By: Mark Schieffer, CFA
EVP Chief Investment Officer
Many economic and financial indicators are now at or above the pre-Lehman collapse figures from September 2008. Retail sales are as strong as they’ve been in the last 15-20 years as the consumer savings teeter-totter moves toward the pent-up demand side. Auto sales continue to rise at a steady pace (up to 12.5 million units annualized), though far from the 16 million unit rate we experienced 5-6 years ago. There are clearly opportunities for credit unions to get involved again in auto lending. Even the manufacturing sector, long written off in the U.S., is creating jobs again. The major U.S. stock markets have rebounded strongly over the last two years, lead by strong cash positions held by corporations, low interest rates, and a renewed emphasis on tech spending. This momentum is likely to continue through 2011 as the capital investment tax credit takes hold. Apple and IBM’s recent outstanding stock performance are great examples of the renewed interest in all things technology.
On the negative side, energy prices are on the rise again, along with nearly all other major commodity prices. Demand is strong for commodities to fuel global growth and to act as a hedge against the possibility of higher expected inflation. Current domestic inflation (outside of energy) is being held down, largely by continued weakness in the housing sector. Foreclosure activity is back on the upswing after the halt in Q4 2010. The stop/start nature of foreclosures and the weakness in executing without violating proof of title is weighing on the value of residential real estate. Labor conditions are improving, but lagging the rate of the financial markets. This is the usual pattern we see in an inflection point of the business cycle. Hiring always comes last. We are encouraged by the change in rhetorical tone out of Washington D.C. The change in emphasis toward not overtly kicking business around should improve hiring prospects going forward.
On balance, the economy is definitely improving and we’ll need to keep a sharp eye on potential changes in the stance of the Federal Reserve. Three things need to happen before the Fed will ratchet short-term rates higher. First, the Fed will need to stop buying long-term Treasuries. They are not quite halfway through the latest round of planned purchases of $600 billion. This is expected to last into the 2nd quarter of this year. Second, they will begin to sell some of the assets as the economy shows signs of strength. This will mean higher long-term interest rates. Asset sales would not likely take place until late 2011 at the earliest—probably a minimum of six months between the last purchase and the first sale. When the Fed starts to shrink it’s now massive balance sheet, that will be a clear indication that short-term interest rates are poised to move higher. Finally, the Fed will then likely signal a rise in short-term rates with at least a three-month window before executing. So, we’re not looking for the Fed to actually raise the Fed Funds rate until mid-2012 at the earliest.