Thursday, February 27, 2014 - As She Was Saying…

As She Was Saying…

by Sinclair Noe

DOW + 74 = 16,272
SPX + 9 = 1854
NAS + 26 = 4318
10 YR YLD - .03 = 2.64%
OIL - .35 = 102.24
GOLD + 2.00 = 1332.80
SILV + .05 = 21.36

Two weeks ago, the freshly minted Fed Chair Janet Yellen appeared before the House Financial Services Committee to deliver her first bi-annual Humphrey Hawkins testimony on the state of the economy and monetary policy. She read a prepared statement and then answered questions from the Congressional representatives. The next day she was scheduled to repeat the process with senators; that didn’t happen because of a big winter storm that essentially resulted in a Snow Day for Washington DC. Today, Yellen returned to Capitol Hill to continue her testimony before the Senate Banking Committee.

Yellen began today’s hearing with the same prepared remarks from two weeks ago, but then she got to the part about the Fed’s outlook for the economy and this time she said something a little different: “Mr. Chairman, let me add as an aside that since my appearance before the House committee, a number of data releases have pointed to softer spending than many analysts had expected. Part of that softness may reflect adverse weather conditions, but at this point, it's difficult to discern exactly how much. In the weeks and months ahead, my colleagues and I will be attentive to signals that indicate whether the recovery is progressing in line with our earlier expectations.”

Now for the past few months, the Fed policymakers have been reading and repeating the same script from the playbook, that the recovery will pick up later this year and the Fed’s QE stimulus had helped make things better and jobs were coming back, and just be patient and you’ll see that everything is coming up roses and daffodils.

The rosier outlook was behind the Fed decision to cut back, or taper, its bond buying program. The Fed had been buying $85 billion per month in Treasuries and mortgage backed securities; they have since tapered back to just $65 billion a month; and they’re expected to get out of the bond buying stimulus program altogether by the end of the year, based on the idea that the economy will be able to grow without the stimulus. The clear picture of the road to recovery is not so clear anymore.

When will we get a clearer picture of the recovery? The answer is unlikely to emerge before the Fed’s policy-setting committee meets again in March. Yellen reiterated that the winding down of the Fed’s stimulus program is “not on a preset course” and “if there's a significant change in the outlook, certainly we would be open to reconsidering. But I wouldn't want to jump to conclusions here.”

Wall Street just loves to feed at the Fed’s easy money trough. The S&P 500 index has been pushing for new highs, three times in recent days it has inched to intraday highs, and today it found the force to close at a new record high.

There might have been something in Yellen’s testimony that Wall Street won’t like. Pressed by Senator Elizabeth Warren for more transparency on the regulatory from Yellen said the Fed was moving in that direction. Warren noted that the Fed rarely holds public votes on issues such as its enforcement actions taken against banks. Yellen replied: “You have raised a very important question. I do think it is appropriate for us to make changes and I fully expect that we will.”

That may not sound like much, but compared to her predecessors, it is a seismic change. Greenspan was a deregulating regulator, and Bernanke was a reluctant regulator from the Holder school of fear over collateral damage. Yellen isn’t backing down, although she hasn’t yet stepped up.

Meanwhile, Yellen pointed to what she thinks  might be the biggest problem with the economy, saying, “I think the issues of income inequality, of rising income inequality, in this country really date back many decades -- probably to the mid-eighties, when we began to see a very substantial widening of wage gaps between more-skilled and less-skilled workers, and this is a trend that unfortunately has continued almost unabated for the last 30 years."

Like her predecessor Ben Bernanke, Yellen offered a couple of the usual stock explanations for widening inequality: technological change and globalization. But those two trends didn't just abruptly get much worse in 1987, leading to the sudden spike in inequality. A Cleveland Fed study points to cuts in income-tax rates on the wealthy in 1986, directly contributing to the mid-80s spike in inequality. Further tax cuts in 1997 led to another spike in inequality and then the Great Recession came along and hammered low-income  Americans much harder than high-income Americans, driving an even bigger wedge between the haves and the have-nots. Yellen said today: "Households and segments of our population that had already been suffering stagnant or declining incomes for many years have seen the recession take a large toll."

Helping the economy grow is one of Yellen's responsibilities as Fed chair, so it behooves her to understand how to address this problem. So far, aside from identifying the start date, Yellen's thoughts on the issue aren't very encouraging. Asked what Congress could do to help, Yellen offered more stock solutions: More education and training for workers and kids. Those could help with the issues of technological change and globalization, maybe; although more education sure hasn't helped raise the incomes of low-wage workers. And that was as far as Yellen was willing to go today.

In economic news, the number of people applying for unemployment benefits rose last week to the highest level of 2014. This is not a sure sign that the employment picture is getting worse but it doesn’t show anything getting better.

Orders for durable goods fell 1.0% in January as demand tapered off for most big-ticket items except military hardware. Orders for long-lasting goods have fallen in three of the past four months, but up-and-down airline bookings are largely responsible. Aircraft orders sank 20.2% in January. Boeing received just 38 orders for new planes in January, down from a record 319 in December. Stripping out transportation orders, orders were up 1.1% and have been up in 4 of the last 5 months.

Even then, it doesn’t mean we have strong durable goods orders. Orders fell 6.7% for computers, 2.1% for electrical equipment and appliances, 1.8% for primary metals and 0.4% for machinery. That adds to mounting evidence that first-quarter gross domestic product is likely to be weak.

RealtyTrac data reports that institutional investors, defined as entities purchasing at least 10 properties in a calendar year, accounted for 5.2% of all US residential property sales in January, down from 7.9% in December and down from 8.2% in January 2013. This was the biggest one month plunge in history. It gets worse: the January share of institutional investor purchases represented the lowest monthly level since March 2012. This does not appear to be a weather related event, as some colder weather cities posted gains in investor purchases, while warm weather cities saw declines. Perhaps this will be another bit of data the Fed will consider before continuing to further taper MBS purchases.

The institutional or private equity investors have a fairly short-term view toward single family residential. In the past, many smaller investors have jumped into single family homes and added sweat equity with a long-term view towards slow and steady returns. The private equity money jumped in and jacked rent rates above market combined with unrealistically low levels of reinvestment into their projects. 

The idea was to create a liquidity event by taking the operating company public in an IPO and thus sloughing off the risk on the retail investor. That isn’t flying very high. A few deals were done; then one was pulled. The other short-term liquidity event was planned to come from securitizing rent streams. Blackstone tried that and their efforts dropped as rental income came up short just after it was launched. The market for this synthetically structured mess could be as big as $1.5 trillion, if it ever gets off the ground.

Many have anticipated that the large institutional investors backed by private equity would start winding down their purchases of homes to rent, and the January sales numbers provide early evidence this is happening. And if the institutional investors aren’t buying, then who is? Existing homeowners just swap one home for another. Normally, first time buyers would jump in and pick  up slack, but with higher prices, and higher mortgage rates, and ubiquitous student loan debt, potential young buyers aren’t.

The Treasury Department reported today that the deficit has dropped, quite a bit, from about $1.1 trillion in fiscal year 2012 to $680 billion in fiscal year 2013. That is the smallest deficit since 2008, and marks the end of a five-year stretch when the country’s fiscal gap came in at more than a trillion dollars a year.

Growth in tax revenue accounts for much of the decline in the deficit. Increases in taxes and cuts in federal spending figure strongly too, as does a surprising long slowdown in the pace of health-spending growth.

The Treasury said that revenue climbed $324 billion to $2.8 trillion between 2012 and 2013. That is growth of around 12.9 percent, reflecting both higher income rates, including higher top marginal rates and the expiration of the payroll tax holiday, and a strengthening economy. At the same time, government spending grew relatively slowly, to $3.9 trillion from $3.8 trillion a year earlier.