June 20, 2010 Week In Review

 

The issue is still jobs, without which, consumer spending is not going to revive. Whether households remain cautious over income security or municipalities struggle with decreasing tax revenues, everyone has become very price conscious. Rising wholesale prices are threatening profits. However, consumers aren’t very tolerant of price hikes. Aggressive price shopping becomes deflationary as store loyalty is replaced by the desire, or need, to spend less.

 

Based on consumer spending, our economy has been contracting since January. The supporting data will not be reflected in government GDP reports until July or October. The current contraction is almost half again as long as in 2006 and is now deeper. The 2008 contraction was much more severe, but our current one continues its declining trajectory.

 

Former Fed Chairman, Alan Greenspan, has received blame for contributing to, if not causing, the 2008 financial crisis by his decisions to keep interest rates low facilitating speculation in both the stock market and real estate. He now warns that the sovereign debt problems Greece faced are not improbable for the US.

 

Taxpayers understand that “The current federal debt explosion is being driven by an inability to stem new spending initiatives.” The spending will come to an end either voluntarily or by imposition from the credit markets. Neither will be comfortable, but the latter will be more so as Europeans are discovering.

 

Europe:

 

The hedge fund industry is $2 trillion in size. One of its largest annual conferences ended this week in Monaco with some interesting conclusions:

 

“…there has been a dramatic shift in the macro-economic environment over the last month.”

“It’s increasingly looking like a world of volatility and uncertainty.”

“If Greece had gone bust then so would Portugal and Spain and the entire banking system would have come down.”

“The European austerity…will likely lead to a double dip recession”

 

Luxemburg is the only EU country that has its spending under control and in compliance with the Central Bank’s deficit guidelines. Romania, after imposing distasteful pension and pay cuts, has resorted to begging. It is asking for donations to a government fund to counter budget shortfalls.

 

Since Warren Buffet thinks the wealthy should pay more taxes, perhaps the Administration should copy Romania and create an account encouraging Mr. Buffet to lead by example. He might reduce our need for China for a few hours.

 

Real Estate:

 

Banks are continuing to work through home foreclosures with every state having increases in May. April and May set a record for the number of homes foreclosed. In the past five years, over three million homes have been repossessed. RealtyTrac estimates another five million delinquencies will result in foreclosure.

 

In our opinion, real estate prices will continue to soften for several more years. Without an improvement in job creation, potential buyers will be reluctant to borrow. Lenders will be increasingly cautious about the quality of the equity backstopping any loan.

The cover of Fortune™ magazine, July 7, 2003, had a lead article, “Fannie Mae: Why It’s a Buy.” Front cover of a national magazine is usually the beginning of the end. In 2005, FNMA was defended by Congressmen in spite of apparent financial problems.

 

After the bail-out in 2008 and additional unlimited funding commitments since, FNMA traded this week for $0.35 and will be delisted from the NYSE. Financial failure of government enterprises, however, does not mean the end of taxpayer liability. It is not being shut down, unfortunately. Apparently, we will ask China for another loan and leave it for our grandchildren.

 

Stock Market:

 

An old adage is that “The stock market climbs a wall of worry.” Certainly, there is no shortage of items to cause worry. Whether watching the Dow or the S&P, May was the worst in many decades. With the number of stocks in positive trends declining precipitously, June has begun to exhibit some magnetism for institutional buyers.

 

Bullish percent indicators have turned positive at week’s end for the NYSE, NASD, equity mutual funds and world stocks. Using a football analogy, the ball has changed hands, and it is time to put the offensive team back on the field. Unlike football, we don’t have to put all of the players on the field at once.

 

Careful selection of portfolio components is always required. Remember that there is no crystal ball for tomorrow’s market outcome. Everyone will make some wrong decisions. Just do not rationalize away a reversal in your expectations. Do not stay wrong for long. Opportunities are easier to find than replacing capital.