Venture Capital Quarterly Update
Silicon Valley Bank publishes a quarterly synopsis of VC investment trends, and it is now available. As a weekly reader of Investment Strategy Outlook, SVB Securities invites you to download this valuable report. (PDF-format, 900 KB)
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Era Of Low Rates Ending
The Fed is widely expected to raise interest rates by a quarter point on Wednesday, bringing to an end a 12-month period where rates were at a 45-year low of 1.0 percent. Futures markets have priced in rate hikes that would bring the federal funds rate to 2.25 percent by year's end. This is the equivalent to a quarter point rise at each of the Federal Open Market Committee's remaining meetings. Investors expect a Fed funds rate of 3.75 to 4.0 percent by the end of 2005, the lower end of the four to five percent range considered to be interest-neutral territory. (FT.com)
Treasuries Spooked by More Signs of Inflation
Treasury debt prices began the week down after a key reading on U.S. inflation proved higher than many expected. The Core Personal Consumption Expenditures Price Index rose 0.2 percent in May, when many had been hoping for only a 0.1 percent gain. Higher inflation could also mean the Federal Reserve would have to be more aggressive in tightening. The market is already priced for a quarter point increase to 1.25 percent, after the Fed concludes a two-day policy meeting on Wednesday. Some fear the central bank will have to be more than "measured" to head off inflation. (Reuters)
Phantom of the Fed?
Over the past year, two key inflation measures that the Fed uses may have been kept artificially low by the Fed's own actions, according to some economists. The long-but-soon-over, era of one-percent rates was justified by a lack of inflation as seen in the numbers. Capacity utilization was stubbornly low for an expanding economy, but there is real concern that much of that was due to outsourcing and obsolescence. In addition, declines in the Consumer Price Index have been found to be 70 percent, explained by rents and used-car prices - both heavily influenced by low rates. (NY Times)
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Alliance Promotes Shared Digital Content
A group of 145 global electronics companies have formed the Digital Living Alliance to support the development of PCs, electronics, and mobile devices that share digital content, such as music, movies, and television programs. The group will establish guidelines for building compliant consumer electronics that will display a seal of approval for products that meet the guidelines. (Reuters)
Semi Shortages Likely until 2006
Semiconductor shortages are likely through 2005, according to analysts at Future Horizons. Demand for integrated circuits continues to outpace supply, and no enhancements in yield or productivity will be able to keep up. Investments to improve wafer production will reach $50 billion in 2004, but the improvements won't ramp up production until 2006. (Future Horizons)
Pharma Industry, Moderate Thyself
In the next few years the federal government will impose price controls on prescription medicines, unless U.S. drug makers begin to moderate their prices, said Ernst and Young. The U.S. is the only developed nation without drug price controls, and the average medicine in 2002 cost 77 percent more in the U.S. than in Canada. The report urges the pharma industry to take steps to solve price woes before the government steps in. (Reuters)
California's Biomed Industry to the Rescue
California's biomed industry has become a linchpin of the high-tech economy over the last five years, according to a report by the California Health Care Institute. Of the 126 biotech, pharmaceutical, and medical device companies surveyed, 60 percent plan to expand their research efforts within the state over the next two years. Past investment in biomed companies is starting to pay off, as regional companies reported $32.3 billion in revenue last year and an estimated 643 prescription medicines are in development. (San Jose Mercury News)
VCs Advised to Proceed with Caution
The venture capital industry seems to be moving into a recovery period, although some industry experts caution VCs to shift slowly into gear rather than racing into risky investments. The pace of investment has picked up, with fundings of 28 percent, to $11.3 billion, so far this year, according to VentureWire. Valuations of previously funded companies are rising up: 17 percent in Q1 from earlier financing rounds. (Wall Street Journal)
Merge Lane
Dealogic reports that M&A volume in the U.S. doubled to $411 billion over the first six months of 2004. Global M&A volume jumped 47 percent, to $941 billion, while the number of transactions increased only 4 percent over last year, reflecting a preference for bigger deals. The most active industry sector was financial services, up 89 percent from the same period last year. (CBS Market Watch)
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Home Is Where Your Bubble Is?
About two-thirds of Americans have title to the place where they sleep every night. That is more than any country in the world by a fair measure. Secure property rights are a core part of our capitalist system. In the early days of the republic, if you weren't a white male and a real property owner, you couldn't vote. Although we feel that this is part of American culture, this home-buying behavior has been built by years of massive government incentives. Houses can be leveraged to the extreme, and the interest is tax deductible. "You, too, can buy property with no money down," scream the ads from late night television. Further, any capital gain on sale can be tax exempt. It's the only asset class we can think of where both the holding period and the sale are tax-advantaged. This combination of low interest rates and tax incentives has been nothing short of intoxicating. Leverage is good, our government told us.
A couple of data points are in order here. Debt service payments are above 18 percent of household disposable income versus 16 percent in 1992. The percentage of mortgages with adjustable interest rates is at an all-time high and the rate forwards have the 1-year Treasury yield advancing 350 bps in the next five years. The ratio of household mortgage debt-to-equity has also hit record territory. Meanwhile, prices have jumped 75 percent in the last 12 years. It seems like we are teetering on the top of an asset bubble of some magnitude; but before we all start hyperventilating, recall that the Nasdaq was up 632 percent in the eight years before the collapse in 2000.
The first signs that this party has gone on too long appeared last week. New and existing home sales shot up 14.8 percent and 4.6 percent respectively last month, but home prices overall fell by 2.2 percent. Many interpret the volume as a rush by buyers to capture the dream before that happy elixir of low rates and tax incentives disappears. Sellers are happy to get out with their profits while they can. One source has it that a one-percent increase in mortgage rates means a ten-percent reduction in affordability: read price. So, is what we're seeing here that last burst of exuberance before a collapse?
The bigger worry is not the foreclosures, property auctions, and evictions, but a broader wealth effect. Sir Alan made his mark in his early career by analyzing this phenomenon in great detail. Most American households look at their 401k statements once a quarter and fret a bit over the quality of their eventual retirement. But when the Johnsons down the street sell their house for less than you paid for yours, it changes the psychology in a dramatic fashion. Consumer spending drops, savings rates go up, and the demand part of the economy suffers. Although the housing bubble appears modest in most markets compared to the bubble in equities a few years back, it's axiomatic that bubbles are not easily deflated. So how long an adjustment period will be needed if this one bursts? Good question.
Well, that fateful day has almost finally arrived. We're not referring to the handoff of the administration in Iraq to the Iraqis (hopefully with gifts of top quality body armor), but, rather, the widely expected inflection point at the Fed. We anticipate that they will tighten monetary policy by 25 bps, but will also employ some soothing words for the bond market in the process. In fact, the words may remain "measured." This will be the first move up since May of 2000. What they do on Wednesday is not much in doubt, but what happens after that is the subject to considerable debate. The inflation hawks see the Fed pushing straight through to north of 4.0 percent before they stop for a breather, despite the fact that inflation data is still benign. Others are looking at a 1.0 percent real rate tacked on to a core inflation of 1.0 to 2.0 percent, and see 3.0 percent as the ultimate goal. Greenspan was recently confirmed for another four-year term as chairman but he must step down in February of 2006 as his non-renewable 14-year term as governor expires. He is probably thinking about his legacy and would like to leave behind that Fed nirvana of strong economic growth, low inflation, and full employment. But legacies are funny things. They seem to have a life of their own — impervious to all the speeches, interviews, and book writing.
— The Editor
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Consumer Spending Jumps with Inflation
U.S. consumer spending jumped last month, but inflation accounted for half of the gain. Personal spending was up a surprising 1.0 percent in May, according to the Commerce Department. The increase was the largest since October 2001's 2.4-percent rise and well above April's revised 0.2-percent increase. Analysts were not alarmed by the inflationary data, but virtually all agree that along with health economic growth, inflation is building momentum. (Reuters)
Q1 GDP Revised Down
The Commerce Department said The U.S. economy grew at an annual rate of 3.9 percent in the first quarter, slower than the 4.4-percent growth rate previously estimated. The economy, as measured in terms of gross domestic product, has now slowed steadily after a surge of growth in the third quarter of last year. The economy grew 4.1 percent in the final three months of 2003, following an annualized growth rate of 8.2 percent in the third quarter. The downward revision to GDP was unexpected. (CBS.MW)
Consumers Upbeat in June
Consumer sentiment improved slightly in late June, according to research from the University of Michigan. The University's Consumer Sentiment Index improved to an above-expectations 95.6 in late June, from 95.2 earlier in the month and 90.2 in May. Economists were expecting a slight decrease. Most of the improvement came from the consumer expectations component on the index; the Current Conditions Index actually fell. (CBS.MW)
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