Economic and Capital Market Update

Morris Segall      2009 economy, business landscape, Cash for Clunkers, consumers, economics, recession, trends

It looks like it is all falling into place. Improved housing sales, increased factory orders and shipments, the “Cash for Clunkers” program moving autos off of dealer lots and stimulating increased automobile factory production and the best news of all, stock markets around the world are hitting 12 month highs. World central bankers, including our own Ben Bernanke, pronounce the recession over as GDP for the June quarters show positive growth in France, Germany, Japan and most of Asia. The capital markets buying the rumor are soaring fed by huge amounts of liquidity added to monetary systems by the world central banks as they embarked on economic bailout and stimulus programs. This past Friday’s U.S. stock market action has typified the recent ebullience among bankers and investors. The Dow Jones Industrial Average breached the 9500 level for the first time since last October buoyed by further good news in existing home sales and Ben Bernanke’s positive comments.

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The July Monthly Employment Report: More Good News But…

Morris Segall      2009 economy, Cash for Clunkers, consumer credit, economic, employment report, Establishment Survey, Federal Reserve, government, unemployment

On Friday, the Labor Department reported the monthly employment situation report for the month of July. The Establishment Survey, the one most widely used as the benchmark for measuring monthly job creation showed nonfarm payroll employment declined by 247,000 in the month of July, a number better than widely held forecasts. It is the lowest level of monthly job losses since last August before the massive economic declines in the fourth quarter of last year and the first quarter of this year. It is also two thirds lower than the peak level of monthly job losses recorded in January of this year at over 740,000. With a number this low, naturally job losses in most major industry sectors measured by the survey saw significant declines in job losses from the surprisingly weak June levels. The exception was retail trade which saw job losses in this category double from 21,000 in June to 44,000 in July reflecting the continued poor consumer spending environment. Nonetheless, economists and financial commentators viewed the dramatic improvement in the monthly numbers as further evidence of the recession’s end and imminent economic recovery. To be sure, we concur the huge decline in monthly job losses reported since March’s 652,000 follows the general trend in first time unemployment claims which peaked at 674,000 in late March and has declined to 550,000 as of August 1st and signifies a peaking in new job destruction in this cycle and fortifies other economic data suggesting the recession has bottomed.

However, as we have written in previous posts, “Current Economic News Needs a Dose of Reality“, May 15th, 2009, the dramatically improved job loss numbers in the government’s Establishment Survey continues to be at odds with other government employment reports and empirical data we are getting from job seekers and businesses. Inconsistencies include:

1. While job losses in July measured 247,000 and a 9.4% unemployment rate, the civilian  labor force saw over 400,000 people leave it in July versus June and over 570,000 since May. The civilian labor force participation rate in July fell to 65.5%, matching the lowest level of worker participation in this cycle in March of this year.

2. While monthly job losses per the Establishment Survey have declined from 652,000 in March to 247,000 in July, first time unemployment claims, representing new job layoffs, have declined from 674,000 to 550,000 over the same period. A figure twice as high as the establishment survey estimate.

3. The number of unemployed workers including discouraged workers and part time workers who cannot get full time employment continued to increase in July. The number of people leaving or not in the work force increased substantially (over 1 million people) in July reflecting discouragement with finding gainful employment. This is consistent with the empirical information we hear from job seekers who say jobs are very hard to land and employers who tell us they are still not hiring and will have to lay off more workers if sales do not pick up.

4. The average work week increased by .1% to 33.1, the second lowest work week during the entire recession. We will see if the recent three month trend of monthly job losses per the Establishment Survey of approximately 330,000 is accurate. We continue to believe these recent numbers are vulnerable to downward revision when the Labor
Department makes it annual benchmark revisions next March. For now, the consensus is taking the numbers at face value.

There was another very important economic announcement on Friday. The Federal Reserve released its report on Consumer Credit for the month of June and for the fourth consecutive quarter, consumer credit declined. Consumer credit contracted at nearly a 5% annual rate in June, nearly double the 2.6% annual rate of decline in May. Since its peak in the third quarter of 2008, consumer credit outstanding has declined 3% or over $75 billion at the end of June, 2009. Most of this decline has occurred in revolving credit, i.e. credit cards. Since the third quarter of 2008, revolving credit has declined 6% or over $55 billion. Clearly consumers are continuing to pay down their debt in an attempt to de-leverage their balance sheets. Combined with a continued high savings rate in excess of 4% at the end of the second quarter, it is clear American consumers are paying down debt and increasing their liquidity. These trends and the existing high levels of unemployment continue to suppress consumer spending.

The government is artificially creating increased consumer spending and retail sales via its “Cash for Clunkers” program and the other stimulus package spending that will be impacting the economy over the next four quarters. However without job creation rather than “less worse” job destruction, a sustained consumer led spending increase is unlikely. In fact, to the extent the government creates consumer spending near term, it could result in deflated consumer spending longer term when the government stimulus ends. The key to a real economic recovery continues to be the revival and return of the consumer, with a job and the financial capacity and creditworthiness to spend. The consumer led us into the recession. He will have to lead us out. Recovery in this cycle was always going to be a long stretch in re-liquifying and de-leveraging the consumer so he could “get back in the game”. He is doing just that but the loss of his job is making those tasks longer and more difficult. While these trends hurt the economy in the short term, they will help sustain the recovery in the longer term.

Morris R. Segall, CFA, CIC

Healthcare Reform and the Democrats: We have seen the enemy and they are us!

Morris Segall      Blue Dog Democrats, democrats, economics, economy, healthcare plan, healthcare reform, obama, republicans

As I feared from the beginning, the future of President Obama’s proposals were going to be in the hands of conservative or “Blue Dog” Democrats largely from the south, west and midwest. Their opposition to the high costs of the plan and a large federal presence in the system was going to be the defeat of the President’s program, rather than the expected “knee jerk” Republican opposition. The Republicans are now a marginal party lacking numbers and influence in the Congress to pass or defeat any legislation. It now appears the “Blue Dogs” will win out and “water down” the President’s plan to the point where it will be largely a failure in terms of progressive healthcare reform. It will eliminate a federal entity to offer insurance in competition to the private insurance industry. It will exempt thousands of so called small businesses, even those with payrolls of $500,000. It will also extract higher health insurance premiums on low-middle income wage earners. And most egregiously, push more of the increased Medicaid burden on the states who are already facing massive budget deficits and have no money to pay for anything. As a result of the “Blue Dog” opposition, in conjunction with the negative statements from the Republicans and the propaganda from the healthcare industry, popular support for the President’s program has been seriously eroded and the fact that Congress will adjourn for the month of August without passing healthcare reform legislation will give the President’s opponents an entire month to erode popular support further and “gut” the pending bills in committees even more.

I fear the final result will be little if any real healthcare reform; increased premiums for insured’s, particularly if private insurance firms have to accept less healthy members; and a continued increase in uninsured people as businesses are exempt from providing mandatory healthcare coverage. The winners will be the insurance and pharmaceutical industries who will have “dodged” a bullet for massive healthcare overhaul and reform. The costs to them will be a fraction of what the President’s program would have cost them and they will make it up by charging higher prices to the public. The losers will be the public who will continue to pay more for an unworkable system and doctors who will get paid less in an effort to control healthcare costs. By the way, the cost saving from the current compromise plan agreed to by the Democrats in the House is  $100 billion, the amount we sunk into General Motors and Chrysler in a futile attempt to save them from bankruptcy. As I said in my previous piece, it would appear we are more prone to spending billions saving corporate America than insuring the health of the American public.

The Democratic Party offered the American public comprehensive healthcare reform in the last two elections and the American public gave the Democratic Party the electoral majority they needed to get it done. It appears the Democrats decided that was a promise they are not willing to keep.

Morris R. Segall

Recommended reading:

Turning the Corner: GDP, Housing and Cash for Clunkers

An Open Letter to Congress

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Turning the Corner: GDP, Housing and Cash for Clunkers

Morris Segall      2009 economy, Cash for Clunkers, consumers, economics, GDP, government, housing

Friday’s news of the “less worse” second quarter GDP was received as another piece of good news by the stock market as further evidence of the end of the recession. It capped a week of improving economic news on housing. But the real economic sweetener that offers a tangible boost to the economy in the near term was the announcement on Friday that the government’s “Cash for Clunkers” program was extended by the House of Representatives and augmented by a further $2 Billion in government funds.

Of all of the various government schemes and bailout programs to stimulate the economy over the past two years, the government finally got it right with this one. We have stated repeatedly, the economy was not going to recover until the consumer started moving “goods off the shelves”. Well goods are moving off the shelves or rather cars are flying off of car dealers lots. OK  the U.S. government is buying the cars but the end result is dealers are emptying their inventories and will soon reorder from the factories as long as the government program is in force. The Senate needs to also approve the program’s extension or it will expire by the end of this week. We are optimistic the Senate will vote to continue the program before they adjourn this Friday. This will in turn start the manufacturing replacement cycle. The “Cash for Clunkers” program is expected to increase retail sales beginning in July, increase industrial production by the fourth quarter and even help factory employment due to the higher production rates. Higher auto production will have a widespread positive impact on manufacturing and distribution sectors. It is our belief this program will insure a positive growth in U.S. GDP in both the third and fourth quarters of this year. Now let’s be clear. This is artificial consumption and will deflate when this program expires which we assume will be at year end. We don’t think Congress will ante any more money for this when the current funding is used up. By that time, the rest of the economy may be starting to fill in the void .

To that end, we are seeing for the first time a trend of positive news on housing that would support our long standing forecast of a bottoming in the housing cycle in the second half of this year and obviously remove a major depressant to the economy. This past week both new and existing home sales rose for the third month in a row. And for the first time since the housing market imploded, home prices showed a monthly increase according to the widely followed Case-Shiller Home Price Index. In addition, inventories of existing and new homes are now getting down to normalized levels. Here again, the recovery process is not widespread and is largely centered in homes in the $150,000-$300,000 price range as home buyers take advantage of bargain prices, ample supply and willing sellers in the deflated housing market.

Lastly, the second quarter GDP was reported with a contraction of 1%. While this was better than consensus economic forecasts including our own, it is the first of three readings on the quarter and the one subject to the most revision as more data is processed over the next month. The second reading on the quarter will be reported at the end of August and will be more definitive. While the report was mixed with continuing depressants in consumer spending and business fixed investment, the quarter saw the beginnings of increased government spending which helped offset the weakness in consumption and business investment. Nonetheless, the quarter fulfilled our forecast of a decidedly “less worse” performance than the severe contraction of the first quarter. Importantly, the huge decline in business fixed investment appears to have bottomed in the second quarter and will not be the huge depressant on the economy going forward.

So for the following reasons we now believe the third and fourth quarters of this year will show positive growth though we are not forecasting an economy embarking on a full recovery. Unemployment is still too high and there is a great deal of unutilized production capacity that will keep private sector spending suppressed. However, the bulk of the government stimulus spending will hit the economy in the next four quarters providing a strong plus for GDP growth and exports are picking up from rising economic growth in Asia led by China. These pluses along with reduced minuses from consumption and business fixed investment should equate to positive GDP growth in the second half. The question is can the private sector recover on its own without the huge and finite pull of the federal government. The answer remains the level of unemployment and consumer incomes.

As the macro economic environment improves, the outlook for corporate profit growth also improves providing further stimulus to rising stock markets here and abroad. The likelihood of a sizable correction in the equity markets is diminishing the further we go through this year and into next. We have long been bullish on equities over the 2010-2012 period and increased equity allocations in our capital markets strategy this past spring once a bottom in the recession was perceptible. We have hit that bottom and reaffirm our longer term capital markets strategy of getting fully invested in U.S. and overseas equities with a strong allocation to commodities, including gold.

Morris R. Segall, CFA, CIC