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Fed Sparks A Stampede Out Of Bonds

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
July 2, 2013

IN THIS ISSUE:

1. 1Q GDP Below Expectations – Markets Rally Anyway

2. Other Economic Reports of Late – Most Looking Better

3. Markets Still Unhappy Over Bernanke’s QE Decision

4. The Stampede Out of Bonds Has Begun Thanks to Fed

5. So Now What? A Volatile Summer & Maybe Even Longer

6. Obama to Dictate Carbon Tax Via EPA & Executive Orders

Overview

No doubt you are aware that interest rates have spiked higher in the last two months. As a result, there is a stampede to get out of bond funds that have been clobbered recently. I have been warning about this repeatedly since late last year. Now it’s happening and it may well continue. We’ll discuss that more as we go along today.

With the Fed’s latest decision to start winding down its unprecedented quantitative easing stimulus program later this year, the investment markets are not happy. Stocks, bonds and precious metals have been hit hard in recent days and weeks. While stocks and bonds have recovered modestly, the selling pressure may not be over. Investors are really nervous!

On the political front, President Obama just can’t help himself. Despite the various scandals swirling around his administration, he has resurrected his formerly failed plan to institute a new tax on carbon emissions. Only this time he plans to circumvent Congress and enact this costly tax via the Environmental Protection Agency and new Executive Orders that are almost impossible to reverse. He apparently does not care that a new carbon tax will increase energy prices for everyone, including low income folks who will be hit the hardest.

But before we get into those issues, let’s take a quick look at the latest economic reports, including last week’s very discouraging 1Q GDP report that showed the economy is still just limping along. From there, we’ll look at some other economic reports which offer at least a little encouragement.

1Q GDP Well Below Expectations – Markets Rally Anyway

The economy grew at a measly 1.8% annual rate in the 1Q according to the government’s third and final report released last Wednesday. This was significantly below the previous 2.4% estimate in May as well as the pre-report consensus that expected the number to remain at 2.4%.

Stocks rallied strongly after the GDP report was released. So why would stocks jump on a clearly disappointing report on the economy? There was a general agreement that the weak GDP report would cause the Fed to delay its planned “tapering” of QE-3. So stocks rallied even though it remains to be seen if the weak GDP report has any effect on the Fed. Now let’s look at some of the details of the latest GDP report.

The biggest change was a cut in the government’s estimate of consumer spending growth, which dropped from the previous estimate of 3.4% annualized growth to only 2.6%. Since consumer spending is more than 70% of the economy, this reduction was disappointing, although it was still better than in the 4Q of 2012. This was despite the January expiration of the two-year payroll tax cut, which cost the average worker’s take-home pay about $20 a week.

While 2.6% spending growth still represents a decent pace, given the backdrop of tax increases hitting households at the start of the year and the sequester, it paints a picture of an economy with clearly less growth momentum than previously assumed. Most forecasters are now suggesting that consumption probably slowed further in the 2Q. Perhaps the worst detail in the report was the fact that real disposable personal income fell by 8.6% in the 1Q, and corporate profits fell 1.4%.

US Economic Growth

The new GDP numbers reinforce the picture of an economy slowing in the middle of the year, due in part to federal spending cuts. Federal spending dropped at an 8.7% annual rate in the 1Q, while private investment in factories and office buildings dropped at an 8.3% clip. Private investment in both buildings and equipment was weaker than initially reported, in a further sign that businesses are reluctant to bet aggressively on the recovery.

Based on data released so far, the economy is likely to show a 1.7% annual rate of growth in the second quarter, according to Moody’s Analytics. However, Moody’s projects that GDP growth will hit a 3% annual rate by the 4Q. That may be a bit optimistic. The consensus of the 50+ economists surveyed by Blue Chip Economic Indicators is that GDP will grow by less than 2.5% in the second half of this year.

Other Economic Reports of Late – Most Looking Better

The Consumer Confidence Index, which unexpectedly fell in May, rebounded sharply in June to a reading of 84.1, up from 74.3 in May. That is the highest level since January 2008 (87.3). According to the Conference Board which publishes the Index, consumers are considerably more positive about current business and labor market conditions than they were at the beginning of the year.

Conference Board

Source: Conference Board, dshort.com

The University of Michigan Consumer Sentiment Index also rose in June to 84.1 from 82.7 earlier in the month. Personal income rose 0.5% in May while consumer spending inched up 0.3% after falling by the same amount in April. Retail sales rose 0.6% in May from 0.1% in April.

Orders for durable goods rose a solid 3.6% in May, matching the same rate of increase as seen in April. The ISM manufacturing index for June came in at 50.9, up from 49.0 in May. This beat the consensus of 50.5 and indicates that the manufacturing sector is expanding again, although only modestly.

On the housing front, sales of existing homes rose 4.2% in May to an annual rate of 5.18 million units. That was the highest rate since November 2009 and almost 13% above year-ago levels. The median existing home price rose to $208,000 – up 15.4% from this time last year. The tight supply of homes for sale has helped drive price gains in many markets. Nationwide, 45% of all homes sold in May were on the market for less than a month, according to the National Association of Realtors.

New homes sales in May rose 2.1% over April levels to 476,000 units. Year-over-year, new homes sales were up 29%, according to the Commerce Department. Housing starts climbed 6.8% in May to 914,000 units. That was the fastest pace since May 2008. Building permits, on the other hand, fell modestly in May.

On the inflation front, there’s not much going on. The Consumer Price Index increased only 0.1% in May on a seasonally-adjusted basis. Over the last 12 months, the CPI was up only 1.4% according to the Bureau of Labor Statistics (BLS). The Producer Price Index (wholesale) rose 0.5% in May and was up 1.7% over the last 12 months.

Remember that the unemployment report for June will be out on Friday morning. The consensus is that the headline number will be 7.5-7.6% with around 170,000 new jobs created. This week’s report will be especially interesting since it is one of the most important indicators watched by the Fed.

Markets Still Unhappy Over Bernanke QE Decision

As I discussed at length last Tuesday, stocks and bonds plunged immediately after the Fed’s QE policy decision announced on June 19. It was then that the Fed announced its plan to begin “tapering” monthly Treasury bond and mortgage purchases starting as early as late this year, with the hope of ending QE altogether by around the middle of next year.

The QE announcement should not have been such a big surprise, as I argued last week, since Fed Chairman Bernanke first warned on March 22 that the Fed would probably come to such a decision in the next few months. He hinted of this again in late May, and it was then that the markets started taking him seriously.

  Dow Jones Industrial Average
DJIA

Stocks, as measured by the Dow, hit a new recent high of 15,400 on May 28, and then began a retreat as the Fed’s June 19 policy date approached. As I’m sure you are aware, the bottom fell out of stocks and bonds in the days after the QE announcement and Bernanke’s press conference.

Historically, the summer months are not the best for stocks, and in light of the Fed’s QE decision on June 19 and the sharp downward reaction in the markets, some forecasters have turned negative on equities, at least in the short- to medium-term.

The bond markets – especially Treasuries – took the Fed’s QE decision even worse than stocks, which should not have been a surprise to my readers. I’ve repeatedly warned about this since my Bond Bubble Special Report last August. The yield on the 10-year Treasury Note spiked from a low of 1.63% in May to above 2.5% last week. That’s a 53% move in a few weeks!

The bellwether 30-year Treasury Bond was hit even harder, again no surprise to my readers. The 30-year yield rose from the low under 2.85% in May all the way to 3.60% last week. Again, that’s a gigantic move in such a short time.

  30-Year US Treasury Bond

30 Year Treasury

The Stampede Out of Bonds Has Begun

One of the main points in my bond Special Report last August was that much of the flood of money flowing into bonds and bond mutual funds the last couple of years had come “late to the party” (ie – after interest rates had fallen to near historic lows). I warned that this “hot money” would be quick to head for the exits at the first sign of trouble for bonds.

I was right and now we’re seeing a mass exodus from bond funds. Bond mutual funds and exchange-traded funds (ETFs) together lost $79.8 billion in June (through June 27), according to TrimTabs, an outflow that was nearly double the previous monthly record of $41.8 billion reached in October 2008 during the height of the financial crisis.

From what we’re seeing in the mutual fund/ETF inflows and outflows, most of the money flooding out of bond funds is not going into stock funds. This tells me that much of this money has gone to the sidelines, and investors are not sure what to do next. No surprise there.

So Now What? A Volatile Summer & Maybe Even Longer

The investment markets are basically in chaos. The Fed’s $3+ trillion QE stimulus is unprecedented, and no one knows what will happen when it ends, much less how the Fed will unwind its position. While Bernanke has hinted at least twice now that the Fed might just sit on its huge Treasury bond portfolio for the next 20+ years until those bonds mature naturally, it is unclear what it might do to exit its huge mortgage-backed securities holdings.

Making matters more complicated, rumors are swirling that the Fed may delay its decision to start tapering QE purchases before the end of this year and ending them by mid-2014. So in addition to not knowing what happens when the Fed starts winding down QE, now there’s the question of whether the Fed will delay everything in light of the severe market reactions in recent days. In short, no one knows what will happen just ahead.

And then there is the other question: What happens when Fed Chairman Ben Bernanke steps down in January? Who will be his successor? Will it be Fed Governor Janet Yellen, as most expect? If so, Ms. Yellen is thought to be quite liberal and many believe she would lean toward expanding QE even further and for longer. So much to think about!

This kind of uncertainty usually leads to some volatile markets. Some analysts suggest that this means we will see the stock and bond markets go into broad trading ranges for the rest of this year. That’s certainly possible. But it’s also possible that stocks could go lower than expected, especially if interest rates go higher than expected.

No doubt, it’s a frustrating time for most investors. Too many unknowns to think about. Too much risk if you get it wrong. Pardon me if I sound like a broken record, but I argue yet again that you should consider letting professional money managers oversee at least part of your investment portfolio, including your IRA.

That’s what we do at Halbert Wealth Management. We search the universe of professional money managers to help our clients meet their investment goals and help reduce the risk of being in the markets. You can call us at 800-348-3601 for a free, no pressure consultation to see if the investment programs we recommend can help you in these challenging markets. Or if you prefer, you can visit our website at www.halbertwealth.com.

Obama to Dictate Carbon Tax Via EPA & Executive Orders

In June, President Obama announced that he is resurrecting his failed “Cap & Trade” policy that would impose an across-the-board carbon tax on all commercial carbon-dioxide emissions. You may recall that this plan failed miserably in Congress in 2009 because almost no lawmakers wanted to sign on to a measure that would raise energy prices on all Americans, especially for low-income folks who can least afford it.

Well, President Obama is back at it again. This time he vows to side-step Congress and ram through this legislation to “save the planet” by way of onerous new EPA regulations and presidential “Executive Orders” which do not require congressional approval to become the law of the land. What else is new for this president?

President Obama is ready to take one more controversial shot at forcing new “global warming laws” with the last, least-popular and messiest tool he's got left: new regulations from the politically besieged Environmental Protection Agency and/or Executive Orders that are very difficult to override by Congress.

Congress can pass legislation to overturn or reverse Executive Orders; however, the president can veto such measures. In most cases Executive Orders can only be abolished if the Supreme Court rules them unconstitutional, or if a subsequent president reverses them – and that won’t happen if the next president is Hillary Clinton.

What Obama outlined last week is nothing less than a national energy tax, which seems odd in that he will once again pivot away from jobs – which remains the #1 issue with voters. But as I reminded my readers ahead of the 2012 elections, Obama has a far-left agenda, and now that he does not face re-election, we can expect that agenda to materialize.

Chief among Obama’s climate change agenda is greenhouse gas limits on existing power plants that eventually would result in the death of coal-generated electricity in the US. Never mind that the coal we stop using will be sold to China, which has far fewer environmental regulations and dirtier power plants than we do.

Nevertheless, the EPA has already proposed tougher emissions standards for new coal-fired power plants that all but guarantee that no new coal facilities will be built. Those rules have yet to be finalized. In any event, Obama plans to implement even tougher regulations, either by empowering the EPA to enact them, or by presidential Executive Orders.

I warned in these pages before President Obama was re-elected that we would see the most liberal elements of his left-wing agenda in a second term – when he was not facing re-election. His renewed proposal for a carbon tax via the EPA or through executive fiat is just one more example that will raise energy prices on everyone, including the poor.

The Democrats and President Obama maintain that they are advocates for the poor. Yet they support increased energy prices for all in their supposed passion for environmental change. That won’t help the poor – it will hurt them in the form of higher heating, cooling, transportation costs and more.

I had better leave it there for now. I appreciate your comments, pro or con. They make me think.

 Wishing you happy 4th of July,

SPECIAL ARTICLES

Stocks rally despite disappointing GDP report

Was Bernanke’s announcement to end QE just a trial balloon?

Obama plans new carbon tax via EPA & Executive Orders

 

 


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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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