Wednesday, January 15, 2014

Economic Indicators That Really Matter

The “talking heads” on the financial news networks broadcast a seemingly never-ending stream of numbers and discuss the implications of those numbers on the investment market. While we at Paragon Financial Advisors do not presume to be economists, there are some numbers which definitely warrant following. Some of the major ones follow:

Gross Domestic Product (GDP)

The gross domestic product of the United States is a measure of its economic activity. For the mathematically inclined: GDP=C+I+G+NX (or Consumption + business Investment + Government + Net eXports). Consumer spending accounts for approximately two-thirds of GDP. Some of the categories here include durable goods (autos, furniture, etc.); non-durable goods (food, clothing, etc.); and services (approximately 45% of GDP). Investments (excluding real estate) in business equipment and furniture account for approximately 18% of GDP. Third quarter 2013 GDP showed an annualized rate of about 4%; however, estimates for 2013 in total are in the 2% range. Estimates for 2014 are in the 2-2.5% range. The bottom line at this point in time is spending is up but at a lower rate than recoveries from previous recessions; non-durable goods spending is weak but improving.

Unemployment

Employment is down approximately 8 million people in the recession and about 3.5 million jobs below pre-recession levels. The most commonly quoted “unemployment rate” is the U3 rate—the current number of unemployed divided by the civilian labor force (currently 7%). There has been much discussion about this number. The “unemployed” in the numerator is affected by people dropping out of the job search and “part time” employees. Therefore, other employment data warrants consideration. The U6 rate captures these discouraged and part time workers—it is approximately 14%. Another consideration is the extended unemployment figure (unemployed persons for greater than 27 weeks). There are approximately 4 million such persons (about 3 million greater than prior recessions). One of the most significant numbers (in our opinion) is the civilian participation rate. That ratio is the number of people in the labor force divided by the working age civilian population (currently 63% and at levels not seen since the mid-1970s). From a societal standpoint, there are significant differences in unemployment rates; the unemployment rate for high school graduates over the age of 25 (with no college) is approximately 15%.

Interest Rates

Quantitative Easing (I, II, Operation Twist, and III) has increased the nation’s balance sheet by approximately $4 trillion with the first sign of tapering just appearing in December. The large scale asset purchase plan is still buying $75 billion in Treasury and mortgage backed securities per month. In addition, the second part of the interest rate plan (the zero interest rate policy) of 0 to 0.25% on feds funds appears to be in place until the 2016 or 2017 time frame. The fed funds rate in the ’81-’82 recession was 18%; in the ’74-’75 recession it was 12.5%. In spite of the excess liquidity coming into the system, inflation (see below) has been below Federal Reserve target levels. The money multiplier has dropped significantly as the reserve required for banks has been increased by banking regulators.

Exchange Rates

The rate of exchange of the US dollar vs. other major currencies is much lower than previous recessions; this rate has a direct impact on the net exports included in GDP.

Inflation

Inflation, as measured by the personal consumption expenditures (PCE) price index, is currently below 2% (the Federal Reserve desired level). The current rate (excluding food and energy) is approximately 1.5%. The PCE rises less than the Consumer Price Index (CPI); however, the CPI does not take into account “substitution” (where consumers have substituted goods whose prices are stable for those goods whose prices are rising). Lower inflation raises the prospect of deflation—a much harder problem to manage. Just ask the Japanese over the last two decades.

So what does all of this mean for the investor? Weak GDP growth, high unemployment rates, low interest rates, low foreign exchange rates, and low inflation lead to modest expectations for 2014 (as the Fed keeps QE and ZIRP in play). Pension benefit obligations of $7.5 trillion on federal government retirees and approximately $21.6 trillion in unfunded Social Security benefits are not included in our current $17 trillion national debt. These unfunded obligations, and the declining number of workers per retiree (from 9:1 to 3:1), imply that there will be significant changes in the future.  What are those changes? Ah, remember the old curse—“May you live in interesting times.”

If you have unanswered questions or need additional guidance please call us. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management services for clients.


There was an error in this gadget