April 29, 2013
In a recent interview, Andy Brooks, Head of U.S. Equity Trading and T. Rowe Price Chief Economist Alan Levenson discuss the state of the U.S. economy and the financial markets.
The first quarter of this year was just terrific. Investors that have stayed the course were really well rewarded. We had essentially a +10% quarter—and that's tough to annualize, but that's a heck of a start—and really, very positive momentum in the markets. Corporate earnings are a little bit better. The economy is a little bit better. Unemployment has gotten a little bit better. Balance sheets are probably a lot better, and consumer behavior seems to be improving. The housing market has gotten better, and all of those things, I think, have allowed investors to feel more positive about the environment. You saw it in equity prices, especially in the U.S. Stocks were very strong in the U.S. In Europe, a little bit of a mixed bag. Japan, very strong. China was down for the quarter. But, by and large, investors in the U.S. were very well rewarded for equity exposure.
Well, I think investors, broadly, are frustrated by Washington. And the country at large, their patience is being tried here, as Washington continues to kick the can down the road, or not make the tough decisions, or not focus on entitlement programs and other structural issues.
But trying to keep it focused on the markets, it does cause anxiety, and it becomes high anxiety when it looks like Washington refuses to deal with our issues. So the sequestration, if you will, might not be exactly what everybody wanted, but you were not given a choice, and it was probably intended that way. If you can't properly prioritize, then you're going to get stuck with this. It might not be what you want, but it's what you're going to get.
I do think it's going to be incredibly important, over time, for the markets to be comfortable with the knowledge that Washington will get it right at some point. It's never as fast as we want it, it's never exactly what we want, but I think at least it's kind of an American ideal. Generally, we make the right decisions. Generally, we get there. Generally, we do the right thing, and the markets need to know that, because that's key. All the easing that the Federal Reserve has done, and all the priming of the pump and the liquidity that's been put into the markets—you know, interest rates are essentially at zero, for gosh sakes, and that has a wonderful benefit for everybody's balance sheets—but at some point we've got to put that in reverse, and the government is going to need to reassert some discipline. Hopefully, they can do that in a measured way that's carefully constructed and reasonable. And if they can do that, I think this market has a long way to go on the upside, frankly. That would be very bullish, in my opinion.
You know, the international markets continue to be challenging as well, and a lot of sovereign debt issues have bubbled up, and the first quarter was no exception. Cyprus was on the front page for a number of weeks, and you just never know where these things are going to get exposed. The Asian markets were challenging, China had a tough quarter. Japan, on the other side, a terrific quarter. Lots of challenges abroad, though. But I think, just like the U.S., the O.U.S. regions, the outside the United States regions, particularly in Europe, they will deal with their issues, and they might not deal with them as effectively or as quickly as people want, but they'll get to it. I'm sort of a believer in the glass is half full, and decisions will get made, and choices will be made, and things will improve.
Again, so often improvement is sort of in the eye of the beholder. It never comes as fast as some people want. It comes too fast for others. So it's that give and take, if you will, that really makes markets. But there was some volatility in the O.U.S. markets, and I think we can continue to expect volatility, and that's why it's important to be a very thoughtful, careful, long-term investor.
I think the pursuit of value and sort of the pursuit of investment return, if you will, it's an everyday job, and you're always analyzing stocks and markets and sectors of the economy, looking for opportunities that are misunderstood. Value investors, that's what they do. They sort of play excess. They play what's expected or what seems to be so certain, and they perhaps lean into that and try and take the other side. Good investors are always trying to identify good companies that are out of favor that won't stay out of favor, and that's what our team, globally, spends a lot of time trying to do.
I think it's hard for all of us, but you maintain a commitment to stocks and to a balanced portfolio, and to asset allocation. We used to have a fellow here that retired. He was a terrific investor and he used to say, "Today is the hardest day to invest." So you can always come up with reasons why, "Oh, I can't invest today. I've got to wait until next week, when things are better." The reality is, next week, as in last year, as a metaphor, last year the market was up 17%, and money markets paid zero. So if you were waiting for a better time, boy, you missed the train. The bus left the station. Not so good. This first quarter, terrific numbers. So I think it's another example that you have to stay in the markets, and good investors figure out ways to rebalance and to play excess again, so that if you've been in the markets the last five quarters and you're up significantly, you're saying, "Gee, this feels a little frothy. I might take a little off the table and then rebalance." So that's a good exercise to go through, but I think all of us would probably be better served if we didn't look at our portfolios every day. Try and take a longer-term view and be thoughtful about your asset allocation. But I think it's really hard to be all in or all out. I don't know who can do that well, but not too many people. So that, I think, is a challenging approach to try and figure out when exactly is the right time to be 100% in an asset class or 100% out of an asset class.
You know, I think when we have a first quarter like we've had, we need to expect that we might back and fill for a while and the markets could retrace. You might remember last year, the market had a very strong start, and it gave up most of that in, as I recall, the April/May/June time frame, so people got anxious. But yet, by the time the year was over, we were back up [to a] 17% total return in the S&P 500, as a benchmark. So I think the landscape suggests there is a strong possibility that we will be higher year-end than we are today. A lot of things are going well. Valuations are reasonable. Corporate earnings seem to be on track. Balance sheets are improving. The Federal Reserve has a steady hand on the tiller, and they've said they're going to keep rates low for a long time. In that environment, boy, that's a great time to be an investor, and that's a great time to buy a house. That's a great time to expand your business and to hire people, because money is cheap. Now, you need to be judicious and careful and responsible, of course, in borrowing, but, boy, this is a great environment to do a lot of things, and it's a good environment for companies to do things. So I think there's a strong probability that the markets will end the year better. Outside the U.S., probably more volatility than our markets, probably more uncertainty, but that also suggests there might be more opportunity. So I think if there are some markets that have been good in the past but have been particularly weak, they are probably worth a look. I have really no view on China growth, but the Chinese market has given up a lot recently, so maybe it's time to revisit that. I think European markets provide some opportunities as well, and I think careful investors need to have international exposure. With anything, be thoughtful about it and try and lean into it when others are leaning out.
I'd characterize the growth in the first quarter of 2013 as solid. Not only did we have good advance in consumer spending of about 3%, but overall, GDP [gross domestic product] will be about 3.5%. It was a pretty broad-based increase. That first-quarter growth rate did contain some surprises, and the biggest of those was the strength of consumer spending, in light of the tax increases that we had at the beginning of the year: the payroll tax increase and the increases in tax rates for upper-income individuals. Yes, in a sense, that strength in the first quarter borrows from the second quarter. Consumers were lauded for having been resilient in the tax hikes, but the way they did it was by dipping into savings. The saving rate went from 4.7% in the fourth quarter to 2.3% in the first quarter, or 2.4%. That's the lowest saving rate since 2007, before we started rebuilding our balance sheets. So looking into the middle of this year, that savings is going to have to be rebuilt. So now spending is going to have to grow slower than income, and I'm expecting that consumer spending will slow from around 3% in the first quarter to something below 2% in the middle two quarters of the year.
The housing outlook has been improving for two reasons. The first is that we see housing starts, just the new construction, rising more rapidly at the end of last year, and that's a direct contribution to growth, just because we're building more apartment buildings and more houses. But we're also seeing the recovery broadening in two senses. The first is that now, in order to keep building more houses, we've got to start adding people to construction payrolls, building supply stores, and the like are hiring more workers. And so I think we'll get maybe 300,000 or so jobs from those housing-related sectors this year. And finally—and maybe more prominently—is that house prices began to rise last year. Now, admittedly, it was from a very low level at the beginning of last year, but we're not at a year-to-year gain of almost 10%, and houses are still undervalued relative to their long-term trends, so we could see another 5% or 10% gain this year, and that helps build wealth for homeowners. It's not that we can run out and take out a home equity loan because credit standards are tight, but it does mean that close to 2 million people who owed more than their house was worth last year now have a house that's worth more than they owe.
Well, they're going up in no time soon. You look at the federal funds rate, the base rate that the Fed charges is 0 to 25 basis points, zero to one-quarter of a percentage point, and they have indicated that they are going to keep it there, at least until the unemployment rate gets to 6.5%, which they don't expect until the middle of 2015, and that's not an unreasonable timing. Maybe it's a little sooner; maybe it's a little later. So we know that they're going to raise that rate over time to something like 4%, but that's way in the future. For the longer-term rates, the Fed has been keeping their thumb on the scale by buying $85 billion in long-term securities per month since September. They're going to start to wind down those purchases as the labor market improves, and it has improved some. I think they'll start that process in the second half of this year and end those purchases late this year, early next year, so that we'll start to see some lived-for long-term rates by the end of this year.
Well, we're now going through a repeat of the last two years, where, over the turn of the year, we get strength in the labor market. The three months through February averaged 200,000 jobs a month. Then, in March, we get a surprisingly weak 88,000 increase. Now, you can look at March and February together, and February was 270,000 jobs, almost, and say, well, that's pretty good, 170,000 jobs in the two months, but we're in for a spell of somewhat slower job growth than we've seen. But we're still creating 1.5 million or 1.75 million jobs a year, gradually absorbing the ranks of the unemployed.
With our fiscal cliff deal at the end of the year, we limited the tax increases that went through, but we ultimately did not stop the spending sequester from taking effect. We pushed it out two months, but it took effect in March. Over the balance of the year, we'll cut spending in the federal government by about $65 billion, or taking about half a percentage point off of GDP. We haven't seen much of that impact so far, because it rolls in very slowly. For example, even though the sequester took effect on March 1, it's only in the first week of April that the Defense Department rolled out their plan for furloughing their 800,000 civilian employees, and those furloughs will be, I think, 14 days of unpaid leave per employee over the course of the rest of the year, so that will be very slow to take effect. Again, to say that it's the all-clear, that the government is learning to do more with less, doesn't make a lot of sense, because even if most of that spending is going to be wages of government workers and that services will continue to be provided, for the most part, that's still less income going into the economy. There are ways that the impact of the sequester can be softened because, now, it's almost to the effect that if I have to a 10% across-the-board cut in my own spending at home, I have to cut my clothing budget by 10%, and I have to cut my mortgage payment by 10%. I can't cut my mortgage payment by 10%. The Congress and the administration made a deal on a continuing resolution that funds the government for the rest of this fiscal year, that gave the agencies a little more discretion about how to meet these spending cuts, so they can cut the things that are sort of easily done without and not cut core things. So that reduces the impact on people, and that's to the good. The other possibility is that the President, in his budget that he proposed to Congress, proposes a package of spending cuts and tax increases that would replace the sequester. Now, the particular budget probably doesn't go too far in Congress, because it's got more tax increases than they want, but if we were to be able to have a compromise on a budget plan before the fiscal year starts—and that's a rare event—the sequester could be replaced with other measures to reduce the deficit. But I don't give that a great probability.
In terms of the outlook for this year there's not a great probability that we're going to get the perfect fiscal policy out of Washington, but I think the chances of a mistake at this point are much lower because we've already dealt with the fiscal cliff and the sequester. We're still alive, we pushed off a lot of the tax increases, and the private sector can go on healing and resuming growth. So if you've got the government doing less harm, that nets out to a pick-up in growth from 2% this year to 3% next year. I'll take it. A year ago we were looking at an outlook for 2% or 2.5% growth. It came in weaker than that, but the bigger point was that we were fearful about the debt ceiling here, we were fearful about the euro area breaking up, we were worried about a hard landing in China. We're now past the debt ceiling—again, with much less scope for policy mistakes here—we've taken action in Europe that reduces those tail risks in Europe, and China was able to shift to a lower rate of growth without having a hard landing. So there's a lot less risk in the background as the economy slowly heals and gains momentum.
The views are as of April 9, 2013, and may have changed since that time. This information is provided for informational purposes only and is not intended to reflect a current or past recommendation or investment advice of any kind. Opinions and commentary do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.
Stocks and sectors may not perform in line with the managers' expectations.