The $64,000 question . . .
by Guy Baker
So the $64,000 question (remember that game show?), should you be optimistic the recovery is in process or pessimistic and concerned it is going to get worse? All you have to do is read a few of the “name’ economists – Nouriel Roubini, Brian Wesbury, the WSJ and various other random sources to realize a lot is happening, but no one can read the tea leaves, yet.
You don't have to be an economist to feel a bit schizophrenic. One part of you is euphoric because we have seen the best market performance in decades. Another part of you reads “the economy is in … the worst recession since the Great Depression." So which is it?
We have to look beyond the hype and gain perspective. The only way to do that is look at some of the more critical indices and metrics. Realize too, the negative viewpoint is always rear view mirror driving. It is about what has occurred. And who wouldn’t be a bit depressed when we see the drop in GDP, the impact on the markets and the current massive unemployment?
My favorite economic phrase is, “on other hand". The markets have reacted to lower taxes and massive government spending expecting it will stabilize the economy and eventually put the it back on a growth path. According to The U. S. Bureau of Economic Analysis (BEA), the stimulus package has reduced income taxes just under $1 billion a month starting in March.
On the other hand, the GDP report for the first quarter was awful – a drop of (-6.14%) based on the Commerce Department's advanced estimate. We have now had the worst two-quarter performance in almost fifty years when we combine this with 4Q 2008. Ungirding this drop was a huge reduction in fixed investment, (-38%). The economy saw business cutback virtually everything, equipment, software, facilities.
This was the biggest quarterly decline in fixed investment in our history, going back to 1947 when these statistics were first kept.
Would it surprise you to know personal income dropped (-0.3%) in March? This was the 5th drop in the last six months. Probably the continuing job losses in the economy contributed to fading consumer confidence. Initial jobless claims remain over 600,000 a month.
We did see the savings rate increase to an annual rate of 4.2% of disposable income in March. This was the third consecutive month above the 4% level. But is this truly savings or not spending? Once consumer confidence is restored, this savings will likely return to spending, reflective of our financially illiterate populace.
Even so there was a slight increase in consumer spending. Even though GDP was down, personal consumption rose at an annual rate of (+2.2%) in the first quarter. This was reflected in the Conference Board's Index of Consumer Confidence rising for the second straight month.
Conclusion: Maybe the worst is past? The economy is still shrinking, but the rate has slowed. Most of what I read says growth is expected to resume in early 2010, but don’t look for the growth rate to be rapid. All those lost jobs are not coming back anytime soon. Wonder if we will ever see a 4% GDP growth rate again?
Some Indicators to keep in mind:
| Volatility | 36.5 |
Below 30 is good – |
ISM Orders |
47.2 |
Above 50 is expansion |
Pending Home Sales |
84.6 |
Above 100 is good – |
Unemployment |
631,000 |
Below 400,000 is good |
THE MARKETS
The markets didn’t really react to the Chrysler bankruptcy. It probably had been discounted over the last 6 months. The Dow [+1.69%; -6.42%], the S & P 500 [+1.30%; -2.82%], and the NASDAQ Composite [+1.47%; +9.02%] all advanced during the month. Total market gains over the past two months were nearly a 30% increase.
What is interesting is that the P/E multiples for the S & P 500 are basically flat. Maybe this is part of Greenspan’s concern about "irrational exuberance" on the part of investors. There is no rational reason for the market to gain given the fall in the GDP over the last 6 months and the decline in corporate profits.
I have been calling it the march of the lemmings. Other commentators refer to it as a "bear trap" because prices have risen so quickly. Given the proposed government spending, the looming increase in taxes and the potential for inflation, it is hard to see why any investors would be optimistic.
The optimistic answer is that the markets were oversold. And granted, the banks are in virtual ruin, there is no mortgage industry and housing developers are filing for bankruptcy, but so what? Other parts of the economy have been remarkably stable and energy prices have come way down. So maybe the pendulum has swung too far and we are reaping the benefit of the bounce. Who knows?
The "spread" between long and short U. S. Treasury yields continues to widen. T-bills remained at near zero levels, while the "long bond," 30-year Treasuries, moved up to over the 4% level. This difference of 3.93% is very large historically and portends future growth.
The good news for banks is that their profits on lending should improve considerably. Institutions that are not burdened by subprime mortgages or other "toxic waste" can borrow short and lend long. Their "net interest margin" is improving.
We just saw that Oil prices in the spot market are now $54 per barrel. It has not impacted the price of gasoline yet, but look for that to happen in the near term.
The U.S. dollar is still steady against the Euro (€). The Euro is holding at about €1 = $1.32. It was up as high as $1.57 at the end of last summer. Despite the world problems, the US economy has been a safe place for money. Perhaps, if this recovery is real, the dollar could strengthen even more.
Lot’s of wait and sees.