Hutchens Investment Management: “The Game Of Rates”

CONCORD, N.H. - April 9, 2013 - PRLog -- With the easing policy introduced by the Bank of Japan’s Harukiko Kuroda on April 4th, the Central Banks of the developed world are almost all engaged in maintaining low interest rates at least through 2014.  When rates were initially cut to these levels during the 2008-2009 financial crisis, it was viewed as a short-term expedient, but now this broad-based policy is the norm.  Four years after the stock market bottom, the major economies are still showing marginal or erratic growth.  Businesses and investors have adjusted.  Large corporations have taken advantage of low rates to strengthen their financials, borrowing in the bond markets, locking in cheap financing for years to come.  While there are signs of a strengthening economy in the US, the cheap money has not lead to growth-igniting investment.  Europe, mired by the sovereign debt problems, has 12% unemployment and the EU borders on full-fledged recession.  

Low rates have had, on balance, a positive effect in the US.  With the Federal Reserve buying $85 billion in mortgage-backed securities on average monthly, yields have declined becoming a catalyst for the housing recovery.  Current rates on a 30-year mortgage are about 3.50%, near the record low of November 2012 of 3.31%, which was the lowest level since data began in 1971.  The housing recovery has been well-documented in our reports over the past year.  Existing home sales were 4.66 million in 2012, below the record 5.04 million in 2007, but 9% above 2011.  Inventory levels have declined rapidly as new construction lags and prices rise.  Higher home prices have brought back the “wealth effect”, giving consumers more confidence and increasing discretionary spending.  Additionally, low rates have boosted equity prices, with both the Dow Jones Industrial Average and the S&P 500 reaching all-time highs in early April.

Recent revisions to the BLS employment data show the largest 358 metro areas created 464,000 more jobs in 2012 than the 1.472 million previously estimated, a 32% increase. In total, 310 of the 358 metros showed growth.  This does not soften the blow of the dismal 88,000 net new jobs created in March or the fact that labor force participation is only 63.3%, levels not seen the Carter Administration.  Aside from the unreliability of the monthly employment survey, which has a +/– 100,000 job estimating error, the more detailed metro revisions bode well for housing as job creation is the most significant variable for a recovery.  

Our investment strategy is a full position in equities.  The recent run-up since the beginning of the year and a more bullish sentiment for equities opens the possibility of a short-term correction if there is an earnings shortfall.  Longer term this is inconsequential as earnings growth rebounds later in the year and along with a dose of inflation will be the ultimate catalyst for a sustainable bull market and deficit reduction.