SPG Trend Advisors Blog

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

Economic Trends 2009 economy, corporate earnings, deflation, Economic Growth, economic outlook, GDP

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:

Presentations 2009 economy, Add new tag, business landscape, Capital Markets, consumers, crisis, debt

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:

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

Economic Trends 2009 economy, consumers, economics, future trends, GDP, global, government, recession, stimulas, 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:

Economic Trends 2009 economy, Capital Markets, economics, GDP, global, government, international, treasury, trends, 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.

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Economic and Capital Market Update

The September Employment Report: More Unsettling News

The Economy, Capital Markets, Healthcare and Geopolitical Events

Economic Trends 2009 economy, Capital Markets, commodity markets, consumers, debt, depression, economics, GDP, unemployment

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

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

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

Economic Trends 2009 economy, business landscape, consumers, economic, economics, employment report, 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 Trends 2009 economy, Capital Markets, Cash for Clunkers, economics, Geopolitical, healthcare plan, trends, unemployment

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.

Continue reading this premium article at spgtrend.com

Economic Trends 2009 economy, business landscape, Cash for Clunkers, consumers, economics, recession, trends

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

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

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

Economic Trends 2009 economy, Cash for Clunkers, consumers, economics, GDP, government, housing

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

Economic Trends 2009 economy, business landscape, earnings report, economic, economic recovery, economics, GE, Intel, trends

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:

Presentations 2009 economy, business, business landscape, climate, crisis, debt, economic, future trends, globalization, recession, slowdown, strategy, trends, unemployment

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

Economic Trends 2009 economy, business landscape, consumers, economy, government, slowdown

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

Economic Trends 2009 economy, bailout, banking system, business landscape, economy, The new Fed actions

The news this week from corporate America regarding job cuts and declining earnings is so bad that it marks a new unfortunate chapter in the current U.S. recession. The fourth quarter earnings annoucements being released this week reveal a rapid collapse in U.S. corporate earnings that rival the earnings implosion of U.S. companies in 2001-02. The U.S. recession has now hit corporate America hard and there is no sector of American business that is not feeling the impact of the current zero demand environment.

We expect a 4th quarter earnings decline for the S&P 500 Index to exceed the 22% year over year decline in last year’s third quarter. At this point, the magnitude of U.S. corporate earnings declines is now an active contributor to the recession rather than collateral damage from the recession. The continuation (six consecutive quarters) and deepening severity of corporate earnings declines are making the U.S. recession more severe by leading to further job cuts, reduction in pay for existing workers, weakening corporate balance sheets and credit quality. With further earnings weakness, the corporate sector is a major incremental negative for the economy in 2009 which will prolong the current recession. The decline in U.S. corporate earnings are being replicated by massive earnings declines in companies in Western Europe and Japan which will intensify recessions in those regions.

Economic Trends 2009 economy, business landscape, crisis, debt

The current panic in worldwide equity markets beginning overseas and today hitting the U.S. reflects a new round of concern due to continuing bank losses starting with Asian and U.K. banks and extending to further losses being reported by U.S. banks. A year ago we wrote about the worsening credit crises in banking here and abroad, “Is Something Burning”, January 22, 2008. At that time, the equity markets were in severe decline and we warned about breaching cycle lows. A year later we are witnessing a repeat as the Dow falls again below 8000 and the S & P 500 Index approaches the lows of 2002-03. Despite all the efforts by governments and central banks to stabilize the banking system we face a new round of asset writedowns. We are struck by the difference in this credit downturn and the savings and loan debacle of 20 years ago. In our opinion this adverse credit cycle is being extended by the preponderance of paper backing and leveraging the asset bubbles in real estate and consumer lending. While hard assets will reach an defineable intrinsic value in a reasonable period of time after the asset pricing bubble bursts, paper asset valuations are more ephemeral. They are subject to the vagaries of investor psychology and risk appetites. The new round of bank losses have more to do with the re-pricing of market value of paper assets than a new decline in hard assets and this is more difficult to stabilize. Government and central bank “bailout” programs are fighting to stablilize assets that have no hard value and increasingly illiquid. The cost of saving the world’s banking system is becoming staggering and may result in the system essentially becoming nationalized at least for a period of time. We are entering uncharted territory in the post war economic period with governments and central banks becoming the buyers and market makers for privately held debt.

Economic Trends 2009 economy, crisis, economy

Economic Trends 2009 economy, business landscape, economic intelligence report