2011Jun13 Summer Doldrums? Enough Already!

"...structuring concentrated portfolios and owning out-of-favor securities generally prove both helpful to investment success and hurtful to [a manager's] personal reputation."¹

Stock Market:

The long-term trends for equities remain in bullish trends in spite of the six week correction that we have been enduring. As we illustrated last week, most sectors of the market are oversold which we believe to be temporary. Japan's auto and technology production is expected to be back at normal levels adding to our GDP. Japanese car ads have increased in an effort to regain market share. Over the next few months, the recent pullback in gas prices should provide an up-tick in consumer spending. However, if GM's CEO gets his wish cheap gas won't be around for long. He wants Congress to raise gasoline taxes by an additional $1/gallon as incentive to buy smaller cars!

Even though Congress fails to recognize it in the budgeting processes, changes in tax rates change behavior. With tax benefits expiring at year end, we should see an increase in businesses' capital spending before then add a bit to our GDP.

Job growth is essential for sustainability. Last week's reported 54,000 new jobs report was not only pathetic but a rigged number. The federal government does not include jobs lost due to business closures. It assumes the 206,000 who lost their jobs last week due to closures were hired by surviving firms. However, reporting 54,000 sounds better than if subtracting the 206,000 for a net job loss. Increasingly, "Hope and Change" is becoming "Hope for Change." 

Bonds:

Chairman Bernanke's recent comments on the economy's weakness should result in the Fed delaying sales of its bond inventory. Though who will step in to buy the 85% of Treasuries that have been sucked up by the Fed is a great unknown. We doubt that any buyers will show up for the current interest rate. We have been expecting a spike in interest rates as a magnet for investors and to compensate for the risk of a potentially declining credit rating for US debt instruments. When that spike happens, long dated bonds will become very attractive and PIMCO's short position will turn around and be strongly positive.

Oil:

Each of several US oil service companies have prevailed at Iranian auctions to drill up to 3,000 oil wells per year. Some big ifs exist about the government's ability to rebuild the pipeline infrastructure over the next six years. If all comes to pass, Iran will supply as much daily oil as the Saudis. Two offshore terminals are under construction with another two in planning. This could be a massive benefit, especially for China's growing need.

Europe:

While Portugal, Iceland, Ireland and Greece (PIIGS) have dominated European credit concerns, it is soon to have an extra "I" as Italy's government stimulus is ending due to lack of affordable credit. Current debt is already 119% of GDP and austerity measure are anticipated for 2012. Sale of consumer durables is negative 6.8% from last year. This indicates consumers are downcast in their view of the future. Economic stagnation from deferred spending and more saving leads to deflation. Continuing Keynesian policies will result in downgraded credit and steeper austerity measures with greater decreases in Italy's standard of living. It is not a good ending. Will they not learn from the PIIGs before becoming one?

The yield on Greek bonds has risen to 26% as speculation increases on Greece being not so politely pushed out of the EU. Germany has a lot to lose in Greek loans but supporting a failing country may be even more expensive. US financial institutions only hold $1.8 Billion of Greek debt. If the Greeks think EU austerity is bad, wait until they are operating on their own. Even the IMF will be stretched to bail them out if it wants to have any reserves left for the other PIIGs. The good news? The U.S. Treasury Bill remains the global haven of safety.

Real Estate & Unexpected Hope:

The difficulties of the single family home market have been reported here and discussed at length on our Saturday morning radio program. This market segment is not going to heal for some time to come. However, foreclosures and job losses have displaced families still in need of shelter.

Rental rates have been increasing due to rising demand. As new owners of foreclosed properties, banks are not in the rental business. They remain reluctant to accept deep discounts to unload their property inventory. Multi-family construction was ignored during the "housing bubble" of the last decade but is beginning to rebound. According to Societe Generale, it may be a source of job creation that we really need in spades. However, we are skeptical that it will be sufficient to offset reductions in force by state and local governments.

Are you upset, even angry, about our country's economic malaise and single family home price declines? You are not alone. Gretchen Morgenson is assistant business and financial editor and columnist at the New York Times. Her new book, Reckless Endangerment, explains the decades of decisions that laid the foundation for the Real Estate Bubble and its collapse.

¹ David F. Swensen, Unconventional Success, pg.296