Charge!

Morris Segall      consumer credit, consumer sentiment, consumer spending, consumer spending sea change, credit card debt, Economic Growth, future trends, GDP

This past Monday afternoon, February 7th, the Federal Reserve released its report on consumer credit for the month of December, 2010.  Since peaking in the third quarter of 2008 consumer debt has steadily declined over the past two years by over $150 billion. Most of that reduction has been in revolving debt, largely credit card debt. This has reflected a combination of consumer debt repayment and the write-off of consumer loans in default by lending institutions and credit card issuers. After a further decline in November of last year, consumer revolving debt increased by nearly $2 billion on a seasonally adjusted basis or a 3.5% annual rate in December. This was the first increase since August of 2008 and most of that increase came in consumer credit card debt. Non seasonally adjusted data is more impressive, showing a better than $9 billion increase in revolving credit led by credit card gains at commercial banks. This change in credit card debt balances could be a signal the consumer de-leveraging is about over and consumer evaluations about their finances are sufficiently improved to allow them to begin increasing credit card purchases. If the December increase is not an aberration and continues in 2011, it will signify a dramatic change in the consumer spending dynamic.

 Up until last year’s fourth quarter, consumer spending had been anemic due to high unemployment and lagging consumer income growth, in addition to the de-leveraging of consumer balance sheets. That changed in the fourth quarter as consumer spending surged to pre-recession levels. The Federal Reserve data would indicate expansion of consumer spending in December was supported by the use of credit cards. This would explain the large increase in consumer spending (.7%) in the month of December, well above the .4% increase in consumer income growth in that month. If the December data portends a return to credit card financing by consumers, the prospect of continued high levels of consumer spending in 2011 is heightened. The willingness of consumers to increase credit card debt will counteract the suppressing forces of moderate consumer income growth and a continued high level of unemployment. This will promote a greater consumer spending contribution to the economy than one would have expected and augments the outlook for improved GDP growth this year, importantly led by the consumer.

 It remains to be seen if the December data is the beginning of a trend and we will be looking at future data to confirm or deny this important development. However, a note of caution. If consumers abandon the financial discipline of the past two years and return to spending in excess of income growth, a consumer spending renaissance will be short lived and a financially weak consumer sector will re-emerge, constricting long term economic growth.

Morris R. Segall, CFA, CIC

January Employment Report: Weak but Contains “Green Shoots”

Morris Segall      "green shoots" in employment, 2009 economy, 2010 employment data, employment report, future trends, strenthening 2011 economy, unemployment, winter recovery in jobs

The January monthly employment report reported on Friday showed a dispappointing creation of 36,000 jobs versus the 150,000+ again expected by economists and analysts. 2010 job market data for both the Household and Business Surveys have been revised to reflect new Census numbers and new seasonal adjustment and other measurement changes. Since October’s 171,000 revised level of new jobs, November, December and now January’s job growth have not been close to the 150,000 level expected since October. Yes, the revisions to November and December job growth numbers  have been positive, as we expected, amounting to a cumulative 40,000 additional jobs from previously reported data. Nonetheless, the average number of new jobs created in November and December of last year amount to a weak level of slightly over 100,000. We have no doubt the very low level of job creation in January was negatively affected by harsh winter weather and expect an upward revision when February monthly job data is reported because of the absolutely low level of job creation reported. We also believe the weather in January interrupted timely and more complete survey reporting. However, December winter weather was harsh also and still allowed for over 120,000 new jobs being created. In addition, the weather so far in February continues to be severe, so it might be a March thaw before job creation, per the monthly surveys, show a more normalized pattern. In addition, major benchmark revisions to 2010 data will be forthcoming in February which will reflect new readings on the 2010 labor market. Finally, the unemployment rate surprisingly dropped for the second month to 9%. However, the drop in the unemployment rate since November primarily reflects a decline in the labor force of over 750,000 workers, a sign of continued discouragement among American workers.

Despite the low level of new jobs reported, the January employment report shows some continued improvement in  labor market trends that we mentioned in our January 9th blog article. Namely, further improvement (+ 49,000) in manufacturing employment making it three consecutive months and a cumulative increase of 78,000 jobs in this important sector. It supports the strengthening in the manufacturing sector in the fourth quarter of last year which is leading to increased hiring. In addition,  jobs were created in wholesale and retail trade, in furtherance of the fourth quarter hiring in these sectors. This reflects the strong retail sales trends in the fourth quarter of last year and the positive indications for retail sales in January as recently reported by major retailers. Lastly, the January data show a drop in temporary help hiring, the first such decline in a year, and significant increases in IT and administrative jobs indicating a broadening of permanent hiring in the important Professional and Business Services category. Continuing a positive trend first seen in December, job losses due to the ending of temporary assignments dropped again by nearly 500,000 and the number of  unemployed 5-14 weeks in duration dropped by 168,000 and are down over 400,000 since October. Thus, while the overall employment situation is still weak, we see “green shoots” in the monthly data and improvement in the weekly unemployment claims data. Other positive data on consumer and business spending and manufacturing orders and production augur well for further improvement in job creation going forward.

Morris R. Segall, CFA, CIC

Fourth Quarter 2010 GDP: First Cut in Line with Expectations

Morris Segall      consumer spending outlook in 2011, Fourth quarter and full year 2010 GDP, highest level of consumer spending, inventory restocking cycle, negative impact on GDP from low inventory accumulation

This past Friday, the Commerce Department released its first reading on the fourth quarter and full year 2010 report of U.S. GDP. As we stated in our website article, “Great Expectations-2011″, January 6, 2011, we projected fourth quarter GDP to be stronger than that of the third quarter led by consumer spending.  Fourth quarter GDP increased at a  3.2% annualized rate, within the 3%-4% range we had projected in our January 6th article. It was the largest increase in GDP since before the recession,  matching the 3.2% of the second quarter of 2007. In the preliminary numbers released on Friday, Personal consumption expenditures led the advance, growing at a 4.4% annualized rate, the largest increase since the 4.5% annualized growth in the first quarter of 2006.  Personal consumption expenditures comprised over 3% of the total growth in fourth quarter GDP, once again the largest increase since the 3.1% contribution to total GDP in the first quarter of 2006. Personal consumption surged (up nearly 22% annualized)  in durable goods and increased strongly (up 5% annualized) in nondurable goods. Both levels of growth were at pre-recession levels. However, unlike previous reports on GDP growth since the recovery from the recession, Private domestic investment recorded negative growth (-22.5% annualized), due to a large decline (over $100 billion) in inventory investment in the fourth quarter from third quarter levels. Indeed, the decline in private inventory investment reduced fourth quarter GDP by nearly 4%. The decline in private business investment in the fourth quarter was the first since the 18.5% decline in the second quarter of 2009, just as the recession was ending. Bolstering GDP in the fourth quarter was an increase (+8.5% annualized) in net exports as imports fell and exports strengthened. Government spending was negative in the quarter with a reduction in federal defense spending and a continuation of reductions in state and local spending.

The first reading on GDP growth for all of 2010 was an increase of 2.9%, consistent with our forecast of 3%. Clearly the fourth quarter surge in consumer spending pushed full year GDP growth to the 3% level which was not visible at the end of last summer as the economy sagged during the late spring and summer months. However, as we noted in our January 6th website article, we do not believe the rate of increase in fourth quarter consumer spending can be sustained into the first half of 2011 as the level of spending is far outstripping the gain in consumer income. We believe the consumer will restrain his spending in the first quarter to restore liquidity he drew on to finance his purchases in the fourth quarter. Our economic analysis just published on the Presentations page of our website (www.spgtrend.com) reveals no increase in consumer credit card debt through November of last year. We thus believe consumer spending was done with cash and debit cards. In addition, discretionary consumer spending in the first quarter will be suppressed by the harsh winter weather curtailing shopping at the malls and the large increase in food and fuel prices which will “pinch” consumer incomes.  A rebound in consumer spending may occur in the spring and summer of this year as the weather thaws and pent-up consumer demand reappears. However, the degree of consumer re-emergence will depend on the level of job creation in the first half of this year. While we have noted in our previous blog (January 9th) article on December unemployment, an improving trend in unemployment, conclusive evidence of a change in the chronic unemployment environment remains to be seen. 

Two further observations. Friday’s GDP report is the first of three. It is subject to material revisions as more complete data is collected over the months of February and March. Because the level of inventory accumulation recorded in this initial report is so low, we would not be surprised to see it revised higher and thus increase the readings on the fourth quarter and full year GDP for 2010. Second, the large increase in consumer spending in the fourth quarter depleted retailer’s shelves. There will be an inventory replacement cycle in the first half of this year which will partially fill the void of reduced consumer spending and keep the U.S. economy growing at a heightened rate.

Morris R. Segall, CFA, CIC

December Unemployment: Still a mixed Story

Morris Segall      employment report, improvement in unemployment trends, unemployment

Friday’s unemployment report for the month of December continued to show the mixed data we have been seeing since late last summer. While the unemployment rate for the month dropped steeply to 9.4% from 9.8% in November ( due primarily to a contraction in the labor force), the job creation in the month was a disappointing 103,000 jobs. Estimates of new job creation for December had ranged from 150,000 to 300,000. Consistent with our comments in our December 6, 2010 website article on November unemployment, we believe erroneous seasonal adjustment factors and incomplete business survey results are again understating new job creation in the initial monthly report. As we stated in that article, we believed the very low job creation data reported initially for the month of November, 2010 would be revised upward. Indeed, in Friday’s December monthly report, November job creation was substantially revised upward from 39,000 to 71,000 and October’s job creation data was also substantially revised upward from 151,000 to 210,000. In fact since July, revised monthly job data has shown a cumulative increase of 280,000 additional jobs being created versus initial estimates. We had stated in our December 6 website article that we noted the trend of upward revisions to the initial job creation data and the revisions in the December report confirms this trend. We expect a similar upward revision to the December data when the January monthly data is reported and when the semiannual revisions to 2010 data are made in February. We base this on the large reduction (over 500,000) in December in the number of people who have lost their jobs due the completion of  temporary jobs. This is the largest positive change in this category in a year. In addition, we also note a major positive shift in the number of unemployed by the duration of unemployment. The December report showed a reduction of over 500,000 people who have been unemployed from less than 5 weeks to 26 weeks. This also is the most dramatic improvement in this series since the end of the recession.

These positive trends do not change the fact that while employment is improving (we also believe there is a marked improvement in initial unemployment claims below the 450,000 level which had been a sticking point for so long), it is still well below levels necessary for accelerated economic growth. The fact remains that over 15 million Americans are unemployed and under-employed and over 6 million of these have been unemployed for over 27 weeks. The latter continues to grow and represents an increasing problem of long term unemployed. Labor remains a surplus commodity and wage growth in 2010 was less than 2%. The new fiscal stimulus of extended and new tax cuts enacted by the “lame duck” Congress aids the environment for increased job creation and offers the best hope since the end of the recession of improving employment. It remains to be seen if the promise will be fulfilled but the data is moving in the right direction and our optimisim for improvement has increased.

Morris R. Segall, CFA, CIC

The 12th Congress: And We’re Off

Morris Segall      federal debt ceiling, government funding, new Congress, political gridlock, reduce federal government and national debt, Tea Party conservatives

Tomorrow the 112th Congress will be sworn in and members of the new Republican majority in the House have already declared their first order of business will be the repeal of President Obama’s healthcare legislation enacted last year. It would appear the bipartisan cooperation of the lame duck Congress last month  is over and the ideological divide resulting from the November elections will be prevalent particularly in the House. Of the 242 new Republicans in the House, nearly 90 will be conservatives ideologically aligned with the Tea Party. They will represent a large, dogmatic contingent committed to reversing the legislative and fiscal spending programs of not only the Obama administration but those of the Bush administration as well. They feel empowered by the mid term elections to move forward with a concerted effort to cut federal spending, reduce the size and power of the federal government and reduce the national debt. Their efforts will cause friction within the Republican party whose mainstream leadership is committed to producing legislative results that will produce jobs and help the economy. Nonetheless, the House Republican leadership has announced its intention to cut $100 billion from the Federal budget this year as a concession to the “Tea Party” agenda. Details of where the cuts will come from are missing. Keeping the hard line conservatives “in line” will prove a challenge to the Republican leadership.

While providing a challenge to the Republican party leadership, the new, hard line conservatives will represent an attack force to the Democratic Party whose slim majority in the Senate will have to hold back efforts to undue their legislative programs of the past two years and their legislative legacy of the past seventy years. The partisanship that has intensified since the Clinton administration promises to become more vehement given the rhetoric and promised zeal of the newly elected conservatives. One thing is certain. The federal largess doled out over the last two years to “jump start” the U.S. economy is over. The level of federal stimulus promises to be reversed by the new fiscal conservatives and that will force the private sector to fill the void and carry the burden of economic recovery going forward. It remains to be seen if the private sector can successfully accomplish that task.

In the meantime, the first battles between the parties and the President will be the funding of the federal government and the raising of the debt ceiling. The current continuing resolution funding the federal government expires in March and the current debt ceiling of approximately $14 trillion is expected to be reached in the spring. At this time, the rhetoric from the Republican conservatives indicates opposition to raising the debt ceiling and refusal to fund the government without substantial fiscal and regulatory reductions. We expect a game of “chicken” for the next two months as we near the deadlines for both. We expect the President to be conciliatory as he continues to move towards the political center, avoid devastating gridlock and attempt to paint his Republican opposition as irresponsible and unable to effectively serve the body politic. The President wants to get re-elected in 2012 and he stands to win politically if the Republicans grind the government to a halt.

Stimulus is in place for aiding the economy and the stock market in 2011. The new Congress will decide the future trends in both thereafter.

Morris R. Segall

Europe’s Debt Crisis: “Off With Their Heads” ?

Morris Segall     

This evening in London, angry student protesters attacked the Prince of Wales and his wife in their car as they were enroute to a theatre event. As the protesters pounded the Prince’s car several were reported to have shouted “off with their heads”. Off with their heads? Europe’s debt crisis and the resulting austerity programs are now spawning intensifying public outrage. Thank goodness this was 21st century London and not 18th century France. We have witnessed a series of public demonstrations, including riots and strikes from Greece to France and the U.K. However, the attack on Prince Charles and his wife signals a new, uglier and more dangerous public reaction to the draconian austerity measures adopted by Eurozone governments in their attempts to deleverage their national balance sheets.

Fortunately, Prince Charles and his wife were unhurt and were able to escape serious injury from the mob. The fact that this attack was in London on the heir to the British throne is historically unprecedented. The fact that the protesters were primarily students is also noteworthy. The students were protesting the huge increase in college tuition enacted by the British government as part of its harsh deficit reduction program. The increase in college tuition will put a college education out of reach for many students and thus doom their economic future. In addition to alienating a typically activist segment of the population, the result of denying advanced education to the next generation will condemn Britain and other countries adopting the same measure, to a future of economic decline. In our blog article of May 10, 2010, “From Panic to Relief”, we stated that “spending reduction programs will not be popular domestically and social unrest should be expected.”  We also commented in that article of the political costs of such social unrest. We will comment on these developments in more detail in a soon to be published article on the European debt crisis and its consequences on our website, www.spgtrend.com. However, tonight’s attack on the Prince of Wales raises the extent of the public backlash to a new, disquieting level and could be the beginning of an ugly winter of discontent in Europe that could result in serious political upheaval in the Eurozone with negative repercussions for the European Union.

Morris R. Segall

And now it’s Ireland

Morris Segall      another European debt crisis, failure of EU austerity measures, Irish debt crisis, Irish loan bailout, more debt crises in Spain and Portugal, political upheaval and shift to left in Europe, social unreast in Europe

In our blog articles published in May (May 6, 10 and 31, 2010) we commented repeatedly that the European debt crisis and the responses by central banks and the European Union’s austerity programs were not going to “go away” and would continue to resurface as the solutions offered were untenable and the loan facility made available were not more than “band aids” to keep the countries in the European Union from defaulting on their sovereign debt. We never doubted the European Union, IMF and the European Central Bank would be able to forestall those disastrous occurrences. We were far more suspect of the ability of the European populations to support the austerity measures and the success of those austerity measures to meet the debt reduction goals outlined. Furthermore, we were skeptical the capital markets would continue to be accommodative to the more distressed European economies in providing financing at affordable interest rates. Finally, given the ongoing pressure from high unemployment, weak real estate markets and continued high loan losses, we believed it only a matter of time before the inevitable pressures would create another round of loan losses within European banks. Since we published those articles, Greece has been “bailed out” by the European Union’s-IMF sovereign debt facility which has also helped Spain and Portugal avoid similar fates. However, popular discontent with the austerity programs announced by most of Europe has resulted in demonstrations, riots and strikes from the Aegean Sea to the U.K. including France, Spain and Portugal.

Now it is Ireland’s turn. After hearing all summer and into the fall of Ireland’s financial soundness despite its chronic debt issues, it seems Ireland is not so financially sound at all. Indeed, despite the statements by the Irish government of its “control of the situation” over the last several weeks, the Irish government is about to accept a loan of approximately $100 billion from the European Union-IMF loan facility to stem the weakness in Irish sovereign debt caused by the deteriorating situation in Irish banks. Increased loan losses in the Irish banking system, which is fully backed by the Irish government, have caused Irish debt to increase to almost one-third of Irish GDP. Financing costs have escalated and there has been a virtual “run” on Irish banks. Capital markets were increasingly becoming closed to Irish government and Irish banking financing and capital markets around the world were getting “ hit” on another resurfacing of the European debt crisis. So with another sovereign government bailout, another “band aid” has been applied to salve market fears of a government default. However, the ruling Irish government has become so unpopular as a result of the weak economy and draconian austerity measures due to go into effect next year, that it will likely be replaced in elections due to be held next year by a center-left government even if it is one of a coalition of parties. This is the prevailing shift in politics within Europe as a result of the debt crisis and the tax increases, worker layoffs, pension cuts and other austerity measures enacted by European governments as they attempt to reduce debt levels. We warned of social unrest leading to political upheaval in Europe in our May blog articles and we are getting it.

So if Ireland accepts the EU-IMF bailout we expect a brief period of relief but the unfortunate truth is the European debt crisis is not going away. This month it is Ireland. Over the next several months it will be Portugal and Spain and if European economic growth slows down next year, it could be Italy as well that need EU-IMF support. The question becomes, how much money will the EU-IMF have available if those other countries need loans to avert financial disaster.  We have steadfastly been of the opinion that the EU solutions to the debt crises in their member countries are ill advised and doomed to failure. We will be publishing a major article on our website, www.spgtrend.com after the Thanksgiving holiday outlining in detail the problems in Europe and why we believe the Union will fail.

 Morris R. Segall

The President Travels to South Korea: The Fallout Continues

Morris Segall      currency devaluation, Fed monetary stimulus, inflation, protectionist measures, trade wars, weak capital markets, weak President, weak U.S. Dollar

President Obama went to Seoul, South Korea last week to attend the G-20 economic summit in the hopes of getting international cooperation on the low valuation of the Chinese currency and to sign a landmark trade agreement with South Korea that was supposed to open South Korea’s markets to increased American exports. The President failed in both initiatives and found himself the object of increasing foreign ire at the recent Fed monetary stimulus. This trip was supposed to be a high profile offset to the political drubbing the President suffered the week before. Instead the trip was an extension of the election debacle and added a new element of international rejection of American policy objectives and leadership. 

In our blog article, “The Fed Adds More Stimulus”, November 3, 2010, we commented on the negative effect the Fed’s stimulus would have on the value of the Dollar on international currency markets. This turned out to be a major confrontational issue with our trading partners in Seoul and clearly caught the President and his advisers off guard with its intensity and raising the possibility of a new round of trade protectionist measures and international currency devaluations. These threats and new sovereign debt concerns in Ireland caused stock and bond markets to decline around the world last week. While the leaders of the G-20 nations vowed to work to avoid such destructive actions, they were notably vague on the specific measures they would implement to accomplish these objectives. This lack of specificity led to the capital market nervousness and declines.

The failures of the President in Seoul and the broad and sharp criticism of American monetary and economic policies signify the shift in economic power from the mature, industrialized nations, led by the U.S., to the emerging economies led by China, India and Brazil. This power shift has been accentuated by the recessions in the U.S., Europe and Japan which have left these countries in a weakened financial status versus the fast growing Asian and Latin American economies. We should not underestimate the negative impact the Fed’s stimulus program is having on our own capital markets and our financial relations with the rest of the world. Since announcing its bond purchase program on November 3rd, the bond market has plummeted as fears of inflation and rising interest rates in the future overshadowed the benefits of current bond purchases. In addition, the spectre of international retaliation to the Fed actions via protectionist measures and competitive currency devaluations is also unsettling world capital markets. The Fed action is very unpopular abroad and has tarnished the reputation and esteem of the Fed and Fed Chairman Ben Bernanke. This needs to be defused and we expect the Fed to “step back” from the stimulus program at the first opportunity to do so. A stronger than expected reading of economic growth in the fourth quarter and an increase in wholesale and retail inflation numbers in the fourth quarter and first half of next year could be the excuse the Fed needs to “defer” this program.

As for the President, he is more wounded than before he traveled to Asia. He has been rebuffed bilaterally and collectively by nations that are our allies and trading partners. The President looks weak and may be considered by the rest of the world as increasingly irrelevant in view of the political setback at home and the continued weakness of our economy. We have written previously of the perils to American foreign policy when a U.S. president is deemed irrelevant on the international stage. Such a perception in the world of President Obama will have far reaching consequences in other important foreign policy initiatives such as disarming Iran and fighting international terrorism in Afghanistan and Pakistan. The remaining two years of the Obama presidency look to be difficult ones for the U.S. both domestically and internationally.

Morris R. Segall

September Unemployment Report: Is job growth really improving?

Morris Segall     

The financial news has been ablaze with the seeming improvement in job creation contained in the October employment report released on Friday. While the creation of 151,000 new jobs in that report was far in excess of analyst estimates, let’s look at the facts.

1. Of the 151,000 new jobs in the Business Establishment Survey, over 7,000 were in wholesale trade, approximately 28,000 were in retail trade and nearly 35,000 were in temporary help services. That totals 70,000 jobs or nearly half of the 151,000 job gain.  Both wholesalers and retailers have announced in October they were increasing their hiring of seasonal employees for the holiday selling season. It is reasonable to ask how many of the 70,000 hires in wholesale, retail and temp services will be permanent hires after New Year’s.

2. The average workweek in the October business survey was only 34.3 hours, unchanged from the level of August and consistent with the low level of hours worked during the entire recovery period since the summer of 2009. With the continued low level of hours worked, it is hard to make the case businesses are now stepping up permanent hiring.

3. In the Household survey, the number of workers who could only find part time work in October increased by 116,000 to almost 2. 6 million people. In October, 2009, the comparable number was just under 2.1 million and in August of 2010, the number was 2.3 million.

4. In the October Household survey, the number of people in the civilian labor force dropped by over 250,000 from September and a little over 200,000 from the number in August. This reflects people who are leaving the work force because they cannot find work and are disillusioned with the prospects of finding employment. As a result, the labor force participation rate in October fell for the second straight month to 64.5% from 64.7% in August and September and is below the 65% participation rate of October, 2009. As a corollary, the number of people not counted in the labor force in October grew to 84.6 million, an increase of over 460,000 from September, an increase of 637,000 from August, 2010 and an increase of nearly 2 million people from October, 2009.

5. The number of workers unemployed 27 weeks and longer reached a level of 6.2 million, up 83,000 from the level in September and 586,000 from the comparable level of October, 2009.

6. First time unemployment claims for the week ended October 30th showed a deterioration back over 450,000, a level the labor market has not been able to consistently breach on the downside all year.

So, while the headline numbers of job growth in October look impressive, we remain unconvinced they signal a turning point in employment. In regards to the upward adjustments to job creation in August and September, the multiple revisions we are seeing in prior months employment numbers are making the monthly employment report very unreliable. Our analysis of other employment measures continue to paint a weak employment situation.

A final note. Nothwithstanding our skepticism about employment, we sense an improvement in GDP growth in the current quarter from the weak levels of the second and third quarters led by an increase in consumer spending and manufacturing shipments. Consumer spending is being induced by the upcoming holidays and cannot be sustained thereafter without a dramatic improvement in job creation. The manufacturing sector will need sustained growth in end demand to sustain the recent improvement from the summer lull. Both are question marks after the first of next year.

Morris R. Segall, CFA, CIC

The Fed adds more stimulus

Morris Segall      cost of capital, high unemployment, inflation, monetary stimulus, Wall St. speculation

This afternoon the Fed announced its long awaited monetary stimulus in the form of additional purchases of  U.S. Treasury securities. The amount of the package is $600 billion in the 2-10 year maturity range and will average approximately $75 billion per month until the end of June, 2011. An additional $300 billion in security purchases will be made from reinvestment of securities maturing during the next six months.

The purpose of the Fed action is to stimulate the economy which everyone admits is growing at too weak a pace to reduce unemployment and stimulate consumer spending. We have been against further intervention by the Federal government and the Fed to artificially stimulate the economy in an effort to generate growth that the private sector is not providing. These efforts distort normal market forces and trends and result in nothing more than temporary surges in economic activity that relapse when the artificial stimulus is removed. With interest rates already near zero, this additional stimulus via security purchases is all the Fed has left to accelerate economic growth. We remain skeptical it will succeed and fear it will lead to more economic problems down the road.

We believe the additional liquidity created by the Fed will lead to higher inflation next year as higher commodity prices are already being passed along in the wholesale and retail sectors. Nominal inflation for the three months ending September 30 has jumped to 2.7% from .6% in the six months ending September 30, led by higher cotton, food grain and energy prices. This will filter through in higher prices for food, gasoline, heating oil and clothing to consumers. In addition prices are going up in the service sector for education, medical and auto and home repair costs. Adding additional liquidity will add further inflationary pressure at a time when the economy doesn’t need it. While the Fed action will depress interest rates on intermediate term bonds, it will also further depress the value of the U.S.  Dollar which is also inflationary. Finally, the additional purchase of $600 billion of new securities that will be added to the Federal Reserve balance sheet which will take the Fed’s asset holdings to approximately $3 trillion or approximately 3 times the normal level for the Fed. This will strain further flexibility for the Fed if conditions warrant. We have consistently warned of the consequences of “pumping up” the economy with excessive liquidity and federal deficit spending. There is a price to be paid for those actions and we have already begun to see it in the swollen federal budget deficits and national debt which are depressing the U.S. Dollar and ultimately leading to higher inflation. We do not believe this new form of stimulus will lead to job creation which is needed to change consumer psychology and increase consumer incomes and spending. This additional liquidity will go into the capital markets to fuel additional speculation and risk taking using cheap U.S. debt and a depreciated U.S. dollar. Another boon for Wall St. and a dubious help to Main St. Contrary to the prevailing Fed belief, the lack of economic growth is not due to the cost of capital. It is being retarded by the lack of demand for and the availability of capital because of high unemployment and high credit risks. Artificially reducing already low interest rates on U.S. debt is not the solution.

Morris R. Segall, CFA, CIC

First Reactions to the Election

Morris Segall      angry electorate, gridlock, mid term elections, one term president, Tea Party, vote against not a vote for

Final results of the mid term election are still being tabulated but results to this point are unmistakable. We will comment more fully on the election results on our website. This much we believe:

1. The President and the Democratic party were soundly rejected by an angry electorate that we have been observing since the 2006 elections.

2. The voters also were sending a message that they want politics and national policy to change and fast.

3. The instrument of voter ire was the Republican Party but the vote on Tuesday was a vote against President Obama and his policies not a vote for Republicans. Voters have repeatedly voiced their discontent with both major political parties.

4. This election has further polarized the nation between liberals and conservatives. This election has further split the electorate along ideological lines transcending political parties. Newly elected Republicans are decidedly conservative. This increased ideological split will make governance in Washington going forward very difficult and we reiterate our prediction that this election would result in gridlock in Washington for the remainder of President Obama’s presidency.

5. The conservative ideology of the Tea Party which was so instrumental in the Republican victories will be difficult to absorb and harness in the traditional Republican Party and presents a challenge for the Republican Party to unify and present a unified party with a coordinated agenda for positive change.

6. The vote on Tuesday is a challenge to the entire Washington establishment and if the Republicans can’t effectuate change that creates jobs, control federal deficits and spurs economic growth, they will be voted out in 2012.

7. The Democratic Party will not be as supportive of the President as it has been in the first two years of his presidency. We have commented on the split in the Democratic Party in our blogs last summer on the healthcare debate. A split Democratic Party and an ideologically conservative Republican Party may result in a lame duck President who may not be reelected to a second term. Increasingly, this election and its fallout brings comparisons to the ill fated Carter administration which we have alluded to in previous blog postings.

8. While the anticipated gridlock in Washington may be applauded in the near term by the stock market, this gridlock will exacerbate the long term economic problems facing this country, and that will not be appreciated by the stock market longer term.

In summary, yesterday’s mid term election was a “sea change” event that portends ill for President Obama and the Democratic Party but the increased conservative mix of victorious candidates also raises problems for Republican Party. It remains to be seen if the President will abandon his ambitious agenda in favor of compromising with the Republicans and whether the new, conservative Repbulicans are disposed to compromise with the President. One thing is for sure. The American people have little patience for gridlock and want results for the middle class.

Morris R. Segall

Industrial Production declines in September

Morris Segall      declining manufacturing orders and backlogs increased inflation, industrial production

After growing at an average annualized rate of nearly 7% from the third quarter of 2009 through the second quarter of  2010, industrial production declined in the month of September for only the third time since June, 2009 and industrial production in the third quarter dropped to an annualized rate of 4.7%.

We have been noting the weakening trends in manufacturing over the spring and summer in our website article of September 7, 2010, our Economic Update Presentation of September 28, 2010 and our blog articles of October 2nd and 5th, 2010. The cumulative effect of weakening orders, a book to bill ratio of less than 1 and the most recent readings of contraction in manufacturing and non-manufacturing backlogs appears to have taken its toll on industrial production. The decline in September was broad based led by machinery, autos, appliances and furniture and utilities. It is possible the decline reported in September will be revised upward but our concern about the weakening trend in manufacturing remains.

The recovery in the manufacturing sector has been a huge prop to the economic recovery since last summer. We have been fearful the dissipation of strength in this important segment will cause a relapse in the economy and sap the upward momentum in corporate earnings. We must see if the weakness in September continues through the fourth quarter. If so, the first half of next year will be in danger of experiencing little, if any, economic growth. Such an outlook will undoubtedly move the Fed to use monetary policy to avoid a double dip recession. They may be successful but the price will be increased inflation in the future and we are skeptical added liquidity by itself will create jobs and stimulate private sector demand. For now, we remain vigilant to the signs the current economic expansion is expiring. We remain defensive in our capital markets strategy and continue to advise caution to our business clients.

Morris R. Segall, CFA, CIC

The Stock Market Approaches 11,000: Watch Out

Morris Segall      business landscape, Capital Markets, currency devaluation, Economic Growth

Today the stock market rallied almost 200 points on the Dow Jones Industrial Average and all major averages moved up by 2% or more. What happened. First, the Bank of Japan cuts interest rates overnight to zero and infuses another $400 billion in liquidity via asset purchases. Second, the ISM non-manufacturing index for the month of September rises to 53.2% from 51.5% in August. Conclusions: Bank of Japan continues worldwide reflation measures of industrialized countries to stave off double dip recessions. ISM non manufacturing index shows U.S. economy is growing and not going into a double dip recession.

Reality: Japanese economy is weakening and in danger of falling back into recession. Added liquidity and lower interest rates will delay it but unlikely to stave it off completely. Further liquidity additions may be necessary. These actions are not an indication of economic strength and results in another industrialized currency (yen) devalued.

Yes, the ISM index improves in September led by gains in imports, exports and employment.

BUT: At 52.3% the index is below the 55.4% levels of March, April and May of this year. The Business Activity sub-index declined to 52.8%, down from 54.4% in August and a peak of 61.1% in May. The New Orders sub-index increased to 54.9% in September from 52.4% in August but has not recovered to the 57%-62% levels of March, April and May of this year. The Inventories sub-index in September contracted at 47.0%, down from the expansion levels of 53.5% in August and a peak reading of 62.5% in May. Inventories are being reduced. The backlogs sub-index in September contracted to 48% from a peak reading of 56.0% in May. As we reported in our October 2nd blog article on the ISM manufacturing index, backlogs are now declining from the extended weakness in new orders versus shipments. Declining backlogs usually precede declining shipments going forward.

The news from Japan and the ISM indices portend economic weakness, not strength.

The stock market is now trading at more than 15 times estimated corporate earnings for 2010. Wall Street estimates for corporate earnings in 2011 range from 15%-20% growth next year. Given our weak economic outlook for next year (see our website articles of August 30 and September 7, 2010 and our Economic Update of September 28, 2010) , we expect much weaker corporate earnings growth of 5%-10% in 2011. If we are correct, Wall Street earnings estimates will have to be reduced and the stock market will not be perceived to be as attractively valued as the Street currently believes. Lastly, the rise in the stock market since Labor Day has been led by commodity and materials stocks. These are “plays” to offset the dramatically declining U.S. Dollar over the same period. With the accompanying surge in gold, the upward move in “hard assets” belies the attractiveness of “paper” assets represented by common stocks. The technicals and upside momentum in the stock market are strong and will add to gains short term. However, we continue to believe the decline in the value of the Dollar and the weakening economic trends portend a peaking in corporate earnings by the early part of next year and a major risk to the current stock market trend. As we have said previously, momentum driven stock markets can “turn” quickly. We think this market move is fraught with danger.

Morris R. Segall, CFA, CIC

The ISM index for September: “We are entering the Motari Nebula”

Morris Segall     

Captain Spock: “Admiral, We are now entering the Motari Nebula”. Star Trek III.

On Friday, the Institute for Supply Management (ISM) released its index of manufacturing activity for the month of September. The overall index was 54.4%, down from 56.% in August, and still nominally showing expansion in the manufacturing sector. However, in looking at the survey’s subsets, the picture is more ominous. In the key areas of orders, production, employment and inventories, respondents show ongoing deterioration that threatens to derail this major prop to the economic recovery begun in the spring of 2009. We note the following:

1. Only 26% of survey respondents reported an increase in new orders, the lowest since 27% in May, 2009. Conversely, 22% of respondents reported a decline in new orders, the most since last November. Overall, the New Orders Index was 51.1%, the lowest since 51.4% in May, 2009 and modestly above the 50% expansion threshold.

2. The overall Production Index was an expansionary 56.5% in September but was the lowest overall reading for this index since the 57.5% in September, 2009 and is down from the recovery high in this index of 66.9% in April, 2010.

3. The overall Employment Index was 56.5% in September, down from the recovery high of 60.4% recorded last month. Of note is the 13% of respondents who indicated lower levels of employment, the highest this year and more than twice the low level of such response at 5% recorded last month.

 4. The overall Inventories index measured 55.6% in September, the highest reading since 57.8% recorded in July, 1984. In the September survey 27% of respondents indicated higher manufacturing inventories, the highest level of such response in published ISM data going back to January, 1988.  We have been worried about involuntary inventory accumulation as consumer spending and retail sales remained sluggish over the summer and we commented on it in our website article of September 7, 2010. We are now more convinced inventories are a problem at the manufacturing level and will need to be reduced going forward. That does not augur well for GDP growth where inventory accumulation has been a major contributor in this recovery.

5. The darkest news in the September ISM survey is in the area of Manufacturers backlogs. The overall index of Order Backlogs in September was 46.5%. It is the lowest reading since 47.5% in June, 2009 and is down from the recovery peak of 61.0%  recorded as recently as this past February. Only 19% of respondents reported an increase in factory order backlogs, matching the low of May, 2009. Here again, we have been concerned about the continued gap in manufacturers book:bill ratios since the spring and we have noted it in our economic presentations and communications to clients.  We feared the continued excess of shipments over orders would come out of backlogs and the September index is confirmation. More importantly, the reading below 50% indicates this series is now contracting which again is bad news for the economy as lower backlogs will result in lower manufacturing shipments going forward unless manufacturing orders rise dramatically in the fourth quarter.

Also reported on Friday, was the August report on personal income and spending. While personal income increased a healthy .5% from July, personal spending increased less at .4% and the consumers savings rate increased to 5.8% from 5.7% in July. The consumer continues to restrain spending in favor of saving and debt repayment.  

Bottom line, the manufacturing sector is in danger as the economy retrenches from what is a cyclical recovery peak in April of this year. Inventories are backing up and consumer spending remains subdued. See our current economic update, “The Economy Stalls”, September 28, 2010, on the Presentations page of the SPG Trend website. We fear the disconnect between the economy and the stock market will not end well for investors or the economy.

Morris R. Segall, CFA, CIC

Second Qtr. GDP, Ben Bernanke and Intel

Morris Segall      2009 economy, corporate earnings, deflation, Economic Growth, economic outlook, GDP

On Friday the Commerce Department released its first revision of second quarter GDP, Fed Chairman Ben Bernanke delivered the opening speech at the Fed’s annual summer retreat and Intel announced a downward revision to its third quarter earnings outlook. All of these items were important news stories and all served to cement our previous comments on our blog and website that the economic recovery in the U.S. has stalled and is in danger of aborting.

The downward revision to second quarter GDP was expected after the June trade deficit widened to almost $50 billion led by a surge in imports and a surprising decline in U.S. exports. Economist estimates dropped into the 1%-1.5% range. The actual number reported on Friday was 1.6% and the equity markets breathed a sigh of relief and rallied that the number wasn’t worse. It shouldn’t have. Details behind the headline number reveal economic growth from the last vestiges of federal stimulus that we believe will not be repeated in future quarters. So we view the revised GDP report as dangerous to the outlook for the economy going forward. Personal consumption is not improving and government and business spending in the quarter have been augmented by factors we do not believe will continue.

Ben Bernanke announced on Friday the Fed would not allow the economy to fall into a deflation cycle similar to the Japanese experience in the 1990′s. However, his speech was devoid of new details about how that would be accomplished. Nonetheless, the stock market was reassured and rallied strongly if incorrectly.

Lastly, Intel reported a downgraded outlook for revenues in the current third quarter. Of all the news on Friday we believe this was the most important because it is a warning to us of the vulnerability of the current recovery cycle in corporate earnings. A faltering in corporate earnings would remove the primary support to the stock market and a major prop to the U.S. economy.

Please see our detailed article on these items and a more thorough analysis of the economy in a new Economic Presentation we are publishing on our website, www.spgtrend.com.

Morris R. Segall, CFA, CIC

The Stock Market: Economy over Earnings

Morris Segall      aborted stock market rally, consumer sentiment, oversold stock market rallies, peaking in corporate earnings cycle, pessimistic Fed outlook

In our July 6th website article, “Economic and Capital Markets Update”, we concluded our bearish forecast with the advice, “we would use an anticipated market rally in July from good second quarter corporate earnings to move towards our intermediate-longer term strategy”.  Despite our negative assessment of the economic data of the last two months and our downgraded economic forecast for next year, we expected the combination of an oversold stock market and strong second quarter corporate earnings reported in July, would produce a strong equity market rally that we would use to sell equity positions in favor of the re-allocation we advocated for the intermediate-longer term. As if on cue, the equity market rally we were expecting arrived the next day, July 7th, as the major U.S. equity market averages rose approximately 3%. Over the next five trading sessions, the major averages added another 3%-4%, peaking on July 14th on the backs of strong earnings from major bellweather companies like Alcoa, CSX and particularly Intel. However the economic news released last week continued a string of weak reports including retail sales and industrial production for June, a pessimitic Federal Reserve economic outlook and finally another collapse in consumer sentiment, this time in the University of Michagan survey reported on Friday. The weakening economic data and outlook  undermined the earnings rally and accompanied by weak operating earnings from major international banks, the stock market rally of July 7-14 reversed with a 3% decline in the major averages on Friday. Importantly, the rallies in virtually all of the major U.S. equity indices failed at or around the 50% retracement from the June market lows, a key development for market technicians and traders who now believe the aborted rally at such a key technical level spells the end of the July rally and a resumption of the market decline begun this past May.

From a technical standpoint they may be right. From an economic standpoint they could also be right. The stock market is a forward looking mechanism and the increasingly weak economic data being reported look like it is corroborating our stated belief that the economy is stalling. The Fed’s downwardly revised economic outlook and the huge decline in consumer sentiment in both the Conference Board and University of Michigan surveys portend the kind of economic retrenchment we warned about in our July 6th website article. The consumer sentiment readings are particularly worrisome because they reflect a deep level of pessimism that can be a self fulfilling contraction in consumer spending, already weak in this recovery. We still expect a summer spike in consumer spending from increased vacation travel and we think it may provide another oversold rally in the equity markets when reported in August and September. However, the stock markets could be at or below the June lows when the news hits and the economic outlook for late this year and next could have eroded further.  This week will be crucial to see whether Q’2 earnings can halt the market reversal and give investors a better exit point. We still believe stock market rallies in July or later should be sold into. The stock market uptrend from March, 2009 is over.  Current earnings no matter how strong cannot outweigh a deteriorating economic outlook that portends a peaking in the earnings cycle over the next four quarters.

Morris R. Segall, CFA, CIC

June Unemployment: More Bad News

Morris Segall      recovery cycle, stock market, unemployment

Friday’s unemployment report for the month of June was weaker than economists had expected and weaker than the surface numbers show. It also was the latest in a series of weaker and disappointing economic data reported last week. Last week saw a continuation in weak consumer spending  in May for the second month in a row despite healthy gains in consumer incomes over the April-May period. The consumer savings rate increased in May for the second month in a row to 4% reflecting consumer caution. Also, last week, the Conference Board reported consumer confidence in June fell dramatically from 62.7 to 52.9. Clearly the stock market declines in May and June are depressing consumer attitudes but respondents are also again expressing difficulty in getting jobs and are increasingly pessimistic about both current conditions and future expectations. We have repeatedly stated in our economic presentations, since the economy began recovering last year, that the absolute level of consumer confidence in this survey have been well below levels normally seen in postwar economic recoveries and indicated to us a muted consumer reaction to the economic recovery.  Rounding out last week’s economic reports were: a greater than expected decline in the ISM purchasing managers index reflecting a pause in the upward trend in orders and shipments seen since last year and a decline in hiring  by respondents; an increase in first time unemployment claims for the last week in June, taking first time claims to over 470,000 for the third time since May and well above the level of 350,000 seen in previous economic expansions; and finally, factory orders for May dropped for the second consecutive month after rising steadily since last spring. 

But the June employment report contained cause for concern despite the expected decline in census worker jobs and a reduction in the unemployment rate for the first time this year. The number of discouraged workers at 1.2 million is up by over 400,000 from last year. The number of people in the work force, as measured by the Household monthly data,  is down by over 1 million workers since June of 2009 and despite that drop in the labor force, the employment participation rate is down to 64.7% from 65.7% in June, 2009. A full year after the economy began recovering, the average workweek is only at 33.4 hours versus 33.0 hours in June, 2009. Over the last twelve months, average hourly earnings are up by only 1.7%, less than the 2% annual rate of inflation as measured by the CPI through May of this year. The private sector created only 83,000 jobs in June, below an expectation of approximately 100,000+. Of that 83,000, approximately 21,000 were in temporary help services and 37,000 were in leisure and hospitality. A number of leisure and hospitality jobs, 28,000, were in amusements, gaming and recreation that may be seasonal hires to cope with a very active vacation season. Other professional and business services added another approximately 25,000 jobs and healthcare added approximately 17,000 jobs. Most of the remaining sectors in goods producing, services and governments cut jobs in June. The June numbers follow a downwardly revised estimate of 33,000 private sector jobs created in May and establishes a pattern of weak private sector hiring for the two month period when empirical and other evidence should be creating the opposite result.

Tomorrow we plan to publish our updated economic and capital markets analysis and forecast on our website, www.spgtrend.com. It will extend the theses we have articulated in our blog articles since May. That is the expansion cycle in the U.S. equity market has reversed because of the international credit alarms caused by sovereign debt issues in Europe and these developments are having a negative impact on the U.S. economic recovery cycle. The economic data of last week, particularly the monthly job report, lead us to believe the U.S. economic recovery is  pausing while businesses and consumers assess the outlook for the remainder of this year and next.  We are afraid businesses in particular are already starting to plan “cutbacks” in anticipation of a weaker economy going forward.

Morris R. Segall, CFA, CIC

It Looks Like It is All Unraveling

Morris Segall      Barack Obama, elections, foreign policy, Jimmy Carter

Today looks like one of those watershed events which could mark a defining moment in the Presidency of Barack Obama. First, the President is forced to fire his hand picked general leading the war in Afghanistan for at the least conduct unbecoming and at the worst insubordination. Second, the Federal Reserve Board at its monthly meeting described the economic recovery as “proceeding”, i.e. stalled and weakening. Today’s Fed statement confirms for us the change in our economic and capital market outlooks we have been expressing in our prior blog articles beginning last month. We have believed the situation in Europe is serious and will get worse and it is having a depressing effect on the capital markets and in turn our economy.

In our website article, “The Election”, November 17, 2008, we commented that Barack Obama and the Democrats in Congress had a “short window to pacify a desperate electorate” and risked enacting programs that had “short term palliatives at the risk of eroding longer term U.S. financial strength and flexibility”. It would appear that window of opportunity to turn the economy around and fulfill the mandate of 2008 is about closed. The angry electorate of 2008 is absolutely livid in 2010. Voters are angry with the “bailouts” of Wall St. and corporate America while “Main Street” still struggles with unemployment, stagnant income and surging health care costs. The lack of success in the wars in Iraq and Afghanistan add to voter discontent. The object of voter ire is President Obama and his party that look disconnected and ineffectual. The President’s style of eloquent speeches but lack of decisive follow through is wearing thin on the American electorate.

Nowhere does the President look more ineffectual than in the arena of foreign policy. We commented in our website article on “The Obama Foreign Policy…”, January 7, 2010, the President was in danger of committing serious mistakes in Afghanistan by forcing a short timetable for military victory on the U.S. military. The President’s Afghanistan policy was clearly not supported by military leadership in the field who felt they were given an impossible task predestined for failure. No military officer accepts that. The shock in General McChrystal’s dismissal is the fact that he and his aides were so publicly contemptuous of the President and his administration. You have to go back to Vietnam for this kind of military “mutiny” to the President’s war policies. On the heels of foreign policy setbacks in the Middle East, soured relations with Turkey and Brazil and now a disconnect on economic policy with Europe, the Obama foreign policy is notably devoid of success and apparently now losing respect.

The loss of confidence in the President and his party to successfully deliver results domestically and overseas is in our opinion,  making the Obama presidency resemble that of Jimmy Carter and we believe will have similar electoral results in this year’s congressional elections and the presidential election of 2012.

Morris R. Segall

May Retail Sales: Unexpected weakness

Morris Segall      consumer spending, disinflation, wealth destruction

May retail sales reported this past Friday showed a surprising decline of 1.2% from upwardly revised April levels. We usually would would look at the May decline as a normal respite to strong gains in the previous month. So while retail sales, excluding food and gasoline sales, did increase significantly (.7%) in April, the comparable decline in May sales amounted to 1.2% and the declines encompassed many areas of discretionary consumer spending including building materials, clothing and autos. In addition, the level of retail sales in May, again excluding grocery and gasoline station sales, was also approximately .5% lower than comparable retail sales reported in March. After surging through the first four months of this year, consumer spending may be stalling, at least temporarily, as a result of the dramatic and severe decline in the stock market last month. We commented in our last blog posting, June 6, 2010, that “ the pace of the U.S. economic recovery could be retarded by the current stock market decline”.  Combined with the expiration of the home buyer tax credit and impending expiration of extended federal unemployment benefits, consumer spending could be at least taking a hiatus if not a more serious retrenchment. We expect consumer spending will rebound from May levels over the summer as Americans take vacations this year and increase domestic travel  due to lower gasoline prices and overseas travel due to the strong value of the U.S. dollar.

 The question is will it and if so by how much. Consumer incomes will have to grow consistent with the .3%-.4% rates of the March-April periods to provide the resources necessary for consumers to step up their spending. The psychology of consumers facing new wealth destruction from the stock market, suppressed equity in their homes and new fears regarding economic and job growth could cause consumers to become cautious again. A cautious consumer will not fill the void being created by abating Federal stimulus and aid programs.

At this time we are sufficiently concerned about the recent confluence of negative events in Europe, the worldwide capital markets and the suppressing effects on U.S. economic growth to revise downward our projections of  U.S. and overseas economic growth for this year and next. In our April 4th blog posting, “Happy Days Are Here Again…”, we projected U.S. economic growth in the second quarter would be in the range of 4%-6% largely based on the surge in consumer spending we were detecting coming out of the severe winter. Indeed, consumer spending in the first quarter accounted for 2.4% of the 3% growth in the first quarter, the highest level since the onslaught of the recession. We now believe second quarter GDP growth in the U.S. will range between 3%-4% due to lower expectations of consumer spending from our previous forecast. We continue to project total U.S. GDP growth for 2010 of 3% but within a range of 2.5%-3% rather than the 3%-3.5% previously projected. For 2011, we are using a projected range of 1%-3% for U.S. GDP growth next year, down from our previous expectations of 2%-3% growth and we are telling clients and audiences that this revised outlook is subject to further change as developments here and in Europe become clearer. Commensurate with our lower expectations of  U.S. and worldwide economic growth this year and next, we now project disinflation in the U.S. over the remainder of this year and into next as the upward pressure from rising commodity prices seen in the first half of this year reverses from the recent fall in energy and industrial commodity prices.  

We will publish a more detailed discussion of our current economic and capital markets analyses and forecasts on our website, www.spgtrend.com.

Morris R. Segall, CFA, CIC

May Unemployment Disappoints; So does Europe

Morris Segall      capital markets strategies, Economic Growth, European sovereign debt, May unemployment, stock market

Friday’s unemployment report for May was just what the stock market didn’t need- a disappointing jobs creation picture. Total nonfarm payrolls grew by a little over 400,000 in the month of May, but virtually all of that increase was due to temporary hires for the U.S. Census. Most of those workers will be terminated by the end of the summer. Only 41,000 jobs were created in the private sector in May according to the business establishment survey, well below the 150,000+ jobs expected. We have been commenting in previous blog postings about the increasing inaccuracy of the monthly business establishment survey in reporting job creation. Most of our criticism has been focused on the erroneous seasonal adjustments and the errors in reporting job creation in the small business sector. Most of the monthly reporting errors result in overstating job creation that are then reversed when the Labor Dept. makes its semiannual revisions in the winter and summer of each year. However, this time we believe the May jobs report is actually understating job creation. Empirical data and other employment measures point to a larger job creation in May than the 41,000 reported on Friday. We believe the May number will be revised upward in subsequent monthly reports over the summer. But that is where the good news on jobs ends. First time unemployment claims are “stuck”  around 450,000, far too high to indicate strong  job creation. In addition, other measures in the May jobs report continue to point to high levels of discouraged and underemployed workers and most discomforting,  a continued high level, nearly 50%,  of workers unemployed are jobless for 27 weeks and longer. We estimate that we are building a “hard core” unemployment rate of over 6% as a result of the recession and the historically weak economic recovery.

Also on Friday was news from Hungary that their fiscal situation was becoming dire to the point of possible debt default. The announcement was a surprise since it was assumed the IMF bailout of Hungary last year was sufficient to avoid default. The prospect of another European country sliding toward debt default was sufficient to break the euro below critical levels of $1.20 on Friday and raise the threat levels again of more widespread financial crisis in Europe. The Hungarian announcement created new strains on the financial system in Europe with lending spreads and costs of credit default insurance rising again. The situation in Europe is becoming more alarming as default risks spread from Southern Europe to Central Europe and likely to Eastern Europe next. The austerity programs being enacted by the governments in Southern and Western Europe and the U.K. will exacerbate the problems in Central and Eastern Europe that depend on exports to the Eurozone for much of their GDP growth. The financial system is now on heightened alert again to see where this latest emergency in Europe will lead. The outlook for containing the European sovereign debt problems is becoming more bleak.

The combination of a weak employment report and the dire news from Hungary, reversed a stock market rally that began before Memorial Day and carried strongly through last Thursday. The market decline on Friday eroded market technicals and has cast doubt on the view that the market decline in May was a correction and not more serious. We have stated in our most recent blog entries that we believe the market action in May signals a “Sea Change” in the international capital markets cycle. The market action on Friday confirms that view for us. We now believe we are moving towards a short-intermediate term trading range on the Dow 30 Industrials of between 9,000-11,000. We reiterate our belief that the market highs recorded at the end of April-early May, are the highs for this market cycle. While the U.S. economic news has been improving since last summer, going forward, the economic news becomes more problematic as Federal stimulus recedes and the stock market itself becomes the main story in the economy. It is estimated a trillion dollars of market value was lost in the month of May and June is extending that. The market decline is replacing risk assumption with risk aversion and when investors see their portfolio values at the end of May, there is the fear consumer spending will retrench just when the economy needs more robust consumer spending. We believe it is possible the pace of the U.S. economic recovery could be retarded by the current stock market decline. We  continue to stress defensiveness in our capital market strategies and emphasize U.S. dollar denominated assets.

Morris R. Segall, CFA, CIC

Memorial Day

Morris Segall     

As we conclude the celebration of Memorial Day and the end of the month of May we look back at a month that in our opinion signaled a “Sea Change” in the international capital markets cycle of 2009-10 and a refocusing on the crisis of international sovereign debt. As we wrote in our blog entries of May 6th, “From Optimism to Panic: A Greek Tragedy” and May 10th, “From Panic to Relief…”, the swift and severe collapses in equity and commodity prices signalled to us something more than a correction in overbought markets. The events since then have confirmed that despite substanial moves on the part of  worlwide international banking authorities to support the Eurozone and the euro currency. As we forecast, international monetary support has also been joined by austerity fiscal programs forced into enactment by the large debtor nations of Europe. Very good economic news around the world, particularly in the U.S., has largely been wasted by eroding asset prices and declining investor confidence. Unfortunately, the European efforts to “turn” the crisis are shorter term palliative measures and do not address the longer term concerns of successful debt reduction and economic vitality. We mentioned in our previous posts that the sovereign debt issues in Europe and the U.S. are longer term problems that will not go away with monetary bailout and fiscal austerity programs. The capital and commodity markets are signalling that. We will publish shortly our analysis of sovereign debt problems on our website, www.spgtrend.com. Suffice it that we are pessimistic because of retarded economic growth and strained liquidity in Europe and our belief lower debt/GDP targets in Europe over the next 2-3 years will not be met. We believe this will continue to overshadow the equity markets. 

As a result, we have dramatically shifted our capital markets strategy after our May 10th posting. While near term rallies from oversold conditions are likely, we are not expecting the capital markets to resume their sustained “uptrends” and reach new highs in this cycle. We have been counseling our clients and our audiences of our concerns and the need to become more defensive, reduce volatility and protect principal. We will delineate our new Capital Markets strategy in a new website article also forthcoming.  Readers should contact us for details.

The ongoing oil spill in the Gulf of Mexico is a long term ecological disaster and will have more serious economic consequences the longer it continues. The governmental and public response will parallel the reaction to the Nuclear power accident at Three Mile Island in 1979. America’s nuclear power program has been stunted ever since. We believe one of the beneficiaries of the Gulf oil spill will be a revisiting of the nuclear option as an answer to America’s power generating problems.

Lastly, some good news in May. On Friday, the Commerce Dept. announced  increases in personal income in March and April that would signal improvement in consumer disposable incomes. Just what is needed to support a continuation in consumer spending that increased in the first quarter. While consumer incomes increased in April, consumer spending did not and we now have to worry whether the stock market decline in May will show up in restrained consumer spending in June and beyond. With the stimulus to housing expiring, elevated consumer spending will become more important to overall U.S. GDP growth going forward into next year. Readings on consumer income and spending will become amongst the most watched economic statistics as we go forward. We will certainly be among the spectators.

Morris R. Segall, CFA, CIC

From Panic to Relief: The EU Steps Up

Morris Segall     

In our last posting, “From Optimism to Panic…”, May 6, 2010, we stated last week’s panic in the capital markets needed a quick and forceful international response to restore order to avoid further destructive speculation. Refreshingly, the Europeans moved quickly and decisively and along with assists from the IMF, the Federal Reserve and the Bank of Japan, structured an aid and liquidity package totalling almost $1 trillion. Importantly the package includes mechanisms for the European Central bank to purchase sovereign and bank debt and, along with other central banks, add liquidity to the Eurozone. Clearly, the EU leaders and finance ministers meeting in Brussels over the weekend learned the lessons from their mistakes in the Greek bailout. They wasted little time and came up with a large package that addressed the current problems facing  European governments and banks. It was also important for the response to be global so the participation of central banks around the world left no doubt of the international support for the euro and the eurozone.

In response, equity markets around the world, led by Europe, have surged today, relieved at the strong international response to the current crisis.

However, the sovereign debt problems in Europe are not solved and the countries of southern Europe and the U.K. will need to initiate significant spending reduction programs as part of overall debt reduction plans. Those spending reduction programs will not be popular domestically and social unrest should be expected.

 There are political costs as well as seen in the indecisive elections in Britain which turned out the long reigning Labor Party but left the victorious Conservative Party short of a majority in Parliament. The Conservatives will have to fashion a parliamentary coalition in order to govern. In yesterday’s regional election in Germany, Chancellor Merkel’s governing Christian Democratic Party lost decisively thus depriving Chancellor Merkel of a mjority in the Upper House of the German Parliament. She will now have to compromise with opposition parties to successfully govern. Indeed, today Chancellor Merkel announced she would not be seeking tax cuts that she had promised to pursue in her fiscal agenda but have been opposed by her principal political opposition.

The political uncertainty now being created in Europe will raise political and economic risks in Europe and the U.K. While Europe has for the time being avoided financial disaster, the longer term problems of sovereign debt risk remain.

Morris R. Segall, CFA, CIC

From Optimisim to Panic: A Greek Tragedy

Morris Segall     

Thursday’s roller coaster ride in the stock market, punctuated by a nearly 1000 point drop in the Dow Industrial average before recovering 700 of those points, is culminating a shift from market optimism to outright panic. Since Monday, May 3, the major market averages have declined 6%-7% based on increasing fears of debt defaults in Europe led by the well publicized difficulties in Greece.  After protracted negotiations with its eurozone partners and the International Monetary Fund, a financial “bailout” package for Greece was announced last weekend that would appear to have headed off an imminent debt default.  Prior to the selloff of the last three days, the major market averages had risen on average 9% from the period February 3 to May 3  spurred by improving economic news in the U.S. and confidence in a “bailout” solution to Greece’s debt problems. Investor sentiment was overwhelmingly positive and risk aversion had been replaced by risk assumption. So what went wrong?

First, the Europeans, particularly Germany, horribly botched the Greek bailout and turned a serious dilemma into a full blown crisis. The reluctance of Germany to agree to contribute to a eurozone loan facility for Greece dragged out the process of support and brought Greece to the precipice of default. It allowed market traders and creditors to speculate on a Greek default when the issue should have been put to rest weeks ago.

Second, the draconian spending terms imposed on Greece by its European partners and the IMF apparently did not allow for the response of the Greek people. Reform of Greek finances and reducing its outsized debt must certainly entail large spending cuts by the Greek government. However, a population long dependent on public spending was not going to accept such life changing spending reductions without protest, including demonstrations, riots and strikes. The violent reaction of Greeks to the austerity program approved by its government has upset investors, market analysts and market traders. It has led to questions about the ability of the Greek government to enact the austerity program and thus successfully access the bailout money and avert default.

Third, once again the credit rating agencies have not done their jobs and have added to the current climate of fear by now lowering credit ratings on eurozone countries including Spain and Portugal. Italy may be next. Where were these agencies over the last two years when the balance sheets of these countries became so leveraged?  The credit ratings of these countries should have already been lowered. Reducing them now only adds to the negative speculation.

This “Greek Tragedy” has now led to rampant speculation about possible debt defaults in other eurozone countries, namely Spain, Portugal and Italy. It has refocused attention on the massive sovereign debt levels of the industrialized world, including the U.S. and raised fresh questions on how these debt levels will be reduced or if they can. We believe the events of the last three days have dramatically changed the equity market environment here and abroad. In the short term the panic selling of the last three days will expend itself. It may have done so on Thursday. It is also possible that U.S. equity markets may have seen their highs in this cycle. We are reevaluating our capital market strategies.  A strong employment report for April will help stabilize the equity markets temporarily.  A dissapointing report will accentuate the current market downslide. 

The sovereign debt issues in Western Europe are not going away. They will overhang debt and equity markets until creditors and investors are convinced credible debt reduction fiscal programs are enacted and accepted by the local populations. We will address the intermediate and longer term issues of soverign debt in a more extensive article on our website. For the moment, we believe a forceful international response to the destructive speculation regarding soverign debt defaults in Western Europe is necessary, and quickly, to restore order to the equity and credit markets.

Morris R. Segall, CFA, CIC

Happy Days Are Here Again: But How Happy and for How Long?

Morris Segall      business landscape, consumers, economics, GDP, government, March monthly unemployment report, trends, unemployment

The March monthly unemployment report was the latest in a series of positive economic reports that confirms an expansion in the economic recovery. Since late February, we have observed a perceptible pick-up in consumer spending since the end of the severe winter weather. We have noticed an increase in traffic in restaurants and malls and have heard firsthand of increased travel by consumers. This empirical data has been confirmed by reports from major retailers and cruise ship lines over the past two weeks of increased revenues in the month of March.  The spring thaw has unleashed pent up spending which we have expected would spur a real economic recovery when the unemployment situation improved. While we believe new job losses have peaked, we have stated in previous comments that the chronic level of long term unemployment and the suppressed level of wage and salary income growth would be depressants to increased consumer spending.  Despite repeated evidence that the level of long term unemployment is not improving, consumers are apparently satisfied with their financial conditions to allow an increase in discretionary spending.  Combined with a continued surge in factory orders from businesses and rising exports, we expect first quarter GDP to be a solid 3% based on a strong March performance and the second quarter could be even stronger with growth in the 4%-6% range based on:

1. A strong rebound in housing to take advantage of the extended home buyer tax credit set to expire in June. We  would not be surprised to see that credit extended again to compensate for the lost time in January and February due to harsh winter weather.

2. An increase in auto sales as replacement demand increases due to the extended age of the automobile fleet and the detrimental impact on cars from this winter’s weather.

3. Continued and broader increases in capital equipment orders from businesses that are seeing increased sales, pent-up demand for capital equipment and rising corporate profits.

4. Increasing exports to fast growing and recovering overseas economies.

5. Increased federal spending from the accelerated release of stimulus funds.

If our projections are correct, strong consumer spending in the second quarter will lead to an inventory replacement cycle in the third quarter and increased industrial production from building backlogs. We do not foresee a double dip recession in the second half of this year.

However, we do expect a slowdown in GDP growth in the second half because the current surge in consumer spending cannot be sustained under current employment and consumer income conditions. We expect the current increase in consumer spending will come from savings and reduced reduction in consumer debt. While that helps spending in the short term it is cause for concern longer term. We have consistently commented in our posted economic presentations that a consistent effort on the part of American consumers to save more and reduce debt results in a healthier, more consistent and more creditworthy consumer that can sustain an increasing level of economic growth. Thus, while the industrial sector and exports can keep economic growth going through this year, reduced federal subsidy programs and lower levels of consumer spending make the economic outlook for 2011 more difficult to predict. Furthermore, commodity and energy prices are already on the rise which will increase inflation going forward and we expect the Fed will have to raise interest rates by this summer. The confluence of rising prices and interest rates will put additional pressure on consumer incomes and spending.

So while the economy is improving, sustained recovery still needs permanent job creation and the absorption of the large pool of long term unemployed.

Morris R. Segall, CFA, CIC

The Fed, Consumer Confidence and Toyota; Bad News All Around

Morris Segall      business landscape, Consumer Confidence, consumers, economics, economy, government, The Fed, Toyota

Beginning with last week’s sudden increase in the discount rate by the Fed, the expanding product scandal at Toyota and Tuesday’s surprising decline in the consumer confidence index from the Conference Board, the news has been bad for the economy and bad for the equity markets.

While the increase in the discount rate was no surprise, given Chairman Bernanke’s prior comments signalling such a move was likely, the timing and manner of the increase was quite surprising and unsettling. For months the Fed and Chairman Bernanke have stated the economy was still quite fragile despite its recovery. Public statements repeatedly reaffirmed the highly accommodative Fed policy of low interest rates. So why did the Fed not wait for its March Board of Governors meeting to announce its increase in the Fed funds rate?  Why did the Fed wait until the stock and bond markets were closed last Thursday to make its announcement?  These actions have been uncharacteristic of Fed actions which have emphasized transparency. We believe the Fed action is another in a series of moves toward normalization of monetary policy and an effort to drain excess liquidity from the financial system. But we believe the nature of the Fed action was aimed more toward foreign investors than for domestic consumption. We believe the continuing rumblings of overseas discontent with current American monetary policy and the revelation of significant sales of U.S. Treasury holdings by China created enough unease in Washington to send a signal to foreign investors that the Fed was ready to move on excess liquidity concerns. Keep in mind the current backdrop of increasing sovereign debt risk in Europe and the Middle East. The rising concerns over the increasing national debt and credit ratings of the U.S. government and the ongoing auctions of U.S. Treasury notes and bonds that are running on average at $100 billion per month. If the Fed action was precipitated by foreign concerns, monetary policy may not be as dependent on the fragile state of the U.S. economy as the Fed has stated.

The unraveling of the Toyota product image as more and more product defects surface and the company’s response becomes more suspect will hurt Toyota manufacturing and sales in the U.S.  Of course this will benefit Ford and GM but the manufacturing, parts supplier and dealer networks of Toyota in the U.S. are important contributors to the U.S. economy and are not fully replicated by domestic manufacturers, particularly given the downsizing of Detroit in the recession. Toyota imports are important economic contributors to West Coast ports and domestic rail and truck volumes. The problems of Toyota are an important reminder of the vulnerability of brand image and customer brand loyalty and how vigilant company managements must be to maintain them. This will be a textbook case taught in business schools of how not to handle quality control and customer relations issues.

Tuesday’s unexpected steep decline in the Conference Board’s consumer confidence index for February is very disturbing.  After showing improvement as the economy recovered and the stock market moved higher the Conference Board index plunged to a reading of 46 from a level of 56.5 in January. The steep decline in the third quarter of economic recovery is not at all typical.  The reading of 46 is consistent with the low levels recorded in the depths of the recession last year.  More distubing are the subsector readings within the index.  The measure of responses indicating positive sentiment to  current conditions was less than 20%, a 27 year low. Almost 50% of respondents felt jobs were hard to get versus less than 5% of respondents who felt jobs were easy to get. Over 45% of respondents felt business conditions were poor. Sentiment readings on the near term outlook also fell significantly from January levels. In short, consumers are depressed currently due to ongoing unemployment and consumer income pressures and discouraged about meaningful improvement in the near term. This level of pessimism can be self fulfilling and act as depressants to consumer spending which must improve if the current economic recovery is to be sustained and expanded.

All of this will not be lost on the stock and commodity markets as witnessed by Tuesday’s declines.  Unless news from the consumer sector reverses, the equity and commodity markets will be hard pressed to rally further from current levels in the near term. Conversely, strong corporate earnings and a steady improvement in the manufacturing sector are providing support to the markets. We still believe the markets are vulnerable to correction in the near term but remain positive on equities and commodities intermediate-longer term. The signals coming from the Fed herald the end of zero interest rates and augur ill for the fixed income markets, particularly at the short end of the maturity spectrum.

Morris R. Segall, CFA, CIC

January Unemployment: Are we there yet?

Morris Segall      business landscape, consumers, economic improvement, economics, economy, GDP, government, January Unemployment, Labor Department, politics, U.S. Census

Today’s unemployment report for the month of January was revealing for what it did not tell us. That is, are we about to turn the corner on unemployment ?  The report showed a modest 20,000 loss in jobs in the month of January,  a virtual flat performance with the month of December, 2009. Of more note was a .3% drop in the stated unemployment rate from 10% to 9.7%, the lowest rate since last summer. However, as we commented in our blog article, “November Unemployment: Is this the Peak?“, December 4, 2009, the Labor Department made annual revisions to its monthly employment reports. As expected, the revisions show more job losses in 2009 than previously reported. According to the revised calculations, the economy lost over 600,000 more jobs in calendar 2009 than previously reported including a large downward revision of 65,000 lost jobs in the month of December, 2009 to a revised total of 150,000 lost jobs in that month. So a flat January job loss result with December is not a job improvement. We therefore are skeptical of the drop in the unemployment rate. In addition, the average workweek in January remains depressed at 33.9 hours and the civilian labor force participation rate in January continued to reflect historical lows below 65%. There are other important items in the January employment report. Goods producing industries, largely in construction, lost another 60,000 jobs bringing the total for the last three months to almost 150,000. Financial activities and transportation and warehousing sectors lost another 35,000 jobs in January on top of the almost 29,000 jobs lost in December. These are generally high wage jobs.  Finally, long term unemployed, those out of work 27 weeks and longer, continue to rise to a record 6.3 million in January. This is the chronic problem in the unemployment picture. While new job losses continue to diminish, continuing job losses continue to rise.  The increasing universe of long term unemployed will continue to suppress consumer spending and therefore an acceleration in the economic recovery.

The January unemployment report did contain some positives. The number of temporary help workers increased by another 50,000 in January and since September by nearly 250,000. While this number is being augmented by hiring for the U.S. Census this year, the recent five month trend augurs well for ultimate permanent job creation later this year. For the first time since the recession began, manufacturing added jobs in January, albeit a small number (11,000), but it is significant and supports the economic improvement in the factory sector which we noted in our recent “Economic and Capital Market Update“, February 1, 2010 on our website. We expect further improvement in manufacturing employment reflecting the upside momentum in factory orders, particularly in the technology sector.

All in all, the January monthly unemployment report while encouraging is still not conclusive evidence of a transition to meaningful job creation in the current economic recovery.

Morris R. Segall, CFA, CIC

Ben Bernanke, the Stock Market and the Economy

Morris Segall      Ben Bernanke, economy, employment report, GDP, government, stock market, trends, unemployment

After playing politics with Ben Bernanke’s nomination in the wake of last Tuesday’s election loss in Massachusetts, the Democrats with help from the stock market on Friday, thought better of their populist pandering on Monday and began to rally around the beleaguered Fed Chairman. Criticism began late Friday with the stock market selloff and built up over the weekend. In our blog article of December 8, 2009, “Ben Bernanke: Hero or Goat“, we warned of the market ramifications of politicizing the Fed and its Chairman’s reappointment process. Congress got the message over the weekend and will now probably vote to reappoint Ben Bernanke.

Friday’s stock market sell off culminated a week that saw the market decline over 500 points and erased the gains accrued in the first two weeks of the year. After rising virtually non stop since its lows in early March of last year, the stock market entered 2010 strectched and overdue for a correction. Last week’s market decline could be the beginning of such a correction. Despite good news on corporate earnings and sound fiscal action on the part of the Chinese government to curb speculation in their economy, stocks sold off reversing their pattern of seeing the “glass half full” on virtually all economic and corporate news. It remains to be seen if this new pattern of stock price decline will revert to the short lived selloffs of last year or develop into a long overdue correction. Such a correction would be good for the stock and commodity markets longer term. The latter have been particularly ebullient over the last year with outsized gains that are ripe for profit taking.

In a couple of days we will get our first look at the fourth quarter GDP. Consensus estimates are for growth of 4%-5%. In our blog article, “Third Quarter GDP Revised Down“, November 25, 2009, we stated “strong contributions in consumer spending and business fixed investment would be needed from downwardly revised third  quarter GDP levels”.  After watching numbers “see saw” in housing, unemployment and retail sales in the fourth quarter, we believe fourth quarter GDP will be within consensus estimates led by large gains in business fixed investment, notably machinery and equipment, and government spending with a solid contribution from personal consumption and a positive contribution from net exports. Since the third quarter of last year the manufacturing sector is the strongest part of the economy with factory orders and shipments maintaining their recovery from depressed recession levels. However, the strength in fourth quarter economic data is not expected to be sustained in the first quarter of this year. Post holiday retail and housing sales are expected to dip leaving economic growth to the government and industrial sectors. Economic growth is still dependent on government stimulus in the face of continued high levels of unemployment and the improvement in unemployment is still the key to sustained economic recovery. At this time we do not expect a “double dip” recession when government stimulus ends in the second half of this year but the visibility of economic growth is clouded by the stimulus programs which have distorted the normal trends of economic recovery and have resulted in a “sawtooth” pattern of economic data since the recession ended in the third quarter of last year. We expect that to continue until the private sector can sustain this recovery on its own.

Morris R. Segall, CFA, CIC

Republicans win in Massachusetts: The vote heard “round the world”

Morris Segall      Democratic Party, democrats, economy, Election, government, Massachusetts, Massachusetts Senate, political, politics, President Obama, Republican Party, republicans, Scott Brown, Ted Kennedy

Tuesday’s  stunning victory in Massachusetts by Republican Scott Brown to fill the Senate seat of the late Ted Kennedy is undeniable evidence of the failure of the Democratic Party and President Obama to capitalize on their voter mandate in 2008. In what should have been a year of great accomplishment with passage of landmark legislation in healthcare, the environment and economic reform the President marks his inaugural anniversary with no great success in his domestic agenda and his party losing its super majority in the Senate. Coupled with recent Republican victories in gubernatorial elections in New Jersey and Virginia and the retirement of several leading Democrats in the Senate, the Democratic Party is firmly on the defensive with low voter approval ratings and the object of intense voter anger. We have been commenting on building voter anger in our website articles (See “Long Term Outlook“, October 8, 2006, “The Election“, November 17, 2008 and “I am Mad as Hell…”, March 23, 2009) and it has now reached a fever pitch exacerbated by the severe recession. We repeat the mantra we have stated since 2006, “an angry electorate is an unpredictable electorate”.  A more detailed review and analysis of the domestic political environment and its implications will be covered in an upcoming website article. For now, we make the following observations:

1. The President must take responsibility for his party’s decline and his program failures. The President is an eloquent speaker but he does not follow the speeches with forceful actions. We commented in our July and August blog articles on the failure of the President’s healthcare initiative BECAUSE of splits within the Democratic Party. With all of the political capital expended by the President on healthcare, his failure to unify his own party and rally public support on this issue have been fatal. The election of Scott Brown in Massachusetts and the decline in public approval have made the President’s healthcare initiative all but dead.

2. Likewise, the loss of the Massachusetts Senate seat will now slow if not halt the President’s initiatives on carbon taxation, immigration, financial system regulation and other major agenda items that encompass higher taxes and increased federal government presence.

3. The anger in the electorate and the failures of the President and the Democratic Party have now resurrected the Republican opposition and make them a credible threat to unseat Democrats in this year’s Congressional elections. Faced with public anger and reelection, Democrats in Congress will be less inclined to support the President. Significant losses by the Democrats in the House and Senate will likely result in legislative gridlock for the remainder of President Obama’s term. The President would increasingly look like a one term president. This will prevent solutions to the major socio-economic issues we face in the next decade and cloud our longer term economic outlook. This will however alleviate increased regulation of business and provide a more benign environment for the stock market in the shorter term.

4. This latest political setback for President Obama will not go unnoticed overseas. A president already viewed as weak and unsuccessful overseas (See our recent website article, “The Obama Foreign Policy“, January 7, 2010), will be weakened further if he cannot control his own political party and win the public debates on domestic policy.  It will be harder to get agreements from allies and concessions from adversaries particularly if the president looks like a one termer.

Tuesday’s Senate election in Massachusetts has altered the domestic political landscape and thus the economic outlook for the next two years. Its repercussions will be felt not only here in the U.S. but around the world as well.

Morris R. Segall

Today’s Economic Landscape and What’s on the Other Side

Morris Segall      2009 economy, Add new tag, business landscape, Capital Markets, consumers, crisis, debt, economic, economics, employment report, future trends, GDP, government, recession, unemployment

We recently updated our presentation on today’s economic landscape and what’s on the other side with some fresh data.  We hope you continue to find value in our slides:

Ben Bernanke: Hero or Goat

Morris Segall      Ben Bernanke, business landscape, Capital Markets, credit crisis, economics, economy, government, obama, treasury, trends, unemployment

Ben Bernanke appears to be fighting for his life before Congress where several members from both major parties and one of the independents in the Senate are rejecting his reappointment as Chairman of the Federal Reserve Board for a second four year term.  The opponents of his reappointment blame Mr. Bernanke for aiding and abetting the excesses in the financial system that resulted in its meltdown and taxpayer bailouts of many of its institutions. In their zeal to lash out at the stewards of fiscal and monetary policy during the financial crisis of the past two years, the critics of Ben Bernanke fail to include one of the most culpable parties to the worst financial crisis since the Great Depression and that is Congress itself. From the enactment of the Bank Holding Company Act in 1956 and its subsequent amendments which allowed banks to buy non bank financial entities outside of the supervision of the Federal Reserve System, to the repeal of the Glass Steagall Act which had separated the commercial and non-commercial banking activities of banks in 1999, to the lax oversight of Fannie Mae and Freddie Mac, federally chartered institutions that were the backbone of mortgage securitizations and transactions which fed the lending bubble. For over 40 years the Congress has consistently enacted legislation that enabled banks and other lenders to engage in high risk activities OUTSIDE of the supervision of the Federal Reserve Board. So when the Fed complained that it was losing control of the financial system, Congress did nothing.

In our website article of December 7, 2007, “The Treasury Plan: Is This the Solution?“  we outlined our skepticism of the success of the Treasury plan of then Treasury Secretary, Henry Paulson, to effectively “dance around” the mortgage crisis by adjusting mortgage rates and terms in the hope of forestalling the inevitable losses from mortgage defaults. It was not until March, 2008 that the Federal Reserve forcefully attacked the loan loss problem by swapping Treasury paper for the problem debt held by mortgage lenders. The Fed subsequently expanded Discount Window facilities to both commercial and for the fist time, non-commercial banks like investment banks and brokerage firms so these firms could have liquidity. In fact in our ongoing economic presentations such as the ones  posted on our blog and website,  there is an entire section of slides and commentary entitled “The Government”s Response” to the severe credit crisis. It shows the leadership of the Fed in increasing the money supply, reducing interest rates and expanding its own balance sheet by purchasing the “toxic” assets of the banking system to provide it with liquidity necessary to keep the system afloat.  By most objective scutiny of the Federal Government’s handling of the credit crisis, including our own jaundiced view, if there is a hero in this debacle, it is Ben Bernanke who literally pulled out all the stops to keep the financial system in this country from totally collapsing, particularly after Henry Paulson triggered a system panic by allowing Lehman Bros. to fail. We may not have liked the bailouts of many of these instituions but as we have stated in prior commentaries, the country runs on credit and letting the banking system fail was just not an option.

If one wants to point a finger at the Fed for allowing the credit bubble to build, it needs to be pointed at Alan Greenspan who instead of musing on the illogical low level of interest rates in 2004-05 in the face of the real estate boom should have raised interest rates and loan reserve and capital requirements to slow the creation of credit. Upon succeeding Greenspan in January, 2006 Ben Bernanke’ s Fed started raising interest rates through the spring and into the summer of that year and held those higher rates until the recession began in late 2007.

We and other observers believe Ben Bernanke will be reappointed to another term after this current thrashing. He better be. A rejection of Ben Bernanke AND an ill advised replacing of the Federal Reserve as the nation’s principal regulator of monetary policy and the financial system, would create a loss of confidence in foreign bankers, creditors and traders and would depress our bond markets and exacerbate an already “free falling” U.S. dollar. The President needs to show leadership on this issue and strongly reaffirm his support for the reappointment of Ben Bernanke and not let Congress make him the “goat” of the recession. If Congress wants to assess blame for the financial mess, they should begin by looking in the mirror.

Morris R. Segall, CFA, CIC

November Unemployment: Is this the Peak?

Morris Segall      consumers, debt, economic, economics, economy, employment report, GDP, government, recession, trends, unemployment

Today’s unemployment data for November was a surprising loss of only 11,000 jobs, well below economists’ expectations of 100,000-150,000 jobs lost in the month. In addition, the unemployment rate for November declined unexpectedly to 10% from October’s 10.2%. Consensus expectations were for the unemployment rate in November to be flat at best with October’s cycle high. The Labor Dept. also revised downward previously reported job losses in September and October. Monthly job losses have been revised downward for each month since August by a total of over 200,000 jobs. Since August, monthly job losses have averaged below 200,000 versus over 300,000 average monthly losses in the May-July period. The decline in monthly job losses parallels the strong improvement in first time unemployment claims reported weekly. Since mid September, first time unemployment claims have fallen approximately 100,000 and are now running at approximately 450,000 for the last two weeks in November.

In isolating the areas of reduced job losses we note that healthcare continues to be the area of the economy that has consistently added workers during the recession. Since September, healthcare has added an additional 100,000 workers and nearly 900,000 workers since the recession began in December of 2007. Other areas of job improvement since September are: the federal government and state government education accounting for an increase in approximately 50,000 jobs; and professional and business services adding over 100,000 jobs largely in temporary help services.  Importantly, for the first time this year, the average workweek increased to 33.2 hours from a cycle low of 33.0 hours in October.  The average workweek improved more in the manufacturing sector expanding to 40.4 hours from 40.0 hours in September. This reflects the recurring order and shipment strength in the manufacturing sector since last summer.

Conversely, most other areas of the economy continued to record job losses including manufacturing, finance, construction, retail and wholesale trade and information services. While the Labor Dept. reports almost 41% of reporting industries are now hiring, a cycle high, that leaves nearly 60% that are not. The surge in temporary help jobs indicates businesses are wary of the economic recovery and are reticent to add to payrolls. Furthermore, the labor force has declined by over 100,000 workers since September indicating an increase in discouraged workers despite the improvement in the economy. The decline in the civilian labor force would also partly explain the decline in the unemployment rate in November. Another benchmark of employment in the weekly and monthly reports indicate no improvement in the numbers of long term unemployed and under-employed workers. In fact, the numbers of long term unemployed increased to over 9 million or 38% of total unemployed at the end of November, a record level.  In addition, while first time unemployment claims have declined sharply, they are still recording well above 400,000 claims per week. Finally, the response from consumers in recent surveys indicate jobs are hard to get by an overwhelming margin despite the economic improvement in the third and fourth quarters. These measures do not support the monthly improvement in employment reported by the Labor Dept. since August and we have repeatedly said so in our blog articles on the monthly employment reports going back to last July.

Nonetheless, if the monthly employment report from the Labor Dept. is indeed true and not distorted by seasonal adjustments and faulty assumptions that are part of this survey’s results, then  it would appear that unemployment in this cycle is peaking and job creation is virtually around the corner early next year. This would be well ahead of consensus expectations, including our own, in projecting a peak in unemployment and the transition to job creation in the middle and latter part of 2010, respectively. It is important to note that the Labor Dept. will be making final revisions to its 2009 monthly employment data in March of 2010. In its initial revision to 2009 monthly employment data in August, the Labor Dept. revealed that unemployment this year was actually almost 900,000 workers higher than originally reported. Similar revisions were made to monthly data in 2007 and 2008. With that as a background and the contradictory results of other unemployment data and surveys, we are skeptical the employment cycle is turning this strongly and this fast.

Morris R. Segall, CFA, CIC

Third Quarter GDP Revised Down

Morris Segall      2009 economy, consumers, economics, future trends, GDP, global, government, recession, stimulas, unemployment

Yesterday’s second reading on the third quarter GDP showed a downward revision from the robust 3.5% preliminarily reported at the end of October. As November wore on expectations of the second and more definitive read on the third quarter was for a downward revision to the 3% level but no one was alarmed. It was considered more or less statistical.

After taking a look at the revisions from the preliminary report we are concerned for the following reasons:

1. Personal consumption was revised down from 3.4% growth to 2.9% with spending on goods dropping from 8.1% growth to 7.2%.
2. Business capital spending dropped from 11.5% growth  in  the preliminary report to 8.4% in the revision with large downward revisions in the growth of inventories and business structures.
3. Federal government spending growth was revised upward from  2.3%  to  3.1%.
4. Growth in final sales of domestic product was revised downward from 2.5% to 1.9%.

This revised mix of weakness in business and consumer spending with all of the federal government stimulus in the quarter is alarming and casts further doubt on the underlying strength in the economy as federal stimululs abates going into next year. Our assumption of 1%-3% GDP growth in the fourth quarter will need strong contributions in both consumer and business fixed investment from the revised third quarter levels. We detect an improved level of retail sales in the quarter but  will need to see sales results of “Black Friday” to see if that is true. A disappointment in this weekend’s sales will cause a shift in outlook for both the economy and particularly the capital markets which have been seeing the glass “half full” in November despite the warning signs in consumer sentiment, new home sales and continued high levels of unemployment. It is noteworthy that the market gains in November have been accompanied by low levels of trading volume, an ominous sign for sustained capital market gains.

In our previous website and blog articles on the preliminary third quarter GDP, we remained skeptical of the durability of the third quarter gains and said we would be watching fourth quarter economic data closely for future direction. With the downward revision in third quarter numbers, we will be even more vigilant to see if this economic recovery has “legs”.
Best wishes for a Happy Thanksgiving holiday and stay tuned.

Morris R. Segall, CFA, CIC

Today’s Economic Landscape and What’s on the Other Side

Morris Segall      2009 economy, Capital Markets, economics, GDP, global, government, international, treasury, trends, unemployment

We recently updated our presentation on today’s economic landscape and what’s on the other side with some fresh data.  We hope you continue to find value in our slides:

The Government Stimulates the Third Quarter but Doubts Remain

Morris Segall      2009 economy, Capital Markets, commodity markets, consumers, debt, depression, economics, GDP, unemployment

GDP for the third quarter comes in strong stimulated by the government but the details and other consumer economic data create doubts on sustainability and make the capital markets nervous. Continue reading this premium article at spgtrend.com.

Related reading:

Economic and Capital Market Update

The September Employment Report: More Unsettling News

The Economy, Capital Markets, Healthcare and Geopolitical Events

Dow 10,000; the Dollar and Commodities

Morris Segall      2009 economy, Capital Markets, Commodity Prices, consumers, Dollar and Commodities, Dow, Dow Jones, Dow Jones Industrial Average, Economic Growth, economics, trends, Wall Street

After reaching the 10,000 level last week, the Dow Jones Industrial Average stalled reflecting an overextended condition. Over the same period the U.S. Dollar and commodity prices, led by oil, moved to new lows and new highs, respectively, for this year. These trends are inconsistent with a rising stock market and something had to correct. Either commodities, driven recently by speculation, reversed course or the stock market would retreat under the downward pressure from a falling dollar and rising commodity prices. We have expected a correction in the stock market as it became overextended and vulnerable to softening economic data for the month of September. That correction may have started today with a nearly 100 point decline in the Dow that accelerated in the last hour of trading, reversing the recent trend of strengthening prices as the market closed. As expected, corporate earnings reported for the third quarter were a catalyst for the market “run up” in October. Analysts and investors took heart that earnings were better than expected, notwithstanding that expectations were quite low. However, the economic data on retail sales, factory orders, housing starts and consumer confidence measures for the month of September receded from the July and August increases. This faltering of economic growth is our main concern for extended stock market gains from current levels. We will continue to digest economic data for signs of the direction of the economy in the fourth quarter as government stimulus wanes.

The free fall of the U.S. dollar is now a chronic problem for international finance and capital markets. We noted in our September 8, 2008 website article, “Stocks, Recession and the Bail Out”, the adverse impact of the government’s stimulus programs on the U.S. dollar and the U.S. government balance sheet on international currency and credit markets. With the Dollar at record lows versus other international currencies, foreign governments will now put pressure on the U.S. to support the Dollar. They in turn will consider measures to restrain the rise in their currencies to protect the competitiveness of their export industries, including protectionist measures which we expected to be a reaction to the severe worldwide recession. Unfortunately, the U. S. economy is not strong enough to endure a rise in interest rates which would make the Dollar more attractive on international currency markets. So the Fed is in a quandry with no near term solutions to the falling Dollar given the weak U.S. economy and the massive federal deficits that have been incurred. As we have stated previously, a weak U.S. dollar is inflationary as imports become more expensive. Combined with the large increase in oil and other commodity prices, inflation becomes a problem despite the weak economy. Already manufacturers are reporting a rise in the cost of production inputs which most cannot pass on to customers. Gasoline prices have also risen and will negatively impact consumer discretionary spending.

The rise in oil and commodity prices are a reaction to the falling Dollar. They do not reflect current supply/demand conditions. So the more the Dollar declines, the more commodity prices increase. We believe commodity prices, including oil, are streched and will recede if U.S. economic growth weakens in the fourth quarter and/or the first half of next year. Longer term, gold, oil and other commodity prices will increase reflecting the longer term weakness in the U.S. Dollar and rising overseas demand, particularly from emerging industrial economies in Asia and Latin America, for raw materials. China is aggressively buying up raw material sources in Africa and Latin America, outbidding U.S. companies. This will also raise commodity prices on international markets, longer term.

In summary, capital markets, both bond and equity, here and overseas have had huge gains since the March lows as have commodity markets. We believe all of these asset classes are overextended and vulnerable to faltering economic data, particularly from the U.S. We remain vigilant to near term trends in the economy and price levels in capital and commodity markets. Longer term, a weak U.S. currency and rising commodity prices raise the specter of inflation which validates our commitment to gold, energy and other commodities in our strategic asset allocation model.

Morris R. Segall, CFA, CIC

The September Employment Report: More Unsettling News

Morris Segall      2009 economy, business landscape, consumers, economic, economics, employment report, unemployment

Friday’s monthly employment report for September was bad. September job losses, per the Business Establishment series, was a -263,000, worse than analysts projected. Job losses were widespread between manufacturing, construction and a huge 147,000 loss in service sector jobs. The stated unemployment rate increased to 9.8%, another record level. The unofficial unemployment rate that includes underemployed and discouraged workers rose to 17%. The average workweek declined to a record low 33 hours and the employment to population ratio declined to a record low of 58.8%. That means less than 60% of the available working age population are employed in full time jobs. Unemployment rates increased in all demographic groups led by teenagers at a crushing 26% and minority groups in the low to mid teens. The unemployment rate for adult men escalated to over 10%. While these numbers have chronic economic implications they also have negative social impact as well and we are seeing it in an increase in crime, divorce, domestic violence and physical and psychological disorders. We wrote about the social and emotional toll of this recession in our website article of March 23rd, “ I am Mad as Hell…“. The scars from this growing and continued high level of unemployment will be felt long after the economy recovers.

As if the current level of unemployment were not distressing enough, the Labor Dept. announced that a preliminary estimate of its annual benchmark revision to the monthly unemployment data shows that private sector employment going back to March of this year is lower than originally reported by 855,000 jobs. In a previous blog article, “The July Employment Report…“, August 10, 2009, we stated that we believed recent monthly unemployment numbers would be revised downward when the annual revisions are made next March. The 855,000 increase in lost jobs is a PRELIMINARY estimate and we are expecting it to go higher when the final revisions are made next year.

Friday’s unemployment data on the heels of Thursday’s increase in first time unemployment claims is the latest in a string of weakening economic data last week. We stated in our last blog article, “The Economy, Capital Markets…“, October 1, 2009, that we are getting “uneasy about the underlying improvement in the economy”. Friday’s unemployment report is more unsettling and increases our unease.

To be sure we need to see more economic data for the month of September before making revisions to our economic and capital market outlooks. However, we are advising our capital markets clients to take some capital gains where tax considerations are not an issue and hold onto cash as a defensive measure. We still believe there was enough “pop” in the government stimulated economy in the third quarter to generate 3%+ GDP growth. But we are increasingly unsure about subsequent quarters as government stimulus wanes. If our fears are realized, equity markets here and abroad have considerable downside risk from current levels. As we have stated repeatedly in previous blog and website articles, there is no recovery without the consumer moving “goods off the shelves” on a continuing basis. Worsening levels of unemployment just keep postponing that development. Investors and businesses will need to be flexible and nimble in planning for next year. Stay tuned as we continue to analyze data and events over the remainder of this year.

Morris R. Segall, CFA, CIC

The Economy, Capital Markets, Healthcare and Geopolitical Events

Morris Segall      2009 economy, Capital Markets, Cash for Clunkers, economics, Geopolitical, healthcare plan, trends, unemployment

Today the government released its third and final revision to the second quarter GDP numbers and shaved the 1% contraction to .7%. There were no major shifts in trends from the previous report but the positive direction of business fixed investment and consumer spending was aided by a surge in government spending, as expected. As we have stated previously, it appears the recession ended in the second quarter. Led by rising home and auto sales, positive trends in industrial production and retail sales continued through July.

The expectation was for these trends to continue through August and into September led by continued government stimulus and subsidy programs. However, August numbers for existing and new home sales declined in August from July levels and factory orders for durable goods in August were also unexpectedly down from July levels. This makes us uneasy about the underlying improvement in the economy. We have stated previously that government stimulus and subsidy programs, notably the “Cash for Clunkers” program and the tax credit for first time home buyers, were likely to spur positive GDP growth in the third and fourth quarters of this year. The question in our mind was what happens when those programs expire. Now we see that despite the positive demand stimulus from the government programs and the momentum of increased home sales and prices and auto sales in June and July, there was no follow through in August. And there should have been. The decline in factory orders is particularly disturbing because the positive trend in auto and home sales should be leading to a steady improvement in factory orders and production to replace goods sold.

The decline in many of the components of the factory orders report suggest that businesses are not ready to ready to begin a sustained capital spending uptrend. If they are not going to increase spending with government stimulus, what happens when that stimulus ends. It will be very important to see housing and business spending levels for September and the remainder of this year to gauge whether we are really in recovery or facing a downleg in the “W” shaped economic outlook we raised in our August 3rd blog entry, “Turning the Corner…“. While the “Clunker” program has expired we expect the current home buyer tax credit program to be extended into next year given the success of that program.

Today also marks the end of the third quarter and stock markets around the world concluded one of the most successful quarters in decades. The Dow Jones Industrial Average gained 15% in the quarter and overseas markets showed bigger increases including Europe and Japan as well as emerging markets. Fed by infusions of liquidity from central banks and the specter of worldwide economic recoveries, capital markets surged. In recent weeks, increased speculation and appetite for risk have reappeared in debt and banking transaction markets. Year to date the Dow is up 50% from its March lows. Overseas markets show comparable and greater gains. But at this point both bond and stock markets here and abroad are stretched and need further evidence of economic and corporate profit improvements to protect present gains and sustain additional appreciation. If the outlook for worldwide economic growth proves correct we believe worldwide debt markets are vulnerable to declines from higher interest rates next year from the current depressed levels. Here again, economic data over the remainder of this year will influence the direction of worldwide capital markets. If our concern over a “W” shaped economic outlook proves correct, expect a major correction in U.S. and overseas markets from current levels. We are watching developments closely.

In our blog entry, “Healthcare Reform and the Democrats…“, of August 6, we raised concerns over passage of the President’s healthcare proposal and the split in the Democratic Party that we felt would be the undoing of the President’s plan. Events since then have validated that concern and it now appears that for the same $1 trillion price tag Congress will pass a healthcare bill that omits a public option. This will leave the private healthcare and pharmaceutical industries intact and escaping significant third party competition. The political “fallout” is considerable. The President is wounded and his party is split. There is concern about Democratic Party losses in next year’s Congressional elections as the debate over healthcare reform has been framed as big government socialism versus libertarian, individual democracy. A perceived defeat of the President and a fractious Democratic Party will have international implications as both our allies and foes evaluate the strength of this President.

Speaking of geopolitics, this weekend’s victory of Angela Merkel in German elections lends further support to our contention that Europeans are turning to the political “right” (See our website article, “I am Mad as Hell…“, March 23, 2009). Running on a pro business, lower tax platform, Chancellor Merkel and a right of center, pro business party won nearly 50% of the popular vote. The long time Social Democratic Party garnered less than 25% of the popular vote, its worst defeat in postwar history. Angela Merkel joins Nicholas Sarkozy of France heading a center right European government and the victory of center right parties in this year’s European Parliament elections. Furthermore, it is widely believed Britons will elect a Conservative government in next year’s elections. The disillusionment of European voters with socialist governments is the direct result of the economic damage to those electorates from the recession and the increase in protectionist sentiments to protect domestic jobs and incomes.

Additionally, geopolitical events from Afghanistan to Honduras are hurting President Obama and his foreign policy agenda. The President is in danger of being viewed as impotent and more style than substance. While he remains very popular overseas, his policies and lack of forceful actions in the face of antagonistic behavior will erode his ability to lead a free world coalition against rising threats. We will publish on our website in the near future an in depth analysis of international events and the Obama foreign policy.

In summary, as we conclude the third quarter recent economic data is disquieting and if continued will threaten the outlook for economic recovery in the U.S. and the large gains in worldwide capital markets achieved to date. Overseas events also threaten to undermine the “honeymoon” in foreign affairs enjoyed by President Obama to date. We are not changing our intermediate and longer term positive economic and capital markets outlooks at this point but we are watching data and events over the next three months very carefully.

Morris R. Segall, CFA, CIC

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

Intel’s Second Quarter Earnings—A real “Green Shoot”

Morris Segall      2009 economy, business landscape, earnings report, economic, economic recovery, economics, GE, Intel, trends

In our July 5th blog entry, “June Employment Report–Green Shoots Fading“, we commented that a doubtful economic recovery expected in the third quarter and pessimistic earnings guidance from companies reporting second quarter earnings this month would in our opinion herald stock market corrections here and abroad near term. Since that posting the Dow Jones Industrial Average declined approximately 5% in the ensuing five trading sessions before rebounding on expectations of robust bank earnings to be reported this week. Indeed, Goldman Sachs reported a “blowout” quarter led by its investment banking activities. However the more significant earning news yesterday came from Intel that reported a surprisingly strong second quarter highlighted by a surge in revenues and unexpected expansion in gross margins from increased unit volumes of consumer products. Even more importantly, the company reestablished earnings guidance for the remainder of the current fiscal year as the outlook for its business became more visible and positive. This is the kind of earnings encouragement that is necessary to sustain the market recovery begun last March. To be sure, Intel’s business turn may be truly singular to itself and not indicative of a broader upturn in the technology sector but as a bellwhether in the industry and in the major market averages, the substantial improvement in Intel’s performance and outlook lead us to believe we are at or near the bottom of the earnings cycle for non-financial companies. Indeed, we feel Intel’s results signal the same kind of shift in corporate earnings we saw at the opposite end of the spectrum in early 2008 when we wrote our article, “GE, the Earnings Cycle and Food”, April 14, 2008. In that article, we noted the deterioration in GE’s first quarter 2008 earnings and the very negative implications for the rest of S & P 500 corporate earnings last year.

The Intel results reflect successful new product introductions, stringent cost control, inventory reduction and strong sales. The strong sales reflect strong demand for PC products from China and the U.S. aided in the latter by bargain selling prices by the company’s resellers and buying stimulus from accelerated write-offs offered by the Federal government. The higher sales volume and cost reductions allowed the company to record much expanded gross margins in the quarter despite lower average selling prices and lower unit margins on consumer products. This has been a theme of ours supporting a positive outlook for common stocks led higher by rapidly increasing corporate profits from increased gross margins from increased unit sales volume.

The new, improved visibility for increased unit sales, continued cost controls and tight inventory control is allowing the company to forecast improved gross margins for both the third and fourth quarters of the current fiscal year which may force analyst earnings forecasts to be raised. This is also reinforcing another of our themes for the recovery cycle, namely the pent up demand for computers that can only be deferred for so long before a new sales cycle begins. Currently, the new demand is coming in consumer products but the company expects business demand to pick up next year for the same reasons. Importantly, the higher end business products carry higher unit margins which should amplify Intel’s earnings when the economy recovers.

Thus, we are encouraged that the Intel earnings report contains the seeds of a bottoming in earnings in the technology sector and possibly other areas of Producers Durable Equipment sector, i.e. capital goods as pent up demand, bargain purchase prices, accelerated equipment write-offs and fast return on investment and increased productivity lead to a recovery in this sector. We expected this sector to be a leading element in the economic recovery forecasted for next year due to short lead times for purchase and profitable returns. The Intel earnings report and new guidance give us reason to believe in that forecast. And yet we still believe in our comments of July 5th that many companies will not have the positive guidance outlooks of Intel, i.e. consumer discretionary, real estate, transportation to name a few. In view of this and the continued weak near term economic environment, we still believe the capital markets are vulnerable near term to the downside as economic and corporate earnings remain weak. Neverthless, our intermediate and longer term outlooks are reinforced by the Intel results.

Morris R. Segall, CFA, CIC

An Open Letter to Congress

Morris Segall      government, healthcare, healthcare plan, insurance, medical insurance, Medicare, obama

Dear members of Congress,

I am writing to you regarding the current debate on President Obama’s national healthcare plan. As you may know I head an economic and capital markets research and consulting firm. My firm and our affiliate, Sage Policy Group, engage in economic and public policy analysis and ideas. Healthcare is one of several policy issues we have and are currently studying.

I have been involved in either administering or participating in private sector insurance programs for most of my 25 year corporate career. More recently, I have had to engage both the public insurance program of Medicare and the private hospital and insurance industry as a result of chronically ill parents who are both incapacitated. As a result, I have developed a keen understanding and awareness of the mortally broken and dysfunctional healthcare system currently in place in our country. After opposing the Clinton healthcare plan over 10 years ago I have come to the realization that comprehensive and affordable healthcare for most Americans must be built around a Federal entity.

The present system based on the private insurance and drug industries has not contained healthcare costs and has not increased the number of insured Americans. To the contrary, medical insurance costs are skyrocketing, even in the midst of this great recession. Many businesses report medical insurance plan increases in 2008 and 2009 well in excess of 20% and employees in those plans are facing higher deductibles and increased insurance premium and co-insurance payments, in some cases of nearly 50%. This at a time when American workers are facing historic unemployment and reduced “take home” pay from wage and salary reductions and fewer hours worked. Seniors on Medicare are now facing exorbitant costs for required drugs as they hit the “doughnut” hole in prescription drug coverage. While the costs of medical insurance and drugs go up, the reimbursements to doctors and hospitals are being reduced causing doctors to either leave practice or refuse to accept private insurance and Medicare patients. The increase in uninsured Americans forces them to seek medical treatment at hospital emergency rooms overwhelming those facilities. Likewise the increase in our aging population is now overwhelming acute care hospitals and nursing home facilities that are facing chronic shortages of trained personnel to care for an increasingly sick patient population. And the costs of hospitalization and nursing home care are crushing. Hospital and related services costs have increased nearly 8% in the six months ended this past May according to the Government’s CPI report.

So after decades of trying to fix America’s healthcare system and control escalating costs what is wrong? What’s wrong is we are asking FOR PROFIT companies that are primarily focused on increasing earnings and shareholder value and paying bonuses to its senior managers for doing so, to make less money by reducing its prices and accepting less than totally healthy insured’s that will “eat” into their profits. Critics of national healthcare raise the alarms of out of control costs, rationed and inefficient treatment in a federal system. Healthcare is already rationed if you are not on a corporate healthcare plan and if you have the misfortune of going to an emergency room and waiting for a physician for up to 12 hours, you will see firsthand the inefficiency of healthcare in today’s environment. This system is broken and will collapse entirely under the weight of the impending case load of the baby boomers. There are national crises that inure properly to the Federal government for solution.

It is now time to recognize the failures of the present system and move boldly toward a federal government health insurance program offering and administering, preferably under a single payor system, comprehensive, diagnostic and wellness programs to all Americans. It is also time to rectify the injustice in the Medicare prescription drug program and eliminate the so called “doughnut hole” in prescription drug coverage for seniors that forces many seniors to either skip their medications or have to choose between their medications and other necessities. But the cost of such a comprehensive federal program you say. How will we pay for it? What will it do to the federal deficit? How can it be run efficiently with some cost effectiveness?

No one is more cognizant of the erosion of U.S. finances than we. We have been warning our clients and audiences since last September when we first raised the specter of the long term cost to our currency and balance sheet from the huge bailout spending programs to resuscitate our economy. Now on top of that spending are ambitious spending programs of the President for energy independence, healthcare and education. The costs of huge federal deficits which we have projected in excess of $2 trillion this fiscal year and nearly that much in fiscal 2010 are already being felt in the currency and bond markets. The costs of such deficits will have to be borne by all of us, consumers and business, in the form of higher taxes and fees. We will also have to be creative in charging for increased government services on a means testing basis including higher co-payment terms for health insurance for those that can afford it. And don’t let the recent spate of propaganda from some medical authorities convince you there are no healthcare cost savings from wellness programs. You and I both know that just isn’t so.

We believe the American public has endorsed an increased federal presence in their lives with the election of a Democratic Congress in 2006 and the sweeping victory of President Obama in 2008 on a populist platform. We believe Americans are willing to pay higher taxes for increased government services and assistance in healthcare, education and energy which are draining middle class incomes and threaten our standard of living. If the U.S. government can spend billions on bailing out GM, AIG, credit card, banks, investment and insurance firms, what is our economic future and public health worth?  Therefore, I ask you to support the President’s proposal for a strong, comprehensive federal insurance program including a payor system. By the way, such a program would be an enormous help to the thousands of unemployed white collar managers, professionals, and administrators who have been especially hard hit in this recession. You might look at a federal health insurance program as the equivalent of the WPA program under President Roosevelt in terms of putting people back to work and helping to resuscitate the economy. Furthermore, this pool of highly experienced managers and professionals is one of the reasons I believe you can implement a large federal healthcare program successfully.

Sincerely,

Morris R. Segall

President

msegall@spgtrend.com

June Employment Report—”Green Shoots” Fading

Morris Segall      business, economics, economy, employment report, unemployment

Thursday’s release of June unemployment numbers has cast a pall over the economic recovery thesis for the second half of this year. The report was pervasively weak. The overall job loss reported of 467,000 was much higher than expected and the breadth of the job losses was even more disappointing. Every industry sector except healthcare saw
increased job losses in June than in May with striking increases in the Professional and Business services and Government sectors. The negative tone and implications of the June report sapped the stock market on Thursday, knocking the major market averages down almost 3% and leading market sectors like commodities down even more.

We believe the June employment report and the attending stock market reaction signal the beginning of the long awaited stock market corrections both here and abroad as the prevailing optimistic sentiment regarding the U.S. economy is now in doubt. This change in sentiment and the upcoming earnings guidance from companies reporting second quarter results this month are expected to put increased pressure on the elevated stock markets. We expect the capital market declines to be led by commodities, particularly energy, which have paced the market gains since March. The weakening economic outlook diminishes the recovery story for materials and energy given a protracted weak demand environment.

Our capital markets strategy of holding significant cash reserves in anticipation of market corrections, while the U.S. economic recovery was in doubt, should provide a cushion to near term market declines but more importantly, provide liquidity to invest in the market at lower prices. We are “bullish” on stocks over the 2010-2012 period and believe the stock market lows of this past March are the cycle lows for this recession. But the markets, particularly foreign stock markets have appreciated very much, very fast and needed confirmation of an economic recovery to stimulate an upsurge in corporate earnings to sustain the recent market strength. Failing that, the markets were in our opinion, fully valued. So we will watch the slope of market weakness to see where it lands but be prepared for at least a 5% to possibly 10% correction, particularly if corporate earnings guidance for the remainder of this year and the early part of next year is disappointing.

Morris R. Segall, CFA, CIC

Third Quarter — Still at the Bottom of the “L”

Morris Segall      2009 economy, business landscape, consumers, economy, government, slowdown

I continue to be surprised at the over-optimism of the mainstream financial press and government spokespeople on the current economic environment which is leading to increased forecasts of economic recovery beginning as early as this year’s third quarter.

Headlines indicating some economic improvement from higher consumer sentiment readings, a guarded optimistic reading on the economy from the Federal Reserve Open Market Committee this past week, a marginal improvement in the rate of economic decline in this year’s first quarter GDP and an impressive growth in the Advance report on Manufacturers Factory Orders for May were used as the basis for this continued optimism and a reversal in the stock market slide of the week before.

So once again I must put the facts on the table:

1. The fractional improvement in first quarter from -5.7% to -5.5% was entirely due to a smaller reduction in business inventories. In fact, consumer spending was actually reduced from a 1.3% gain to .95% thus shading the contribution from consumer improvement.

2. The strong improvement in Manufacturers Factory Orders in May is up only 1.5%, excluding transportation (primarily commercial aircraft), from the severely depressed level of March and is down 23% from May, 2008 levels. More importantly, the book/bill ratio of orders versus shipments in May was 95% versus approximately 96% in March and April. Thus non-transportation factory orders are no better and in some respects worse than they were at the end of depressed first quarter levels.

3. The Federal Reserve statement, while expressing guarded optimism that the worst of the economic contraction was behind us, kept interest rates at essentially 0% because the economy is still functioning at a depressed level.

4. On Friday, the government reported a surge in consumer incomes in May of 1.4% fed largely by government social security stimulus checks. On the other hand, consumer spending in May increased only .3% and the personal savings rate increased to 6.9%, a 15 year high. This low level of spending and the further increase in consumer savings on top of already historically high levels tells us the consumer is still very much concerned about the current economic environment, refuting his statements on consumer surveys, and is not ready to start pulling us out of recession by a surge in spending.

In our blog posting, “Beware Over-Exuberant Reactions to this Week’s Economic News,” (May 28, 2009), we stated “the second and third quarters of this year will be “less worse” than the first quarter but not an end to the recession”. We characterize the current economic environment as the bottom of an “L”. We have been projecting second quarter GDP to contract 2%-3% but with the continued weakness in consumer spending through May, GDP contraction in Q2 could reach 4%. Furthermore, we see little evidence that consumer spending will miraculously turn higher in Q3, particularly with continued high levels of unemployment which we expect will go higher over the summer spurred by layoffs from GM and Chrysler. Thus at this juncture, we expect Q3 GDP to be in a range of 0% to down 2%-3% depending on the level of U.S. government spending in the quarter. This is well below the 1%-3% growth in third quarter GDP many economists are currently projecting. If we are right, stock markets here and around the world are setting themselves up for a material correction from the elevated levels achieved this week.

An economic recovery will occur and we still believe it is largely a 2010 event but the continuation of the current economic torpor is pushing the recovery further into next year. We continue to be vigilant for real indications of a sustainable improvement in consumer spending which is a prerequisite to any recovery from this recession.

Morris R. Segall, CFA, CIC

The President’s Financial System Overhaul: It’s Time

Morris Segall      2009 economy, bailout, banking system, business landscape, economy, The new Fed actions

After a year of speculation and discussion, President Obama released his plan for reform and regulation of the nation’s financial system. There were few surprises. With more oversight and control centered in the Federal Reserve and augmented with newly created boards, the plan brings under new regulation and supervision virtually all major sectors and products of the financial services industry.

Born out of the cataclysmic financial losses of the current recession, the President’s plan seeks to avoid a repetition of the circumstances and events that led to the recent financial system meltdown. It is the quid pro quo for the federal government bailing out the U.S. credit system and nobody should be surprised at the far reaching reform and regulation embodied in the plan.

In the most sweeping regulation of the financial sector in this country since the Great Depression, it creates unprecedented power to seize banking institutions and intercede in the transaction systems in the financial marketplace. This would include the “breakup” of large financial conglomerates that pose a heightened risk to the functioning and integrity of the financial system.

Critics are bemoaning that the increased intrusion of the federal government in the affairs of the financial marketplace may cause restriction and higher costs of credit to borrowers. With all due respect, that has already occurred as a result of the massive debt losses sustained by the nation’s credit intermediaries and its investors and placement firms.

Like it or not the financial marketplace and its players are going to have to deal with more stringent governmental oversight and regulation to protect the country from another financial meltdown from insufficient credit risk underwriting.  The constriction of credit, the inability to conduct market transactions in asset backed securities and consumer and banking failures necessitate the comprehensive overhaul of the nation’s financial system.

The mandating of increased oversight of the nation’s banks including higher capital and liquidity standards and the assumption of prudent risk and the offering of high risk products will force the banking system to adopt a more stable lending and responsible posture. The regulation of credit card companies and mortgage brokers and other financial intermediaries serving consumers is required to also enforce higher standards of professional conduct, better risk underwriting and most of all, consumer protections from fraudulent and abusive practices.

Importantly, the overhaul plan includes regulation of the “paper” created around the asset based lending that leveraged and securitized these transactions and have been a major contributor to investor and lender losses as the value of such paper eroded more than the assets they backed and became illiquid.

Unfortunately, the President’s plan does not use this opportunity to streamline the regulatory system. We believe there are still too many agencies involved in the new regulatory framework and may lead to inefficiencies and inconsistencies in industry oversight. However, no new regulatory plan of this magnitude was going to be perfect and the overall benefits will outweigh the organizational faults. We also believe industry participants will adapt and operate successfully in the new environment and/or exit the more risky sectors of the financial marketplace. This will inure to the benefit of lenders and borrowers in providing a safer and fairer financial system.

The credit industry over the 2004-2007 period lost its way and its mistakes in the extension of credit to poor credit risks and the leveraging of those risks would have plunged us into a massive depression were it not for the Herculean federal rescue. It’s time we got this critical industry and system back under control.

Morris R. Segall, CFA, CIC

Europeans are Mad and Turn Right

Morris Segall     

The recent European Parliament elections held this past weekend confirmed our observations in our blog and website articles, “I am Mad as Hell and I am not Going to Take it Anymore,” March 23, 2009. Voter dissatisfaction with left leaning and socialist governments and their policies handed conservative and right wing nationalist parties a clear majority in the European Parliament and unseated and inflicted major losses on sitting governments in Hungary, Ireland, Great Britain and Spain. This move to the political right is expected to have the following repercussions:

1. A move toward less free trade and globalization and more protectionist
measures to protect local businesses and local workers.

2. A move toward anti-immigration measures to protect local workers.

3. Increased divergence between Europe and the U.S. in regard to massive federal
government stimulus spending to accelerate economic recovery in the Eurozone. In our blog
posting, “Is the U.S. a Party of One, ” we called attention to the divergence of opinion
between the U.S. and Europe on this matter. The conservative electoral victories will make
this divergence even greater which will undermine the strength of the U. S. Dollar and the
attraction of U.S. Treasury debt and stall an increase in U.S. exports to Europe that would
stimulate the U.S. economy.

4. Some increased concern about the future of the European Union as more countries adopt
increased nationalistic policies and viewpoints and re-think subjugating national policy to a
European Parliament and European Union bureaucracy.

I also cannot help but see the parallels between the social and political movements in Europe today and those of Europe in the Depression of the 1930s. In the 1930s the Great Depression saw the rise of fascism as a solution to the terrible deprivation of Europe’s populations. Some of the parliamentary and national government gains over the weekend were achieved by far right wing, nationalist parties preaching anti-immigration and often bigoted platforms. The appeal to a population’s patriotism diverts attention from the real economic problems facing Europe’s governments and for which there are no easy answers and more importantly, no quick fixes.

Morris R. Segall, CFA, CIC

Unemployment And The Cycle

Morris Segall      Chrysler, economy, GM, unemployment

Today’s unemployment report for the month of  May,  showed a stunning decrease in the monthly trend of job losses since the recession intensified in the fourth quarter of last year. The Labor Dept reported non farm payrolls declined by 345,000 in May, the lowest monthly level of job losses since last September, and far below analysts’ expectations of 500,000 lost jobs in May. Combined with the recent downward trend in first time unemployment claims seen in the months of April and May, we believe the current level of monthly losses in the U.S. economy has subsided from 600,000-700,000 to 500,000-600,000 reflecting the already massive cutbacks in payrolls over the last six months. However, we are highly skeptical that monthly job losses have declined below the 400,000 level at this point in the cycle for the following reasons:

1. The May figure of -345,000 is not consistent with the ongoing level of first time unemployment claims of 600,000+ reported through the month of May.

2. The May figure of -345,000 is not consistent with the rising level of long term unemployed workers that reached over 6.7 million during the month of May.

3. The May figure of -345,000 in the Business survey is not corroborated by the less quoted Household Survey which showed an increase in unemployment of 787,000.

4. The May figure of -345,000 does not reflect the continued increase in part time and discouraged workers which now number over 11 million.

We believe the May job losses will be revised downward when the June unemployment report is released next month. The monthly unemployment report from the government is becoming increasingly unreliable in its initial release, and has been subject to consistent and often large revisions in subsequent monthly releases.

Nonetheless, were it not for the forthcoming increases in job cuts coming from the restructuring of GM and Chrysler, we would be comfortable in stating that the rate of new job destruction has peaked for this cycle, which is a prerequisite to a bottoming in this recession. Next must come a peaking in the level of long term or continuing unemployment claims. But a recession bottom is not an economic recovery. The current level of TOTAL unemployed, and part time, discouraged and underemployed workers is approximately 25 million, and there can be no recovery until these people get back to work and start spending again. So while we have hit the nadir of this recession in terms of rate of economic contraction, we fear it will be the fourth quarter of this year before any measurable economic growth will be reported.

Morris R. Segall, CFA, CIC

Beware Over-Exuberant Reactions to this Week’s Economic News

Morris Segall      consumer sentiment, economic

This week the Conference Board Consumer Confidence Index for the month of May came in at an impressive 54.9, a surprisingly strong increase over the rise in the index in the month of April. The strong increases in the Conference Board’s and Michigan Consumer Sentiment Surveys in April and May we believe are largely due to the continued strong gains in U.S. stock prices since mid March.

Indeed, we mentioned in our Economic Update of May 1, 2009 that the March reading in this index in the mid 30s would likely be the low point for consumer sentiment in the current cycle. The news of the cycle results and its  attribution to perceived improved labor conditions, mentioned in the  survey, were the catalysts for the recent strong stock market rally.

What Does it REALLY Mean?

There has always been a strong correlation between strong stock markets and rising levels of consumer sentiment. We, along with many other market analysts,  are skeptical of the intermediate and long term predictive value of consumer sentiment surveys. One of the unexpected measurements of  strength in the survey was a perceived improvement in job availability  among consumers to 44.7 from 46.6. Such a slight statistical  improvement is not a convincing improvement in trend particularly when one notes the absolute high level (approximately 45%) of respondents reporting “jobs are hard to get” versus the level of approximately 6% reporting “jobs are plentiful”.

We stated further in our May 1 Economic Update that consumer sentiment surveys can be fickle and inaccurate as a predictor of actual consumer spending trends. To be sure, we believe the just concluded Memorial Day holiday will show a strong increase in consumer spending as more Americans hit the road for vacation travel. We are expecting strong retail spending numbers for the first holiday weekend of summer. Our concern is that the current depressed economic environment may become one of a “sawtooth” pattern of economic activities. One month of increased retail sales and factory orders and industrial production followed by a retrenchment due to the continued  high levels of unemployment and weak consumer and business demand.

In short, we do not believe there is sufficient strength in consumer finances and psychology to sustain a consistent rise in consumer spending in the near term.

Take a Look at the Hard News

Conversely, the news coming into the Memorial Day holiday was far more disturbing for the following reasons:

1. Rising Interest Rates

The yield on the U.S. 10-year Treasury Note rose on Friday to nearly 3.5%, up from 3.17% since the middle of May and 2.53% since the middle of March. This is the highest yield on 10-year U.S. Treasury securities since last November. We have warned in previous blog and website articles the massive negative impact on longer term U.S. economic growth from rising interest rates and a large decline in the U.S. Dollar. Both of these developments are occurring now despite the action of the FED to buy Treasures to keep interest rates low.

2. Federal Budget Deficits

Coincident with the dramatic rise in intermediate and long term U.S.  Treasury interest rates have been equally dramatic increases in the projected Federal budget deficits for fiscal 2009 and 2010 and the chronic increase in the government’s national debt. This deterioration in the U.S. financial condition is causing alarm among national and world investors, including foreign governments and world banking institutions that the U.S. credit rating would be downgraded like that of Great Britain last week.

3. Credit Crunch on Farmers

Deteriorating credit availability for farmers which may affect the procurement of fertilizer, seeds, animal feed and farm equipment. The credit crunch on farmers could negatively impact upcoming harvests and thus cause a rise in food prices next winter.

4. The State of California

The continuing chronic fiscal woes of the State of California whose  budget deficits are projected to rise to more than $40 billion in fiscal 2010. We fear the Federal government will have to bail out the state within the next two-three years to avert a major state default and cutbacks to state services that would be injurious to the public wellbeing. A federal “bailout” of California would rank among the largest and most expensive and long lasting in this current financial crisis. It would certainly add to the deterioration of the Federal balance sheet and pressure our credit rating and currency. It would also lead to further  demands from severely depressed states for increased Federal assistance.

Reality Check

We continue to be wary of over-exuberant stock market reactions to encouraging news du jour which needs to be confirmed by improved and sustained underlying improvement in unemployment, a bottoming in residential housing and a peaking in bank loan losses.

Until we see that, we maintain that we have hit a DEMAND bottom at the end of the first quarter but not a recession bottom. The second and third quarters of  this year will be “less worse” than the first but not an end to the  recession. We might see some slight improvement in GDP in this year’s  fourth quarter but more likely we will have to wait until 2010 for gradual economic recovery. Bullish reactions to this week’s economic news is  premature.

Current Economic News Needs A Dose Of Reality

Morris Segall      economy, news, recession

Pardon us for interrupting the party but we felt the economy was going to hit a DEMAND bottom at the end of the first quarter as inventories, employment, factory orders and consumer spending plummeted to depths at which they were unlikely to contract further. But a demand bottom did not mean we were at a recession bottom. The current economic condition is comparable to falling to the bottom of a swimming pool. You reach a point where you hit bottom. That doesn’t mean you rise back to the surface. One can lay on the bottom for a while longer. That is where we believe we are in the current cycle. Here’s why:

1. The April unemployment report which showed a reduction in job losses to under 500,000
masked a large component of temporary federal government hires for next year’s census.
Job losses in the private sector were over 600,000 and continued to afflict every industry
sector except government and healthcare, the only sectors that have added jobs in the
last seven months. In addition, prior months job losses have been revised downward. The
average monthly loss in jobs in the first quarter of 2009 is now approximately 700,000
versus a little over 500,000 in the fourth quarter of 2008. More importantly, continuing job
losses have risen to over 6.25 million from approximately 4.5 million at year end 2008. To
come are large job losses from the downsizing and restructuring of GM and Chrysler over
the summer.

2. Reflecting the increased level of job losses and constricted credit availability, consumers
continue to reduce their outstanding debt. In March consumer debt outstanding declined by
a record $11 billion. Since the third quarter of last year consumer credit outstanding has
declined by nearly $32 billion and consumers savings rate has climbed to over 4%. Further,
consumers are using debit cards instead of credit cards paying cash instead of increasing
the use of credit.

3. After holding below 3% since the fourth quarter of 2008 the yield on 10 year U.S.
Treasury Notes rose above 3%, escalating to over 3.25% last week. We have been warning of the upward pressure on interest rates lurking in the skirts of a recession bottom. As optimism of such a bottom increases and stocks continue to rise, money shifts from bonds to stocks. More importantly, the supply of new Treasury financing for the burgeoning federal budget deficits are forcing interest rates up. Speaking of federal deficits, we have projected the current fiscal year deficit of $2 trillion
(See our latest Economic Update, May 1, 2009). Today, the White House increased its
projection of the current fiscal year deficit to $1.8 trillion. We don’t think they are done.

4. Not so quietly, oil prices have escalated 20% to over $55 per barrel since mid April. Likewise, gasoline prices have escalated and are now well over $2.00 per gallon at the pump.

We believe these factors are going to slow down the consumer recovery and prolong the demand bottom we believe we are now experiencing. Yesterday’s April retail sales report was surprisingly weak, further evidence of the consumer’s unwillingness and inability to increase his spending currently. Given the continued high levels of unemployment and consumer spending retrenchment plus the new increases in interest rates and gasoline prices, we do not think the nascent improvement in economic activity is sustainable through the summer when auto job losses hit. We may be seeing a “sawtooth” pattern of episodic improvement followed by retrenchment. We are hopeful the fourth quarter may be the first concrete period of economic recovery but the auto industry job cuts make that forecast less predictable than we believed earlier. This may push recovery into the first half of next year.

So yes it looks like we are reaching a deceleration in the rate of economic contraction but it is too soon to break out the champagne and the stock market needs a correction to stay healthy. We have been bullish on the 1-3 year outlook on U.S. stocks for some time believing the stock market would “smell” out a recession bottom well before the economy recovered as it always has. The rally in stocks since early March is consistent with that trend but it is now vulnerable to disappointing economic data. However, we believe the early March market lows are this cycle’s lows and we expect a correction near term to hold above the early March levels. We would use such a correction to increase investment allocations in equities with a 1-3 time horizon.

Morris R. Segall, CFA, CIC