I set my alarm for 1:35 a.m. this morning to watch the total lunar eclipse. As a kid, my family used to take our sleeping bags out into the yard on our farm to lie in the grass and watch meteor showers, and the chilly overnight temperatures last night reminded me of those times. As the eclipse reached totality shortly after 2:00, my wife and I decided that we should wake up our boys to see if they were interested in viewing it. Our youngest son groggily rolled out of bed, walked to the window, turned around with a “meh,” and went back to the bed. Our oldest son at least walked outside to get a better look. His reaction was “that’s it?” They may not be budding astronomers yet, but I thought the show was amazing.
The following release was prepared by Michael Fleagle and Nicholas Viner on behalf of the 2014 Henry Fund research team. The team updates its economic outlook several times throughout each semester. This analysis forms the basis for class discussions, company selection, and investment research.
There is no significant change from our initial January economic outlook. Even after taking into consideration some of the weak economic reports in 2014, we feel there are no major data points to change our outlook consensus for expected GDP growth, inflation, or interest rate expectations. There have been surprises above and below consensus on data relating to housing, manufacturing, and employment; however, the surprises have been trending towards the negative. Taking into consideration the weather, these misses cannot be given too much weight nor are there enough data points to forecast a weakening economy. The Fed indicated that it did not perceive the small number of reports as requiring a change to the rate at which they are winding down asset purchases, coming down from $85 billion per month to zero by the end of 2014.
The one significant change to our forecasts is in the employment situation. The labor market shows continued strength, with non-farm payrolls coming in above the consensus (150,000) for February at 175,000. The team’s six month outlook for unemployment fell from 6.8% to 6.6%, with the February data showing an unemployment rate of 6.7% and near term employment trends that appear to be positive. Our two-year unemployment outlook declined from 6.5% to 6.2% and could trend towards 6%. Even with a significantly improved unemployment forecast, we are holding our forecasted treasury rates constant as the Fed has removed the 6.5% unemployment target from rate discussion. The Fed appears to be centering their rate decisions on inflation, and we can expect to see a change in rates as the CPI begins to climb.
Last Wednesday, the Henry Fund research team hosted a conference call with Doug Ramsey, CMT, CFA, Chief Investment Officer of the Leuthold Group. Leuthold is an independent, quantitative and contrarian institutional research firm based in Minneapolis. During our conversation, Doug provided a great technical and quantitative overview of the current equity market environment.
Interestingly, Doug was also an original member of the Henry Fund advisory board when the program began 20 years ago in the spring 1994 semester. It is great that even two decades later, Doug has continued to serve as a valuable resource for our students.
The following release was prepared by Jarom Dilworth and Adam Walter on behalf of the 2014 Henry Fund research team. The team updates its economic outlook several times throughout each semester. This analysis forms the basis for class discussions, company selection, and investment research.
We are cautiously optimistic regarding the state of the economy over our six-month and two-year forecasting periods, as equity markets transition from record setting levels in 2013. The U.S. economy experienced steady growth over the first, second, and third quarters of 2013 at 1.1%, 2.5%, and 4.1%, respectively. We predict slower growth in the fourth quarter of 2013 due to unusually cold winter weather nationwide and the high level of inventory buildup in Q3. Our six-month GDP growth target of 2.72% is driven by increases in capital investment and personal consumption expenditures.
We feel that many large-cap stocks reflect full valuation and represent a sector where it will be difficult to obtain alpha. Given the 32.39% return from the S&P 500 index in 2013 coupled with slower than expected revenue and profit growth, we expect difficulty finding good values in the equity market. Overall, our team feels that the S&P 500 will return 8.7% (excluding dividends) over a two-year holding period, significantly slower than 2013 and with more potential near-term downside volatility.
Despite the easy money policies of the Federal Reserve (“the Fed”), CPI inflation increased 1.5% over the prior year. However, with the Fed’s December and January announcements to reduce its monthly bond buying program $10 billion per month from $85 billion to $65 billion, we feel this reduction will inevitably create headwinds as U.S. and world markets adjust to a reduction in the unprecedented levels of liquidity. Our six-month CPI inflation target is 1.92% annualized.
Labor markets showed relatively positive trends as non-farm payrolls averaged 182,000 per month in 2013. December reported disappointing job growth of 74,000, which was below economist estimates of 197,000, but this looks like an outlier when taken considered with the positive ADP report. The unemployment rate maintained a downward trend throughout the year with a steady decline from a high last January of 7.9% to a low in December of 6.7%. As moderate growth continues into 2014, we believe this rate will remain relatively unchanged in the near-term with our consensus six-month unemployment rate forecast of 6.79%. Our two-year outlook estimates an unemployment rate of least 6.5% due to companies slowing investment in capital expenditures as interest rates rise.
As the Fed pulls back on its monthly asset purchases, they have committed to maintain historically low interest rates by setting the Federal Funds rate target at 0.0-0.25%. Although the Fed has expressed that this rate may increase with noticeable improvements in other areas of the economy, we believe this rate will remain unchanged for the next six months. As the Fed continues to pull various “levers” to manage monetary policy, we believe short-term treasury yields will modestly rise to 0.16% over the next six months, while long-term yields, as represented by the 10-year treasury bond, will rise to a target of 2.95%, up approximately 20 basis points from its current level. Additionally, without significant investment by the Fed, we believe that the 1-year T-bill rate will rise 25 basis points to 0.36% and the 10-year rate to rise 60 basis points to 3.44% over the next two years. Moreover, as inflation remains steadily low we expect the fed funds rate to remain at its historic lows in our two year projection.
With continued operational efficiencies in extracting and transporting oil from America’s abundant shale formations, U.S. crude oil production in 2013 surged more than 1.0 million barrels/day to its highest level in 24 years. This increase helped stabilize the price of West Texas Intermediate (WTI) crude oil which recorded a low of $92.02/barrel in April and a high of $106.57 in August. Revised IMF forecasts raised 2014 global GDP to 3.6%, driving our six month target for WTI crude oil to $102.60 per barrel. Driven by the geopolitical volatility in the Middle East, we expect oil prices to continue to rise and as global consumption increases we expect this demand to drive the price of oil to $109/barrel over the next two years.
We expect Japan to continue their current monetary policy, keeping the Yen at a low FX rate going to 102.92 JPY/USD over the next two years. With intra-year fluctuation, we expect the Euro to remain close to 1.36 USD/EUR over the same period.
I have been told that finance people tend to see the world a little differently.
This morning I read a news article stating that the price of first-class postage stamps was to increase from 46 cents to 49 cents this weekend. Although I use only about 10-15 stamps per year, my initial thought was that it is not often you come across a guaranteed one-day return of 6.5% in today’s market. (OK, technically first-class postage is increasing more than 6.52173%.)
My second reaction was to wonder whether it was possible to purchase 100,000 “Forever” stamps before Sunday. A little research showed that one could theoretically order large quantities of stamps online through the USPS.com website. However, the US Postal Service charges shipping and handling fees for online orders, not to mention the not-so-small problem of how to sell a large quantity of stamps without incurring substantial auction or shipping fees, which would of course both lower the expected profit margin.
Interestingly, the very first “Forever” stamp debuted on April 12, 2007 at a rate of 41 cents. If you had invested in these stamps at the time, their value would have increased 19.51% after this weekend. This works out to an average compound annual return of nearly 2.66% per year, which would have provided a better return in your portfolio than money market accounts or short-term U.S. Treasury Bills.
While I am not planning to pursue this investment strategy any further, I may still stop by the local post office this afternoon to pick up at least one book of stamps. That would save me 60 cents and probably last until mid-2015.
This morning, the Tippie College hosted a presentation and discussion with Charles Evans, President of the Federal Reserve Bank of Chicago. Mr. Evans spoke on a variety of subjects including the current state of the economy, his outlook for 2014 economic growth, the Federal Reserve’s quantitative easing (QE) policies, the unemployment rate, economic philosophy, and how Fed policy may shift moving forward. It was a great opportunity for members of the Finance Department faculty and graduate students (including members of the Henry Fund research team) to interact with someone who holds a prominent role in shaping U.S. economic policy.
The Henry Fund and Krause Fund portfolios finished 2013 with solid performance numbers, as domestic equities experienced strong market returns. The benchmark S&P 500 index increased 32.39% for the year ending December 31, 2013 period.
During 2013 the Henry Fund portfolio increased in value by more than $713,000 and also distributed over $113,000 to support scholarships and educational programs.
After uploading my post-run photo the other day, even colder temperatures to hit the Iowa City area. So, I’m going to post an even better picture taken after my run yesterday morning, when the temperature was -14 degrees (F) and the wind chill was report as -38 degrees. The icicles that formed on my eyelashes actually made for a nice pair of sunglasses. While I did receive some strange looks from passing motorists, I was actually very comfortable during my workout since I was wearing nearly 8 lbs. of clothing layers.
The side effects of running 5 miles when the base temperature this morning was -12 degrees.