Recently in Dr. Brian Jacobsen, CFA, CFP®

• After falling in March, durable goods orders increased 3.3% in April
• Weak growth in orders and high levels of inventories signal only modest employment growth
• S&P 500 Index still on course for our 2013 target of 1,720

April durable goods orders rose 3.3% from March. Excluding the volatile transportation component, orders rose 1.3%. Shipments of durable goods decreased 0.6% after increasing 3.3% in March. Inventories reached their highest level since the series began in 1992.

Defense aircraft and parts orders rose 53% for the month but are down 37.6%, reflecting the anticipated and actual effects of the sequester. The big drag from cuts to defense should be pretty well behind us. While defense might not add much to growth, it might not subtract much more.

The Japanese stock market, as measured by the Nikkei 225, dropped more than 7%, while the yen strengthened by more than 1.65%. This is after weakness in the U.S. stock market and a rise of the 10-year Treasury to more than 2%. Major indexes in Europe and the U.S., meanwhile, opened sharply lower, although losses were nowhere near as dramatic as the Nikkei’s. Does this presage a more pronounced movement down in the markets? Probably not.

To me, it looks like the market moves were driven by confusion over central bankers’ commitments to continue easing and concern over the pace of deceleration of the Chinese economy. The Bank of Japan upgraded its growth outlook, but it simply affirmed its previously announced expansionary policy plan. In the U.S., Chairman Bernanke testified that monetary policy would be flexible and adapt to changing economic conditions. The minutes from the May meeting of the Federal Open Market Committee (FOMC) didn’t provide any new information, but it was reported that a number of participants discussed tapering asset purchases by June. It was after the release of the minutes that the market started to weaken.

The Bank of Japan announced that it would leave its plan of qualitative and quantitative easing, announced in April, in place. Chairman Bernanke, testifying before the Joint Economic Committee of Congress, effectively said the Federal Reserve (Fed) would leave its previously announced asset purchase program in place. So, where do we go from here?

For the Bank of Japan, it will still try to double the monetary base (currency in circulation and bank reserves) over the next two years. I doubt that this will increase the rate of inflation to 2%, the Bank of Japan’s stated goal. The problem Japan faces is not that there is not enough monetary base to support a vibrant economy. The problems Japan faces relate to a dysfunctional financial system that isn’t translating the monetary base into money supply. Only structural reforms can fix those problems, and that is the third arrow of Shinzo Abe’s plan for reviving the sleeping giant. I’ll be watching developments on the trade and regulatory fronts in Japan for signs of life. Thus far, there is a compelling reason to believe these changes will be forthcoming. Japan’s willingness to participate in talks to enter the Transpacific Free Trade Area is encouraging. It will be difficult to execute on this agreement, though, because it will require the Japanese government to open up its heavily protected agricultural and health care markets.

The Consumer Price Index (CPI) declined 0.4% in April. Year-on-year, the CPI is up 1.1%. Back-to-back months of declines in gasoline prices pushed the headline number lower. Over the past 12 months, food prices are up 1.5% and gasoline prices are down 8.3%. The decline in gasoline and energy prices is helping consumers bear the burden of higher taxes.

Producer prices (prices received by producers) decreased in April by 0.7%, and consumer prices (prices paid by consumers) declined by 0.4%. Deflation may be the Federal Reserve’s more immediate concern when it meets next on June 18 and 19. Considering that housing starts in April came in at a seasonally adjusted annualized rate of 853,000—down 16.5% from the March rate, but up 13.1% from April 2012—the Fed may want to keep mortgage rates low by possibly increasing the pace of mortgage-backed securities purchases. If the hallmark of the economic recovery is the recovery in housing, the Fed may not want to jeopardize the progress that has been made.

Industrial production declined 0.5% in April after a utilities-driven 0.3% increase in March. March was unseasonably cool, so the output of utilities companies increased. April’s temperatures were a bit more normal, so utilities output declined 3.7% from the elevated March levels.

Manufacturing output declined 0.4% in April on the back of a 0.3% decline in March. Factories appear to be operating at 75.9% capacity, which is 2.8 percentage points below the long-run average. Whether it’s manufacturing for durable or nondurable goods, capacity utilization rates are below their averages. There is little need for major expansions or investment at this point.

Year-on-year, manufacturing, mining, and utilities outputs were all up, 1.3%, 4.2%, and 3.4%, respectively. Although measures like retail sales and gross domestic product have surpassed their prerecession peaks, industrial production and employment still have some catching up to do. This may raise the question of whether the market has run ahead of the economy. Perhaps, but I don’t think so. The market overshot on the way down, declining much more than the economy did. It’s probably only reasonable to assume that the market had to catch up to the economy.      

Retail and food service sales for April increased 0.1% from March, according to the advance estimate from the U.S. Census Bureau. March’s decline in sales was revised from -0.4% to -0.5%. Excluding motor vehicle and parts sales, April retail sales declined 0.1%. 

Although the increase in sales seems weak, the parts that showed declines may have primarily been driven by falling commodity prices: Gasoline station sales declined 4.7% and food and beverage store sales declined 0.8%.

General merchandise store sales increased 1.0%, and non-store retailers (for example, online sales) posted a 1.4% increase. Year-on-year, online sales have grown more rapidly than in-store sales, increasing 15.4% versus a decline of 0.7%, respectively. This trend has persisted ever since the advent of online shopping. Online sales are now approximately 78% the size of general merchandise store sales. For general merchandise sales, warehouse clubs and supercenters have the biggest slice of the pie, accounting for more than 61% of sales. Consumers apparently like deals. When job gains and wage increases are weak, consumers may continue to show frugality.      

When it comes to investing, risk can create opportunity. Find out how as Dr. Brian Jacobsen, CFA, CFP^®, interviews Peter Speidel, CFA, investment analyst with Wells Fargo Funds Management, LLC, and Scott Engroff, CIMA^®, CFS^®, sales manager with Wells Fargo Funds Distributor, LLC, in this excerpt of On the Trading Desk^SM from Friday, May 3, 2013.

Watch the full interview.

When we think about the word risk, we often think of the fear of loss. But it's when you put risk into perspective that you can begin to see the opportunities that risks can also bring. So we want to bring you a few programs this year specifically to discuss risk: revising your perspective on risk, refocusing on your goals, and refining your investment strategy to meet your goals.

Let's address the headline question. Peter, in terms of investing, how can risk be an opportunity?
Speidel: Risk and return go hand in hand, and from an investment perspective, it's important to ask yourself, "Am I being rewarded for the risks that I'm taking?" The opportunity is: Can I possibly take on risks or more risk that may offer more return?

And, Scott, for financial advisors and individual investors, how can be risk be an opportunity?
Engroff: Risk is often associated with fear—the fear of losing money. So the opportunity is to question what fears investors have and learning how to alleviate those fears.

When it comes to investing, risk--believe it or not--can create opportunity. Find out how as Brian Jacobsen, Ph.D., CFA, CFP®, interviews Peter Speidel, CFA, investment analyst with Wells Fargo Funds Management, LLC, and Scott Engroff, CIMA®, CFS®, sales manager with Wells Fargo Funds Distributor, LLC.

The European Central Bank (ECB) cut the target rate for its main refinancing operation (MRO) from 0.75% to 0.50%. The ECB also lowered the rate on its marginal lending facility (MLF) from 1.50% to 1.00%.

The MRO is the main policy tool of the ECB, providing weekly liquidity to eurozone banks. The MLF provides overnight liquidity to banks and is used to help set a cap on overnight bank lending rates. The ECB also pays interest on reserves through its deposit facility, and that rate has been at 0% since July 11, 2012. The deposit rate and the MLF create a type of corridor for overnight bank lending rates, where rates shouldn’t go below the deposit facility rate or above the MLF rate. The ECB has, effectively, narrowed that corridor from being 1.5% wide to being only 1% wide.

Will the MRO rate cut and the narrowing of the corridor do much good? Probably not. It may help lower funding costs for some banks, but contraction in credit in the eurozone is probably not due to banks not being able to borrow from the ECB at low enough rates. The bleak growth outlook and push to get banks to shrink or raise capital are the more likely culprits.

The rate cut is symbolic. It symbolizes the ECB’s endorsement of the recent shift in tone from many fiscal policymakers who seem to have backed off austerity demands. In this case, the symbolism is the substance, and it could signal a meaningful shift in future policies to promote growth in Europe. Now, we’ll have to wait to see if voters get behind this shift.

The Federal Open Market Committee voted to continue its asset purchase program and keep its target for the federal funds rate at zero. The policy statement had very few changes, but it did note that fiscal policy has been moved from being “somewhat more restrictive” to “restraining economic growth.” A note was added, which reads, “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.” 

I think the Federal Reserve (Fed) wants to make sure people understand that when it comes to asset purchases, or tapering, or whatever else the Fed decides to do, it’s not like Hotel California, where the Fed can check out but never leave.

When it comes to when the Fed might start tapering, I think it’s important to remember that the Fed does not have a dual mandate of targeting full employment and stable prices. Yes, I know Chairman Bernanke says the Fed does, but legally, the Fed has three mandates:  full employment, stable prices, and moderate long-term interest rates. Nobody ever talks about that third mandate. Maybe because that smacks of price controls or something, but when it comes to thinking about what might happen to interest rates when the Fed gets around to tapering or raising rates, I think it will be wise to remember that third mandate.

After President Napolitano was elected to an unprecedented second term, the 87-year-old leader nominated Enrico Letta as prime minister. Letta is from the center-left party, which has a slim lead in the lower house of parliament. In the upper house of parliament, former Prime Minister Silvio Berlusconi’s center-right party has a slim lead.

Today, the lower house of parliament elected Letta as prime minister. The upper house is likely to follow suit. This is a significant step forward for Italy, as the danger was that Letta wouldn’t have had the confidence of parliament, and they would have had to call fresh elections soon, throwing the country into a political and fiscal quagmire.

Personal income and expenditures both increased 0.2% in March. Real disposable income--after adjusting for price changes and taxes--increased 0.3%, as did real personal consumption expenditures. Durable goods and nondurable goods expenditures both decreased in March, but expenditures on services increased.

The personal savings rate (savings as a percentage of disposable income) was 2.7% in March. Although this is low by historical standards (6.9% is the average going back to 1959), there's nothing unusual about this or any reason why it must start to rise. When interest rates are as low as they are, there is little incentive to save. Basic economic theory suggests that when the reward for saving is low, people will save less. That’s precisely what's happening. Besides, from February 2003 to December 2007, the savings rate averaged only 2.7%. It can stay low for a long time.

Summary

• The advance report of first-quarter gross domestic product (GDP) showed a 2.5% increase from the fourth quarter of 2012.
• I believe that the U.S. Federal Reserve (Fed) is likely to continue its asset purchase program at least until the summer and early fall home sales season is over.
• U.S. economic growth may have hit a high-water mark with the first-quarter reading of GDP.

The advance report of first-quarter GDP showed a 2.5% increase from the fourth quarter of 2012, on a seasonally adjusted and annualized basis. This was slightly below my estimate of 2.9%, although the GDP numbers will likely be revised over the next few months. As a reminder, the fourth-quarter GDP reading was initially a contraction but was subsequently revised to an increase of 0.4%. The growth in the first quarter may have been due do a bounce back from the weak end to 2012. Averaging the first quarter of 2013 and the fourth quarter of 2012 would likely give a strong indication as to what the rest of the year could look like.

On April 23, around 1:07 p.m. ET, the S&P 500 Index dropped 1%, wiping out $120 billion in market value. Or did it? 

Similarly, on March 6, 2010, the Dow Jones Industrial Average dropped 9%, destroying over a trillion dollars in value. Or did it?

The answer to both is no. Just because a stock market indicator, like the S&P 500 Index or the Dow Jones Industrial Average, moves up or down doesn’t mean value was created or destroyed. There’s a difference between a stock’s price and a stock’s value, but the popular media often conflate the two. There’s a concept in finance called market capitalization, which is equal to the number of shares of stock outstanding multiplied by the current market price of the stock. That is not the same thing as the market value of a company. What would have been more accurate to report on April 23 was that, in those brief moments after a fictitious tweet went out that pushed stocks lower, the market capitalization of the S&P 500 Index declined by $120 billion, not that $120 billion of market value was wiped out.

Italy’s elections at the end of February left a hung parliament. The lower house was controlled by the center-left party, headed by Pier Luigi Bersani, while the upper house was fractured, with the center-right party, headed by Silvio Berlusconi, holding the most seats. Parliament elects the president, but the fractious parliament was unable to make progress, settling on reelecting the outgoing President Giorgio Napolitano. Most likely, President Napolitano will reappoint Mario Monti as a temporary prime minister until new elections are held anytime between July and October.

While the Greeks had a similar experience with their 2012 elections—having to go to the polls twice—the Italian experience could be quite different. Italy does not immediately need any cash from international lenders, so there is less pressure to form a parliament that will negotiate with creditors. The most recent polls show that popular opinion may result in another hung parliament, but this time the center-left and center-right parties might swap spots.

One thing of consequence from this process is that Bersani stepped down as head of the center-left party. The unity of the center-left party is crumbling, which could lead to increased popular support for both the center-right party and the Five Star Movement. The Five Star Movement is squarely in the anti-euro camp, and the center-right wants to ease up on the austerity and reforms that have been implemented.

No matter how I look at it, it looks like people could discuss an Italeave scenario, where Italy leaves the eurozone. Personally, I don’t think Italy will leave the eurozone yet, but it is likely to demand a slowdown to reforms that are being asked for by the International Monetary Fund, the European Central Bank, and the European Commission. This increases risks to investing in the eurozone across the board.

Where are the investment opportunities in South America? What is there to avoid? What are the risks? Derrick Irwin, portfolio manager on Wells Capital Management’s Emerging Markets Equity team, provides perspective in this excerpt of On the Trading Desk^SM from Friday, April 12, 2013. This follows up on the previous edition, Understanding South American Economies, featuring guest expert, William R. Cline, Ph.D., senior fellow at the Peterson Institute for International Economics.

Watch the full interview.

I’d like to begin this interview where we left off last week with Dr. Cline’s interview, where he expressed a caution in terms of investing in that region—government intervention, volatility in the exchange rates, and the economic ties that many of these countries have to China and Europe.
Well, I think he’s pretty well spot-on, identifying three of the big risks. From an equity investment standpoint, I think of the three, what we’re most concerned about is the sustainability of investment-led demand from China, which has driven demand for basic materials and many of Brazil’s major exports over the last decade. And we need to understand, as that investment-led growth slows down, how does that impact Brazil? Now, we think, going forward, Brazil, being the largest market in South America, has its own internal demand and internal growth dynamics that will eventually take over, but it will certainly be a rocky transition.

The opportunity set. You’ve brought three names to consider. First is Ambev.
It’s the dominant brewer in Brazil, with about a 70% market share, with operations in many smaller South American countries where it has a very strong market share as well. Attractive because it has a dominant market, but there’s a lot of room for growth left in terms of premiumisation, where people buy more expensive brands of beer. It’s a great example where the compounding growth opportunities, over the years, are laid out in front of us very clearly.

The Consumer Price Index for All Urban Consumers (CPI-U) decreased 0.2% in March. Year on year, the CPI-U increased 1.5%, well below the Federal Reserve’s (Fed’s) 2% inflation target. CPI-U declined in March mainly due to declines in energy and commodity prices. All other categories rose meager amounts. Year over year, medical care services increased the most, 3.9%, while gasoline costs decreased the most, 3.1%. 

The low rate of inflation gives the Fed plenty of room to focus on keeping mortgage rates low. Mortgage rates will likely be a key factor in the Fed’s determination of when it would be best to start slowing the pace of its asset purchases. The summer is peak selling season for homes, and it’s unlikely the Fed will want to mess much with mortgage rates by tapering its asset purchases before September.

Housing starts rose an unusually large amount in March, up 7% from February and up 46.7% from March 2012. The increase in multifamily starts drove the housing starts number higher, considering single-family starts actually declined 4.8% from February. These numbers point to not only how effective Fed policy can be in stimulating interest-rate-sensitive sectors of the economy like housing but also how much perceived demand there is for renting over owning. People still seem to like the option value of renting over owning: It’s easier to move to a new location or downsize when  renting compared with selling a home. I don’t expect that pattern to change much anytime soon.

Summary

• On Sunday, Venezuelans went to the polls to elect a new president to succeed Hugo Chavez—who passed away on March 5—and China posted some important macroeconomic statistics for the first quarter.
• For investors, the election probably has few near-term consequences because Venezuela is not classified as an emerging market.
• As China’s population migrates from rural to more urban areas, we could see many years of above 6% growth but probably few, if any, years above 8% growth.

For those who follow global economics, this past Sunday was an exciting day. Venezuelans went to the polls to elect a new president to succeed Hugo Chavez—who passed away on March 5—and China posted some important macroeconomic statistics for the first quarter.

Nicolas Maduro won the presidential election in Venezuela. This was widely expected considering Chavez handpicked him as successor and opinion polls had Maduro favored by double digits. Maduro effectively pledged to continue the socialist policies of Chavez while the leading contender, Henrique Capriles, ran on a platform to reverse many of Chavez’s policies. According to Capriles, Chavez squandered Venezuela’s massive oil wealth, putting the nation on the road to perdition.

What opportunities do South American countries present investors? And what is there to avoid? Here to answer is Derrick Irwin, portfolio manager for Wells Capital Management's Emerging Markets Equity team.

William R. Cline, Ph.D., senior fellow at the Peterson Institute for International Economics, discusses drivers of South American economics with Brian J. Jacobsen, Ph.D., CFA, CFP^® in this excerpt of On the Trading Desk^SM from Friday, April 5, 2013.

Listen to the full interview.

Can you give us a primer as to what have been historically and what may be the engines of economic growth throughout South America?
The big picture for Brazil, Chile, Colombia, and Peru is that they have greatly strengthened their economies since the lost decade of the 1980s and the debt crisis. The engines of their growth in recent years have been commodities, the very rapid growth of the market in China. But a crucial element is they’ve adjusted their fiscal policies. They’ve sharply reduced their foreign debt, which used to be something like 400% of exports of goods and services, now down to about 100%. Their inflation 3% to 5% annual rate, whereas in the 1990s, Brazil’s inflation reached triple digits. Their average growth has been on the order of 4%, and that’s solid but it’s not overwhelming for emerging markets. They did pretty well in the Great Recession. They didn’t have as huge a decline as for the United States and Europe. 

I think Brazil warrants special attention. It’s the region’s largest economy. It had high growth in this decade based on strong commodity prices, large inflows of capital. It has large offshore oil resources for future development. But last year, its growth fell very sharply, from almost 8% the year before to only about 1%, and its inflation went up to 6%. So it’s in an awkward moment of what you might call stagflation. It’s also taken a whole series of interventionist measures. Thirty percent tax on the auto imports, requirements of high local content for the ships, and the equipment to develop the offshore oil. A whole set of tax cuts for a special list of industries, pressure on the banks to increase the volume of their lending, pressure on Petrobras and minerals exporters to keep prices down. And this atmosphere of an intervention has increased uncertainty, and Brazil has a not too good history of protection, so the auto tariffs give one pause. Even so, I think it is a good bet that Brazil will have strong growth over the longer term, and forecasters are putting its growth at about 3% this year.