This morning the Bureau of Economic Analysis (BEA) released its second estimate for 2009 4th quarter gross domestic product (GDP), which they estimated at just under $14.5 trillion. GDP measures the output of domestically-produced goods and services. The real (inflation-adjusted) GDP increased at an annualized +5.9% from the third quarter, a jump from the previous quarter’s +2.2% increase. And while annual GDP decreased -2.4% from 2008 to 2009, last quarter’s GDP was +0.1% higher than the 4th quarter of 2008. The current report indicates positive shifts in a number of important areas, and is consistent with a country beginning to claw its way out of recession.
GDP is divided into four broad categories: personal consumption, private investment, government spending and net exports (the difference between exports and imports). The largest increase from the prior quarter came from private investment, which increased an astounding +48.9%, thanks in part to improvement in private inventories (after a -23.1% decrease over all of 2009). The change in private inventories accounted for 64% of the total change in real GDP. Both this change and the +2.8% increase in consumption of goods reflect the improved consumer spending as well as anticipated spending. They also demonstrate what I discussed yesterday in my email article – that both recessions and recoveries are driven by business spending, not consumers. Consumers buy after Corporate America: if Wal-Mart is re-stocking their inventory, they do so because they are expecting us to buy more of their products.
As for government expenditures, which include federal and state/local spending, you may be surprised to learn that they decreased by -1.2% from the prior quarter. State and local governments decreased spending by -2.0% while the federal government increased spending by +0.1%. Federal government spending is broken down into defense and non-defense spending, which dropped -3.5% and increased +8.3%, respectively. The fact that a small decrease in defense spending and a large increase in non-defense spending effectively negate one another shows how much of our discretionary spending (64%) is devoted to national security.
Another favorable economic indicator from the recent GDP estimates is the increase in both exports and imports. While we are still running a trade deficit of -$347 billion, we can take some solace in the fact that exports increased +22.4% from the previous quarter while imports rose +15.3% over the same time period. This capped off a 2009 that saw a +$138.9 billion increase in net exports (a decrease in the trade deficit) from the previous year and a fourth quarter increase of +$10.3 billion. Historically, a substantial increase in both imports and exports is a strong indicator of economic recovery.
While it is promising to finally see significant growth in consumer spending, private investment, exports and other important areas, it only means things are headed in the right direction. Last year’s real GDP is still a -2.4% decrease from 2008. We are definitely on the road to recovery, but we still have a ways to travel to get there.
Friday, February 26, 2010
Friday, February 19, 2010
Treasuries
Last week we looked at historical returns on gold and showed that, despite widely-held beliefs about the commodity, it’s a risky investment that barely keeps up with inflation. We showed that over time, gold has proven itself to be significantly riskier and far less profitable than stocks.
This week we look at treasuries, which by their nature are not as risky as stocks or commodities, but are still perceived to be far safer than they truly are when you look at real (inflation-adjusted) return. Treasuries are unique in being fully guaranteed by the US government. If you buy a $1,000 10-year treasury bond with a 6.8% coupon, you will undoubtedly receive $34 semi-annually until the bond matures, at which point you get your $1,000 back. The total interest earned over this period (before reinvestment) is $680. But even with the ultra-safe, guaranteed return, you could still lose money!
You may be wondering how it’s possible for an investment with guaranteed returns to lose value. The answer is inflation. For example, $1,000 in 1970 had spending power equivalent to over $2,160 in 1980. If you collected any less than $1,160 in interest payments over the life of the bond, your real (inflation-adjusted) return was negative. In the example above, you would actually have lost $480 over the 10-year period.
Let’s compare treasury bills, which mature in one year or less, treasury bonds, which mature between 20 and 30 years, and common stocks. Since 1871, stocks have returned +6.3% annually after inflation, compared to +1.9% for treasury bills and +2.4% for treasury bonds. So stocks provided far better returns over the long term.
Now let’s look at risk. Over the past 110 years, the worst decades for stocks were the 2000s, when they returned –2.2% annually, and the 1910s (–2.1% annually). Treasury bills, on the other hand, returned –4.5% per year during the 1940s, while treasury bonds dropped –4.8% per year in the 1910s and –3.2% in the 1940s. Not so safe after all it seems.
So while treasuries fluctuate less than stocks in the short term, their worst-case performance over a decade is lower than for stocks. And stocks’ best-case performance is far better: +15.7% in the 1990s vs. +8.1 for treasury bonds and +3.7% for bills in the 1980s. So while bonds are an important part of a diversified portfolio, and usually yield a positive real return, it is important to understand that risk is inherent in any potentially profitable endeavor. US treasuries are no exception.
This week we look at treasuries, which by their nature are not as risky as stocks or commodities, but are still perceived to be far safer than they truly are when you look at real (inflation-adjusted) return. Treasuries are unique in being fully guaranteed by the US government. If you buy a $1,000 10-year treasury bond with a 6.8% coupon, you will undoubtedly receive $34 semi-annually until the bond matures, at which point you get your $1,000 back. The total interest earned over this period (before reinvestment) is $680. But even with the ultra-safe, guaranteed return, you could still lose money!
You may be wondering how it’s possible for an investment with guaranteed returns to lose value. The answer is inflation. For example, $1,000 in 1970 had spending power equivalent to over $2,160 in 1980. If you collected any less than $1,160 in interest payments over the life of the bond, your real (inflation-adjusted) return was negative. In the example above, you would actually have lost $480 over the 10-year period.
Let’s compare treasury bills, which mature in one year or less, treasury bonds, which mature between 20 and 30 years, and common stocks. Since 1871, stocks have returned +6.3% annually after inflation, compared to +1.9% for treasury bills and +2.4% for treasury bonds. So stocks provided far better returns over the long term.
Now let’s look at risk. Over the past 110 years, the worst decades for stocks were the 2000s, when they returned –2.2% annually, and the 1910s (–2.1% annually). Treasury bills, on the other hand, returned –4.5% per year during the 1940s, while treasury bonds dropped –4.8% per year in the 1910s and –3.2% in the 1940s. Not so safe after all it seems.
So while treasuries fluctuate less than stocks in the short term, their worst-case performance over a decade is lower than for stocks. And stocks’ best-case performance is far better: +15.7% in the 1990s vs. +8.1 for treasury bonds and +3.7% for bills in the 1980s. So while bonds are an important part of a diversified portfolio, and usually yield a positive real return, it is important to understand that risk is inherent in any potentially profitable endeavor. US treasuries are no exception.
Friday, February 12, 2010
Gold – Not So Safe after All
Following a disastrous 2008 for equities, stocks have come to be perceived as risky, volatile investments, especially for investors funding retirement accounts and other conservative portfolios. Instead of trying to find the next Google, investors have become more interested in finding safe places for their money – low-volatility, minimal-risk investments that hopefully protect against inflation. Gold has recently developed a reputation for being one of these “safe” investments after posting a comparatively fantastic +11.28% annualized return from 2000-2009, a decade during which stocks actually declined for the first time since the 1930s. Seems like gold is the place to be!
But wait one second. An historical analysis of gold returns against the S&P 500 shows that not only has gold been less profitable than stocks over the long-run – it has also been more volatile. You may be surprised to learn that gold has only outperformed stocks in three of the eleven decades since 1900, and has barely posted a positive return since 1871, with less than +0.8% annual growth, while stocks have grown +6.3% annually over the same period (both of these figures are after inflation). To get an idea of the significance of this difference, over 30 years at the above rates of return, $1,000 worth of gold would have grown to $1,266, vs. $6,252 for stocks (again, after inflation).
Until 1968, the price of gold fluctuated little owing to fixed prices and the Bretton Woods System, which held gold to a fixed price relative to the value of the US dollar, the system’s anchor currency. The system was enacted partly because the US government had nearly $26 billion in gold reserves, and by controlling the price of the commodity it virtually ensured the value of its gold would not substantially decrease. Bretton Woods eventually became unsustainable and was ended in 1968, at which point the price of gold was free to fluctuate. But in comparing returns on stocks and gold since the 1970s, a decade where gold returned an average of +16% annually after inflation, we still see a greater annualized return for stocks (+5.2%) than for gold (+4.2%) in the 40 years since 1970. The 80s and 90s saw a massive disparity between the two investments: stocks posted annualized after-inflation returns of +9.9% and +15.7% respectively over each of the two decades, while gold lost value at annualized rates of -8.2% and -5.3%. So much for hedging against inflation!
My point is not that one should only own stocks and never own gold. Nor do I necessarily disagree with analysts who project that gold will be a profitable investment over the near term. I am just using historical analysis to show that gold has been a relatively poor investment and ineffective inflation hedge over the long term, and is even more volatile and unpredictable than stocks. Its recent reputation as the perfect inflation hedge or as a “safe” investment is not deserved.
This is an illustration of how $100 would have grown over the last thirty years (click to enlarge):
But wait one second. An historical analysis of gold returns against the S&P 500 shows that not only has gold been less profitable than stocks over the long-run – it has also been more volatile. You may be surprised to learn that gold has only outperformed stocks in three of the eleven decades since 1900, and has barely posted a positive return since 1871, with less than +0.8% annual growth, while stocks have grown +6.3% annually over the same period (both of these figures are after inflation). To get an idea of the significance of this difference, over 30 years at the above rates of return, $1,000 worth of gold would have grown to $1,266, vs. $6,252 for stocks (again, after inflation).
Until 1968, the price of gold fluctuated little owing to fixed prices and the Bretton Woods System, which held gold to a fixed price relative to the value of the US dollar, the system’s anchor currency. The system was enacted partly because the US government had nearly $26 billion in gold reserves, and by controlling the price of the commodity it virtually ensured the value of its gold would not substantially decrease. Bretton Woods eventually became unsustainable and was ended in 1968, at which point the price of gold was free to fluctuate. But in comparing returns on stocks and gold since the 1970s, a decade where gold returned an average of +16% annually after inflation, we still see a greater annualized return for stocks (+5.2%) than for gold (+4.2%) in the 40 years since 1970. The 80s and 90s saw a massive disparity between the two investments: stocks posted annualized after-inflation returns of +9.9% and +15.7% respectively over each of the two decades, while gold lost value at annualized rates of -8.2% and -5.3%. So much for hedging against inflation!
My point is not that one should only own stocks and never own gold. Nor do I necessarily disagree with analysts who project that gold will be a profitable investment over the near term. I am just using historical analysis to show that gold has been a relatively poor investment and ineffective inflation hedge over the long term, and is even more volatile and unpredictable than stocks. Its recent reputation as the perfect inflation hedge or as a “safe” investment is not deserved.
This is an illustration of how $100 would have grown over the last thirty years (click to enlarge):
Tuesday, February 2, 2010
Looking for Bad News in Greece and China
There are times when investors want to find reasons to see the glass as half-empty—looking for some issue or problem to confirm our fears and justify scaling back our positions or becoming more conservative in our investing. Last week was one of those times. It should have been a good week for stocks, between Bernanke’s reconfirmation, better-than-expected corporate earnings and a +5.7% jump in GDP for the 4th quarter, the most in six years. Instead, we saw sharp declines in stocks around the world from Tuesday through Friday. The two most obvious scapegoats are Greece, with the possibility of its national government defaulting on its debts, and China, which intends to curtail its own economic growth over fears of future inflation.
Analysts and stock market reporters can write much better stories by looking at what happened (stocks fell) and trying to explain why it happened (people were scared about Greece and China) rather than addressing the real issue—investors are still scared of being burned, and are looking for every reason not to invest, even if they are not good reasons.
We haven’t seen a national government default since Argentina in 2002. Before that we saw Russia and Ecuador in 1998 and North Korea in 1987 (that last one must have been a real shocker!). And though there is a slim possibility that Greece could default on its debt, I find it hard to believe, especially in view of recent statements, that the other EU nations will let this happen and endanger their monetary union. It is hard to say what effect an EU bailout of Greece would have on the US stock market, but the distant possibility of a foreign default is not reason enough for investors to shy away from investing when conditions are otherwise as promising as they were last week.
With China, why is it such a big problem if the government there wants to ease growth from too fast to just fast enough? Might they overshoot and slow the economy more than they would like? Of course they could, but their recent actions to rein in lending were triggered by data showing that the Chinese economy has been growing much faster than expected. Even investors in “China-sensitive” stocks, such as energy and materials, must have been surprised by 2009’s upwardly revised GDP figure of +8.2%. China’s economic growth rate had actually been accelerating throughout last year. The rest of the world should be so lucky.
Make no mistake, I am not saying that the possibility of Greece defaulting or China’s future economic growth slowing a little too much should not be considered in our decisions today, because they could affect our global economy and equity markets. I just question the sudden and indiscriminate selling of securities amidst the reality of better than expected economic news and corporate earnings reports on the basis of “what-if” scenarios that probably won’t ever happen.
Analysts and stock market reporters can write much better stories by looking at what happened (stocks fell) and trying to explain why it happened (people were scared about Greece and China) rather than addressing the real issue—investors are still scared of being burned, and are looking for every reason not to invest, even if they are not good reasons.
We haven’t seen a national government default since Argentina in 2002. Before that we saw Russia and Ecuador in 1998 and North Korea in 1987 (that last one must have been a real shocker!). And though there is a slim possibility that Greece could default on its debt, I find it hard to believe, especially in view of recent statements, that the other EU nations will let this happen and endanger their monetary union. It is hard to say what effect an EU bailout of Greece would have on the US stock market, but the distant possibility of a foreign default is not reason enough for investors to shy away from investing when conditions are otherwise as promising as they were last week.
With China, why is it such a big problem if the government there wants to ease growth from too fast to just fast enough? Might they overshoot and slow the economy more than they would like? Of course they could, but their recent actions to rein in lending were triggered by data showing that the Chinese economy has been growing much faster than expected. Even investors in “China-sensitive” stocks, such as energy and materials, must have been surprised by 2009’s upwardly revised GDP figure of +8.2%. China’s economic growth rate had actually been accelerating throughout last year. The rest of the world should be so lucky.
Make no mistake, I am not saying that the possibility of Greece defaulting or China’s future economic growth slowing a little too much should not be considered in our decisions today, because they could affect our global economy and equity markets. I just question the sudden and indiscriminate selling of securities amidst the reality of better than expected economic news and corporate earnings reports on the basis of “what-if” scenarios that probably won’t ever happen.
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