Category: Chart of the Week

Expect Fed Funds Rate to Remain Unchanged at 6.5% Unemployment

With the unemployment rate (6.6%) approaching the Fed’s forward guidance target of 6.5%, this week’s chart examines two additional labor market indicators: the number of people working part time for economic reasons and the number of individuals who have been unemployed for longer than six months.

With the unemployment rate (6.6%) approaching the Fed’s forward guidance target of 6.5%, this week’s chart examines two additional labor market indicators: the number of people working part-time for economic reasons and the number of individuals who have been unemployed for longer than six months. In her February report to Congress, the new Fed Chairperson, Janet Yellen, identified these two data points as important gauges for evaluating the health of the U.S. job market.

While we have seen steady improvement in the headline unemployment number (down from a high of 10.0%), much of the “recovery” has been due to a decreasing labor participation rate, and overall the labor market remains relatively weak. Many individuals have resorted to working part-time due to poor labor demand and this segment constitutes 5.3% of currently “employed” workers. While below the high (7.0%) it is still above the long-term average of 4.4%. In addition, a large percentage of the unemployed (35.6%) have been so for more than six months. This is above the long-term average of 25.5% yet below the peak of 45%.

With the risk of inflation remaining relatively low, the market expects the central bank to refrain from increasing the fed funds rate at least through the first half of 2014 in an attempt to strengthen the economy and labor market even if the unemployment rate drops below 6.5%.

Price Recovery in Secondary Market for Private Equity

This week’s chart looks at median secondary market pricing for private equity fund interests. Because private equity is an illiquid asset class, investors that have private equity portfolios and need immediate liquidity must sell their interests in existing private equity funds to other investors.

This week’s chart looks at median secondary market pricing for private equity fund interests. Because private equity is an illiquid asset class, investors that have private equity portfolios and need immediate liquidity must sell their interests in existing private equity funds to other investors. This is called the “secondary market”, which has grown substantially since the credit crisis; over $20 billion of fund interests traded hands in 2013 on the secondary market. The above chart shows that in the immediate aftermath of the credit crisis, during 2009, buyers required a steep discount to net asset values to assume the risks of existing fund interests. At the bottom of the market, during the second quarter of 2009, sellers received just $0.30 on the dollar if they decided to sell their private equity investments. However, as the crisis abated those steep discounts vanished. Pricing was particularly aggressive in 2013 with secondary buyers requiring only a 7–10% discount to net asset value. Given these modest discounts, it appears the opportunities in the private equity secondary market are scarce these days.

Youth Unemployment and Aggregate Student Debt

This week we take a look at the unemployment rates among young people and the rising levels of student debt. Following the crash in 2008 the aggregate student debt has more than doubled, rising from $500 billion to over $1 trillion. This is the result of not only traditional students struggling to afford tuition, but also due to many people returning to school in the hopes of improving their skill sets in a tough job market.

This week we take a look at the unemployment rates among young people and the rising levels of student debt. Following the crash in 2008, the aggregate student debt has more than doubled, rising from $500 billion to over $1 trillion. This is the result of not only traditional students struggling to afford tuition, but also due to many people returning to school in the hopes of improving their skill sets in a tough job market. The drastic increase is even more worrisome given the high levels of unemployment facing those who carry the majority of this debt. Workers between the ages of 15 and 24 are significantly more likely to be unemployed than their elders, with their current unemployment rate at 14.2% compared to 6.1% for those ages 25-54.

However, this is not necessarily as bad as it seems. As high as the present unemployment numbers are compared to the rest of the population, they are fairly consistent with historical averages. Additionally, the systematically high youth unemployment is not unique to the U.S. Most recently available data shows this figure in the European Union as 23.3% compared to 10.8% for the total population, and 16.0% and 7.8% respectively, among OECD countries.

Ultimately, there are two primary worries about the massive level of student debt. The first — and most obvious — is a widespread pattern of defaults on this outstanding debt, a potential disruption to the credit markets, and by extension, a headwind for growth. The second — while not as severe but still a threat to economic growth — is a reduction in consumption from students who are spending a larger percentage of their income on debt service, rather than consuming goods and services. Collectively, these two forces could emerge as a drag on economic growth at a time when the U.S. economy seems to need all the help it can get.

The Fragile Five

Given the continued poor performance of emerging market (“EM”) investments, this week’s chart examines the structural issues challenging a number of EM countries, namely the “fragile five” (Brazil, India, South Africa, Turkey, and Indonesia). The chart illustrates how countries with high inflation and large current account deficits have seen their currencies decrease dramatically against the U.S. dollar.

Given the continued poor performance of emerging market (“EM”) investments, this week’s chart examines the structural issues challenging a number of EM countries, namely the “fragile five” (Brazil, India, South Africa, Turkey, and Indonesia). The chart illustrates how countries with high inflation and large current account deficits have seen their currencies decrease dramatically against the U.S. dollar. In comparison the currencies of Mexico and South Korea have remained relatively resilient.

As liquidity is gradually withdrawn from the global economy, these structural issues within emerging markets have come to the forefront. Investors are concerned that after years of expansion and unlimited access to cheap capital despite poor policy fundamentals, these EM countries will have a very difficult time implementing the necessary structural reforms, while also maintaining strong growth.

In response, central banks of all the fragile five countries have taken decisive action and increased their benchmark interest rates within the last four months. Furthermore, due to emerging markets’ continued weak performance, valuations are not only attractive for the asset class as a whole, but more importantly for stronger and more stable EM countries such as Mexico and South Korea. While there is still policy and political uncertainty affecting emerging markets, there is no doubt that value is present in the asset class.

*Currency return from January 1, 2013 to February 4, 2014.

Can Continuing Employment Growth Boost Business Spending?

This week’s chart of the week compares business spending (represented by non-defense capital goods orders) to employment (represented by total nonfarm employees) in the United States. As the chart illustrates, both employment and business spending have been steadily rising since the economic recovery began back in 2009.

This week’s chart of the week compares business spending (represented by non-defense capital goods orders) to employment (represented by total nonfarm employees) in the United States. As the chart illustrates, both employment and business spending have been steadily rising since the economic recovery began back in 2009. However, the growth of business spending, which contributed significantly to economic growth in the early stages of the recovery (increasing by an average of approximately $640 million per month from May 2009 through December 2011) has slowed as of late (increasing by an average of approximately $34 million per month from January 2012 through December 2013).

Employment growth, on the other hand, has been fairly steady over the past several years (increasing by an average of approximately 180,000 jobs per month each of the past three calendar years). With the ongoing strength in employment growth, the United States is approaching a new all-time high in total employment (i.e., peak employment). At the current rate of employment growth, the United States should reach a new peak employment this summer. This is a significant development because reaching new peak employment has historically led to significant growth in business spending, as businesses have to purchase new technology, equipment, and space to accommodate a larger workforce.

It will be important to monitor how businesses react once the economy reaches new peak employment. If business spending increases as it has in the past, it will provide another tailwind to an already strengthening economic recovery.

Is the Stock Market Overpriced?

Given the monumental run of the equity markets in 2013, we have frequently been asked if the stock market (as measured by the S&P 500 index) is overvalued heading into 2014. The answer unfortunately is not a simple yes or no, because it depends on the valuation method and measurement period.

Given the monumental run of the equity markets in 2013, we have frequently been asked if the stock market (as measured by the S&P 500 index) is overvalued heading into 2014. The answer unfortunately is not a simple yes or no, because it depends on the valuation method and measurement period. This week’s Chart of the Week looks at one valuation measure, the S&P 500 trailing 12-month price-to-earnings (P/E) ratio. We compare today’s P/E ratio with its 10, 20, 30, and 40-year averages.

As the chart shows, there is no clear cut answer when comparing these different averages to the current value — the analysis is very much contingent on the time period utilized when calculating the long-term average. Based on the 20- and 30-year averages one may conclude that the market is fairly priced, if not underpriced. However, the exaggerated P/E ratios as part of the tech bubble likely provide an upward bias to truly objective “long-term” averages. Fortunately, the 40-year average is sufficient to more effectively smooth out the spikes from the Tech Bubble valuations. Using this time period to determine the long-term average, it does indeed appear that the market is overvalued and expensive by historical means. However, this is far from a guarantee that the market will experience a correction in 2014, though we encourage our clients who experienced outsized gains in their equity portfolios in 2013 to consider rebalancing back to their target ranges. If nothing else, one thing is for sure: in order to sustain this current bull market run, the S&P 500 will need to produce strong earnings growth over the next year.

A Challenging Year for Core Bonds

This week’s chart depicts the challenging environment core fixed income investors faced in 2013. The ten-year Treasury rate jumped causing significant price depreciation while the coupons failed to cover the losses.

This week’s chart depicts the challenging environment core fixed income investors faced in 2013. The ten-year Treasury rate jumped causing significant price depreciation while the coupons failed to cover the losses. The Barclays Agg index declined 2.0% in 2013, the first negative calendar year return since 1999. This performance was made up of a -4.6% price return and a 2.6% coupon return.

Facing the prospects of low income and prices losses, many investors transitioned away from traditional core bonds in favor of higher yields and/or lower interest rate risk. It should be noted that this allocation change generally accompanies an increase in credit risk as there is no free lunch. While the bull market in fixed income is likely over and return expectations have been lowered, traditional bonds still serve an important role as an anchor to diversified portfolios, providing a steady source of income and principal repayment to investors.

Fixed Income Repositioning

This week’s Chart of the Week examines the estimated net mutual fund flows that occurred within fixed income from January 2013 through November 2013. Notable fund flow trends during this time included investors diversifying away from more traditional bond categories such as intermediate-term, municipal, government, inflation-protected bonds, and money markets.

This week’s Chart of the Week examines the estimated net mutual fund flows that occurred within fixed income from January 2013 through November 2013. Notable fund flow trends during this time included investors diversifying away from more traditional bond categories such as intermediate-term, municipal, government, inflation-protected bonds, and money markets. With generally low yield levels across fixed income asset classes and the expectation of a rising interest rate environment, investors added to categories such as bank loans, nontraditional bonds (which include unconstrained and opportunistic categories), world bonds, and short-term bonds.

Favored bond categories in 2013 tended to carry less interest rate risk such as bank loans and shorter maturity securities. Tactical investments like nontraditional bond and world bond categories where the investment manager typically has more control over interest rate or credit exposures taken at any given time also drew investment dollars. Short and ultra-short bonds were favored as a substitute for money market funds in the current low yield environment.

As investors reposition their fixed income portfolios for an expected low growth and rising interest rate environment, strategies with low interest rate risk or an emphasis on tactical flexibility within their mandates will likely continue to see net positive fund flows.

Has Household Income Peaked for Good?

In this week’s Chart of the Week, we track the real median household income in the United States over the last twenty-five years. The movement in this economic variable illustrates how the purchasing power of the typical American household has changed over time. This is an important statistic because it underpins the American ideal that every generation will do better than the previous.

In this week’s Chart of the Week, we track the real median household income in the United States over the last twenty-five years. The movement in this economic variable illustrates how the purchasing power of the typical American household has changed over time. This is an important statistic because it underpins the American ideal that every generation will do better than the previous.

Currently, real household income is sitting near a twenty-year low and has declined every year since 2007. In fact, since peaking in 1999, real household income has decreased in ten of the last thirteen years. Given the importance of consumption to GDP growth — about two-thirds of total GDP growth is driven by consumption — this downward trend in real income for the median household would appear to pose (another) notable headwind to stronger economic growth in the near future and adds to the murky outlook for 2014 GDP expansion.

An End to Household Deleveraging?

This week’s chart of the week compares the total household mortgage liability (i.e. outstanding mortgage balances) to the total owners’ equity in household real estate (i.e. home equity) for all households in the United States. As the chart indicates, in 3Q 2013 the total owners’ equity in household real estate exceeded the total household mortgage liability for the first time since the 2007/2008 financial crisis.

This week’s chart of the week compares the total household mortgage liability (i.e., outstanding mortgage balances) to the total owners’ equity in household real estate (i.e., home equity) for all households in the United States. As the chart indicates, in 3Q 2013 the total owners’ equity in household real estate exceeded the total household mortgage liability for the first time since the 2007/2008 financial crisis. This recent turnaround was driven primarily by the rebound in housing prices over the past few years (causing an increase in owners’ equity) and the large number of foreclosures on underwater homeowners over the past several years (causing both a decrease in outstanding mortgage balances and an increase in owners’ equity).

This development is significant because it may signal that household deleveraging, which has been a drag on economic activity for the past several years, is finally starting to come to an end. While still too early to determine if this data point is part of a larger economic trend, further readings of a positive gap between equity and liability should translate to stronger economic growth in the coming years.