Author: Marquette Test

Stock up on Soybeans in 2012

This past Friday, March 30th, the United States Department of Agriculture (USDA) released the 2012 Prospective Plantings report, which included various estimates. According to the report, “Soybean growers intend to plant an estimated 73.9 million acres in 2012, down 1 percent from last year and down 5 percent from 2010.

This past Friday, March 30th, the United States Department of Agriculture (USDA) released the 2012 Prospective Plantings report, which included various estimates. Amongst the estimated data, the Prospective Planting report included a lower than anticipated soybean forecast. According to the report, “Soybean growers intend to plant an estimated 73.9 million acres in 2012, down 1 percent from last year and down 5 percent from 2010. Compared with last year, planted acreage intentions are down in many areas as some acreage is expected to shift to corn” (USDA).

The projections on soybeans from the USDA indicate that soybean ending stock is expected to reach dangerously low levels. After the release of the USDA prospective planting report, soybean future prices quickly skyrocketed as anticipated rationing of soybean stock will most likely result throughout the year. The price of soybeans ended up over 3% from the previous day’s close indicated from the chart above. Although it may be too late for U.S. farmers to switch acres to soybeans this season due to the fieldwork they have already completed, the higher prices have the potential to entice South American farmers to switch during their next planting season. This additional soybean production will be necessary to fulfill Chinese demand as they continue to be a dominant player in the agricultural market.

Sources:

  • USDA Prospective Plantings report
  • Farm Press Article: by Dr. Scott Irwin, Dept. of Agriculture and Consumer Economics, University of Illinois
  • Bloomberg article – China reference

Where’s the Yield?

Driven by the stock market’s upward trajectory during the past six months, the yields of various asset classes illustrate a return to riskier asset classes and a change in the landscape for income-driven investors. Our Chart of the Week shows the disparity between this week’s yields and those of roughly six months ago, when we last examined this topic.

Driven by the stock market’s upward trajectory during the past six months, the yields of various asset classes illustrate a return to riskier asset classes and a change in the landscape for income-driven investors. Our Chart of the Week shows the disparity between this week’s yields and those of roughly six months ago, when we last examined this topic.

Investors’ return to riskier asset classes has caused an increase in Treasury yields and a decrease in the yields of more volatile bonds and equities. Since September 26, 2011, when we last produced a chart of the week on this topic, the S&P 500 Index has increased by 21.5%, from 1,162.95 to 1,412.52 as of March 27, 2012. European debt woes that threatened the global economy throughout the 3rd and 4th quarters of last year have subsided and yields have diminished as investors add risk back to their portfolios. The 10-Year Treasury’s yield has increased by 22 basis points over the past six months and is now greater than that of the S&P 500, which declined by 24 basis points. For the week of March 12, 2012, global bond funds enjoyed their 11th straight week of inflows and emerging market bond funds had their 2nd best week of the trailing year, manifested by the 1.18% drop in the yield of the BarCap Emerging Market Bond Index over the past six months. High yield bond funds have also seen noteworthy inflows over the past six months, which has driven yields down 1.94%. U.S. Treasuries are again becoming more attractive for the income-driven investor as the yields of more volatile asset classes have decreased, and the income-focused portfolio will likely return to a more traditional structure as the yields of various markets move closer to historic averages.

An Apple a Day…

On March 19th, Apple made news once again by declaring the payout of a dividend for the first time since December 1995 and buy-back program of company stock. Apple announced a $2.65 per share dividend that will begin in July 2012. This represents a 0.45% quarterly yield and a 1.81% annual yield (dividend / share price).

One cannot walk down the street, shop at a mall, or sit next to someone on an airplane without those ubiquitous white ear buds visibly present. With the introduction of Apple’s iPod on October 23, 2001, and the subsequent releases of the iPhone (June 2007) and the iPad (January 2010), Apple’s technologies have been accepted as the premiere gadgets to own. This success has catapulted Apple to be one of the best performing companies in the United States and the world.

On March 19th, Apple made news once again by declaring the payout of a dividend, the first time since December 1995, and a buy-back program of company stock. Apple currently has $100 billion of cash on its balance sheet. Investors and pundits alike have wondered, what will Apple do with all that cash? Keep investing in the business? Increase the retail presence? Buy a strategic partner? Buy a competitor? Buy back stock? Those questions have been put to rest, at least for now.

Apple announced a $2.65 per share dividend that will begin in July 2012. This represents a 0.45% quarterly yield and a 1.81% annual yield (dividend / share price). The $10 billion released for the stock buy-back program will begin in the fourth quarter of 2012. All in, this plan will cost the company approximately $40 billion over the next three years ($29.7 billion for the dividends and $10 billion for the buy back).

The price of Apple stock has steadily increased over time (as depicted in the chart above), resulting in an increased market capitalization of the company. With approximately 932.4 million shares outstanding, the company has a market capitalization value of over $560.5 billion. Apple is easily the largest constituent in the S&P 500. Exxon Mobil is the next closest company at $408.6 billion.

The Improving Outlook for Construction Jobs

This week’s chart shows the month over month change in construction jobs and the month over month change in annualized housing starts in the U.S. (based on rolling six month averages for each). As the chart illustrates, the steep drop off in housing starts that began in late 2006 resulted in significant job losses in the construction sector starting in mid-2007. However, over the past several months, a positive trend has started to emerge in new housing starts.

This week’s chart shows the month over month change in construction jobs and the month over month change in annualized housing starts in the U.S. (based on rolling six month averages for each). As the chart illustrates, the steep drop off in housing starts that began in late 2006 resulted in significant job losses in the construction sector starting in mid-2007. The construction sector, which added approximately 1.1 million jobs from January 2003 to December 2006 (an average of about 24,000 jobs a month), lost approximately 2.1 million jobs from January 2007 to December 2010 (an average of about 44,000 jobs per month) according to ADP payroll data. However, over the past several months, a positive trend has started to emerge in new housing starts. This positive trend in housing starts has largely been driven by an increase in construction of multifamily housing units (i.e. apartment buildings) due to the increased demand for apartments (as a result of many households transitioning from homeowners to renters).

While this improvement is a welcome development in the housing market and construction sector, the recent increase in construction jobs is nowhere close to the kind of growth required to make up for the lost construction jobs during the recession and its aftermath. We have had an increase in construction jobs for five consecutive months with approximately 56,000 construction jobs added in the U.S. At this pace, it would take over 15 years to recover all the construction jobs that were lost from January 2007 to December 2010.

Update on Europe

March 2012 Investment Perspectives

As the threat of sovereign defaults and subsequent contagion in the eurozone persists, international leaders have continued to work towards a long-term solution for the fiscal issues threatening Greece and the rest of the eurozone.

This newsletter summarizes the latest efforts to rectify the European debt crisis as well as significant events that have transpired since our last European Update. Much emphasis is given to Greece and its latest bailout package, since the recently approved assistance will likely have a large impact on both investors and the future of the eurozone.

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Beware of Changing Correlations!

This week’s chart shows the dynamic nature of correlations between asset classes by comparing correlations amongst traditional asset classes over 20-year and 5-year historical periods. The chart above shows how much these correlations have all increased when comparing the 5-year figures to the longer dated 20-year period.

This week’s chart shows the dynamic nature of correlations between asset classes by comparing correlations amongst traditional asset classes over 20-year1 and 5-year2 historical periods.3 The chart above shows how much these correlations have all increased when comparing the 5-year figures to the longer dated 20-year period. What does this mean for investors? We see two main takeaways:

  1. For those that rely on mean-variance optimization programs for determining their asset allocation, it is imperative to understand the exact timeframe reflected in the correlations used as inputs, as different time periods will yield not only different correlations but critically, different portfolio structures.
  2. The correlation amongst traditional asset classes has increased in the last five years, thus it is more difficult to truly create a “diversified” portfolio that offers protection from large draw downs in the equity markets. This was never more apparent than during the financial crisis of 2008-2009.

As now outlined in both this chart and “Correlation Doesn’t Tell the Whole Story”, correlations can be helpful in conducting asset allocation studies, but they also feature some notable shortcomings that should be well understood by those who rely on them for portfolio decisions.

1 March 1992 – February 2012
2 March 2007 – February 2012
3 Indices used for analysis were Russell 1000, Russell 2000, MSCI EAFE, MSCI Emerging Markets, and BarCap Aggregate

Velocity of Money

This week’s chart shows the change in the velocity of the money from 1959 through 2011 along with the growth in the monetary base. Velocity measures the frequency with which a unit of money changes hands in an economy over a given period of time. This figure can be viewed as a general gauge of activity taking place within an economy.

This week’s chart shows the change in the velocity of the money from 1959 through 2011 along with the growth in the monetary base. Velocity measures the frequency with which a unit of money changes hands in an economy over a given period of time. This figure can be viewed as a general gauge of activity taking place within an economy. The monetary base represents liquid currency as well as close substitutes for money including currency in circulation, bank vaults, and bank reserves. In monetary economics, the quantity theory of money states that money supply multiplied by velocity equals real GDP times the price level.

Money Supply * Velocity = Real GDP * Price Level

This implies that the price level has a direct relationship with the supply of money in an economy. As the chart shows, the monetary base is at the highest level on record, which would normally lead to an increase in the price level (inflation). However, velocity is at the lowest level since record keeping began in 1959 and is the primary reason inflation remains subdued, despite the large increase in the money supply.

The Federal Reserve has more than doubled the monetary base since December 2007 through quantitative easing in hopes of stimulating borrowing and spending. However, increases in the monetary base have largely sat idle in bank reserves as banks increased their capital ratios, tightened lending standards, and overall loan demand levels decreased, causing the velocity of money to fall. Given the current economic slack in the U.S., it is unlikely that the Federal Reserve’s monetary policies will cause inflationary issues in the near term as long as velocity remains low. However, once economic activity begins to pick up, policy tightening will be essential to reduce potential inflation pressures.

More Challenges for Greece

Another round of bailouts, totaling €130 billion, was approved for Greece on Tuesday. As with other Greek bailouts, the receipt of the money was contingent on further budget cuts and austerity. Going forward, Greece faces two main concerns, one short-term, and one long-term.

Another round of bailouts, totaling €130 billion, was approved for Greece on Tuesday. As with other Greek bailouts, the receipt of the money was contingent on further budget cuts and austerity. Going forward, Greece faces two main concerns, one short-term, and one long-term. In the short-term, Greece will likely continue to experience solvency/liquidity pressures, as large debt and deficits require continued aid and debt write-downs. The approved bailouts help relieve these pressures.

However, continued austerity in the face of negative GDP growth and large deficits may exacerbate Greece’s financing problems. Austerity has improved Greece’s finances less than expected, as budget cuts result in lower GDP and thus lower tax revenues. As recently as March 2011, the IMF expected Greece’s contraction to bottom in 2010, and resume growth by 2012. New estimates from the Eurogroup expect the GDP contraction in Greece to bottom in 2012, and resume growth by 2014. It is difficult to see how this goal is achievable utilizing similar policy prescriptions that have failed to work in the past. Forecasts may still be overly optimistic.

Regardless, short-term solvency issues can continue to be relieved by further bailouts as long as there is political will. Longer-term competitiveness problems may be more difficult to solve. EU officials hope that Greece can transform into a competitive, export-driven economy. Currently Greece, along with other PIIGS countries, runs a large current account deficit. Simultaneously, Germany runs a large current account surplus. One of the main drivers in the competitiveness gap between Greece and Germany are differences in unit labor costs. Unit labor costs measure the average costs per unit of output, and are calculated as the ratio of total labor costs to real output.

The chart above shows the change in unit labor costs for select Eurozone countries since 2002. Greece’s labor costs over this period have risen significantly, while Germany’s have barely budged. The two main solutions to this gap are relative inflation in Germany (unlikely given its history), or years of wage deflation in Greece. This suggests that the adjustment period for Greece as long as it remains in the Eurozone could be quite long indeed.

Unemployment by Education Level

This week’s chart shows the historical unemployment rates for various education levels and their respective averages over the time period of 1992 – present. Despite the well publicized recent drop in the overall unemployment rate, the current unemployment rates for each education level still remain near their 20 year highs and around twice their 2007 pre-recession levels. Also, since the recession began, the unemployment rate for those with only a high school degree has been higher than the unemployment rate for the general population for the first time.

This week’s chart shows the historical unemployment rates for various education levels and their respective averages over the time period of 1992 – present. While the general ordering of the unemployment rates is not surprising, there are some notable takeaways from the chart. First, despite the well publicized recent drop in the overall unemployment rate, the current unemployment rates for each education level still remain near their 20 year highs and around twice their 2007 pre-recession levels. Also, since the recession began, the unemployment rate for those with only a high school degree has been higher than the unemployment rate for the general population for the first time. This shows the growing importance of higher education towards finding and keeping a job.

As the recession carries on, the gap in unemployment rates between those with a college degree and those without remains elevated at historic highs. In addition, for the first time those who have earned a high school degree but continued no further in their education have fallen behind the general population in terms of unemployment. All of this shows that the current recession has exasperated the long term trend of the less educated experiencing much higher unemployment levels than those with a high school or college degree.

Lower Oil Prices?

Domestic energy production has experienced a renaissance over the last few years, mainly driven by natural gas production. While oil prices hovered around $100/barrel for most of 2011 natural gas prices hit lows not seen since the 1990’s.

Domestic energy production has experienced a renaissance over the last few years, mainly driven by natural gas production. While oil prices hovered around $100/barrel for most of 2011 natural gas prices hit lows not seen since the 1990’s. As this chart shows, the relative price of oil to natural gas (shown in gold) was fairly stable during the 1990’s and most of the 2000’s but has soared over the last few years. In the short term some divergence is understandable, but over the long term these two energy sources are substitutes and we would expect to see energy consumers switch from oil to natural gas given the price differential.

The line in gray shows the number of natural gas drilling rigs in the U.S. and the explosion of drilling in 2006 and 2007 led to the increased production and lower prices we see today. What is also interesting is natural gas drilling activity has remained fairly stable over the last two years while oil drilling activity has reached levels not seen in the last twenty years (black line). Will the increase in oil drilling lead to more production and lower prices? If natural gas is any indication, Americans might see more oil production and lower prices at the pump in the years ahead.