Thursday, January 31, 2013

Are U.S. Markets Acting Inefficiently?

By Grant de Graf

CNN Money reports: 
U.S. stocks are flirting with all-time highs, climbing to levels not seen since before the financial crisis. The Dow Jones industrial average is hovering just below 14,000. The S&P 500 recently broke above 1,500 and is inching closer to a new record. Both indexes have risen to their highest levels since October 2007.
Low bond yields and protracted QE by the Fed are some of the reasons why the U.S. market continues to rocket to new highs.

Stocks in the S&P 500 are trading at roughly 14 times expected earnings for this year, which is reasonable.

However, there are significant risks. U.S. growth for 2013 is unlikely to be robust, the challenge of the fiscal cliff has to be resolved and a potential fallout in the European Debt Crisis could significantly dent any progress, which Americans are likely to achieve. Global social political risks remains high, the Iran card has to be played out and North Korea continues to beat the drum.

Historically, the market tends to lag in its response to event risk, hence the difficulty of being able to accurately predict market moves. The gap between market response and actual risk is dynamic and consequently, market inefficiency will always dog traders.

Contributing to the equation of inefficiency, is the fact that investors are being challenged to find a suitable home for their funds. Interest rate yields are at all time lows and real estate fails to impress, especially with the absence of optimism for a strong recovery. This means that investors may be all dressed up, but they have no where to go.

Alternatively, portfolio managers will continue to be content to maintain their percentage allocation to stocks, because on a risk-adjusted basis, stocks will still trump other lower return, lower risk, investment options.


Can QE Ignite Prospects For Growth?

By Grant de Graf

Federal Reserve Chairman Ben S. Bernanke has signaled that he will not ease up on the $85 billion in monthly bond purchases, aimed to spur a stalled economy and bring down 7.8 percent unemployment.

The Federal Open Market Committee said in a statement yesterday that growth, while slowed by “transitory factors,” faces “downside risks” even after strains in global financial markets have eased. The expansion will pick up and unemployment will fall in response to “appropriate policy accommodation,” Fed officials said in a statement after a two-day meeting.

The Feds decision to continue with its program of QE is appropriate, given the constrained prospects of growth and the low levels of inflation which prevail. This will help create the appropriate economic climate to improve investor confidence and allow business to expand more rapidly.

However, monetary policy on it own, will not provide the U.S. economy with a solution that will fast track the economy. To achieve this, the country needs a program, which will result in the investment of billions of dollars in an initiative, of which the nation can be part. Additionally, government investment (not expenditure) in the infrastructure, should be tendered out to the private sector, thus providing business with  the opportunity to participate in economic expansion.

The Second World War provided the U.S. economy with a catalyst to exit the Great Depression. The allocation of funds in infrastructure facilitated a spin-off effect, which benefited business as a whole.

It is folly to suggest that in today's economic environment, increased spending in military can improve the economy. During the Second World War, the manufacturing sector was underdeveloped and the allocation of public funds to private sector initiatives, helped develop industry and secure a term of protracted growth. Today the manufacturing sector is at a very different stage, than it was 70 years ago.

However, a program which will benefit the nation and provide fiscal stimulus is still required. Investment funding needs to be distinguished from expenditure funding, in view of the constraints that exist with the pending fiscal cliff.

Monetary policy on its own, cannot be expected to expedite growth in the U.S., without a national investment program that will catapult the U.S. economy to recovery.

Jan. 30 (Bloomberg) -- Michael Feroli, chief U.S. economist at JPMorgan Chase & Co., talks about the Federal Reserve's decision today to keep purchasing securities at the rate of $85 billion a month, and the outlook for Fed policy and the U.S. economy. Feroli speaks with Adam Johnson and Alix Steel on Bloomberg Television's "Street Smart." (Source: Bloomberg)

The Firmer Euros KO Blow

The WSJ reports: 
The euro, once on death's door, is on a months long tear, rising Wednesday to its highest level since November 2011.
But even some investors who helped propel the currency above $1.3560 Wednesday say it can't fly much further. Europe's economy is still in the doldrums, they say, and a stronger euro could make the situation worse.
Concern is rising that the stronger Euro will impact Europe's ability to export goods at competitively attractive prices. While the Euro was in free fall mode, exports rallied. As the duration of the Euro spike is unpredictable, that celebration may well be short lived.

Irrespective, the segments of the EU who are feeling the pinch the most, are the weaker countries, notably PIIGS, who have to compete with their stronger partners, Germany and France, to capture market share of the lucrative export industry.

The sudden upward adjustment in the Euro for most of the weaker members, is an uppercut to the jaw, which may well leave these smaller nations, sprawled out on the canvas.

German Unemployment Number Pulls Wool Over Eyes

German unemployment unexpectedly declined in January for the first time in 10 months.

The number of people out of work fell a seasonally adjusted 16,000 to 2.92 million, the Nuremberg-based Federal Labor Agency said today. The adjusted jobless rate dropped to 6.8 percent, matching a two- decade low.

Although this is good news for political leaders, as it will give them ammunition to persuade the electorate that they are leading the country in the right direction, popping champagne corks and bring out the wurst, is premature.

Bloomberg reports:
Today’s decline in unemployment may not yet be a turning point, said Frank-Juergen Weise, President of the Federal Labor Agency. “There’s a chance the cold weather in the second half of January may bring an increase in unemployment in February,” he said.
The truth is that the German economic growth slowed to 0.7 percent in 2012 from 3 percent in 2011 and the Bundesbank predicts economic expansion will decelerate further to 0.4 percent this year. That compares to a contraction of 0.3 percent in the euro area, the country’s biggest export market.

Additionally, most of German's trade is conducted within the Euro zone and consequently it is advantaged by the comparative advantage it enjoys over weaker EU countries.