Thursday, May 26, 2011

The Economy - Slowing but Growing

Sometimes the best way to gage the state of the economy is to look at the markets. Whereas economic data are released with a time lag, the market is forward looking. As an example, stocks topped in the fall of 2007 and entered a bear market long before the financial crisis and Great Recession became apparent. Stocks bottomed in early 2009, long before most knew the economy was improving and the recession had ended. What is it saying now? Slowing, but still growing.

Utility stocks are among the best performing sectors over the last month. Investors are shifting away from riskier growth-oriented securities to ones that offer more stability and income. The utility industry’s earnings are fairly predictable and the stocks offer both yield and dividend growth. In a slowing economy utility stocks typically outperform, which is why the Utilities SPDR (XLU) is at a multi-year high.

Even more revealing is the recent rally in income-bearing securities. The iShares Preferred Stock ETF (PFF) rallied to a new 52-week high. Wall Street is pushing back the time that they believe interest rates will raise. That has pushed up the prices of the preferred stocks and debt instruments that I’ve listed in past columns. They continue to offer attractive yields that are well above the money-market rates.

Why are money-market rates so low? “The Economist” recently gave an explanation, and Ben Bernanke isn’t to blame. Fast growing emerging economies are piling up dollars, yen, and euros from trade surpluses and internal savings. It needs to be invested. Because those savers have so few safe and insured investments at home they continue to buy our Treasurys. We’re talking trillions of dollars. It is estimated that our Treasury’s annual financing need (at least $1.5 trillion) equals only 25 percent of the excess overseas savings looking for safe assets.

Investors are tempering their optimism about the economy. Still, it is growing and corporate profits are high, in fact at record levels. That’s why stocks are giving little ground. The main engines that have powered the market are still in place. Those are earnings growth, reasonable valuations, and a lack of alternatives.

— David Vomund is a Registered Investment Adviser. Information on his money management service is found at www.ETFportfolios.net or by calling 775-832-8555. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.