2011Jan9 Week In Review: Positive, but Cautio
“He who will not economize will have to agonize."
Nationally, there is consensus that we have too much government debt. The new Congress has followed through on its first campaign promise and passed legislation in a 410 to 13 vote imposing a 5% reduction in their operating budget. The real challenge lies ahead in actually reducing government spending. Nearly everyone can point to something as government waste. Unfortunately, one’s “wastefulness” is someone else’s “sacred cow.” Cows don’t howl but those losing government largess do.
The government extracts resources from the economy either by taxation or borrowing. Reversing current trends will not immediately impact the current financial health of our country. It will be an important step in preserving it as a global economic leader.
Reports about new job data this week have been all over the map. The official numbers indicated unemployment fell from 9.8% to 9.4% implying a recovery. In December, the economy added 103,000 jobs, but the forecast was for three times that. Plus, we need 150,000+ jobs monthly just to absorb new entrants.
The active employment rate has dropped to a 25 year low. The government statistics exclude those who have given up looking for work. That exclusion is estimated to be just shy of 4 million people. If they are included, the adjusted unemployment rate would be about 11.7%.
Chairman Bernanke’s Senate testimony on Friday indicated an 8% unemployment rate is four to five years away even though “the economy is on track.” He, also, reiterated that the deficit is unsustainable. There was no explanation of how the current “track” would resolve the “unsustainable.”
Consumers are deleveraging as a natural process of aging and financial concerns. Businesses are deleveraging in response to the latter. Fed policy assumes that putting more money in the financial system will reverse this process and create growth. HSBC reports that deleveraging matters but demographics may be the real driver. The Japanese economy may be a truer harbinger than many have wanted to see.
We have had a year over year decline in monthly personal consumption of 2%. This is partially offset by the 2% payroll tax holiday, but not everyone is in the work force to benefit from it.
The housing market remains in turmoil which increased this week as a Massachusetts court ruled against Wells Fargo and US Bank in foreclosure cases. The cases sought to prove the process for securitization of mortgages provided for a proper transfer of lender rights. The court was clear that the very certain conditions for foreclosure in the Commonwealth had not been met. Case Dismissed.
The case is one more foundation stone for those who have been foreclosed to seek damages by suing for proof that the lender actually had the legal right to foreclose. In many cases, the proof will not meet legal standards. The next step will be class action litigation for damages. Major banks are already funding a damages trust from which to pay claimants. That would be unnecessary if they were confidant of their claims and processes.
The negative equity problem is not disappearing, nor is it as large as often represented. Two thirds of homes have mortgage assignments. Without a transaction, real estate values are a guess. It is not possible to distinguish between the slightly positive and slightly negative equity properties. Most of the problems are concentrated in a half dozen states where speculation was greatest.
We view this as a potentially serious problem for mutual fund investors whose funds are principally invested in mortgages. Mortgage funds typically offer higher monthly distributions and the implied safety of GNMA and FNMA “guarantees” about which there should be significant doubt.
Demographics are still the dominant factor in restoring housing. Starter home demand should resurface by the end of next year. Demand for larger trade up homes is a decade away. We still expect housing to have further price declines this year and next. It is not a situation the Fed can solve by pumping money into our financial system.
Investment Company Institute data shows investors reversing an eight month trend preferring bonds and shifting money back into equities. As they have done so, the market has pushed up against technical resistance evidenced in recent selling. The Fed’s statements of continuing support for the economy appears to have finally created some investor confidence in the future. The ever present difficulty today is that the market is much more sensitive to political rationale than to economic fundamentals.
Our “falling dollar” has recently rallied with investors avoiding the Euro. The rally has caused problems for some countries with commodity based economies. Chile, the world’s major exporter of copper, has broken tradition and intervened in the currency markets to protect its own interests. Copper is up 18% since October 1st with corresponding inflation problems for China and other importers. Meanwhile, the Fed is trying to create inflation while ignoring its resurgence in food and energy. But then if you don’t eat, drive or need heating oil…
Oil has risen 10% since then and is generally assumed to reduce GDP by ¼%. Gasoline has risen from $2.70 to $3.15. Robust consumer demand is not driving this. Every penny increase creates a $1.5 billion drag on economic growth. A rise to $4 per gallon would reallocate another $100 billion into gas tanks.
During the last quarter, commodities have been attracting more investors with the asset class gaining strength over fixed income and currencies. Our data still favors domestic and emerging market equities over commodities, but the gap is closing. We agree with PIMCO’s Bill Gross that “All investors should fear the consequences of mindless US deficit spending.”
Historically low interest rates allowed corporate borrows to raise an all time weekly high of $48.2 billion. Whether that is for reducing interest cost on current debt or expansion is to be determined.
This week’s stock decline created a small rally in fixed income. However, the price trends remain strongly negative.
“When the facts change, I change my mind. What do you do, sir?” - John Maynard Keynes
Our plan is “the plan will change.” What is your plan?
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