As a bond investor, I am cursed to worry. It’s the nature of the beast. Last Friday’s disappointing job report, combined with a fresh rise in Spanish borrowing costs, was enough to kick my interminable anxiety up a notch. Is this the beginning of a repeat of 2011? Is now the time to pull in the reins on the portfolio? Before hyperventilation sets in and I have to go searching for a brown paper bag, I must keep reminding myself that while fighting the last battle is instinctively human, reacting thoughtfully—not instinctively—is what distinguishes a portfolio manager.
While I am as disappointed as the next guy that the private sector added only 120,000 jobs in the last March, let’s not read too much into it. Firstly, there is a lot of volatility on a monthly basis. In an economy the size of ours, a variance of approximately 100,000 is a mere statistical anomaly. For this to portend a significantly slowing economy and risk reviving talk of a double-dip, there has to be a lot of corroborating evidence. Where is it? Manufacturing continues to do well. Consumer and business confidence is up. Real-time indicator readings of cyclical sectors such as retail, transportation and housing are still on a flat-to-upward trend. In other words, last quarter’s jobs report was disappointing but the trend is not broken. The sky is not falling, Chicken Little!
That said, I believe the jobs report serves as good reminder of what we are likely to face for a long period of time: the economy is climbing out of a hole at a very tepid pace that is unlikely to meaningfully accelerate anytime soon. And that means all the talk of early tightening and the Federal Reserve being behind the curve in raising rates—a problem I would like to have—is sheer nonsense. On the other hand, I feel quite sure that Chairman Bernanke is not likely to be behind the curve in providing further stimulus if the economy needs it.
Euro woes remain an issue, but I think it’s a stretch to look at Spanish spreads as an indicator of what is likely to unfold in other markets. The European growth rate is going to be under pressure for quite some time and the Spanish economy is at the epicenter of the austerity-led contraction. However, the transmission mechanism for the problem—an over-leveraged and undercapitalized banking system—has been offered a near-term respite thru two massive liquidity injections. I maintain that in this environment, the problems in one part of the Eurozone cannot take the whole continent down. We saw that in the U.S. housing sector. As soon as the banking system was stabilized, although the problems in housing persisted, they didn’t take down the broader economy. Spain could potentially behave the same way in the European context. Widening Spanish spreads are not likely to lead to wholesale deleveraging by the European banking system, at least until the banks need to refinance their 3-year loans from the European Central Bank. I believe European growth will probably be an issue for a long time, but the fears of how asset prices will be impacted, a la Greece, are highly exaggerated.
Growth in China seems to be slowing down— the result of government- induced policies, more than anything else. Just listen to the premier berating the banks and the picture becomes quite clear. But what if the potential slowdown accelerates to a level that becomes an issue for the global economy? China may eventually pay a price thru slow growth for its over investment in the last decade, but that day of reckoning is not yet at hand and the policy makers still have lots of levers to nudge the economy in the right direction. If China ever has a hard landing, it could be due to a gargantuan policy mistake at the peak of the cycle—as the Plaza Accord was for Japan—and it wouldn’t be because the policy makers want to slowdown the growth of the real estate sector. In my book, in their zest for liberalization, the day they give up the controls over the banking system will be a day to hide under a rock. Until then, all the talk of a hard landing in an economy such as China’s is difficult to imagine. In an environment that is fiscally robust with slowing inflation, Chinese policy makers have way too many tools at their disposal for the current slowdown to become a hard landing.
Putting all of this together, in an atmosphere where policy support may be more forthcoming, I need to continuously remind myself that the likelihood of a repeat of 2011 in 2012 is still quite small. It would be reasonable to view the recent bull rally as an opportunity to pull in the reins a tad, but I maintain that a wholesale reduction in risk exposure appears premature. All of this worrying may prove to be for naught.