November 2011

November 30, 2011  |   Monthly Commentary   |     |   0 Comment

Prior to the open of trading on the last day of the month, the Federal Reserve took action to extend swap lines and lower the interest rate on loans to the European Central Bank. The market interpreted the action as being positive for the stock market and negative for the bond market. Unfortunately, the positive price action was not captured in the monthly performance. The reason being, much of the spread improvement came over subsequent days. It happens quite often when there is a big move on the last day of the month, sometimes in favor of the fund, and sometimes against it. The impact was felt across many fixed income funds, including some of the third-party managers held in the fund.

From an economic perspective, the trend of improving activity seemed to accelerate in November. Both manufacturing and consumer consumption were significant drivers of activity. Manufacturing continues to enjoy a renaissance as outsourced industries bring production back to the United States and demand from developing economies for U.S. industrial and technological production surges. Similarly, retail sales registered strong results for the month, rising 0.5% month-over-month in October, with automobiles, electronics, and department store sales leading the way. Retail sales for November, to be released December 13th, are expected to post another strong gain. The “Black Friday” shopping madness shattered revenue records as shoppers lined up at midnight to capture deeply discounted merchandise. The shopping spree, anecdotally, seemed to continue right up to the close of business on Sunday evening. Piper Jaffrey estimated that Apple sold fifteen I-Pad’s per hour during the weekend. That translates into one I-Pad sold every four minutes. There is the risk that consumers will demand “Black Friday-like” discounts for balance of the holiday shopping season or that sales will slow. We don’t think either outcome is likely, as retailers entered the holiday season with lean inventory levels.

The most surprising bright spot was housing. While sales of new and existing homes continue to occur at an anemic pace, home prices showed an unexpected rise, jumping a surprising 0.9% month-on-month as measured by the FHFA home price purchase index. While it’s unlikely that price rise will be sustained, we view it as another indication that the worst is behind us and the housing market has either bottomed or is close to doing so. Given the above outlined scenario, we estimate that Q4 economic activity will top 3% when the measure is released in January 2012.

On a technical note, the Fed has eased interest rates twice in the last week. On November 30th, the Fed announced an expansion of their dollar swap trading with the ECB without indicating a cap on the program. On December 7th, it was announced that the size of the initial operation totaled more than $50 Billion. That’s far more than anyone was expecting. One could argue that it’s a Fed engineered ease for the European monetary system. Separately, it was disclosed yesterday that the Fed is participating in the Mortgage-Backed market through the purchase of newly issued securities in a technical operation known as a “dollar roll.” A dollar roll is similar to a Repurchase agreement or “Repo,” the Feds primary tool for easing interest rates. The operation involves the Fed buying securities while simultaneously agreeing to sell them back to the counterparty one month later. In effect, the Fed is injecting dollars into the monetary system, either temporarily or permanently, depending on what the Fed is trying to accomplish. With this latest operation, it seems as though the operation will remain in place, at least for the immediate future. The size of the operation hasn’t yet been disclosed, but this program could also be termed an easing. Finally, there’s growing talk that the Fed will cut the discount rate at the next FOMC meeting. Given that the Fed has not denied the possibility of the action, we assign a 50% probability to such an occurrence. The action is significant in that the Fed is further easing monetary policy as the economy is accelerating. We deem this to be an additional policy error that will be more problematic when the time comes to unwind it.