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Stocks or Bonds for Yield? – May 7, 2012
In their quest for yield, many investors have been enticed by high dividend paying equities. In fact, the yield on the Dow Jones Industrial Average has been higher than our Interest Rate Composite since September 2008. Before that you have to go back to 1963 to find when stocks yielded more than bonds. Stocks currently yield 1.1 percentage points more than our Composite. That’s also 2.9 points above the historical mean.
With a 15% tax rate on qualified dividends, stocks currently enjoy an even nicer after-tax yield advantage of 1.3 percentage points. If the Bush tax cuts are allowed to expire, the equity advantage will be reduced, but not eliminated, based on current levels.
Read moreU.S. Economy Gaining Strength – April 2012
The U.S. economy appears to be on a more solid footing than at any time since the end of the Great Recession. GDP is growing at an annual rate near 2.5%, which is hardly a boom pace, but should be strong enough to expand employment and reduce joblessness in coming months. The unemployment rate has now fallen to 8.2% and should fall below 8% by the end of the year. Consumer confidence has also been rising rapidly over the last five months, in spite of high and rising gasoline prices.
Higher energy costs pose the biggest obstacle to continued economic expansion, but assuming the conflict with Iran does not boil over, fuel prices may well moderate later this year.
In addition, the European debt situation is still a threat, as are the mounting home foreclosures in the United States. However, both of these threats seem to be diminishing, though resolution will not come quickly, or without additional economic stress.
But the economy’s prospects should continue to brighten—possibly substantially toward the middle of the decade. The household debt load that has been weighing heavily on U.S. growth is lifting as the process of delev-eraging advances. This should translate into stronger consumer spending as household balance sheets continue to strengthen.
The economy is expected to return to full employment—a jobless rate closer to 6%—by 2016. And recent data show good progress toward this outcome. Real GDP grew at a 3% annualized rate during the last two quarters. Consumers—the biggest economic driver—are starting to spend a bit more freely. Retail sales are grow-ing at a respectable mid-single-digit pace and vehicle sales in February topped an annualized rate of 15 million units, the fastest pace since before the recession.
Businesses appear to be responding to better growth by hiring more. While the pace of job additions is still modest, when combined with the low rate of layoffs, the net number of jobs is rising at a sturdy pace, near an average of 175,000 per month. And because the labor force itself is not increasing much, job growth at this pace should be enough to bring down unemployment.
In addition, revisions to 2011 data show that house-holds earned more in 2011 than previously estimated, and that the personal savings rate did not decline as much as initially believed. Future revisions will likely show the savings rate has been stable at close to 5% over the past year. And with stock prices more buoyant, wealthier households are likely to soon be spending more.
The boom and bust cycle in residential real estate has driven the U.S. economic cycle over the past decade. Since the bust, sluggishness in home prices coupled with excessive mortgage debt has resulted in a sluggish eco-nomic recovery. Now however, there are emerging signs that suggest these conditions may be improving. For example, more households are now buying homes. New and existing home sales have firmed and inventories of homes for sale continue to decline. In fact, the inventory of available new houses has never been lower.
Prices, however, are still weak. And it will be nearly impossible for the economy to experience a truly robust recovery as long as house prices continue to erode. However, upon closer inspection, weakness in prices appears to reflect the rising share of sales that involve foreclosures and short sales. At the end of 2011, distressed sales accounted for more than 35% of all home transactions. But prices in non-distressed transactions are actually holding firm.
The residential real estate market is being supported by lower unemployment and favorable mortgage rates— which hover near historic lows, making home ownership more affordable. In the fourth quarter of 2011, The National Association of Home Builders/Wells Fargo Housing Opportunity Index, which tracks home affordability, recorded the highest level of affordability ever in its 20- year history. Prospective home buyers are being constrained by tighter credit stan-dards and a soft economy, but not by prices and mortgage rates.
Real estate investors are also buying properties and contributing to a healthier housing market. As prices have fallen, rents have risen to the point where investors can turn a profit converting houses to rental property. These real estate investments are long-term and reflect a growing confidence that a bottom in real estate prices is finally beginning to form.
The most immediate threat facing the U.S. economy is the rising price of crude oil and gasoline. West Texas Intermediate crude has risen roughly $20 per barrel since the fall and gasoline is up nearly 50 cents per gal-lon. Even if oil prices stabilize at current levels, gasoline prices are likely to continue higher.
With the higher price of gasoline, households will spend roughly $75 billion more on fuel than they would have if prices remained at last fall’s levels, which is equal to half a percentage point of GDP. While certainly meaningful, this alone will not derail the recovery. However, if oil prices continue higher—due possibly to a renewed outbreak of hostility surrounding Iran’s nuclear program-serious economic damage could be done. If oil prices were to surge to around $150 per barrel, and gasoline prices topped $5 per gallon for more than a couple months, a new recession would likely follow.
Assuming such a dark scenario does not occur, the U.S. economic expansion should hold its own in coming months and gain traction after the election. U.S. policymakers still face difficult decisions regarding taxes and spending, but the election will help determine how those decisions are made.
The economy should also receive a lift as households and firms finish repairing their balance sheets. U.S. companies have arguably never been in better financial shape and the banking system overall is well capitalized and profitable. More foreclosures are still coming, but most households have made significant progress in lightening their debt loads. Credit is already flowing more normally, and the spigot should be fully open to qualified borrowers in 2013.
Real GDP growth is expected to accelerate from 2.5% this year to 3% in 2013 and closer to 4% in 2014 and 2015. By 2016, the economy has the potential to return to full employment. This is a long way off and much could go wrong, but there are more reasons for optimism than pessimism about the economy’s prospects.
Read moreS&P 500 Gets 9% Cheaper – Feb 2012
Profits in the Standard & Poor’s 500 Index are rising faster than its price, leaving the gauge 9 percent cheaper than it was in April even after American equities climbed within 6 points of last year’s peak.
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Read moreHow Dangerous is the Ballooning National Debt? – Jan 2012
More than two years after the end of the Great Recession, the global economy cannot seem to shake its effects. Economies in the developed world are struggling to grow. Unemployment in the U.S. and Europe remains near double digits, while Japan is stuck in a 20-year slump.
One impediment to stronger growth is the debt burden the U.S. and other developed countries find themselves under. As annual budget deficits reach record amounts, overall government debt is piling up quickly.
The current fiscal predicament is not the making of the Great Recession alone. However, it did quickly bring longsimmering fiscal pressures to a boil. The U.S., like Japan and many developed economies in Europe, suffers from an aging population and rapidly rising healthcare costs. This situation has long been anticipated, but the financial crisis and economic contraction of the last several years accelerated the day of reckoning, as governments were forced to borrow and spend heavily to avoid even worse outcomes.
Read moreStocks Climbing a Wall of Worry – Jan 2012
U.S. stocks rose nearly 12% in the fourth quarter of 2011, but you would not know that based on investor sentiment. Generally speaking, investors are not an optimistic bunch. To prove this point, one needs to look no further than mutual fund redemptions, which recorded the second-worst year on record in 2011.
It is easy to understand why investors are unnerved. Between April and October of last year, U.S. stocks dropped over 19%, the worst decline since 2008. At the same time, daily volatility intensified. During the third quarter, the S&P 500 moved 2.4% on average between its intraday low and high. The Dow Jones Industrial Average alternated between gains and losses exceeding 400 points on four straight days in August—the longest streak ever. With such dramatic swings, investors seemed to lose confidence that stocks were trading based on any fundamental measures or valuations. As a result, many opted for the relative safety of cash and bonds.
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