantage Germany has within Europe. Because Germany joined the euro when the deutschmark was cheap relative to German economic fundamentals, the common currency has effectively enshrined a competitive pricing edge for German producers across the entire zone, especially compared to producers in Europe's periphery nations, which joined the euro when their respective currencies were dear. International Monetary Fund (IMF) data show that these currency differences initially gave German producers a 6% pricing advantage over their Greek, Spanish, and Irish competitors. But since subsequent developments have encouraged greater industry and investment in Germany while discouraging it in the disadvantaged periphery, that advantage has widened. Calculations using recent IMF data put Germany's pricing edge over these countries at double digits.<sup>5</sup></p> <p>Rather than risk suffering on all these fronts, Berlin knows that it would do well to support the weak periphery and keep the broad eurozone intact. Bailouts and rescue packages might look large in the headlines, but ultimately they impose far lighter burdens than the economic and financial costs implicit in any eurozone dissolution, complete or partial. With this clear pressure and the commitment it engenders added to the political will elsewhere in Europe and the cooperation of the ECB, there is every reason to expect that the euro and the eurozone will survive for the foreseeable future, even as Europe's ongoing crisis drags on and periodically creates false, if understandable, fears of dissolution and default.</p> </p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <hr class="separator_grey"> <p><sup>1</sup> See, &quot;The SDP 'Has to Negotiate' with Merkel,&quot; <i>Spiegel On Line</i>, September 25, 2013, and Anton Troianovski, &quot;Merkel's Next Challenge: Finding New Governing Partner,&quot; <i>The Wall Street Journal</i>, October 5, 2013.<br> <sup>2</sup> Milton Ezrati, &quot;Europe's Queasy Statue Quo,&quot; Economic Insights, August 12, 2013.<br> <sup>3</sup> &quot;On Being Propped Up,&quot; <i>The Economist</i>, May 25, 2013.<br> <sup>4</sup> Ullrich Fichtner and Alexander Smoltczyk, &quot;Schauble's Search for a Way Forward,&quot; <i>Spiegel On Line</i>, September 26, 2013.<br> <sup>5</sup> International Monetary Fund.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 11 Nov 2013 19:41:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/why-some-international-economies-need-more-structural-reforms.htmlWhy Some International Economies Need More Structural Reforms <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <h3>While Japanese policymakers debate critical structural reforms known as the &quot;third arrow,&quot; similar measures will be key to sustainable growth and attractive investment opportunities in a number of other countries.&nbsp;</h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <p>Japanese prime minister Shinzo Abe has a plan for economic revival, and, with typical Japanese symbolism, it relies on three arrows. Two of his three arrows have already been launched: unprecedented monetary easing to achieve a 2% inflation target and a large deficit-financed spending program. The first two arrows are fairly conventional policy prescriptions, acknowledging that the potential magnitude of the monetary easing is anything but conventional. The third arrow, which the market is eagerly anticipating, is structural reforms to unleash growth. Japan is notorious for its inflexible, overregulated, tradition-bound economy. For Japan, the third arrow is an imperative.</p> <p>But Japan is not the only country looking to launch a so-called third arrow. Given that the world's major central banks outside of Japan have extended conventional and unconventional monetary policies about as far as they comfortably can and may be approaching the peak, a successfully implemented third arrow approach could launch the next push of momentum into the world economy. In most cases, it will take courageous and cooperative political leaders. While on balance many programs will ultimately be pro-growth, they may not be in the short term, nor will they be positive for all sectors of the economy. Identifying the implications will be important for positioning one's portfolio to take advantage of the inevitable upcoming changes.</p> <p><b>How Third Arrows Can Spur a Bull Market</b><br> We have seen a few arrows launched in Europe already, and they have helped inform our investment strategies. While the United Kingdom incorporated significant structural and fiscal reforms into its initial response to the 2009 downturn, British officials have continued to tinker with tax rates, both personal and VAT (value-added tax); the availability of credit; employment education; and research innovation. Most programs have been fairly incremental in nature, but they have provided support for U.K. economic growth and a positive tone for the U.K. equity market. (See Table 1.) Some sectors positively affected, such as real estate, have done exceptionally well, and were targeted in our investments. As for U.K. employment, it's the first time since 1999 that private-sector employment has grown faster than public-sector employment, according to GaveKal Research. It's those types of third arrow results that are structurally conducive to a bull market.</p> <hr class="separator_grey"> <p><b><span class="rte_txt_green">Table 1. Even Partial Structural Reforms Have Been Good for Stocks</span></b></p> <p><i>US$ returns for the 52 weeks ended October 15, 2013</i></p> <p><img title="Table 1. Even Partial Structural Reforms Have Been Good for Stocks" src="/content/dam/lordabbett/en/images/articles/charts/whysomeintleconomies_table1.gif"></p> <p><i><b>Source:</b> Source: Bloomberg. Data as of October 15, 2013.<br> Sharp market fluctuations can materially change the performance of equity markets. During other time periods, the equity markets may have experienced negative performance.<br> <b>Past performance is no guarantee of future results.</b><br> For illustrative purposes only and does not represent any Lord Abbett mutual fund or any particular investment.<br> Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.<br> The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. Investing in international securities generally poses greater risk than investing in domestic securities, including greater price fluctuations and higher transaction costs. Special risks are inherent to international investing, including those related to currency fluctuations and foreign, political, and economic events. These risks can be greater in the case of emerging country securities.</i></p> <hr class="separator_grey"> <p>&quot;Structural reform&quot; was a key phrase that European Commission president José Manuel Barosso used last year, when he pointed out the European Union was moving away from more austerity and into the development of &quot;pro-growth&quot; policies to deal with Europe's lingering recession. While the actual reforms have been spotty up until now, this proclamation was the turning point in how investors viewed the European equity markets, and it significantly lowered the perceived European risk premium.<sup>1</sup> Unfortunately, political instability and rudderless leadership in a number of countries have delayed what we believe will be inevitable economic reform.</p> <p><b>Keep Your Eyes on Mexico</b><br> It's not just the developed world struggling with reform. One of the more bold third arrow approaches being launched is in Mexico, where the three main political parties, together with the new president, all agree that the economy is hampered by structural shortcomings in productivity and infrastructure. In a sign of solidarity, they have signed the &quot;Pact for Mexico,&quot; which details an ambitious agenda of reform, focused on labor laws, wage policies, education, antitrust issues, infrastructure, and, most important, energy reform. It's so massive that the cost/benefit mix by industry will be complicated. But there seems to be ample room to identify winners and losers as this far-reaching third arrow gets launched over the next few years.</p> <p><b>Further Reforms Needed in Japan</b><br> Which brings us back to Japan and the imperative of Abe's third arrow. The initial launch is upon us with the hike in consumption tax in 2014. Many investors fear the economic momentum provided by the first two arrows will be derailed with this tax hike. We would likely agree if further reforms were not implemented. However, if sustainable economic growth, not continuously higher taxes, is the only way out of Japan's self-induced fiscal trap, then there must be more. As we have seen over the last 12 months, structural economic reforms are a great tonic for equity markets, and there will be winners and losers for us to identify. With that in mind, an alternative way to view Abe's tax hike is that he understands that Japanese economic revival is not just about printing and spending money, and, most important, that he has the necessary political will to fully launch the third arrow in time.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_1"> <div style="width:auto; padding:0px 0px 0px 0px;margin:15px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_1"> <hr class="separator_grey"> <p><sup>1</sup> Risk premium is generally defined as the return over and above the risk-free rate of return that an investor expects in exchange for each additional unit of risk. According to Markowitz portfolio theory, rational investors accept additional risk only if they expect a greater return.<br> <sup>2</sup> The Nikkei-225 Stock Average is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange.<br> <sup>3</sup> The FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange.<br> <sup>4</sup> The Euro STOXX 50 Index, Europe's leading blue-chip index for the eurozone, provides a blue-chip representation of super-sector leaders in the eurozone. The index covers 50 stocks from 12 eurozone countries.<br> <sup>5</sup> The Mexican IPC index is a capitalization-weighted index of the leading stocks traded on the Mexican Stock Exchange. Note: Buoyed by proposed structural reforms and a rapidly closing wage gap with China, Mexico's stock market was one of the best-performing major markets in the world in 2012.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <hr class="separator_grey"> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Tue, 5 Nov 2013 15:12:00 -0500http://www.lordabbett.com/content/lordabbett/en/perspectives/economicinsights/time-to-rediscover-emerging-markets.htmlTime to Rediscover Emerging Markets<div class="everything heading"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="textheading"> <h3><span class="articlePhrase">Many developing economies still have room for solid growth, and recent market action has created attractive debt and equity valuations.</span></h3> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <p>It is easy these days to generate pessimism about emerging market investments, and it is almost surely wrong, too. To be sure, there are plenty of worries surrounding these markets. Growth rates are slowing, inflationary problems have emerged in some places, capital flight has affected others, and where China is concerned, there are suggestions of demographic problems and asset bubbles. But it would be a mistake to tar one market for the problems in another, as many seem to do these days. These economies, and their markets, are remarkably diverse. It would be an even bigger mistake to ignore the ample opportunity for growth left in these economies, especially since the asset underperformance of late has created some very favorable valuations.&nbsp;</p> <p>Assets prices in emerging economies, both bonds and equities, have suffered of late for two basic reasons. The most immediate is the threat of tapering of bond purchases by the Federal Reserve that would curtail the otherwise generous flow of liquidity it has long provided global markets. Investors, understandably, worry that asset pricing has depended heavily on this liquidity and have, naturally, sought safety at the least hint of the slightest interruption. Investors have, accordingly, pulled back, especially from emerging markets, where information is often scarce and where there is a history of great volatility. The second concern is more fundamental. The pace of real growth in these emerging economies has slowed, raising questions about earnings prospects and the health of their finances, public and private.<sup>1</sup></p> <p>On both counts, the negative response has gone too far. Take the tapering, for instance. Fed chairman Ben Bernanke had often indicated that the Fed would taper only gradually and would turn to subsequent measures only after a long time, waiting until 2015 at the earliest to begin raising interest rates, and then only slowly from still accommodatingly low levels. Unless markets are without any fundamental support and are truly strung out on this flow of liquidity, such a path was never likely to undercut them as dramatically as recent reactions would suggest. Nor were the first stages of tapering (even if it had occurred when it was expected, which it did not) the stuff of which shocks are made. It was suggested that if the Fed moved at all, it would reduce its bond purchase from $85 billion a month presently to $70–65 billion—still an ample flow of liquidity. And as it is, the Fed still has not even begun the policy change.<sup>2</sup></p> <p>To be sure, Bernanke is scheduled to leave office in the new year, to be replaced in all likelihood by Janet Yellen, the Fed's current vice chair. She could, of course, change policy more quickly than Bernanke intended. But that is highly unlikely. After all, she has worked hand in glove with Bernanke to create the present gradualist approach. In the unlikely event that she would want a change, she would have to shift many of the members of the Federal Open Market Committee (FOMC) to do so. Since they, too, are parties to the present policy, it is hardly likely that she could do that. Moreover, her votes at past FOMC meetings suggest that she is more likely to remain accommodative for longer than Bernanke would have.<sup>3</sup></p> <p>The underlying economic fundamentals in emerging markets, too, though much changed from the salad days earlier in this century, are far less threatening than recent market responses imply. This is no place to review prospects for the long, diverse list of emerging economies and markets, especially because each has its own strengths and weaknesses. But it is possible to generalize that these economies, if no longer expanding at the breakneck pace they once were, still have much greater growth potential than the developed economies, the best of which are exhibiting only anemic rates of expansion. The commodity-based economies probably present greater reason for concern than the more broadly based emerging economies, those that are adjusting to the unfolding fundamentals of slower growth, for instance, and the challenge of the still less developed frontier economies. A cursory comparison among the well-known BRIC economies—Brazil, Russia, India, and China—might illustrate these general points, though the overall emerging universe is much broader and remarkably diverse.<sup>4</sup></p> <p>Russia and Brazil lean toward the commodities side of this division. The former, in particular, has made itself highly and needlessly dependent on oil and gas. Half the government's revenues, in fact, come from oil and gas and at least that much of the country's export earnings. Were it not that the current tensions in the Middle East have pushed up oil prices, despite the global growth slowdown, the Russian economy would be struggling, which to a degree might explain the Kremlin's geopolitical strategies. In such a state, Russia's economy, and hence most of the assets priced in it, look highly vulnerable.<sup>5</sup></p> <p>Brazil's situation is less extreme. It is more thoroughly diversified among different commodities than is Russia and more thoroughly diversified generally as an economy. But Brazil's still-heavy dependence on commodities makes it susceptible to the slow-growth global economic environment that will also surely persist. Still more, much of what previously looked like domestic development in Brazil now reveals very shallow roots. Some years ago, many saw broad-based development in the remarkable progress the country had made lifting people out of poverty. But it has become increasingly apparent that those gains came less from development than from the government's redirection of commodity export earnings to poorer families through the &quot;family allowance program.&quot; Now with the abatement in commodity-export earnings, the government can no longer sustain this flow of support. Poverty has risen back toward its old levels, social unrest has increased in tandem, and so also has outright rioting. In this unsettling revelation, many now glimpse the old Brazil, from before the country seemed to adopt a more open, free-market orientation, with even the old problems of inflation beginning to return.<sup>6</sup></p> <p>In contrast, the slowed economic growth in India, China, and the like looks much less threatening. India has, of course, suffered an economic setback from the global slowdown and the outflows of global &quot;hot&quot; money during the world's recent tapering tantrums. But on a more positive side, India has concentrated more on domestic development than many emerging economies and has fostered an active middle class. No doubt India's vibrant democracy would have precluded a narrower development path, even if the authorities had wanted to pursue one. India's recent reemphasis on infrastructure spending, something the economy badly needs, reinforces that emphasis on domestic development. This orientation likely will, in time, help reduce the economy's vulnerability to global economic swings. Similarly, a recent decision by the Reserve Bank of India to allow more foreign financial institutions into the country will likely, eventually, reduce the economy's vulnerability to hot money flows.<sup>7</sup></p> <p>To be sure, India's overall real pace of growth has slowed from 8%-plus a year earlier in this century to 3.2% more recently, with an official forecast of 5.3% for next year. But even accepting the slowdown, the country's domestic development promises at least to maintain the new reduced growth rate, if not in every quarter than generally, and possibly enhance it. Meanwhile, investors should not miss the fact that such growth, though slower than previously, is still twice the pace presently maintained by the United States and that much faster than Europe's.<sup>8</sup></p> <p>China, too, has slowed. In part, the reduced rate of Chinese growth reflects the global slowdown in its export sales. But the slowdown also reflects Beijing's farsighted policy to reorient its economy from a purely export-dependent growth model to one with a broader base that includes domestic development. Despite its tendency to slow the country's pace of growth, the government has committed itself to this pro-domestic reorientation. It knows exports can no longer serve the role they once did. Indeed, Beijing has noted more than once that Chinese exports during the last 20 years have gone from a negligible part of the global mix to fully 12% of all exports sold in the world. Chinese officials know that this figure cannot rise to 24% anytime soon, if ever. Domestic development, thus, is imperative.<sup>9</sup></p> <p>Some skeptics, however, question whether China can sustain even a slowed pace of growth, whatever the shift toward domestic development. These skeptics point at times to the aging of China's population due to the country's long-standing one-child policy, and they see a time when the country will face troubles implicit in an overhang of elderly and a relatively reduced work force to support it. Though this is not a small issue, it is prone to exaggeration, especially for the years immediately ahead. China is indeed aging, but the working-aged proportion of its population is still much larger relative to its retired population than, say, in the United States, and still larger than in Europe, which has even an older demographic. China will have a relative abundance of labor compared with the developed economies for at least a decade to come.</p> <p>Other skeptics point to China's overbuilt residential real estate, and they worry that the country will suffer generally as this bubble will burst eventually. It is easy for Americans, still smarting from their own recent real estate bust, to see disaster in such circumstances. But China's situation is different from that in the United States during 2007–08. Chinese homeowners are not nearly as leveraged as were their American counterparts. In China, by law, a buyer most put down at least 20% on his or her first home and 50% on a second home. The debt burden in China lies less on households than on the provincial governments that were party to the development. Though this debt overhang is hardly welcome or harmless, it is much easier for the central government to handle than the household debt was for the authorities in the United States during its real estate bust. It is better circumscribed, too.<sup>10</sup></p> <p>Meanwhile, China faces an imperative that will force the authorities to do whatever is necessary to maintain relatively rapid growth rates. According to the central government, approximately a million Chinese a month migrate from the countryside into the cities. To give work to this flow of jobseekers, the country must grow at 6% a year at least. Having staked its legitimacy on its ability to provide people with jobs and economic hope, the government in Beijing cannot accept failure on this front. It is well aware that slower growth will create social discord that it can ill afford, and, if recent Chinese history is any indication, riots as well. Faced with this political imperative, more manageable demographics than the skeptics fear, and more contained real estate troubles, it looks as though China will make its targeted 6–7% annual rate of real growth. The figure, to be sure, is well down from the 10–12% rate of the not too distant past, but it is still more than three times the pace likely in the United States.<sup>11</sup></p> <p>Against these admittedly uneven prospects, emerging markets offer very attractive valuations. Sovereign emerging market debt, for instance, pays a handsome yield premium. With a duration of less than five years, the index of such bonds offers yield spreads of 500 basis points or more over comparable Treasuries. That is a wider spread than junk bonds in the domestic U.S. market, even though this sovereign emerging markets index has a 'BBB' average rating. On top of this attraction, two additional considerations stand as noteworthy. First, most of these countries have stronger finances than the United States. China, for instance, has more than $3.0 trillion in foreign reserves, while, on average, emerging economies have public debt outstanding equal to only 35.5% of their gross domestic product (GDP). That is about one-third the relative burden faced by the United States. Even India, one of the most indebted in the emerging world, has a public debt burden of 68.3% of its GDP, still almost one-third lower than America's burden. Second, with adequate growth prospects even at current reduced rates, chances are that the currencies of these countries will appreciate; certainly that is a greater likelihood than further depreciation.<sup>12</sup></p> <p>If anything, valuations on emerging market equities are more compelling. As a whole, the benchmark MSCI Emerging Markets Index<sup>13</sup> carries a price about 10.5 times the consensus expectations on earnings for this year. That amounts to a discount of almost 35% from the price-to-earnings multiple on the overall MSCI EAFE Index<sup>14</sup> of developed market equities. The relationship between these two valuation gauges has varied considerably over time. Emerging market multiplies have at times risen to equal that of developed markets. At their lows (during the Asian contagion crisis of the late 1990s), they fell to half the developed markets' multiple. But within this admittedly wide range, the probabilities going forward suggest that the difference between these two multiples is more likely to narrow than widen, especially for those markets pursuing broad-based development. It is worth noting, too, that these attractive valuations exist even as many of these emerging economies maintain growth rates at multiples of those in the developed economies, with stronger finances as well as better long-term prospects.</p> <p>There are risks, of course—there are always risks. But valuations alone suggest that investors give emerging bonds and equities a second or third look, especially those economies pursuing broad-based development. As ever, these investments are not for everyone—not for those without tolerance for volatility and not for those with a short-time horizon that cannot wait for valuation effects and favorable fundamentals to develop. But for others, a well-diversified portfolio of emerging market assets, chosen selectively from a diverse universe that goes well beyond the BRIC countries, offers an opportunity that warrants attention.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything everything_0"> <div style="width:auto; padding:0px 0px 0px 0px;margin:15px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything_0"> <hr class="separator_grey"> <p><sup>1</sup> For detail, see, J. J. Zhang, &quot;Emerging-Market Fears Hide Enticing Valuations,&quot; <i>Market Watch</i>, August 16, 2013; Reuters, <i>Update</i>, September 6, 2013; and Samuel Rines, &quot;Hitting a BRIC Wall,<i> The National Interest</i>, October 17, 2013.<br> <sup>2</sup> Federal Reserve.<br> <sup>3</sup> Federal Reserve.<br> <sup>4</sup> &quot;Breaking the BRIC Piggy Banks,&quot; <i>The Economist</i>, October 11, 2013.<br> <sup>5</sup> &quot;When Giants Slow Down,&quot; <i>The Economist</i>, July 27, 2013.<br> <sup>6</sup> For more detail, see, Liam Denning, &quot;Shutting Down Emerging Markets,&quot; <i>The Wall Street Journal</i>, September 30, 2013; Blake Schmidt, &quot;Brazil Real Drops on Speculation Central Bank Will Limit Advance,&quot; Bloomberg, October 14, 2013; Thierry Ogier and Lucien Chauvin, &quot;Brazil Unveils Own 'Tapering' Plan,&quot; <i>Emerging Markets</i>, October 10, 2013; and Milton Ezrati, &quot;Same Old Samba for Brazil,&quot; <i>Economic Insights</i>, November 15, 2012.<br> <sup>7</sup> Elizabeth Owen, &quot;India Opens Doors to Foreign Banks,&quot; <i>Emerging Markets</i>, October 12, 2013.<br> <sup>8</sup> Owen, <i>op. cit.</i><br> <sup>9</sup> Elliot Wilson, &quot;China Slowdown Threatens Asia Crisis,&quot; <i>Emerging Markets</i>, October 12, 2013, and Shamim Adam, &quot;China-to-India Price Jump Risks Growth as World Outlook Dims,&quot; Bloomberg, October 14, 2013.<br> <sup>10</sup> Ibid.<br> <sup>11</sup> Ibid.<br> <sup>12</sup> Stephen Yeats, &quot;Mapping and Navigation the Emerging Market Fixed Income Universe,&quot; <i>SSgA Capital Insights</i>, September 2013.<br> <sup>13</sup> The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. As of June 2006, the MSCI Emerging Markets Index consisted of the following 25 emerging market country indexes: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.<br> <sup>14</sup> The MSCI EAFE<sup>®</sup> [Europe, Australasia, Far East] Index is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States and Canada.</p> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> <div class="everything"> <div style="width:auto; padding:0px 0px 0px 0px;margin:0px 0px 0px 0px" > <div class="everythingmain" style="overflow:hidden;background-color:#; border:0px solid #"> <!-- Paragraph Title --> <!-- Anchor --> <!-- Title --> <!-- Separator --> <!-- Set Variables for Image Alignment --> <!-- Text and image --> <div class="everythingText" id="texteverything"> <hr class="separator_grey"> </div> <div class="everythingImage" style="padding:0px 0px 0px 0px;" align="left"> <div style="float:left;"> </div> <div class="clear"></div> </div> </div> </div> <div class="clear"></div> </div> Mon, 4 Nov 2013 18:30:00 -0500