Economic Musings: October 2010

by Fred Ruopp

The U. S. economy lost some momentum this summer, but nearly all indicators continue to point towards a slow but positive recovery. Although manufactured goods orders fell 0.5% in September, this number was skewed by the always volatile transportation equipment sector (which dropped by over 10%). Orders for electric equipment, machinery and computers all rose. Excluding airplanes, non-defense capital goods orders rose by 5.1%.

[caption id="" align="alignright" width="250" caption="Economic book recommended by Fred Ruopp"][/caption]

The Institute for Supply Management’s (ISM) September reading for the

manufacturing sector dropped slightly to 54.4 from 56.3, but it is important to remember that any reading above 50 means the sector is growing. Wh

ile these growth figures do not evidence the kind of growth needed to significantly bring down the U. S. unemployment rate, it also does not suggest a double dip ahead.

With the Federal Reserve poised to ease monetary policy further if required, the probability of a double dip remains remote.

INTERNATIONAL

The BRIC nations (Brazil, Russia, India, China) continue to lead the world in economic recovery. Other emerging nations particularly in Southeast Asia are also doing well. China’s 11% GDP growth rate for this quarter was surprisingly strong and leaves China as the world’s second largest economy after the U.S.

Risks to China’s growth continue, including a substantial stimulus program with buildings and infrastructure which may never be used. Also, substantial inflation in real estate is part of the credit bubble in China. While China could take a tumble, her longer term outlook continues strong. When the U.S. experienced its strongest industrial growth rate in the late 19th Century, there were a series of sharp recessions and each time without Central Bank assistance, the economy came to its feet and forged on to new highs. Given China’s low GDP base per capita and highly organized political and industrial structure, something similar may be in the cards.

The weaker countries in Europe including Greece and Spain, despite internal resistance from labor unions in the form of strikes and riots, continue with tough spending reduction programs. These countries are not having a problem in floating new bonds which indicates a certain level of comfort on the part of outside investors. Germany, Scandinavia and other parts of Europe are experiencing strong growth and are pulling the EU along on its growth path.

ENERGY - GOLD

Crude oil trading in the low $80 range reflects slightly lower inventories but more especially a general opinion that the global recovery will continue and that demand will continue to press on supply.

China has been scouring the world looking for oil and natural gas properties and has reached an agreement to purchase a 1/3 interest in Chesapeake Energy’s South Texas shale gas fields. This will also give China access to shale technology for use elsewhere in the world. China’s growth will continue to fuel attempts to buy resources around the world.

While the BP deepwater well has been capped and much of the crude oil spill has disappeared, U.S. authorities have made the drilling process even for shallow wells in the Gulf more uncertain and time consuming.

Gold, along with other commodities such as grains and metals, continues to advance. Gold is in a peculiar position as not only is it a commodity but it has been a form of money for thousands of years. In times of uncertainty and fear, as people come to doubt paper currencies and credit systems to some degree, gold is bought by individuals and institutions to serve as an insurance policy. This trend is strongly in being and will likely not end for some time yet.

FIXED INCOME MARKET

As we head into the last quarter of the year, investors continue to favor Treasury debt as their primary commitment, continuing the pattern of recent months. This is particularly so of international groups. However, volatility has picked up during the past few days. A brief sell-off took place, resulting in 10-year Treasury notes losing about 2.5% of their value, a move that represents a year’s income.

Pressure is growing to make a fundamental change in the organizational structure of Fannie Mae and Freddie Mac, the two large Federally-sponsored enterprises. Part of this change involves a change in lending standards which have tightened significantly since the 2008 bailout. The yields available from the earlier issues continue to remain attractive today.

Tax-exempt (and taxable) state, county and municipal bonds continue to be a sweet spot of relative opportunity. There is good demand (hence liquidity) as recent offerings have sold out. There may be negative news as overloaded pensions are worked off, but the net return and traditional safety of principal will prevail for carefully selected credits.

EQUITY MARKET

In September, U. S. equity markets posted their strongest single month in over a year. Much of this was a reaction to an overly pessimistic sentiment that developed in July and August (and which we counseled against following) and the growing prospects of future Federal Reserve easing. Reasonable market valuations, coupled with this prospect of future easing, have improved the risk/reward equation for market participants.

Throughout history the equity markets have proven themselves to be perhaps the single best indicator of future economic activity. Should this hold true again, then last month’s rebound may well signal more future gains in the year ahead.

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