Glassman Wealth Services LLC

We have been telling clients that the increase in overall debt in the US and countries around the world will continue to have a dragging affect on domestic and global economic recovery. The June 24, 2010 edition of The Economist includes an impressive interactive map detailing the overall debt levels for a wide range of countries, based on data supplied by the McKinsey Global Institute. Click Here to access the report.

Glassman Wealth Services is proud to be a sponsor of the 2011 American Odyssey Relay, a twenty-four hour, a two hundred mile relay race from Gettysburg to Washington, DC. Celebrating its third year, American Odyssey Relay anticipates over 2,000 runners comprised of teams of 12 who will start at Gettysburg and weave their way through Civil War landmarks in Antietam/Sharpsburg, Harpers Ferry and Riley’s Lock before arriving in Washington, DC on April 30.

A portion of the proceeds from the American Odyssey Relay and 100% of the GWS sponsorship dollars goes to support two very worthwhile charities: The Wellness Community – DC and Hope for the Warriors. For more information, go to Glassman Wealth Services Giving Back.

The resurgence in risk appetite continued apace this past week, allowing the S&P 500 index and the Dow Jones Industrial Average to return to positive territory on the year.  By the end of the week, the S&P was up 2.4% and the DJIA finished up 2.3%. 

Yields on US Treasury bonds ended moderately tighter on the week despite the strong performance in risk assets.  At the beginning of the year, numerous prognosticators were calling for a surge in Treasury yields, but to the contrary, yields fell from 3.8% at the start of the year to 3.2% this past Friday.  The explanation for this move may be simpler than we all realize. 

Based on data from the Federal Reserve’s Flow of Funds report, US households are severely underinvested in Treasury and Municipal securities. With more than 50% of household assets tied up in equities and real estate, the recession of 2008/09 seems to have left a mark on many individuals, especially those in the baby boomer generation who are inching ever closer to retirement.  This is fueling a reallocation away from equities in favor of bonds and income producing securities.

This is certainly not a panacea for low interest rates forever, especially considering the uncertainty around China’s future appetite for Treasuries, but it does provide a sorely needed source of financing for the Treasury Department in coming years. 

Housing: with the government gradually removing its chokehold on the housing industry, economists are growing concerned that housing is set to experience a slowdown in the second half of the year.

As expected, the initial reports surrounding May housing data are weak with housing starts falling 10% due to a 17% drop in single family starts.  The weakness in residential investment represented a major drag on GDP from 2006 through the first quarter of 2009, before finally contributing to positive growth in the second half of 2009.  Those gains were rather fleeting and housing once again became a net detractor to growth in the most recent quarter. 

Perhaps more problematic was the news that Fannie Mae and Freddie Mac, the beleaguered US mortgage financing companies, have requested $145bln from government coffers, with one ratings agency suggesting that a $1trln financing package for those two firms is not out of the question. 

According to the New York Times, foreclosures forced the two firms to take over ownership of a new home every 90 seconds during the first quarter of this year.  By the end of March, the firms owned a combined 163k homes.

This is actually not as detrimental as it appears on the surface because Fannie and Freddie represented a dwindling slice of the market during the years between 2005 and 2007 and were fortunate to avoid a good portion of the poorly originated loans.  However, as we are all acutely aware, the firms are the de facto lender of last resort and by some estimates, account for as much as 97% of the mortgage market. 

Long term, Fannie and Freddie will face years of losses related to sour mortgages, all at the expense of the US taxpayer. 

Taxpayers are also on the hook for the current home modification program, which is looking like an unmitigated disaster at this point.  The Home Affordable Modification Program (HAMP) was originally designed to provide payment relief for homeowners who were struggling under the burden of debt.  Sounds simple enough, but what the government forgot to account for was all the other debts (credit cards, auto loans, student loans, etc) those individuals are carrying. 

For the average person, HAMP provides $500 a month in mortgage payment relief.  Even accounting for that deduction, 64% of pretax income is spent on debt payments.  That is an unserviceable burden and Fitch Ratings estimates that 65% to 75% who enter the HAMP modification process will re-default within 12 months. 

Last week’s news on the inflationary front proved to be as benign as everyone was expecting.  The headline Consumer Price Index was down 0.2% month-over-month and the Producer Price Index for Finished Goods eased by 0.3%.

From the consumer standpoint, headline CPI was off modestly in the month and is now up 2.0% in the past 12 months.  Core CPI, which excludes food and energy, is up only 0.9% in the past year and the Cleveland Federal Reserve’s preferred measure of consumer inflation, which excludes outlier categories, is even weaker at 0.5%.

With unemployment at elevated levels, producers are not able to pass along higher costs to consumers, reflected by the 5.1% increase in the PPI index for finished goods and the 8.4% increase in the intermediate goods index over the past 12 months.

By all accounts, industrial production is well on its way to recovery, largely a function of inventory restocking since early 2009.  Unless consumer demand catches up with that restocking, companies will be facing challenges in the coming quarters.

The primary problem for those companies will be higher input costs that consumers will be unwilling to stomach, placing pressure on profit margins.

On the positive side, monetary policy remains extremely accommodative as the Fed is embracing a zero interest rate policy.  According to the Federal Reserve Bank of San Francisco, interest rates should be even lower based on the interplay between rates of inflation and unemployment.  Even when accounting for asset purchases by the Fed, the first Fed Funds rate hike is not anticipated by the model until 2012.

Unfortunately, should we face the double-dip recession that many are now predicting, the Fed will have little to no room to re-stimulate the economy. 

In the end, inflation is showing absolutely no indication of pricing pressure on the horizon.  On the other hand, companies are dealing with higher commodity prices that will likely eat away at profit margins in the next several quarters and should the economy dip back towards recessionary territory, the Fed will be limited in its ability to provide appropriate stimulation to the economy.

Are We Headed for a Double Dip Recession?

Macroeconomic Advisers, a well regarded economic research firm, places the odds of a recession in the coming 12 months at effectively zero. This suggests to us that what is likely to occur is a softening on economic data, but not an outright recession.

Equity indices logged solid gains this past week with the S&P 500 index up 2.5% and the Dow Jones Industrial Average up 2.6%.  The positive outcome was a result of light trading on Thursday and Friday, although it appears there is little conviction in the rally with trading volume falling well short of the 50-day average over the course of both days.

Part of the reasoning behind the lack of confidence may center on individual investors, who are increasingly wary of stock market volatility.  A measure of confidence from the Yale School of Management, developed by economist Robert Shiller, shows individual investors are becoming disenfranchised with the market which translates into a lack of willingness to buy equities during periods of correction.  Since the beginning of 2009, the individual investor index has been on a distinct downtrend, contrary to institutional investors who are now more willing than ever to buy the dips.

Regardless of the recent market retrenchment, small business owners are tepidly showing signs of confidence, as the National Federation of Small Business (NFIB) Optimism Index rose from 90.6 in April to 92.2 in May.  While the index remains at depressed levels, the trend is clearly moving in the proper direction.  Firms cite improvements in sales and earnings as the reasons behind the swelling optimism, but, 30% of all small businesses point to poor sales as the most important problem facing their business.

The counterintuitive statistic of the week came courtesy of the Bureau of Labor Statistics in its most recent Job Openings and Labor Turnover (JOLTS) release for April.  According to the report, roughly 1.98mln people quit their jobs in the month of April, the highest level in over 12 months.  People are only willing to leave positions if they believe greater opportunity exists elsewhere, the opposite of what we experienced during 2009, when more indiviudals were being forced out of the market through layoffs.

That logic is supported by another statistic in the report which measures the number of job openings as of the end of the month.  On April 30^th, there were 3.1mln open jobs, up from the cyclical low of 2.3mln open jobs in July of last year.  As job openings increase, employment rebounds, ultimately translating into stronger economic growth.

Providing further confirmation of the improved confidence, the Federal Reserve’s most recent Beige Book indicated that “labor market conditions improved slightly with permanent employment levels edging up.”  The Fed noted that consumer spending is “improved from the previous report” but consumers are focused on necessities at the moment, not discretionary spending.  The news was not all rosy however, as the Fed reported that housing activity was “slowing” in the month of May after the expiration of the home buyer tax credit. 

It is likely to be some time before individuals are fully on board with the “recovery” theme, though, as data from the recent Flow of Funds and retail sales reports show.  According to the Federal Reserve’s Flow of Funds release for the first quarter, household net worth is still off $11.4trln from its 2007 peak.

Equity markets meandered through a comparatively benign week before May’s employment report derailed trading on Friday. The S&P 500 Index finished down 2.3% and the Dow Jones Industrial Average was off 2.0%.

Traders were in a fairly pensive state in advance of the employment report and even without reading any analysis of the release, Friday’s market action made it very apparent how market participants viewed the news.

The economy added 431k jobs in May, with 411k attributable to Census hiring. Reflective of the weakness at the municipal level, state and local government trimmed employment by 13k.

From a contrarian perspective, equity mutual fund outflows hit the highest point since October 2008 during the month of May.  Mutual fund investors continue to swap out of equity funds and into fixed income funds. 

As retail investors are bailing on the equity markets, corporate insiders are becoming more confident in their own companies.  Insiders are selling 1.26 shares of corporate stock for each share bought, far below the long-term average and the 7.82 to 1 sell to buy ratio in early April. 

Although there remain pockets of positive news, investors are still wary of the unknowns.  Chief among those unknowns is the ability of the US government to continue financing its debt.  Total US public debt outstanding crossed the frightening $13trln mark on June 1^st.  The gap between US GDP and public debt is growing ever narrower and projections from the International Monetary Fund indicate that public debt will jump above GDP by 2012.

Market prognosticators are full of consternation about the state of the Chinese real estate market, with one publication after another declaring that an asset bubble is only moments away from popping.  Clearly the recovery in the Chinese real estate market is impressive, perhaps curiously so, but the dynamics of the Chinese market indicate that an asset bubble is nowhere to be found…for now. 

In late 2008, to combat the global economic recession, China enacted a $585bln stimulus program.  The announced package represented almost 15% of 2008 GDP and was designed to provide support to housing and infrastructure development in the country.  Fast forward 18 months and the program is an obvious success. 

The concern is that the program is actually becoming too successful as urban property prices are up nearly 13% from the same time last year, the fastest pace on record.  This leaves officials with the unenviable task of slowing a burgeoning housing market without slowing it too far.   

When considering whether China is in the early stages of inflating a bubble, it is imperative to consider the underlying dynamics and stark differences from the housing market in the US.  Whereas prospective homeowners in the US can buy a house with a 3.5% down payment, China requires minimum down payments between 20% and 30%.  Even with that regulation in place, more than 50% of all buyers put 30-40% cash down, according to CLSA.  In the US, loan-to-value ratios hover around 75%.  Similar measures in China are only 46%. 

From an affordability standpoint, the price-to-income index is on the rise, but well below the levels seen in the US, UK and even India. 

Price-to-rent tells a slightly different story as more individuals are electing to buy in advance of higher expected prices. 

One could argue that there is a growing degree of frothiness in the Chinese housing market, and in recognition, Chinese officials enacted a series of measures earlier this year to cool the precipitous rise in prices. This includes tighter lending restrictions, higher down payments, increased mortgage rates, greater reserve ratios for Chinese banks and the reformation of property taxes. 

China is obviously toeing a delicate balance, attempting to cool housing prices, without derailing economic growth.  If Chinese officials were to let prices appreciate at the current rate in perpetuity, a bubble would be inevitable.  Recent actions to stem speculative investment indicate that the government is serious about cooling the market.

It is also important to remember that China is a country with a disposable war chest of $2.5trln and a demonstrated desire to do whatever it takes to defend against even the slightest hiccup in economic growth.

Glassman Wealth Services is pleased to announce that it has been named one of the Top emerging fee-only firms in 2010 by Investment News.

As a Registered Investment Advisor, Glassman Wealth Services focuses on providing their client families with personalized, comprehensive, innovative and objective investment and wealth management services.

“We are committed to the financial health and well-being of our clients,” said Barry Glassman, CFP®, president of Glassman Wealth Services. “Since we do not accept commissions and are not tied to any proprietary products, we are able to offer the objectivity and transparency that investors and their families need to make reliable financial decisions.”

One of the most disheartening aspects of the past several years was the abysmal state of consumer finances heading into the recession.  In the first quarter of 2008, the personal savings rate was a meager 0.8% of disposable income and household liabilities as a share of disposable income reached an astounding 130%.  Levels that severe suggested that even the mildest recession would spiral out of control given the “quick to disappear” nature of consumer credit. 

Surprisingly, consumers shook off the cob webs and made an exceptional comeback over the past 12 months.  But, the story has yet to truly change; consumers are tenuously overextended and unlikely to provide the necessary boost to economic growth in the coming quarters without serious improvement in wage or credit growth. 

The initial phase of the domestic recovery in 2009 was overwhelmingly driven by inventory restocking.  That is, businesses needed to replenish historically low inventory levels to restock the shelves.  Contrary to what many economists were expecting, that phase gave way to robust personal consumption, which contributed almost 2.5% to GDP growth in the first quarter alone.    

Somewhat problematic for consumers is the realization that the economic growth of the past several quarters came at the expense of the personal savings rate, falling from a recent peak of 6.4% to 3.6% in April.  In order to continue spending at the current pace, indivudals need higher wage growth or easier access to credit, neither of which seems likely in the present economic climate.

The other issue which has yet to be resolved is wage growth.  In the past 12 months, disposable income is up 2.5%, after rising only 1.0% in all of 2009.

Even with the problems facing the consumer, there are several factors working in their favor.  The first is lower mortgage rates.  For those individuals with the ability to refinance or purchase a home at today’s historically low interest rates, the monthly savings can be sizeable.  In recent weeks, the number of homeowners opting to refinance, including a fair number of Glassman Wealth Services clients hit a seven month high and as long as the situation in Europe remains unresolved, interest rates will stay low.

Second, retail gas prices are weakening.  The tentative situation in Europe is pushing crude oil prices lower, to the benefit of automobile owners.  Prices, while elevated, are still significantly lower than the peak endured in 2008.

Although consumer spending may slow in favor of a higher savings rate, this could prove to be a positive for the economy.  Higher savings are generally rerouted back to the economy in the form of capital investments, i.e. stocks.  Corporations use those dollars more efficiently and productively than the average consumer, creating sustainable long-term benefits for the economy.  Supporting that notion, the Federal Reserve Bank of St. Louis found that GDP growth is the highest when consumer savings is on the rise, not declining, as one might be inclined to believe. 

Encouragingly for consumer finances, household debt service payments as a percent of disposable personal income is on the decline.   The ratio remains above the long-term average, but is returning to a more appropriate level and indicates that the consumer balance sheet is slowly being realigned.

American consumers are notorious for their spendthrift ways.  That trend is under pressure following the deepest recession in the post-WW II era and while this is likely to create headwinds for the economy in the near term, the long-term benefits to the economy from more productive and efficient uses of that capital will prove important.