"Kee" Points with Jim Kee, Ph.D.

Quick overview: The most recent Wall Street Journal survey of economists (Economic Forecasting Survey), which surveyed over 50 panelists, anticipates GDP growth of 2.78% for 2014 (2.15% for the 1st quarter, 3.05% by year-end). As for interest rates, the panelists expect the 10-year Treasury yield to rise from the current 2.74% level to 3.18% by mid-year and 3.48% by year-end. Core inflation is expected to move upward and approach 2% by year-end. It is hard to find a model that doesn’t argue that this environment implies positive returns for stocks (La Jolla Economics). It will be more challenging for bonds, however, particularly those with lengthy maturities. And it will be challenging for “bond-like” stocks and other yield vehicles that are sensitive to rising interest rates.

 

As for the GDP outlook (and I know Kee Points readers have seen this before!), GDP has a strong seasonal component, never mentioned in the press, with the 1st quarter averaging the weakest by far. Throw in recent harsh weather and you're guaranteed some pessimistic headlines. But for this to presage further weakness I would want to see deterioration in some of the more forward looking indicators, like quality spreads and leading economic indices, which I don't see - not yet anyway.

 

As for dividends, the rising interest rate environment mentioned above can negatively impact bonds and “bond-like” or high dividend yield stocks, just like the spike in rates did last summer. I have mentioned in prior Kee Points that here at STMM we focus on total return, which is comprised of price appreciation (capital gains) plus dividend payments. Historically, about 2/3rds of the market’s total return comes from price appreciation, so you don’t want to neglect that component and focus only on dividends. And if you just focus on high dividend yield, you are going to self-select into risky stocks that are cheap because they have a lot of problems: the yield is high because the price is low, and the price is low because the prospects are bad. Better to focus some of the dividend portion of a total return strategy on dividend growers, with less emphasis on dividend yield and more emphasis on dividend growth. Several of the S&P 500’s top dividend growth companies are in our core portfolio, including Ford, Zion’s Bank, Capital One, Southwest Airlines, and Apple.

 

China in the news: Concerns about China center around the growth of debt there, although China’s overall government debt as a percent of GDP – combined local and central governments – compares favorably with other large countries. Of course, the quality of debt is another story (!), and that’s why potential defaults of some recent high profile wealth management products there, like “Credit Equals Gold” and “Opulent Blessing,” have rattled markets (talk about naming products after their hoped for results!). As I understand it, these products are a main source of funding (i.e. from private investors) for the shadow banking system, which funds some of China’s more entrepreneurial and risky ventures (Yardeni Research). The main fear seems to be that failures of these products could cause a loss of confidence in and stability of the financial systems in China. So the government, recognizing this, might be overzealous in reining them in (i.e. curtailing lending and credit growth), causing a sharp slowdown in growth or hard landing there.

 

I think an interesting perspective on all of this comes from Gavekal’s China-based Dragonomics research service. Gavekal argues that just as investors worried too much at the beginning of 2013 that China wasn't doing enough to control the explosion of credit there, they worry now that it is doing too much in 2014. Gavekal's point being that "current worries risk underestimating the government's genuine and continued commitment to maintaining growth." I do agree that economists - including this one - have underestimated the pragmatism of Chinese authorities over the last 10 years. But the bottom line to me here is the mention in this report (and others) of “consensus growth in the 6.5%-7.5% range.” That’s because I see that the number "six" (as in 6.5% growth) is coming up more prevalently. That’s a real slowdown in growth. And that means an end to the commodity supercycle (but not commodity cyclicality), and that's tough for many emerging markets. That, I think, is the main implication of developments in China.