John Dessauer Investments, Inc. www.johndessauerinvestments.com John Dessauer s market review and update as of Wednesday October 1, 2014 The Fed debates, the Dow dances, and the economy continues to move in slow motion. Federal Reserve chair, Janet Yellen, is worried investors are becoming too complacent and will not be prepared when the Federal Reserve finally raises interest rates. The president of the New York Federal Reserve bank, William Dudley, has a far different concern. He worries that the strong dollar will mean poorer trade performance, fewer exports, more imports, and could dampen inflation, making it a lot harder for the Federal Reserve to achieve its two objectives, (a stronger labor market and higher interest rates). Currency markets are all about interest rate differentials. For example, the euro has been sinking because of Europe s loss of economic momentum. Currency traders are anticipating lower interest rates in Europe. On our side of the Atlantic, traders are anticipating higher U.S. interest rates. That combination has resulted in a stronger dollar. If that continues, and there is every reason to think that it will, U.S. exports will decline and imports will rise. The Bureau of Economic Analysis, (BEA), has revised its data for the second quarter. Instead of 4.2% as earlier reported, the BEA now says the U.S. economy grew at a 4.6% annual rate in the second quarter thanks, in large measure, to exports. Exports have grown as a contributor to economic growth, business investment and jobs. The last thing we need at this point is a slump in exports because of a strong dollar. I doubt the
Federal Reserve will make a mistake and start raising interest rates under these conditions. Although in the mid-1980s, the Federal Reserve, under then Chair Paul Volcker, raised interest rates to counter inflation fears. The result was a soaring dollar, which made U.S. exports expensive and foreign goods cheap. The U.S. economy was jolted and the Federal Reserve was forced to admit the error and bring interests rates back down. The currency market is a great humbler. It is beyond the control of our Federal Reserve. With U.S. interest rates near zero, there is little the Federal Reserve can do to stop the dollar s rise. Europe s economy is so soft that lower interest rates are needed to fend off the downward pull of recession. That makes the euro less attractive than the U.S. dollar. And Europe is not the only soft spot in the global economy. Japan made a huge mistake by raising taxes on consumers. As a result, the Japanese economy is now suffering. Hopefully, the Japanese will reverse that decision and cut taxes. But that will take time. Meanwhile the Japanese yen is weaker versus the U.S. dollar. For the next several months the dollar is likely to remain too strong for the Federal Reserve to raise interest rates. That will not stop Federal Reserve Chair Yellen from warning investors that someday interest rates will have to go up. She does not want a market shock when that day arrives. For its part, the U.S. stock market is torn between pessimists and optimists, with Dow 17,000 the neutral ground. Below that level optimistic buyers multiply. Above that level pessimistic sellers multiply. The consensus sees U.S. stocks as fairly valued - not expensive enough for widespread selling, and not cheap enough to attract large numbers of buyers. Likewise, the economy is neither weak enough to scare off stock buyers nor so
strong as to chase away the sellers. On the positive side, U.S. household wealth reached a new record high of $82.5 trillion in the second quarter. That is almost double the level of 2000. New home sales soared in August, up 18% to a 504,000 annual rate. Year over year new home sales are up 2%. New orders for capital goods were up 0.6% in August. This is a closely watched data point, because orders for capital goods are seen as a proxy for business spending plans. A rise in business spending would be very positive for jobs and overall economic growth. On the negative side, applications to buy new homes were flat in August. The recovery in home prices may be discouraging buyers. And, orders for durable goods fell 18.2% in August. That is not as bad as it looks, because durable goods orders jumped 22.5% in July. Orders - or the lack of them - for commercial aircraft is what pushed July up and then August down. Excluding commercial aircraft, durable goods orders showed modest growth in July and August. Perhaps most significant is the fact that energy prices have not soared. Going all the way back to the 1970s, the U.S. economy suffered from soaring energy prices every time there was trouble in the oil rich Middle East. This time the trouble in the Middle East is extreme, with ISIS capturing oil producing facilities and threatening the entire region. Fortunately, international oil companies from BP and Total to Exxon Mobil have discovered huge amounts of oil and natural gas outside the Middle East, so much that spreading violence in Iraq and Syria has not roiled the oil market. Stocks in the oil companies are understandably down. They are the victims of their own success. However, the violence in the Middle East, and Russian aggression, make it clear that we don t want the oil companies to relax. The U.S. and global economies are still dependent
on affordable oil and gas. At the moment there is a surplus and the price of oil is down. Experience tells us that will not always be the case. Just as interest rates will not stay low forever, so too the oil price will rise again. BP, NYSE, BP, $44.20, is an attractive long term investment with a very attractive dividend yield (4.7%) to make the waiting profitable. Intel, NASDAQ, INTC, $34.55, has been relatively strong, even on market down days. One reason is that Intel is investing $1.5 billion in a Chinese chip-making firm to form a joint venture making chips for mobile devices. This is a very positive development. Intel is a buy. P.S. Hong Kong. Do not be misled by western press reporting on the protests in the streets of Hong Kong. The issue is about the process for selecting Hong Kong s chief executive. The western press sees this as all about democracy versus heavy handed communism. Forgotten is the fact that long ago, in the 1990s, Beijing ordered provincial leaders to stop appointing village leaders. Instead the villagers were to vote to select their own leaders. The reason was economics. The democratic process had a much better economic result. Economics will also be the top priority for Beijing when it comes to resolving the issues in Hong Kong. Beijing has an enviable record of long term economic success. The outcome probably will not satisfy all the protesters, but will support continued economic growth in Hong Kong. I will have the next market review and update for you one week from today on Wednesday October 8, 2014. All the best, John Dessauer
October 2014