Column: Economic Musings
With prospects unclear for when a rebound in consumer activity may materialize, corporations are working hard to recalibrate their future plans while strengthening their balance sheets through tighter cash management and de-leveraging. Until such time as the stimulus efforts of the U. S. Treasury bear fruit, such financially conservative behavior is warranted and can be expected to continue.
Some indicators are starting to suggest stabilization in world trade. For example, the rates for overseas shipping (as measured by the bellwether Baltic Dry Index) have begun to rebound as energy prices have held recent lows. Tight credit conditions are also easing up slightly. All these indicators require close monitoring to see if the rebound can be sustained.
The U.S. and European banking systems have now for the most part been stabilized. The rest of the world, i.e., Asia, Africa, etc., have also made efforts and look at this point to be successful in stabilizations. This is the first step and now bank loans need to be more readily available.
The new Treasury initiative announced by Secretary Geithner hopefully will accomplish much of this for the U.S. through his combination of private sales of toxic debt, underwriting of bank assets and encouragement of bank lending. Other central banks in the world may follow.
Later this year, as corporate earnings continue to decline, some loans which now appear sound or marginal will have difficulties, particularly in areas such as mortgage loans, auto loans, credit card loans, etc.
The dollar may have stabilized recently after rising against the Euro and the Pound, perhaps reflecting confidence in the new administration.
Crude oil has ranged in recent months between $33 and $50 a barrel and is now at approximately $40. We believe the correction, from the $147 level of June, is now largely behind us.
Currently, the continuing declining demand for crude is being met in part by OPEC with two production cuts and a third one being talked about. These cuts appear to have been moderately successful, but will not fully be felt until closer to mid-year. In addition, OPEC countries have delayed more than thirty drilling projects as have nations and oil companies in other parts of the world. Additional capacity in the Canadian Tar Sands has also been put on hold and wind and solar projects are increasingly being put on hold owing to the low competitive price of crude. It seems reasonable to expect a balance to be reached by mid-year and for the oil price to advance beyond that point.
Investors continue to seek safety by focusing on U.S. government-sponsored issues. Despite the looming debt issues and associated monetary expansion, we expect Treasury yields to remain relatively low this year until such point as employment numbers improve. Agency bonds offer better value than U.S. Treasuries on a yield basis. Corporate debt, when carefully selected for quality, should gradually be accumulated.
We continue to look favorably upon state, county and municipal tax-exempt bonds as the yields are attractive on a relative and historic basis. Investment-grade credits, even during the depression, experienced a low default rate, below 2.5% on average. Most defaults were in lower, non-investment grade special assessment districts and special-purpose issues. Within a few years, each default was made complete with no reduction of principal. The structure of the municipal market has changed dramatically since then, but general obligation bonds remain as the first draw on taxpayer funds.
The market continues to digest the recent poor economic data in a resilient way. After making a deep low at about 7550 in November, the Dow Jones Industrial Average has worked its way back to 8000 while market volatility has fallen by almost half as measured by the CBOE Volatility Index.
There are now many high quality companies, with strong balance sheets and cash flows, whose shares offer values not seen in many years. In the months ahead, we look for these shares to lead any rebound.
A well-grounded and thoughtful Catholic, Los Angeles-based founder and CEO of Chelsea Management Company, Mr. Fred Ruopp, Sr., is ranked by Kiplinger's as one of the... MORE »