Into 2016 We Go
This is no way to ring in a new year! US stocks fell 6% to 7% during the first week of January, following world stock markets in a downward spiral. It is the worst first week of trading in years, maybe ever. There were several drivers of this nervous selling activity. First and foremost, China is at it again. Its stock markets are said to have led the world markets plunge, with clumsy attempts by their regulators’ circuit breakers to stem declines actually making them worse. China’s manufacturing data fell for the fifth consecutive month, pulling their GDP growth down to 5.5%, as the painful transition of this Asian economy from a manufacturing one to a consumer one marches on. And China surprised the markets by devaluing their currency- the yuan- again, similar to the sneak attack last August.
Middle Eastern tensions escalated recently between Saudi Arabia and Iran. The Saudis executed dozens of people including a Shiite cleric and Iran torched the Saudi embassy in Tehran. In days gone by, oil prices may have spiked, but in today’s supply-glut-driven energy market, oil prices steadily fell, down by 10% during the first week of January, hitting $32 per barrel. This decline will continue to harm the energy industry, of which many firms are already in decline or recession.
The only Christmas present the markets received in December was a Federal Reserve rate hike of 25 basis points. They said they would raise rates in 2015 and they did. Merry Christmas to consumers and to small businesses, who will pay higher interest rates. The Fed made their decision solely on the “low” unemployment rate of 5.0%, which they tout as proof that their zero rate campaign, which lasted six years, “worked.” Well, certainly it “worked” because so many people dropped out of the labor force, which when coupled with moderate job growth, makes the unemployment rate of 5.0% look pretty good. Record warmth in December contributed to a rise in payroll jobs of 292,000 and household jobs of 485,000, which the Fed uses as vindication that they were “right.”
One look at most of the other economic data shows slowing momentum in both the manufacturing and services sectors. Housing is volatile, especially at this time of year. GDP in the 4Q15 is tracking at 1.0%, according to the Atlanta Fed. In our region, the Philly Fed indices of business activity all turned negative in December, but, hey, higher rates will help, right? Why is the Fed trying to slow down GDP growth of 1%? With the average growth in GDP achieved in the past six years at 2%, why try to slow this down? Inflation readings and inflationary expectations are still quite low and the dollar is strengthening; it makes one wonder why they are so anxious to raise rates. Usually the Fed would tighten in the face of strong GDP, rising inflation and wage growth, and a weak dollar, not the opposite. Well, it is all still “data dependent” says Fed Chair Janet Yellen, so we shall see where the data takes us.
Oh, the Taylor Rule
Oh, wait! I forgot! The Fed follows the Taylor Rule, which is a formula that shows where the short term Fed Funds rate should be- and currently says Fed funds should be above 1%. As a matter of fact, the formula has pointed to above 1% since 2009. But many economists and market participants think that productivity, labor force participation, massive increases in regulatory burden during the past six years, still-high debt levels of businesses and households, financial market behavior, and corporate profits should all be adjustments to formulas such as the Taylor Rule, which considers inflation and unemployment but not other variables. In an environment such as the one in which we finds ourselves, with slow 2% growth, “low” unemployment, high numbers not in the labor force, and slow wage growth, there is little to propel consumer spending, which makes up over two thirds of our GDP. Low oil and gas prices did not propel spending and there is not much on the horizon to do so- unless whoever wins the $1 billion plus Powerball jackpot decides to spend it all.
Despite the waning momentum in the economy, most people, including myself, do not see a severe slowdown leading to recession. One notable exception is Citibank, who has a poor economic forecast. I believe that we will continue to grow between 1% and 2% GDP. Inflation will remain low after rising slightly from a bottom, but the Fed may tighten again this year, not because they see something in the data that tells them to but because they say they must. So I guess they will.
Large Hadron Collider Update
In December, it was announced that an unusual “bump” in the particle collisions data recorded by the Collider. Is it a new particle or two new particles previously unknown to the Standard Model of physics? Is it another form of the Higgs Boson? In any event, it is an unexpected result of the particle collisions now occurring at up to 13 teraelectronvolts, or “TeVs,” which is up from the 8 TeVs between 2009 and 2013.
China is expected to build its own “Larger” Hadron Collider with a circumference of 30 to 62 miles, compared to Switzerland’s 17 miles. CERN, the operator of the Collider, is eyeing its own future construction of a bigger machine to triple its distance. Pretty soon, we will have to worry what is underneath every mountain.
Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.