March 5, 2010
Our economy, as measured by non-farm payrolls, lost 36,000 jobs per this morning’s job report. Expectations had been as high as 50,000 jobs. Our economy is improving, albeit slowly, which is a very good thing. Inflationary pressures are diminishing. The Federal Reserve, also, recently raised the discount rate as it slowly starts to unwind its stimulus tentacles from the economy.
Greece has been the big cloud on the proverbial horizon, given the possibility of default on their government bonds, aka their sovereign debt. This situation has proved to be a significant challenge to the existence of the European Common Union. As a member country of the ECU, each nation is supposed to keep its budget deficit within certain tight parameters. Greece has found this to be a bit of a challenge. David Hale of The Financial Times put it this way in his March 4, 2010 column:
"It accounts for only 2% of European gross domestic product. It has been in default for more than half of its history since 1832, running an average fiscal deficit of 7.8% of gross domestic product since 1988."
"There has been a centre-right government, until recently, which increased the government's share of GDP from 44 per cent to 52 per cent. The public sector is so inefficient that the cost of public administration is 7 per cent of GDP compared with an average of 3 per cent for the eurozone."
The good news is that Greece was able to issue $6.8 billion in 10 year Treasury bonds at a rate of 6.25% yesterday (by comparison, the U.S. Treasury 10 year bond is at 3.68%). The bad news is that Portugal, Italy, Ireland and Spain (now known as the “PIIGS”) may all be up next. If you are traveling to any of the PIIGS nations, be prepared for labor/public worker strikes in response to government wage freezes.
So what does this mean for the U.S. markets and our recovering economy? Whenever there is an international issue (think Dubai before Thanksgiving), there tends to be a flight to quality. In the past, that meant assets had a choice of hiding in U.S. dollars or Euros. Now the choice has gotten rather narrow, with only the U.S. dollar causing the dollar to strengthen. In an export-driven economy such as ours – it has made our exports a little more expensive for buyers overseas.
We believe that these international issues will help drive up U.S. asset prices over time. Because of this, we are still very positive on U.S. equity markets. As mentioned earlier, the ten year Treasury bond is at 3.68%. In comparison, the S&P 500’s earnings yield (the inverse of the S&P 500 price earnings ratio currently at 20) is 5%. Stocks still look cheap to bonds. The two year treasury yield is at 0.91%. The spread between the 2 year and the 10 year is still a very positive 2.77%. As far as bonds go, we are still maintaining our very short stance on maturities, advocating those that are less than one year. JDM continues to like Treasury Inflation Protected securities – inflation will make a comeback but probably not this year in our opinion.
Finally, we'll go out on a limb by pointing to a significant indicator of both economic recovery and rising asset prices in the U.S. Merrill Lynch (a subsidiary of Bank of America) has announced that it wants to hire 2000 more stock brokers, and Wells Fargo announced today that it wants to hire 10,000 additional brokers.
JDM Investment Counsel