Kristina Hooper, CFP®, CIMA® is head of portfolio strategies for Allianz Global Investors Distributors LLC. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
Consumers are confident that an ailing US economy is getting healthier and inflation will remain tame—just not enough to buy stocks.
The Thomson-Reuters/University of Michigan consumer sentiment index jumped to a preliminary 83.1 from a final September reading of 78.3. The move marks the highest sentiment level since September 2007. Specifically, the current conditions index increased to 88.6 from the final September level of 85.7, while the expectations index rose to 79.5 from 73.5—also a five-year high. Interestingly, consumer views on inflation improved especially for the longer term. Consumers expect one-year inflation to be 3.1%, down from expectations of 3.3% at the end of September. And consumers’ inflation expectations for the next five to 10 years declined to a modest 2.6% from 2.8%.
However, their enthusiasm over the economy was not reflected in the most recent Federal Reserve Beige Book. The report, based on anecdotal information received from bank directors and businesspeople across the Fed’s 12 districts, shows an economy that is recovering, albeit modestly. In particular, residential real estate showed significant progress with most districts reporting stronger existing-home sales. But office rental markets, which have shown signs of softening in some districts, remain a concern.
Where Are the Buyers?
Looking at spending, the optimism expressed in the consumer sentiment index has not yet translated into actual purchasing activity. Indeed, consumer spending was flat to slightly higher since the last Fed report, with retail sales growing moderately in most districts. Auto sales were stable and tourism was healthy in most districts. The manufacturing sector had mixed results, but showed some signs of improvement since the last report. It supports at least some of the improvement we saw in the ISM Manufacturing Index in September.
The Beige Book reported little change in the job market despite the lower unemployment rate reported in September. Prices also remained relatively unchanged, the report noted, consistent with consumer views on inflation. Elsewhere, overall loan demand was steady to higher in most districts. Delinquency rates were flat or declining.
Still, it’s disappointing to see that credit standards have not loosened much. A lack of access to lower rates is one of the obstacles to a more robust recovery, as Fed Chairman Ben Bernanke has pointed out. For example, in New York, bankers actually reported greater tightening rather than easing in credit standards for the household sector: “roughly one in five bankers report tighter standards for consumer loans and residential mortgages, while no respondent reports easing standard in any individual loan category.” In Atlanta, there’s been an increase in demand for mortgage loans for both purchases and refinancing. Although “some contacts noted fewer than half of the applications actually were approved.” This is a real cause for concern as strict lending standards offset the stimulative effects of lower interest rates.
A Bond Bias
Unfortunately, the good vibe we’re getting from consumers and the improving economic data hasn’t translated into bullish behavior in the stock market. According to Strategic Insight, investors pulled $17 billion out of equity funds in September—the largest monthly outflow of 2012—while adding $32 billion to bond funds. While some of the equity flows can be attributed to profit-taking and valid concerns over third-quarter earnings weakness, it is part of a larger, longer-term trend. In fact, over the past three years, net flows into fixed income have dramatically exceeded net flows into stock funds, which have actually been substantially negative. This coincides with a time period in which the stock market has produced strong returns.
It seems that over the past few years, many people have been looking in the rear-view mirror by investing like they believe they should have in 2007. But today’s market carries a different set of risks. Arguably, the biggest threat today is financial repression—low growth and low interest rates—and that calls for a very different investing approach. Now more than ever, real returns matter.
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