The last three months of 2014 have brought us some very good financial news. Here are the highlights of 4Q 2014 – together with potential upsides and downsides for 2015:
Interest Rates and Stocks. Notwithstanding the voices of doom and gloom predicting that interest rates would spike when the Federal Reserve tapered its Quantitative Easing (“QE”) program[1] beginning at the end of 2013, it didn’t happen. QE finally ended in October 2014, and interest rates have actually continued to drop a bit. [See Bankrate table here.] This has been very good news for homebuyers, car buyers, and purchasers of other capital goods, such as equipment and machinery.
The conventional wisdom is that the Fed will not begin increasing rates until mid-year 2015 – and then it will be gradual. The question is, how will the market react? The American people have become spoiled in their low interest rate expectations. Even though they know the easy money policies will end in a few months, can we expect the markets to remain rationale?
Back on May 22, 2013, then-Fed Chair Ben Bernanke, made a poorly worded statement suggesting that interest rates might begin increasing sooner than most expected. Within 24 hours, interest rates had spiked and the stock market dropped over 200 points. So much for being prepared….
For fixed income retirees, higher interest rates are not a bad thing, as it helps stretch out their savings. But for homebuyers, even a small increase can mean the difference between an affordable mortgage and none at all. In a September 2014 New York Times article here, it was reported:
According to Zillow, a 1 percent rise in interest rates could raise monthly mortgage payments on a typical home next year by more than $700 in pricier parts of the country. Zillow compared the effect of a rate increase to 5.1 percent from 4.1 percent for a 30-year mortgage in 35 metropolitan areas. Figuring in the expected increases in home values over the next year, Zillow found that monthly payments would rise by as little as $65 in the St. Louis area and as much as $710 in the San Jose/Silicon Valley region.
When QE started pushing down interest rates, investors rushed into the stock market to increase their returns. Since then, the equities markets have been on steroids. What will happen in 2015 is a matter of conjecture. Will it increase, decrease, or remain the same? There are very smart people on all sides of that debate.
Unemployment. The Wall Street Journal reported here that the December 5, 2014 jobs report issued by the Bureau of Labor Statistics (“BLS”) showed that “…U.S. employers added 321,000 jobs last month—the best monthly gain in almost three years–while the unemployment rate held steady at 5.8%….”
However, the 5.8% figure can be misleading, for what it doesn’t reveal. The Bureau of Labor Statistics actually breaks out unemployment figures into six categories, known as the “U-6.” The “official unemployment rate,” i.e. the one the White House focuses on, does not include those “marginally attached to the labor force,” “discouraged workers,” or those “employed part time for economic reasons.” The BLS defines these additional three categories as follows:
- Marginally attached. Those who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the past 12 months.
- Discouraged workers. A subset of the marginally attached, they have given a job-market related reason for not currently looking for work.
- Part-Time Employed. Persons employed part time for economic reasons are those who want and are available for full-time work but have had to settle for a part-time schedule.
When the above three categories are added to the official unemployment rate of 5.8%, it skyrockets to 11.4%. And none of these numbers reflect those “underemployed,” i.e. those withh full-time employment whose skills, education, and/or experience qualifies them for higher paying, but unavailable, jobs.
So for 2015 to be a truly successful year, good full time jobs must be created to bring workers back into the market, and reduce the real unemployment rate.
Oil Prices. As virtually everyone who drives a car knows [with the possible exception of Tesla owners], the oil market has tanked…pardon the pun. This is due in large part to the oil glut resulting from the fracking revolution going on in the U.S.[2] Prices at the pump and for home heating oil have plummeted. This has translated into increased consumer spending – all good news to everyone but Iran, OPEC, Venezuela, and Mr. Putin.
Lower oil prices have directly benefitted consumers in the pocketbook, freeing up money for other uses. The effect, of course, ripples into the retail market, and is good for business. Auto dealers, especially those selling SUVs, have seen an uptick in sales. It’s all good news for the broader economy.
According to the newrepublic.com, here:
AAA estimates that the average consumer is saving $100 a month on gasoline (Goldman Sachs puts the total savings at $75 billion over the past six months), and this has already led to surging retail sales. Lower-income households devote a greater proportion of their incomes to energy, and we can expect them to turn around and spend the extra cash. With consumer spending making up two-thirds of the economy, this results in a nice bump to gross domestic product.
However, in energy states, such as North Dakota, where high employment is tied to high production, there is more of a wait and see attitude. The Wall Street Journal recently reported that:
However, cheap oil now creates economic pressure in energy-producing regions of the U.S. that have experienced job booms in recent years. Analysts expect drilled wells to continue working. But, they say, low prices could lead producers in states like North Dakota to drill fewer wells, and U.S. oil production could fall.
Some analysts believe prices below $50 a barrel would halt shale production. The market has been very close to this for a few weeks, said Sarah Hunter, an economist with Oxford Economics, a forecasting and consulting firm, but she and others expect prices to stabilize at current levels before gradually rising.
Consumers should enjoy it while they can. Cheap gas will last only as long as crude prices stay down.
The U.S. Dollar. On October 30, 2014, the Commerce Department reported a 3.5% growth in GDP for 3Q 2014. As reported by Bloomberg here:
Gross domestic product grew at a 3.5 percent annualized rate in the three months ended September after a 4.6 percent gain in the second quarter, Commerce Department figures showed today in Washington. It marked the strongest back-to-back readings since the last six months of 2003. [Underscore mine.]
According to the LA Times, the dollar just hit a nine year high. While that enables us to buy imports more cheaply, it makes exports more expensive, as it costs other countries more to purchase our goods. This directly affects U.S. manufacturing, employment and GDP. Investopedia defines GDP as follows:
The gross domestic product (“GDP”) is one the primary indicators used to gauge the health of a country’s economy. It represents the total dollar value of all goods and services produced over a specific time period – you can think of it as the size of the economy.
To some, the dollar’s strength is a good thing, as it is a reflection of international confidence in our country. However, a strong dollar could put a damper on GDP in 2015, and that’s a bad thing. The reason is that it makes our exportable manufactured goods more costly for other countries; it also negatively impacts foreign tourism, making food and lodging more expensive to visitors. The New York Post reports that the strong U.S. dollar could cost the city $30 billion in revenues. [Conversely, this encourages Americans to vacation abroad, as their dollars have a greater purchasing power – which is good for the host country.]
Conclusion. It is likely that notwithstanding the apparent good news closing out 2014, the policymakers at the Fed still believe we have a very fragile economy and do not want to move too fast in raising interest rates.
For example, even though interest rates remain at historically low levels, sales of pre-owned homes were better in 2013 than 2014 by approximately 1.7% according to Forbes magazine, using statistics provided by the National Association of REALTORS®. And despite predictions and reports to the contrary, in some parts of the country – including Oregon – there is still a glut of foreclosures, displacing families, and keeping available housing off the market for resale.[3]
A recent statement by former Fed Chair Alan Greenspan [who has had to eat some very sizeable portions of crow for admittedly failing to heed the early warning signs of the impending collapse of the financial real estate and markets in 2007-2008] puts a fine point on the continuing problems with the country’s economy today. According to a December 31 report on bloomberg.com here:
Greenspan said the economy won’t fully recover until American companies invest more in productive assets and the housing market bounces back. [Underscore mine.]
“Almost all of the weakness in the last four, five, six years has been in long-lived investments” in capital goods and real estate, Greenspan said. “Until these pick up, we’re not going to get the kind of vibrant growth that everyone is hoping for.” [Underscore mine.]
Mr. Greenspan is correct – this time. We’re not out of the woods yet. ~PCQ
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[1]QE is a process whereby the Fed purchases large quantities of long-term securities held by big banks. The Fed prints money to make these asset purchases. By reducing the supply of these securities for other investors, the price goes up. When the price of the bonds goes up, their yield goes down. This means that for large companies and municipalities who depend upon the sale of bonds for the financing of projects, their borrowing costs go down. Since mortgage interest rates track the long term T-Bill rates, as QE keeps these rates low, it also keeps mortgage interest rates low. The goal of QE was to keep long term interest rates low and release more money into the marketplace, thereby increasing economic activity for households and businesses. The Federal Reserve first began QE shortly after the credit markets crashed following the Bear Stearns collapse and the Lehman bankruptcy in the fall of 2008. QE2 occurred in 2010; QE3 was initiated in 2011. In its third iteration, QE3, the Fed was buying $45 billion in treasury bills (“T-Bills”) and $40 billion of mortgage-backed securities a month. When interest rates went down – which they did – the hope was that the construction and housing industries would rebound, businesses would increase capital investment, employment would increase, and household balance sheets would improve. The Fed’s mantra at the time was that QE and low interest rates would continue until unemployment, which exceeded 10% at the time, came down to seven percent. However, after three shots at QE, there is no broad consensus that it worked.
[2] How long this will continue is a matter of some debate, however.
[3] Foreclosures actually increased in 2014 over 2013.
