2010May23 Seeking Certainty in an Uncertain World
2010May23 Seeking Certainty in an Uncertain World
Week in Review: May 23, 2010
Are we seeking certainty in an uncertain world?
Well, yes we are.
And certainty is hard to find in a global economy that is in a seemingly endless state of flux.
Economy:
The recently reported increase in unemployment claims is not a good sign. Since President Obama signed legislation extending federal funds for unemployment, we believe the increase is more likely due to people who have run out of benefits than it is optimism from a significant increase in available jobs. Those finding employment are often doing so with a significant reduction in wages. This is part of the deflationary cycle that we have written about for the past several years.
In spite of our government borrowing previously unthinkable amounts of money to “stimulate” the economy, neither business nor consumers are eager to borrow money. The Fed has given banks buckets of money at virtually no interest with the command to lend. First, the borrowers have to walk into the bank. They aren’t.
Home foreclosures continue to be a drag on the economy. Consensus forecasts do not recognize the magnitude of mortgage resets that are due over the next eighteen months. It is as large as the recent sub-prime problem.
A real estate investor recently described his acquisition of property at foreclosure sale for $36,000. The defaulted loan balance was $160,000. The property owner was still in possession and entered into a lease option agreement for $65,000. That was good for the buyer and the defaulting borrower. Not so much for the bank that decreased its assets by $124,000. That is deflationary.
The reduction in outstanding debt through foreclosures has been larger than the government’s borrowing. This is deflationary.
Cash purchasers are more conservative than those using credit. Further, the dollar transaction is smaller. This is another deflationary factor in our economy. The rebound hoped for by all, especially politicians in need of restored tax revenues, remains weak.
Mainstream economists are expecting next quarter’s GDP report to be encouraging and a confirmation that recovery is continuing if not strengthening. We are not so certain. Consumer spending remains the major driver in our economy. Gas and groceries are fairly stable. However, discretionary spending has changed and evidence abounds in nearly every shopping mall with closed stores and restaurants. Consumer spending on discretionary items has been declining since September and has entered negative territory.
The US Bureau of Economic Analysis (BEA) calculates GDP using the same questionnaire and process originally created in 1937 when employment was dominated by factories. The structure of our economy has changed. BEA has not. We expect the July GDP update to be a disappointment with another recession on its heels.
Europe:
The problems in Greece remain. The extension of credit to a spendthrift country cannot resolve the continuing lack of commitment to fiscal responsibility. Repercussions throughout Europe are unknown. However, independent nations cannot remain so without control of their own currency. "The game is up for a monetary union that was meant to bolt together work-and-save citizens in northern Europe with the party animals of Club Med.”
Stock Market:
Interest rates on savings and fixed income instruments are so low that, unlike the 50s, 60s and 70s, retirement is not possible for the average household. Starting with insufficient savings, there just isn’t enough interest at today’s low rates to pay the bills.
The Fed, trying to stimulate the economy, has forced investors into the stock market seeking sufficient capital gain to supplement future income needs. While it has moderated some economic pain, it has merely delayed the day of reckoning. It is essentially what the EU is doing in the attempt to mitigate the problems in Greece. In both cases, this is mal-investment by government.
The Dow Theory Newsletter warned investors this week toliquidate all positions in preparation for continuing market decline. This seems hard to reconcile with the “improving economic outlook” reported by much of the media. Morgan Stanley’s Business Conditions Index (MSBCI) suffered the sharpest decline in 2 ½ years due to sovereign credit problems overseas. Other factors in the MSBCI remain positive with improvement in expected capital expenditures and hiring plans. For the reasons reviewed above, we are more skeptical.
The bullish support for stocks has continued to deteriorate since the “Flash Crash” of May 6th which activated our sell discipline for our remaining ETF holdings. The Monday, May 10th market rebound briefly offered hope that cash was the wrong asset. That hope quickly faded as the week progressed. Our asset allocation model has responded to current trends by shifting to fixed income and cash due to the risk of continuing market decline.
Market segmentation continues to provide opportunities for portfolio growth. However, we will wait until purchasers regain control of market prices before we take positions in equities.
Responding to the unknown causes of the “Flash Crash,” regulators have created new curbs for trading which will be implemented by mid-June.
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