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ALM
First Financial Advisors
Economic Overview
First Quarter 2000
TOPICS
COVERED
Introduction
Today is April Fool's Day, how appropriate. The past couple
of weeks offers a short history of the surreal environment
that we find ourselves situated. Greenspan raises the Fed
Funds target 25 basis points but keeps the TUX in the closet.
The market rallies.
The TUX
in this case is the combination of Regulations T, U and X.
In the end, the construct of these regulations limits the
amount of margin a stock investor may leverage up on his or
her purchase of CDNow.com.
The Treasury
Department begins some bellyaching on the implicit government
guarantee of G.S.E. debt. G.S.E.s, you may recall, are Government
Sponsored Enterprises. You and I know them as Fannie Mae,
the Federal Home Loan Bank and Freddie Mac and we own truckloads
of this stuff. Credit spreads widened on these securities
significantly only to rebound after the Treasury and dignitaries
of the Agencies kiss and make up.
And then
last week, a personal shock across the news wire. Julian Robertson,
the tiger behind Tiger Management and renowned value investor,
hangs up his calculator. As he waves goodbye to Wall Street
and makes plans to withdraw his personal $1.5 billion fortune
from the
market
he is heard to say that these stock valuations just do not
make any sense to him. In the midst of this what-will-later-prove-to-be-an-obvious-statement,
the NASDAQ index is in the throws of an18.42% freefall over
the five trading days. Where does the liquidity from equities
go? The "old economy" stocks and the bond market
are generally where the dollars fall. My goodness, what a
thin line Chairman Greenspan must traverse.
So, you
may ask, what is the point of your musings? I am just trying
to stress the point of conventional wisdom is currently out
of the window. Let's look at the recent gabble of statistics
that will rattle the old bean.
1st
Quarter 2000
The Two-year Treasury note yield, as projected by our firm,
traded within a tight range this past quarter. This is somewhat
novel considering that it did this in the face of two tightenings
out of two meetings over the January through March quarter.
While
the two-year note has stayed within its tight band, the yield
curve itself has undergone a transition to a hump shape. The
hump peaks at the two-year note with the longer maturities
actually yielding less. Indeed, the 10-year out to the bond
itself has been rallying off of the news that the Treasury
is reducing the size of issuance of the 30-year bond with
an end goal of eliminating the bond altogether. In addition,
the Treasury has actually been in the market buying long Treasuries
thereby lowering the yield of the long part of the curve.
This is, of course, a contradictory action to what Chairman
Greenspan was intending to happen, increase interest rates
to slow down the economy. So it appears that Treasury is going
against the flow of the intentions of the Fed. What possible
reason could you come up with as to why Treasury wants to
stimulate growth?
Inflation
The other economic story of the quarter continues to be escalating
oil prices. Indeed, a quick glance at the price of oil is
enough to revive memories of those T.V. commercials of the
Western Company selling oil field equipment here in Texas
stating, "if you don't already own an oil well, get one!"
While
this past week OPEC has agreed on a new production level that
has succeeded in lowering the price of oil, the current price
of crude is still three times higher than where we were 15
months ago. Many economists are espousing the virtues of the
current U.S economy's reduced reliance on oil. However you
want to slice it, oil is still very important to many facets
of our industrial and service structure. A tripling of oil
does not bode well for the overall price picture.
Since
the big jump in the price of gold last year, the precious
metal has returned to its decades of long slumber. Having
raised its head from approximately $250 per ounce last summer
to around $300 last fall, it has failed to spark much confidence
since.
We use
oil and gold as precursors to inflation indications. The tremendous
spike in oil coupled with the moderate rallying in gold last
year would argue for some up-tick in inflation as measured
by the consumer price index and the producer price index.
As can
be seen from the graph above, CPI has been fairly stable,
returning an inflation indication of 0.2% per month throughout
the first quarter for an annualized rate of 2.4%. Most would
agree that this is a fairly docile rate. However, in contrast
to calls for a restructuring of the CPI a couple of years
ago, where many saw CPI as overstating inflation, many are
lining up to state that CPI is now understating inflation.
PPI, while more volatile than its consumer brother, has only
last month shown the pressures of petroleum or other materials
and services. Prior to last month's widely ignored jump of
1% in PPI, the index was averaging an annualized inflation
rate of 1.2% during the previous three months. As in every
economics story, only the future will tell what happens from
here.
Employment
and Wages
Also included on the scary side of the ledger is the entire
employment picture. Payroll growth continues to roll up impressive
gains that are almost set aside by the capital markets. Including
last month's relatively anemic 43,000 job growth figure, the
past quarter has averaged 245 thousand new jobs per month.
This works out to just under 3 million new jobs a year.
With that
kind of job growth, the unemployment rate has flirted with
dropping below the 4% handle. Once the unemployment rate gets
into the 3%s (which could be later this very week) it will
lead the nightly news, and make everyone feel giddy enough
to go out and leverage some more and buy drkoop.com.
Consumers
Speaking of leveraging up, the consumer has done his and her
job in soaking up liquidity to propel the biggest bull market
economy in history further along in its historic adventure.
The past
three months has seen the net change in consumer credit increase
by an astounding $43 billion.
This money
creation has lead the consumer to keep things rolling along
and produced impressive GDP output. In fact, the annualized
growth of our nation's output was over 9% in the fourth quarter
of 1999.
All of
the good news has kept consumer confidence in record territory.
After setting an all-time high in January, the index took
a breather in February and slipped a little.
All together,
things just can't get any better than this.
The
Forecast
The 2nd Quarter of 2000 has two FOMC meetings scheduled. All
things considered we should see two additional tightenings
with the caveat that all bets are off should the entire equity
market tank. Given this outlook of rate hikes we expect the
two-year note to remain as the highest yielding Treasury and
will see it trade between a high of 7.00% to a low of 6.15%.
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