Economic comments, week ending Sept. 23

By John W. Davidson | Sep 26, 2011

This week's Economic releases and Fed comments heightened worries of a double dip contraction. Concern that a Greek default or restructuring could have a "Lehman-like" impact weighed heavily on the markets. In the midst of this, the Federal Reserve Open Market Committee met, acknowledged the weakness, and announced a bigger-than-expected "twist" strategy (see below). Equity markets and credit markets sold off while medium and long term Government Bonds rallied and short term bonds slipped. Energy and metal commodities sold off sharply in reaction to an expected slow down of economic activity.



Listening to the pitches on less-regulated commercial media, one would have thought that gold prices would only go up; gold is an alternative currency, a store of value, and an industrial raw material that should behave well in either inflationary or deflationary periods. It can fund your IRA or bedazzle your jeweled accessories.

This week's sharp declines in energy and metals prices (see chart and Currency tables below) has an important lesson for us all. Energy, metals, and the commodities that reflect their underlying value may not always go up and could decline, along with stocks, during periods of economic contraction. This week's declines in metal and oil prices were a case on point: their prices fell more than equities which experienced one of their worst weeks since 2008.

The lesson is a reminder that all assets have periods of increases and decreases. No asset is one for all seasons. Furthermore, few people can successfully rotate in and out of any asset class; many who claim success of getting their clients out of the stock market before the crashes were also late in getting them back in for the rebound. There is no free lunch. The best we can do is to remain diversified with exposure to asset classes that can dampen the volatility of our overall portfolio.


Economic Releases

The chart below shows the steep decline that has taken place over the last week in energy and commodity prices. West Texas Crude (green) fell to $79.85 from a high over $112 earlier this year. Natural Gas (blue) fell to $3.701 from a high of over $4.75 earlier this year. The CRB Index (red) dropped to 301.87 from a high of over 360 earlier this year.





Source: Bloomberg LP


Other Economic Releases

The Federal Reserve announced that by the end of June 2012 it would purchase $400 billion in Treasuries with maturities of 6-years or longer and fund those purchases with sales of Treasuries with maturities of 3 years or less. Borrowing a title from Chubby Checker, they dubbed this the "twist" strategy, designed to provide liquidity and keep long-term interest rates low through 2013. They also announced that they would resume purchases of agency-backed MBS with the cash flow from their current MBS portfolio, and continue to reinvest their maturing Treasury holdings into newly auctioned issues.

U.S. Housing Starts remained at 571,000, but Permits increased to 620,000 in August. U.S. Existing Home Sales increased 7.7 percent to 5.03 million units in August. Initial Jobless Claims remained at 423,000, but the 4-week average inched higher to 421,000.


In Canada, July's Retail Sales fell -0.6 percent, lowering YOY Sales to an increase of 3.9 percent.

In Germany, the September "flash" Purchasing Manager Indices (PMI) for both Manufacturing and Services slipped closer to 50, the demarcation between expansion and contraction. The EU "flash" PMI's both fell below 50. The Zew Indices for both Current Conditions and Business Expectations declined in September. France's Business Climate Indicator fell 6 points to 99 in September. Similarly, in the UK, the CBI Industrial Trends Survey fell 10 points to -9 in September.


Equities Markets

This week equity prices declined mid-single digits across the globe in fear of further economic weakness.


Bond Markets

Government Bond markets rallied on the back of global growth concerns. Credit spreads widened demanding more yield to assume credit risks. 10-year Treasury Tips promise only 5 basis point plus inflation. The immediate effect of the US Fed's "twist" strategy announcement can be seen in higher short term rates and lower long-term rates this week.



Currencies and Commodities

The U.S. dollar gained against the Pound, Euro, and Looney but gave ground against the Yen. Lower natural resource prices put pressure on the Canadian currency. Energy and Metals prices collapsed.



John W. Davidson has more than 30 years of investment industry experience and holds an MBA in finance and a master's in mathematics from Boston College, as well as a bachelor's in economics from Amherst College. He lives in Camden.







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