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Market Update – February 2011

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Revolts in the Air – Looking for Progress

Well, 2011 has started off with a bang of sorts. The Internet has finally caught up to the developing world of autocrats and dictators. The leaders of Egypt, who reportedly have never written an email, were ousted by a youth movement harnessing the power of social networking. Not that the events have created any progress in that country – it is still run by the military and the constitution is now suspended – but change creates opportunity. And that change is trying to propagate throughout the Middle East. Our hope is that this change creates real progress. Unfortunately, history bodes otherwise.

As we look to the US and our little corner of the global economy, things have gotten a bit brighter during the past few months despite the blanket of snow covering my backyard. Or at least, that is what we are led to believe by the financial news. We’re not as bright on the news. As you’ll read below, we are of the same perspective from the past few quarters: the economic damage from the events of 2008 is going to take us years and possibly a decade to correct. Do not expect that all will be resolved quickly – do expect more volatility.

The Key Factors – Unemployment, Inflation and Real Estate

As you can see from the chart below, our employment level in the US has remained at rock
bottom for many months now despite the “good news” that unemployment dropped to 9.0% last month. The disparity in these facts has to do with the way that unemployment is calculated,
which masks the true numbers. Unemployment claims each week are still at exceedingly high levels, roughly 400,000 depending on the week. But the anomaly is that fewer people are actually in the workforce. Due to months and years of being out of work, folks stop looking and simply don’t get counted. The number of folks who have dropped out of the labor force over the past year is roughly equal to the number of new jobs. No change, no progress.

Combine that fact with regular population growth, and we are backsliding each month when we don’t have substantial jobs growth. January was no exception – 37,000 jobs growth in non-farm payrolls is nothing against the needs of a larger population. The problem grows, not improves.

A stagnant and immobile labor force leads to a tightening of the qualified labor pool, and hence our second concern for the current economy – inflationary pressures. Inflation is the silent erosion of future purchasing power. In a simplistic sense, you need to grow your assets and income at the rate of inflation to keep your standard of living. It seems like a simple task when inflation is typically 2-3% per year, but not so quickly. An ongoing study by Crescent Research points out that real growth in the stock market (gains from price changes and dividends, less inflation and taxes) is often flat or negative when viewed over a 20-year investment period. This data places a severe challenge to the notion of buy-and-hold equities to safely grow your portfolio.

Unemployment Index

Given where we stand today, we believe that inflation is prepared to once again enter us into a period of negative real growth if portfolios are not properly hedged. The factors are all present:

  • The Fed has again entered a period of loose monetary policy: near-zero short-term interest rates and massive amounts of liquidity infusion through the Quantitative Easing program.
  • Energy and food prices are escalating at a rapid clip due to global factors: namely general population and income growth in developing markets and failed harvests from the effects of climate change.
  • A tightening labor pool.

But wait, you say. A tightening labor pool? I thought we just established that people need jobs? In fact, the unemployment situation will factor heavily into the inflation problem because of the lack of mobile, qualified professionals and skilled workers. Those folks who are falling out of the job hunt are often times permanently out of the labor market. Skills degrade, their ongoing training is limited and they find ways to adapt to life without permanent employment. With many of these folks out of the competitive labor pool, you have rising labor costs as firms compete for the fewer qualified candidates.

Adding to the problem is the real estate market. Prices are still down 30% across the country from their highs in 2007 and back to 2003 levels. A third to half of all mortgages are under water, with no short-term prospects of improving. The only way to move is to hope for a short-sale or some other concession from the bank and torch your credit report. Yet the jobs have moved on, to other industries in other regions or in other countries. We have severely limited the portability of the labor pool even as they seek new jobs created by advancements in American productivity and innovation. In short, a tighter labor pool for those firms who are looking to hire skilled workers and professionals.

Contributing to the problem are the banks, those bastions of capitalism who create the efficiencies for our economy to prosper (if you listen to Jamie Dimon and a host of other bank executives). Talk to anyone who has applied for a mortgage of late, and you get an interesting mix of dismay, disgust and a desire to disembowel. With Bank of America/Merrill Lynch losing billions each quarter, they are not exactly inclined to lend money even if they have a claim on your first-born. They’re just trying to survive and justify their next engorged bonus. In the mean time important segments of the economy are starved for credit, the fuel for growth.

So we are left with an interesting mix of circumstances. All the monetary factors are present for inflation, raw commodities are in tight supply, and the labor pool is tightening. Yet, these same factors lead to tougher circumstances for many Americans – fewer jobs, higher costs for daily living, and a dramatic loss of family wealth from market volatility and decimated real estate values.

Companies are Profitable – Why Worry?

Not surprising, companies in the US are doing pretty well. They have managed to keep costs down considerably (lower payrolls is a big start), gained in production efficiencies and have learned to serve a global market. Most companies have beaten earnings projections for the past quarter (which makes one suspect of earnings projections). The stock market is doing well. Corporate bond spreads are very tight, a market belief of nominal credit risk in these firms. Apple has a cash balance larger than most economies. Life is good for the big firms. Life is even good for some of the smaller firms. So what is the worry?

The worry is around tensions. We have created an untenable situation – one that cannot last more than a few years at the current pace. The most obvious tension is the US government debt. Our receipts as a percentage of GDP have fallen dramatically in the recession, by over 20%. Yet government spending, and the annual deficit, continues to grow. From the trillions spent on defense and wars during the Bush administration, to the ongoing state aid in the Obama administration, we are running up the credit card balance. And unless the entitlement programs (Social Security, Medicare and Medicaid) are harnessed and tempered, it will get worse, not better.

That spending has caught up in a dramatic fashion. As Tim Geithner, Secretary of the Treasury
quietly noted in front of Congress, annual debt service will soon be 73% of the annual deficit. Simply put, we will spend a half-trillion dollars a year to keep current with our national credit card bill (kindly issued to us by the First National People’s Bank of China). And that teaser rate is about to expire. Interest rates are going up, slowly, and for every few basis points increase in the cost of borrowing for the US government, the interest costs go up by billions. Not a pretty picture for a consumer who is still shopping at the Blue Light Special on that same credit card.

Municipal Bonds – Another Ratings Game

We are seeing the first signs of this problem in the municipal bond market. Muni bonds, for anyone who has been following, took a drumming in the last half of 2010 despite every other asset class doing well. The problem is state budgets. States have run out of money, and some will face impossible decisions on budget cuts. Remember that in 2010 there was Federal Stimulus money to help cover their deficits – no longer the case in 2011. That means a host of issues for cities, towns and municipalities who depend on the states. Some of these entities might fail – some of their bonds might go into default. One of the most conservative, risk-free, stable asset classes is headed for a Lehman moment.

Analysis: Muni Bond Market from the view of an Institutional Trader

AAA Muni historical spread

This first chart shows the historical spread between the Generic U.S. Treasury 10-year yield and the Generic General Obligation AAA Municipal Bond 10-year yield (in Bloomberg speak: 049M10Y Index USGG10YR Index HS). The top chart shows the two rates going back to early 2006: Treasuries being the orange line and munis the white line. The bottom chart shows the difference in the two rates, with green indicating munis trading at a lower yield than Treasuries, and red is when they reverse. The top chart is measured in percentage points – the bottom chart is in basis points (100 basis points = 1 percentage point).

Back in the day (pre-summer 2007 when the sub-prime crisis began) AAA-muni’s typically yielded 1% less than Treasuries to account for their tax benefits, inferring that their credit risks were effectively the same. This relationship was broken during the crisis, and while the market attempted to restore the relationship in early 2010, it again fell apart at the end of the year. Today, AAA-munis and Treasuries yield approximately the same rate, despite the wide disparity in tax treatment and after-tax yields.

BBB Muni

This second chart shows the same data for the Generic BBB G.O. Municipal Bond yield compared to the Generic U.S. Treasury 10-year yield (Bloomberg: 631M10Y Index USGG10YR Index HS). Note that, as in the previous chart, back in the day BBB-munis had a lower yield than Treasuries by roughly 0.6%. This wasn’t as large as the 1% difference between AAA-munis and Treasuries, but still reflected an institutional trader’s view of them as a “safe” tax-free asset class warranting the lower returns.

Today, BBB muni yields have shot straight through Treasury yields by 1.5% (and peaked at 4.1% in March 2009), indicating a relatively risky asset class despite the tax benefits. Compared to a history of zero losses from defaults (as far as I’m aware), the institutional market has effectively established this as the next crisis asset class, and doubts the validity of the AAA ratings as seen in the first HS chart. Remember that once upon a time, a whole market existed for AAA-rated sub-prime CDOs, many of which trade near zero today. Lesson learned: don’t rely on the credit rating agencies to spot the next crisis.

Next… Patience

Where this goes next, we cannot predict. But in the big picture we need time to heal, with a bit of additional carnage along the way. Our feeling is that the stock market rally is another bubble, inflated by a cycling of asset classes. As an investor over the past few months, there are few places to invest and gain yield. Short-term debt is paying next to nothing (thank you, Fed), risky debt is just that, municipal bonds look like the next crisis, and people feel like they need to restore their 401k plan now. So what-the-hey, let’s get into the stock market! In short, a predictable outcome from the Fed’s policies – create some sense of calm by inflating the one asset class that everyone understands and can play through their web browser.

With all this in mind, our investment direction for 2011 has some of the same from 2010 along with a few new twists. We are maintaining an underexposure to equities in general, and will do so for the foreseeable future. Those equities that we do hold have a handful of important characteristics:

  • The ability to increase cash flow to shareholders in the event of strong inflation. High current dividend yield is an immediate indicator – strong cash flow is an intermediate indicator – and correct market/global positioning is the final indicator.
  • Revenue base that is global. Most of the firms that we hold have at least 50% of their revenues from overseas, and we look for those firms that are able to tap into emerging markets as well. This helps us hedge against a weaker dollar and a weak domestic economy.
  • Lower volatility in the event of a market dislocation. We do expect for increased market volatility, of the sort that we saw in the Flash Crash. Firms with currently low betas that tend to be less volatile are a start, those with stable cash flows augment the approach.

We expect for there to be continued uncertainty in the emerging markets as they grapple with inflation in many cases, and political instability in others. While we currently do not hold an emerging markets exposure, we consider it important to long-term growth in the portfolios. Entry points will be determined by specific events and inevitable market over-reaction.

The remainder of the portfolio is split between alternatives (namely commodities), fixed-to-floating rate corporate bonds, floating rate corporate bonds, and inflation-indexed US Treasuries. The mix will depend on available inventory, current pricing and individual risk profiles. Some interesting opportunities may also arise in the municipal bond market with any volatility or capitulation due to credit defaults.

Irrespective of the actual asset class or security, we will look for the opportunity to generate income to portfolio irrespective of the market conditions and in several cases use the asset to hedge against elevated inflation in the coming years.

Until our next market update, let’s hope that these markets sort themselves out in an orderly fashion and the snow gets a chance to melt. (I think our recycling bins are still buried out there somewhere!)

Regards,

David B. Matias, CPA
Managing Principal

Using Stock Options in your Portfolio

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What is an Option?

Options are very complicated financial instruments that can be used in a portfolio in many different ways. Options are not for everyone, but when used by an educated investor they can actually reduce risk in your portfolio. Before using options you must understand how they work, what the risks are, and the different strategies that can be used.

An option is a derivative financial instrument that establishes a contract between two parties concerning the buying or selling of an asset at a certain price during a specified time frame. During this time frame, the buyer of the option has the right, but not the obligation, to buy or sell the asset, while the seller has the obligation to fulfill the transaction if requested by the buyer. The price of an option is derived from the value of the underlying asset (most commonly a stock) plus a premium.   Simply put, it is a contract that allows you to buy or sell a stock at a predetermined price within a set time frame.

Option Characteristics

  • Type of Option:

o   Call Option – conveys the right to buy the stock

o   Put Option – conveys the right to sell the stock

  • Strike Price – also called the exercise price, is the specified price the stock may be bought or sold
  • Expiration Date – is the specified time frame or life of the contract
  • Each option contract represents 100 shares of the stock (leverage)
  • Amount paid for option is called the premium

Call Options

 

Buying a Call Option (Bullish)

Payoffs and profits from a long call option

Image via Wikipedia

An investor will typically buy a call option when they believe that the price of the stock will go above the call’s strike price, before the call expires. The investor pays a premium for the right to purchase the stock at the strike price. Typically, if the price of the underlying stock has surpassed the strike price, the buyer pays the strike price to purchase the underlying stock, and then sells the stock and pockets the profit. Of course, the investor can also hold onto the underlying stock, if he or she feels it will continue to climb even higher.

Example 1

One way to think of this in everyday life is by relating it to a house you would like to buy in a certain neighborhood.  Today a house that you like is on the market for $200,000 and you don’t know if it is a good time to buy because you’re worried that home prices may continue to go down.  At the same time, you love the house but would hate to pay more than $200,000 if prices go up. Instead of buying it today, you and the seller agree that for a $5,000 fee he will sell you the house in three months for $200,000.  The seller is now obligated to sell you the house at $200,000 and you have the right to buy the house in three months for $200,000.

Scenario 1

After three months the housing market declines and the average house in the neighborhood is now $150,000.  You decide not to buy the house since you can look around and find one at a cheaper price.  You only lose the $5,000 fee you paid the seller. If you had bought the house outright, you would have lost $50,000.

Scenario 2

After three months the housing market improves and the average price in the neighborhood is now $250,000.  You decide to buy the house for $200,000 because if you didn’t you would have to pay $250,000 to buy another house in the neighborhood. Your total cost is $205,000 ($200,000 plus the $5,000 you paid for the option).  Your gain on the house would be $45,000 ($250,000 minus $205,000). If you had bought the house outright, you would have gained $50,000, but you only had to risk $5,000 of your money, rather than $200,000.

Example 2

Now that I’ve walked you through the housing example I want to put it back into stock terms. Let’s say you are interested in a stock and after all your hard work researching it you conclude that it will increase in value over the next couple of months, but you are concerned that there is still a reasonable chance the stock will go down.  There are two ways you can act on your bullish sentiment.

Buy the Stock

One way to do this is to purchase 100 shares of stock at $20 for a cost of $2,000. If the stock rises from $20 to $25 you would have a $500 gain or a 25% increase in value.  If the stock goes down to $15 you would have a $500 loss or a 25% decrease in value.

Buy a Call Option

An alternate way to do this is to control 100 shares of stock by purchasing an option with a strike price of $20 at a premium of $2 per share for a cost of $200 (1 contract x 100 shares x $2 premium = $200). If the stock price at expiration is $25 the option premium would rise from $2 to $5, the original cost was $200 and it is now worth $500. You have a $300 profit, but a 150% return.  If the price of the stock were below $20 you would lose all of your $200 or 100% of your investment.

Don’t get too caught up on the calculations here, the key point in using call options is that it limits your risk by reducing the amount of capital needed, but because of the leverage, it leaves open the potential for higher gains.

In my next posts I will talk about using covered calls to generate income in a portfolio and buying puts to protect your portfolio from volatile downward movements.

Marcus Green

Market Update – October 2010

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An Anxious Summer

It has been three years this fall since the financial crisis began, and by my estimation, it will be another seven years until we have fully recovered.  Yes, I see it as a decade-long event, beginning with the subprime crisis (July 2007) and reaching its height in the failure of Lehman Brother (September 2008).  Under that assumption, we’ve had a pretty good year.  The stock market is up 4% for the year (nearly half of which is dividends), the corporate bond market is up 12%, and commodities are up 4%.  These may not look like great returns, especially if you’re still trying to restore your retirement account from the collapse of 2008, but given the alternative it is pretty impressive.

This view is best understood when you look at the stock market against the VIX, commonly referred to as the “fear gauge.”  The VIX is a composite index that tracks the implied volatility on S&P futures.  Put into plain English, it is a measure of expected future losses.  The higher the VIX goes, the more expensive it is to insure against such losses.  The chart below shows that while the S&P has flat-lined for most of 2010, VIX looks like it went through a cardiac arrest.

SPX and VIX

Specifically, it was the “flash crash” on May 9 that created the anxiety and that stress lasted through the entire summer.  It was only when we arrived in the last week of August that the anxiety level returned to a more normal buzz and the US stock market began a 10% rise to recover the year’s losses.  The question remains – what caused such a stir in early May and why did it create such fear of equities.  While there is now a plausible explanation of the flash crash recently published by the SEC, in fact it could still happen again.  What we did experience through the summer was a rather tame pull-back.  Had things truly gotten worse in the economy and around the globe, we would have likely seen a persistent 20% drop or more.

Fortunately, the net result is a gain.  For the year to date the S&P 500 is up 4% with dividends, and the VIX is sitting at 23 – elevated but not unusually so.  For comparison, prior to the crash, VIX commonly sat in the low teens with 30 being a crescendo prior to a market decline.

My “decade-long recovery” prediction, while frankly a guesstimate, reflects the challenges that we face in all areas of the economy.  During this time, expect for economic growth to be slow and market returns to be in the single digits.  Under those conditions, a total return of 8% for the year is a very respectable figure.  With a 4% gain through the first three quarters, we’re on track to stay within those bounds.

Two of the factors that will determine a full recovery are employment and housing.  In fact, they are intricately tied together with bank lending at the root of the problem.  While large investment-grade public corporations have easy access to the credit markets (Microsoft raised 3-year paper at less than 1%), smaller businesses and private firms with less-than-perfect finances are having a nasty time of borrowing.  The mortgage market is even worse.  Mortgage assessments are driven by comparables, and with so many foreclosures out there the comps look awful in even the best neighborhoods.  To make matters worse, banks are simply not extending mortgages to folks without three years of steady income.

So with so many folks looking for work and valuations at such lows, it is simply impossible for most people to obtain a mortgage to buy or refinance.  With so much potential equity tied up in our homes, a large source of net worth has been frozen.  Complicating matters, it makes it nearly impossible to move cities to find work or change jobs.

Implied in all of this is the plight of small business, a common growth driver in the American economy.  No loans means little capital to expand and grow.  No growth, no new jobs.  The cycle continues.  While I am bullish on the American entrepreneur and our ability to adapt as a country, it will be years for the foundation to be repaired.

Repositioning of the Portfolios

To respond to these conditions, we are looking to reposition the portfolios accordingly:

Equities:  We increased some of our equity exposure in August when the market was experiencing a temporary low, although we continue to maintain an underexposure due to the current economic prospects.  The areas that we are increasing are related to cash or global growth.  Notably, companies with growing dividends are going to continue to be a focus along with industrials and medical technology firms.  Irrespective of the US’s prospects, these industries will continue to remain strong.

Alternatives:  To augment the equity exposure, we have increased our alternative asset class.  Ranging from commodities to REITs, these are assets that have low-to-zero correlation with equities yet maintain similar growth prospects.  The table below demonstrates these correlations against the S&P 500.  Although commodities have a similar growth prospect, a third of the time they move independently of the market.  Gold is far less correlated to stocks, and bonds are effectively not correlated at all.  Emerging markets, on the other hand, is almost always correlated with US stocks.  Incorporating lower-correlated assets allows us to maintain similar growth prospects in the portfolio with less extreme fluctuations in value.

 

SPX Correlations

Two-year daily correlations from October 2008 to October 2010. Because of the significant exposure to oil in the DB Commodity Index, it has a higher correlation over this period than prior to 2008.

 

Fixed Income: With the persistent fear in the markets combined with excessive monetary easing, bond prices have reached highs rarely seen.  Any issue that is less than 10 years is pricing at yields of 2-3%.  If you factor in any inflation into the economy during this period, your bond real-return is likely to be zero or negative.  As a result, we are selling any traditional corporate bond holdings that are less than a 10-year maturity.  This does not include any of the structured notes we currently hold or floating rate bonds, since most of these have mechanisms to generate solid returns in both recovery and stagnation scenarios.

We will closely monitor events this fall, with the election being the next hurdle in market stability.  As usual, uncertainly creates anxiety and just the resolution of the political shift in itself will help to stabilize equity returns.  Please don’t hesitate to contact us with questions or comments, and all the best for the fall.

Regards,

David B. Matias, CPA

Managing Principal

Investing in Bonds? Do you know how they work?

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Over the past two years we have seen a significant rally in the bond market due to the Federal Reserve’s decision to keep interest rates low.  This run up in bond prices raises questions surrounding profit taking and tax management.  In this post I will walk you through an example of how bonds work.  In next week’s post, we will explore how bonds impact your taxes and what you can do to maximize your profits.

Advanced Yacht Builders

Advanced Yacht Builders needs to borrow money to buy supplies.  They would like to borrow $1,000 from you at 5% interest per year for the next 10 years.  You decide that this is a good investment and you loan them $1,000 by buying their bonds.  You will receive 5%, or $50, each year for the next ten years and at the end of the ten years Advanced Yacht will give you your original $1,000 back.

Bond

 

During this ten-year loan, the price of the bond goes up and down and you are able to sell it to someone else if you’d like.  This is how bonds are similar to stocks.  They can be bought or sold at any time and are different from U.S. savings bonds or bank CDs that only pay interest and never change in value.  The price that you are able to sell the bond to someone else is determined by its yield.

By lending $1,000 dollars at 5% interest, you are receiving a yield of 5%.  Calculating the yield of a bond can get a little tricky because there are three main things to consider: bond price, interest and the amount of time the money is borrowed.  I will not get into that calculation here, but the most important things to remember are:

  • The price of a bond is determined by its yield
  • When interest rates go up, the price of a bond goes down
  • When interest rates go down, the price of a bond goes up

Scenario 1:  Interest Rates Drop

Now lets say you’re a year into lending to Advanced Yacht and all of a sudden interest rates drop and they can borrow money at 1% interest instead of 5% interest.  After breaking out a financial calculator, you would find that the price of this bond would go from $1,000 to $1,340 because the yield of this bond went down, causing the price of the bond to go up (When interest rates go down, the price of the bond goes up).  You would still receive 5% interest AND have a gain of 34% in the price of the bond.

Scenario 2:  Interest Rates Rise

Alternatively, if interest rates rose to 9%, the price of the bond would go from having a price of $1,000 to having a price of $760.  Again, as interest rates increase, the price of the bond decreases.  You would still receive 5% interest, but if you needed to free up cash, you would have to sell the bond at a -24% loss.

The price of the bond decreases because investors do not want to buy the bond that you’re holding, which is only paying 5% interest, when they can buy a new bond from Advanced Yacht that is paying 9% interest.

Crane Paper Company in Dalton produces the pap...

Next Steps

The math to calculate the yield isn’t important here.  What is important is the fact that in the scenario where interest rates dropped from 5% to 1%, the price of the bond gained 34% and that requires your attention.  Your options are to:

  • Do nothing and collect your 5% interest, but watch the 34% gain decline over time because at the end of the ten years you will only be paid back the original $1,000 that you lent
  • Sell the bond that you purchased for $1,000 to someone else for $1,340 and lock in a 34% gain, but forfeit the future 5% interest payments

In the next post, we will answer the question of how taxes are impacted in either decision and which decision is right for you.

Financial Crisis – Three Years and Counting

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Wall Street Sign. Author: Ramy Majouji

Image via Wikipedia

It has been three years since this financial crisis began.  Yet if you follow the news, all the discussion has been around the two-year anniversary of the Lehman collapse and how the world has done since then.  If we are to truly understand the nature of this economic malaise, we have to remember its roots – in the subprime crisis of 2007.  That was the year in which the credit markets froze.  From a financial viewpoint the credit markets rule the economy – not the stock market, as you might come to believe if you watch too much network television. Without banks lending to banks, to companies or to people you are not going to be able to grow an economy, much less buy that house you were interested in.

The damage that was caused by the sub-prime crisis and credit market freeze cannot be underestimated.  It dragged the US economy into the worst recession on record.  It pushed millions out of work, permanently.  It pushed two investment banks to the verge of failure – Bear Stearns and Merrill Lynch.  It pushed another into bankruptcy – Lehman Brothers.  That bankruptcy seized the global asset markets – all of them.

So then is it a surprise that three years into this crisis, and a trillion dollars of government stimulus money, that we’re still suffering the effects?  Absolutely not.  And if it is another two years until we have true stability in the global asset markets, it would not surprise me.

David B. Matias

Ben Bernanke ready to act if Economy weakens further

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This week was full of economic data releases as well as some comments about the economy from the Federal Reserve Chairman, Ben Bernanke. To start the week, we had existing and new home sales fall well short of the 5 million annual run rate that was estimated.  The July 2010 sales came in at a dismal 4.11 million annual run rate, a 26% decline from the month before. Durable goods orders also missed estimates for the month of July.  It had been a bright spot in the economy but only grew 0.3% versus the estimate of 3.0%. Thursday’s initial jobless claims fell to 473k from last week’s revised 504k, although encouraging, the 4-week moving average edged up to 487k, the highest since December 2009.

Last month Q2 2010 GDP was reported at an annualized rate of 2.4%, today it was revised down to 1.6%, beating more recent estimates of 1.4%.  The markets seemed to cheer the beat since all the other economic reports were misses.  At 10:00Am today the Federal Reserve committee met in Jackson Hole, Wyoming to discuss the state of the economy. With growth being too slow and unemployment being too high, Bernanke indicated that they will provide additional monetary accommodations to make sure the economy recovers.  This sent the market up about 1% and is so far holding onto those gains.  We’ll have to wait and see what’s in store next week to determine if the market will continue its brief rally. Next week’s economic indicators include Personal Income and Spending, Chicago Purchasing Manager Index, Vehicle Sales, and the most significant of all, Change in Non-farm payrolls & the August Unemployment rate. Any surprises in the payroll report will surely increase volatility and consumer sentiment.

Economic data shows economy still struggling

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Economic reports due out this week include new and existing housing starts, durable goods orders, and the revised estimate to Q2 2010 GDP.  Housing sales will  show about a 12% drop from June 2010 as the housing credits are now fully out of the system and natural market forces are coming back into play.  The annual unit sales rate will come in close to 5 million, the lowest since March 2009. One bright spot remaining in the economy is durable goods which should show an increase of 3% compared to June. Friday’s GDP report will show the economy grew at a  1.4% annual pace, much less than the 2.4% that was estimated just a month ago. This new information is probably the reason why Federal Reserve Chairman Ben Bernanke has stated that they will reinvest payments on their mortgage holdings back into long-term treasuries.

The economy continues to show both strengths and weaknesses, which is probably why the VIX is still elevated and the treasury yields are so low right now. People are confused and the conflicting data isn’t helping to ease their fears of another drop in the market. Uncertainty in the economy is still a large factor and until there is clarity, there will be more volatility.