Searching for Weakness



By Mark Schniepp
April 15, 2015

Peak of the Cycle?                                    

We are at or near the peak of the economic cycle. That’s my opinion.  We could also be in for a longer period of expansion than normal, because the sluggish period of recovery during this economic cycle was much longer than expected.  If so, then my thoughts about the peak could either be premature or the peak could evolve into a longer running plateau of economic growth.

Expansions generally end when the economy overheats, occurring when the labor market is at full employment and businesses are operating beyond their capacity. Inflation begins to rise along with interest rates, and consumers tend to overspend and become debt laden.

inflation

We are not there yet.  The labor markets are not yet at full employment, though that condition is rapidly approaching.  For anyone over 25 years old, the unemployment rate is effectively “full.”  And this will translate into rising wages and salaries this year and a higher rate of inflation in 2016.

unemployment

We are expecting the Federal Reserve to begin raising the federal funds rate this summer, as early as June.  Treasury rates are expected to move higher along with mortgage rates by the fourth quarter. The 30 year conventional mortgage yield is forecast to push past 5 percent next year.

Looking for Weakness                                        

The economy is now in its best condition since the end of the Great Recession. Consequently, we are gradually turning our attention from how strong the current economic expansion will be to a search for any weaknesses, i.e., potential excesses in household spending and debt, financial lending practices, or over extended asset prices.

Household debt is currently at the lowest level since reliable records have been kept. The amount of credit card debt fell to the lowest level since 2002. This is one of the key reasons that the U.S. economy is outperforming much of Europe and Japan.  Corporate debt as a percentage of total corporate equity is also at a 12 year low.

household debt

Household debt is the sum of mortgage debt plus consumer debt including credit card, auto, and student loan payments. Currently, household debt as a percent of disposable income is at its lowest level in more than 35 years

In general, households and businesses are in better financial shape to spend this year and next.  Banks are in a better position to lend.  These conditions in concert, along with likely increases in wages and salaries, point to a predicted 3 percent increase in total spending this year, a meaningful improvement over 2013 and 2014.

Asset Prices: The Stock Market 

Another bubble Building?                                              

The stock market run has been fairly sharp since the beginning of 2013. And to date in 2015, the financial markets continue to move higher. Adjusted for inflation, the S&P 500 is currently at its highest level ever. The Nasdaq reached a near all time record close on March 20, and the Dow Jones Industrial Average is just 300 points from it’s all time record high set on March 2, 2015.

As of April 7, the S&P 500 P/E ratio stood at 20.29.  This is the twelve month trailing price to earnings version of the ratio. The average P/E ratio for companies comprising the index since 1979 is 20.6. The Dow Industrial Average P/E ratio is 16.33, just slightly above the year-ago level. The obvious question is whether current P/E ratios are worrisome, indicative of another bubble?  There is no shortage of current online debate on this subject, which can get quite complex.

price to earnings

The stock market numbers are worth following closely to ascertain the degree of speculative behavior that might be infiltrating current values.  But it’s not an immediate concern because expected earnings reports for the first quarter of 2015 appear to be strong.

No Leaks in the Dike                                

Interest rates remain low, gasoline prices are falling again, and the dollar continues to strengthen.  The economy is stable and growth rates for most of the important indicators may reach their best levels this year.  We’re looking for initial problems, but we don’t see many at this time.  So enjoy the spring.

Good News for the Economy



Good News for the Economy

Written by Gary Wartik

Notwithstanding the current action, or inaction of the US House of Representatives with respect to funding the federal government, there is continuing good news in the American economy on another front.  Time will take care of the budget issues, perhaps with a bit of political blood on the floor before it is all over, but hopefully without substantial delay.

So, what is the good news?  It is no secret that America is becoming energy sufficient.  While a large part of the world’s oil and gas reserves are in “bad neighborhoods,” such as Iran and Venezuela, and in the unstable Middle East, the value and volume of recoverable oil and natural gas continues to grow in the United States as well as in Australia, Brazil, Canada and Mexico.

Shale gas in particular has made headlines as new gas fields have opened up in Arkansas, California, Louisiana, North Dakota, Oklahoma, Pennsylvania and Texas.  These fields have contributed to nearly a 90 percent decrease in the wholesale cost of natural gas as gas production has increased 20 percent during the last four years.  Annual production increases of 5.3 percent are projected by the industry through the year 2030.  As a result, heating homes and industry, and generating electricity will continue to cost less, saving Americans billions of dollars in annual energy costs.

Hunting for oil is known to be very costly, and often consumes huge volumes of energy.  While conventional oil extraction continues in coastal waters off the United States, Norway, Great Britain, Vietnam and Brazil in particular, it is oil extracted from shale rock, employing new technology that is allowing for extraction of oil thought unrecoverable less than ten years ago. With world oil selling for around $103 per barrel on October 1, extracting new oil with new technologies has become cost effective.

The oil boom in the seven states mentioned has contributed to a notable decrease in the amount of oil imported by the US. According to The Economist, new recovery methods have accounted for $238 billion in economic activity since 2009, with 1.7 million new jobs created and $62 billion in new taxes generated by state and local governments.  The benefits of cheaper natural gas and oil are noteworthy, with one estimate cited by The Economist as valued at $342 billion in projected new economic activity in the period 2015-2020 that will include generation of another 1.2 million new jobs.

One of benefits of this change in America’s expanded “Oil Patch” is that new oil should contribute to stabilizing domestic and foreign oil markets, keeping the cost of energy in check.  That scenario should contribute to lower costs to do business in the US, particularly in the manufacturing sector that hopefully will contribute to retaining and also growing the US manufacturing sector.  Absent this change, more factories would likely close with jobs exported abroad.

The second benefit is political.  America will be less vulnerable to political pressure by those who would employ tactics similar to OPEC’s 1973 and 1979 oil embargoes.  The country will also be much less impacted by prospective disruptions in the flow of oil from the Middle East during whatever crisis may be around the corner.

The current financial crisis manufactured in Congress related to funding the government will eventually be resolved.  The future of oil and gas exploration in the US is long-term, and will literally brighten America’s economic and political future.  Something to celebrate for sure.