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Q2 Review – 2013: Is Good News Bad News?

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Since 2008, the Federal Reserve has reached beyond the traditional tools of monetary policy in an effort to fulfill its’ dual mandate of achieving maximum employment and stable prices. Most recently, the Federal Reserve introduced a third round of quantitative easing, purchasing a combination of $85 Billion worth of longer-term U.S. Treasury securities and Mortgage-Backed Securities. These asset purchases have depressed interest rates, allowing businesses and consumers to improve their balance sheets by reducing the burden of debt. As key economic indicators improve (ie. the aforementioned balance sheets), market participants will discover whether these improvements are artificially-induced or a true sign of recovery.

Good News

The U.S. economy continues to grow modestly, as expected. The Bureau of Economic Analysis revised their earlier estimate of 2.4% real Gross Domestic Product (GDP) growth in the first quarter of 2013 down to 1.8%. Although the estimation was reduced, it’s a positive sign relative to fourth quarter growth of 0.4% and compared to our European counterparts.

The Bureau of Labor Statistics kept the “good news” coming as total nonfarm payroll employment increased by 195,000 in June. In addition, the estimate for April was revised from 149,000 to 199,000 and May was revised from 175,000 to 195,000. A less-flattering figure is the 322,000 increase in the number of persons employed part-time for economic reasons. All things considered, the unemployment rate remains at 7.6% while companies face fiscal headwinds and future healthcare uncertainty.

Real disposable personal income (DPI), adjusted for taxes and inflation, increased 0.4% in May as a result of a slight step-up in wages while inflation remains subdued. The personal saving rate bumped up from 3.0% in April to 3.2% in May. Real consumer spending rose 0.2% in May after falling 0.1% in April. These figures have calmed the earlier fears surrounding a payroll tax increase.

U.S. home prices, as reported by Case/Shiller, jumped 12.2% over the last 12 months. This is the highest increase in seven years. The increase has been attributed to record-low mortgage rates and a limited supply of homes for sale.

Stocks, as measured by the S&P 500 Index, rose 2.36% during the second quarter. The increase gives this asset class year-to-date gains of 12.36%. Although equity returns appear desirable, the gains have not come without volatility. In June alone, the Dow Jones Industrial Average closed higher or lower by 100 points a staggering 16 times.

Stock market gains paired with rising real estate prices have caused consumer confidence to rise to it’s highest point since January 2008. Americans are considerably more optimistic about the overall economy and labor markets than earlier this year.

Is Good News Bad News?

On June 19, the Fed released a statement which “hinted” at the tapering of bond purchases later this year or early next year if conditions continue to improve. Though the economy has not reached a 6.5% unemployment rate or 2% inflation target, the market reacted to this “good news” as potentially “bad news.”

The 10-Year Treasury rose from 1.66%, on May 1st, to 2.73%, on July 5th. As interest rates and bond prices are inversely correlated, the rise in rates has put downward pressure on bond prices. The asset class, as measured by Barclay’s U.S. Aggregate Bond Index, has returned -3.45% year-to-date.

Mortgage rates jumped from a low of 3.59%, in May, to 4.58%, in June. Many fear the rise in rates may hinder a recovering, yet vulnerable, housing market.

Many also fear the removal of Fed stimulus may hinder a recovering, yet vulnerable, economy.


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