October 17, 2011
For the last 2+ months I have been writing about the uncertainty in the economy and the resulting volatility in the financial markets. It is nice to bring you some better news for a change, albeit with caution.
Over the past 2 weeks there have been a number of positive developments and economic announcements that led to the strongest 2 week rally in the global equity markets since 2009. On the European front, leaders from Germany and France met and announced their commitment to finding a comprehensive solution to the European debt crisis. In the US, there have been 14 stronger key economic indicators reported over the last 2 weeks. Retail sales, manufacturing and even employment reports have all quietly improved over the last few weeks. Retail sales, perhaps the most important statistic as it reflects consumer spending and accounts for roughly 70% of US Gross Domestic Product (GDP), rose in September more than expected and the figures for July and August were revised higher. Third quarter earnings season started last week and so far more companies are beating earnings estimates (68% of those reporting through 10/14/11) than those falling short.
The good news is that despite being hit by a combination of strong punches (US debt/deficit; European debt crisis; continued housing slump; etc.) the US economy is still standing and continuing to grow, albeit slowly.
However, we are not out of the woods yet. The next several weeks will be quite telling in my opinion. Confidence, among both consumers and corporate leaders, is quite low. Proactive, coordinated and comprehensive action by elected officials both here and abroad is required to rebuild confidence and keep the global economy moving forward.
Here is what I am watching:
1. Starting this coming weekend with the summit meeting of European Union leaders to formally address the debt crisis on that continent.
2. The first week of November will be a meeting of the G20 (20 largest global countries) leaders. The European debt crisis and global economics will be at the top of the agenda.
3. November 23rd – the deadline for the US Super committee to put forth a plan for $1.2Trillion in deficit reduction.
If the powers that be can put their politics aside and put forward rational and workable plans to address they key issues then I believe the global economy will take care of itself. However, if they can’t then I am afraid the uncertainty and volatility we have experienced since early August is likely to continue. Stay tuned!
Please feel free to call me to discuss any questions or concerns you may have.
October 3, 2011
“Ev’rybody’s try’n to hide, to get away from that stormy sky. Perhaps it’s a sign of what we’re headed for” – Ray Davies, the Kinks
It’s looking more and more like the stormy skies that have been hanging over Europe, due to the Greece debt crisis, are turning the skies around the world gray as well.
We just finished the worst quarter (3Q11) in the financial markets since the 4th quarter of 2008 – the height of the financial crisis and recession. Now – as it was then – the only safe place to hide was in US Treasury securities. That is ironic given that the precipitating event to the recent market decline was the US deficit reduction/debt ceiling debate at the end of July, followed by the downgrade from AAA of US Treasury debt by Standard & Poors. In that 10-day period from 7/27/11 through 8/9/11 the equity markets (basis S&P 500) declined 17%. The last 7 weeks (from 8/9 through 9/30) have been on one helluva rollercoaster ride, living through 9 intraday swings (both up and down) of 5% or more. Despite that, we are right where we were on 8/9/11 as the equity markets have been stuck in a range from 1,100 to 1,230 on the S&P 500. Even Gold, which is where investors turned in August as a safe-haven, sold off some 15% late in September leaving it virtually unchanged from the end of July.
As bad as this most recent quarter has been I don’t believe we are in for a repeat of 2008. Below is a comparison of 2008 and today as prepared by International Strategy and Investment (a research firm whose work I follow). I think their points are spot on, with the exceptions noted.
A Comparison of 2008 with Today – 9/25/11
These are the things today that are better than they were in 2008:
1. Private sector debt was increasing at a $2.2T annual rate – now increasing at only a +$0.4T annual rate.
2. A housing bubble was bursting — there are no bubbles in the US today. (except maybe Treasury securities – my comment)
3. Housing and autos are very depressed — we are early in the expansion.
4. Corporate cash had been virtually unchanged for 2 years — now surging almost +20% annual rate for 2 years to +$2.1T,
5. Household financial obligations were 18.4% of income and rising — now 16.1% and declining.
6. Banks’ willingness to lend to consumers and businesses was declining — now increasing and close to record high. (although credit standards are much tougher – my comment)
7. The credit card delinquency rate was around 5% and clearly increasing — now around 3% and plunging.
8. We believe US banks are in much better shape today.
9. The Fed had raised interest rates (Fed Funds) to 5.25% going into the recession — now fed funds are zero and QE/Twist are in place.
10.Because 2008 is still so fresh, policymakers may be more responsive.
These are the things that are worse (or the same) today than they were in 2008:
1. Fueled by a decade of capital misallocation, the smaller European countries have developed bubbles in housing and government finances.
2. A Greece default and contagion into Italy, Eurozone banks, etc, may have the potential to produce a Lehman like shock. (Lehman bankruptcy was a surprise, Greece default is almost a given – my comment)
3. Eurozone fiscal policies are being tightened significantly.
4. US policymakers today have much less room to maneuver than they did in 2008, on both fiscal and monetary fronts.
5. There’s a huge foreclosure overhang in the US and banks are reluctant to make mortgages.
6. Obama and Congress are at an impasse, which among other things, is hurting both business and consumer confidence.
As for the US economy, last week US Gross Domestic Product (GDP) for the 2nd quarter of 2011 was revised up to 1.3% from 1.0%. While certainly not robust, the US economy continues to grow. 15 of the last 19 weekly economic indicators (jobs, unemployment, income, etc.) came in better than expected, including this morning’s Institute of Supply Management (ISM) manufacturing index which showed an increase in manufacturing in August.
My sense is that the recent volatility in the financial markets is based more on the fear of policy errors by dysfunctional governments (both here and abroad) than about deteriorating economic conditions and corporate earnings outlook. However, given that perception is reality and right now the general perception is for stormy weather, I believe it is time to shift to a more conservative posture. While I remain optimistic my level of concern has increased. So far we have weathered the storm, for the most part, by giving back previous gains. I would like to keep it that way.
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