Sunday, February 1, 2009

Bravo! 

If you haven’t picked up a copy of Thursday’s Wall Street Journal, please do.  It reads like Hemingway.  I laughed, I cried, I liked it better than "Cats."  The world suffers no shortage of drama at the moment.  Our new Treasury Secretary has initiated a dangerous economic tiff with the Chinese.  First, he accused them of manipulating their currency, and then they accused us of ruining the world economy; both of which are true.  Nonetheless, given the fact that we need to sell $2 trillion in Treasury bonds to finance our “porkulous” package and they just happen to have $2 trillion in cash, perhaps we should wait until we cash the check to pick the fight.

Also adding dramatic flair was Russian Prime Minster Vladimir Putin’s declaration that the US dollar makes an irresponsible global currency, which might draw attention to the fact that his own currency has collapsed.  Furthermore, when Dell CEO Michael Dell asked him how his company might help them develop Russia’s IT infrastructure, he responded, “We don’t need your help.” 

Also last week, after two days of meetings, the Fed issued a prepared statement that read like an Escher drawing, seeing as it has cut interest rates to zero already and has previously committed to reflating the economy by any means necessary.  As a poker player, the Fed is more or less all in, and has “called” the economy. In a sign of bi-partisanship, the Obama camp held a cocktail party to woo support for the stimulus bill from Republicans, who demonstrated their gratitude by unanimously voting against it.  Eleven of his Democratic allies defected as well, likely bitter that their pork never hit the grill. 

Wall Street resumed its animal spirits by rallying for 4 straight days, led by the financial sector, which may soon have the opportunity to swap their $2 trillion of toxic assets for taxpayer funds or freshly minted dollars.  With the market economy spending all day watching C-Span 2 and trying to trade off each political suggestion, these times make for high drama.  Thursday’s sell-off stems from memories of the TARP debate, which precipitated a 30% decline in the major indices.  A repeat of this tomfoolery seems unlikely, but not guaranteed. 

4th Quarter More Like an  8th  

GDP reports Friday told everyone what they already knew.  The economy shrank significantly in the 4th quarter at the hands of timid consumers, although less than the 5.5% Wall Street expected.  GDP shrank by 3.8%, the most since 1982.  Consumer spending fell 3.5% after falling 3.8% in the 3rd quarter.  For the year, the US economy expanded a mere 1.3%, down from 2% in 2007.  Looking into 2009, the high inventory levels will likely steal from GDP in the 1st quarter.  Here is the bottom line: the US economy has been far too dependent on debt-fueled consumption and must restructure.  Consumer spending dominates our economy and with unemployment rising and confidence falling, it cannot be relied upon to lead us out.  Household saving rates have risen from near 0% to 2.9% as frugality reigns. With the consumer hibernating, investment activity gasping for credit and export markets suffering their own declines, the burden of economic advancement falls on the government.  Government spending increased 5.8% in the 4th quarter, while consumption fell 3.5%, investment declined 19.1%, and exports decreased 19.7%.  This is why the debate over the stimulus package is not “if” we need stimulus, but “how much” we need.  Furthermore, what percentage should be tax breaks vs. spending and transfer payments?  Tax breaks hit the economy faster (see last year’s GDP), while spending programs require bureaucracy for implementation, also known as economic leakage.  If a bill gets passed mid-month, and includes fast acting tax relief, we should look back on the Q1 2009 GDP print as the cycle low.  Hang in there.      

The Price is Right-er

Housing sales increased 6.5% in the month of December, which is good news, as average home prices fell 18.2%, also good news.  While prices falling at an accelerating pace may not seem cause for celebration, the markets may be zeroing in on realistic clearing prices.  Bottom searching in housing requires the following: 1) the cessation of new building (we have plenty of national inventory) 2) rising foreclosure sales to drive prices to clearing levels and 3) frozen buyers re-engaging, drawn by low interest rates and low prices.  Housing affordability has increased to near pre-bubble levels, yet price-to-rent ratios signal further declines.  Prices have fallen 25% since August of 2006, and they likely have another 10% to go.  A buyer’s credit from the federal government would amount essentially to a mail-in rebate for homebuyers, which may artificially elevate the price equilibrium point in question.  But as one who favors removing a band-aid quickly, the sudden drop in prices would hurt but would also allow us to heal more quickly.

Animal Spirits

What makes economies thrive is a well-rewarded sequence of risk-taking.  The opposite of risk-taking is hoarding.  While hoarding has been rewarded to this point by loss avoidance, two forces are now purposely diminishing the attractiveness of hoarding.  First, low interest rates make idle capital expensive.  Many firms are now discontinuing their Treasury-backed money market funds due to the fact that they do not yield enough to accommodate a fee, which forces capital to pursue more risk.  Additionally, with the money supply expanding rapidly, the trillion dollar stimulus package in play, and the discussions around the creation of a $2 trillion toxic asset purchase program, inflation expectations have returned.  Nothing eats at low yielding cash quite so voraciously as inflation.  With stocks squarely in a trading range and government bonds showing losses year to date, some signs of profit pursuit are beginning to emerge.  Equity mutual fund flows have been positive each week this year.  New issuance in the high yield bond marketplace has returned with a vengeance and while buyers are still requiring lofty interest payments, these have fallen in 2009.  And in an even more encouraging development, IPOs (initial public offerings) have begun populating the calendar after being almost completely absent last year.  Given the flurry of seemingly relentless government activity, nothing would support the markets more than growing sentiment that the riskier assets might be US bonds and US dollars.  Corporations may not have the ability to manufacture currency to make interest payments, but they certainly have cleaner books than the US government.

Super Bowl Sunday offers the opportunity to give meaning to another meaningless indicator, the “Super Bowl indicator.”  Historically, an NFC victory equates to higher market returns than an AFC victory.  That would favor the Cardinals over the Steelers.  This is no time to abandon superstition.  I will be decked out in Cardinal gear, and likely waving a large foam finger that reads, “Go market!”  I may even paint my face. 

Patience is the investment strategy of the day. We are simply range bound, waiting for a very pregnant Capitol Hill to reveal its progeny.

David S. Waddell 

Senior Investment Strategist

David S. Waddell, biography.

Click here for more information on Waddell and Associates.

**This blog represents the opinion of W&A and is for informational purposes only. It is not intended to be construed as tax or legal advice by the recipient. Past returns of investment are no guarantee of future results.

***Any data reported in this blog has been compiled from the Wall Street Journal, Morningstar, Investors Business Daily, or various other informational internet sites.