Spring Fever? Or Are We There, Yet?
Dear Investor –
Have you been looking and listening? In addition to the beginnings of Spring – the new sounds of the chirping of birds, the longer daylight, the flowering of crocuses – there has been the soft, quiet glimmer of hope poking its head above the landscape of the recent economic devastation. No, it’s not a vibrant, resounding change, but rather a subtle one. One that suggests that while things have not gotten better, they’re starting to not get worse. That maybe, just maybe, we’ve begun to hit an important inflexion point -- an economic equinox, if you will.
In our last communication, we talked at length about the coming challenges and opportunities. We discussed the deep systemic issues affecting the economy, and the psychology which had the ability to dramatically magnify the impact of different issues. We talked about the enormous commitment the new administration was seeking to undertake, and the potential for truly lasting, positive change.
Have you noticed, for example that the broad markets, for what they’re worth as prognosticators, have shown a great upswing in March and the first days of April? Many have called it nothing more than a bear market rally, which suggests more downward movement to come. Maybe so, but certain fundamental economic indicators – like inventories, consumer spending, housing starts – are suggesting that things may be turning. Have we gotten there yet – did we really hit a true bottom, finally? Is this rally for real, or are the fevers of Spring combining with some tidbits of positive data to create an orgiastic investor frenzy, only to disappoint? Have the markets turned from a glass-is-half-empty to a glass-is-half-full psychosis, and numb to the bad news?
The questions fall in line. After an annualized and excruciating drop in GDP in the last quarter of 2008 of over 6%, and a similar one projected for the first quarter of 2009, can we be looking at a leveling this year? Is the economy finally, maybe, possibly entering a phase where the pain is not only slowing, but recovery may even be beginning? Could the latter part of 2009 actually show a positive growth in the economy?
The Arguments For…There are essentially five major arguments in favor of an optimistic outlook for the economy. First, key economic trends – such as retail sales, inventories, manufacturing and factory orders, cargo shipments, copper and commodity prices, mortgage underwriting, new and existing home sales and prices – are all demonstrating real signs of life. Really. Second, trillions of dollars of cheap money from the Treasury and the Federal Reserve’s monetary policy have already resulted in improved bank lending and an improvement in the non-bank “shadow banking” markets. Third, cheap commodity prices – including oil, gas, energy and raw materials – are dramatically reducing production costs. Fourth, the areas of damage and fear of the unknown – the lack of clarity as to toxic assets, variability of US government policy, anxiety about the next shoe to fall and political gridlock – are resolving, and new accounting standards should provide some additional relief to the banking sector. We’ve taken a roll-call of the demons, not just in the US but around the world, and they’re being rounded up and shipped off. Lastly, massive stimulus dollars from the US stimulus package and other programs and tax cuts are about to enter the financial system to the tune of hundreds of billions of dollars, with added dollars from around the world. Check out the recent commitment by the G20 nations for a commitment of $1.1 trillion to the International Monetary Fund.
The Arguments Against…The global recession outside the US is only in its early phases, and the commitment of the governments and central banks to stimulus – China aside – is much less relatively than here in the US. Unemployment is continuing its nasty downward trend, with over 700,000 lost jobs this past month raising the unemployment rate to 8.5% (which climbs to 15.6% if you include those forced into part-time work). Commercial bank lending – particularly for credit card, business loans, and real estate – is still badly lagging. States and municipalities, often the last shoes to drop, are only now going through their round of intense budget adjustments and layoffs. Finally, the impacts of the stimulus package are unknown, and there is valid skepticism about several of the major components of the programs – from the various new acronyms (TARP, TALF, PPIP) and the middle-class tax cuts.
We’re inclined to agree more with the arguments in favor, though it’s still early in the game. In fact, Dr. Paul Kutasovic makes a compelling argument to that effect. For those of you who want to explore these arguments in more detail, I urge you to check into Paul K’s recent slide presentation: Crisis in the US Economy: Causes, Solutions and Outlook, posted on our website.
By the way, for those of us still sober enough after all this misery to notice, the irony is that all this borrowing and extended credit -- the way out of this mess -- is the way we wrongly got in. In other words, massive borrowing by individuals and businesses, poor oversight and irresponsible practices landed us in this firestorm. The government is now borrowing to the hilt and asking us to join in and spend, spend, spend, to get us out. But Americans don’t do well with mixed messages: instead of spending last year’s refunds we used them to reduce credit. That said, it is clear that despite right-wing and libertarian dogma and some significant missteps, this active and massive intervention is essential to our economic survival. There will be negative consequences to be sure – perhaps future inflation, aberrations in the financial markets, an overabundance of construction workers, lack of moral hazard, over-regulation, a weakened dollar, extensive long term systemic debt, etcetera. Capitalism, as a whole, will now have to expend energy to defend itself as the most viable economic system.
Back to the point. We’re not the only ones seeing this positive economic data. The markets – both bond and equity – have been vigilant and responsive to the change in economic sentiment, perhaps even too jubilant. Seeing the economic data as evidence that the doors have been officially opened for the fire-sale, the last several weeks investors have climbed over each other into both equities and bonds driving the markets up over 20% these last few weeks. As the minor deviation of the saying goes, “the harder they come, the harder they fall, and vice-versa.” Rebounds from this much negativity tend to be violent. But we’ve seen this before, only to once again retest the bottom. What makes this time possibly different are the oh-so-dim lights glimmering at the end of the tunnel.
So what’s our investment approach? As indicated in our last newsletter and individual meetings, we’re very much aware of the economic data, and have begun to carefully dip feet in the waters as we indicated we would when we observed changes in certain indicators. Still, we’re taking a cautious approach, as it’s early in the game, the markets are still volatile, corporate earnings season is coming upon us, and as we await the results of the Treasury’s banking “stress tests” – which will give us a sense of the stability of the all-important financial sector. We feel that bonds represent good value at this time, with the exception of Treasuries (which may be experiencing an asset bubble of their own). This includes various government-backed securities and quality companies. Equity opportunities are abundant, but we’re stepping very carefully and slowly. Alternative investments – particularly commodity areas – are poised for rapid run-ups, but are highly volatile. Real estate, currency areas, and international opportunities are present, but demand caution.
This is a difficult dance. As we’ve said many times before, and as evidenced by the explosive March equity run-up, the markets turn around very quickly and violently – in rough proportion to the extent that they’ve dropped. On the other hand, the markets could still turn downward again. So while we’re somewhat optimistic about a turnaround in the economy before year end, we’re going to continue to monitor them carefully. We’re stepping back considerably from our hyper-defensive positions of the past year, but we’re still taking a cautious stance regarding investments.
Please feel free to call with any questions or thoughts.
Peace,
Ron SteinGood Harvest Financial Group
631.423.6501