March 2013 – Monthly Commentary
For the month of March, the bond market was as volatile as the weather in the Northeast, with prices plunging with the falling late winter snow and rising into month end as the mercury began to rise.
During the month, economic activity was decidedly upbeat, surprising investors who were prepared for a sequester-related slowdown. The housing industry demonstrated strength with both existing and new home sales continuing to register impressive results. The primary driver continued to be a very low inventory of new homes and artificially depressed mortgage rates. In addition, a number of private investment funds have been structured to purchase, spruce-up, and rent homes, with the rental income aggregated and paid to the fund holders. This is an especially positive development in that the fund purchases siphon off excess inventory from the market. Moreover, with the intention of holding the homes as long term investments, that inventory is permanently taken off the market. That’s the exact opposite of the detrimental behavior of the house “flippers” witnessed during the housing boom. The nascent recovery is having a beneficial impact on pricing as evident in the 8.08% year-over-year price gain registered by the Case-Shiller 20 city home price index. With the home selling season upon us, we expect a virtuous circle to develop, as an improving housing sector typically creates jobs in the brokerage, insurance, home goods manufacturing, home furnishing manufacturing, service and maintenance industries.
In the final quarter of 2012, Gross Domestic Product expanded a meager 0.4%, as business and consumer spending slowed sharply in anticipation of the impending fiscal cliff. At that time, economists warned that slow growth would likely continue into the first quarter of 2013, as sequestration loomed and fearful consumers retrenched their spending. Much to the surprise of the economists, activity surged in January and continued to accelerate through the quarter. By the end of January, consensus held that GDP would register a 1.8% annualized growth rate. By the end of February that expectation had improved to 2.2%, and with the quarter now concluded, the forecast has risen to a surprisingly robust 3.4% annualized growth rate. Looking forward, opinion holds that growth in excess of 3% is not sustainable and, with that the current consensus Q2 growth is in the low 1% range. We’ll be watching incoming data closely for clues on economic activity. Should economic growth continue to register in excess of 3%, the unemployment rate is likely to continue to fall which, in turn, will prompt the Fed to end their monetizing exercise sooner than expected.
The systemic risk posed by the money market industry, which was first identified by former Securities and Exchange Chairwoman, Mary Schapiro, has still not been addressed. On numerous occasions the Chairwoman publicly warned the industry posed significant systemic risk. Despite her grim warnings, the money market fund industry has been successful at stifling change. The most absurd example of the resistance can be found in Euro-denominated money funds. Several big banks, including Goldman Sachs, JP Morgan and Morgan Stanley have appealed to European regulators to change the rule on “Breaking the Buck.” Money funds enjoy an exemption from marking their portfolio’s to market as long as the market value of the portfolio doesn’t fall in value. Instead, they’re allowed to value the portfolio at 100% of market value, which they represent as a $1.00 share price each day. As they generate returns from investment, the units of the money fund increase, so that the number of shares held by an investor increases as interest is earned. However, if the market value of the portfolio falls below a share price of $0.995, then they are seen as breaking the buck and must mark the portfolio to market value. Typically, in such a circumstance, investors panic and rush to pull their money from the fund, thereby worsening the losses and dooming the fund to failure. To avoid breaking the buck, the large financial institutions in Europe would like to be able to reduce the number of units an investor owns. In effect, they want to mask the value of the portfolio in the event of a decline in price by reducing an investor’s holdings instead of reflecting the true value of their portfolio. Hopefully the regulators will see through this thinly veiled proposal to trick investors and reject this proposal. However, if the European regulators are as reluctant to reform the money market industry as U.S. regulators have been, then the new proposal will likely come to pass. As always, investors must be vigilant in understanding the risks and cost of their investments.