Geopolitics: Why its so important

Morris Segall      Capital Markets, Emerging markets economic growth, European debt crisis, Global financial and banking systems, International economic growth, U.S economic growth, Worldwide recession

Since the spring of 2010 events outside the U.S. have been dominating our financial news and influencing our economy and capital markets. That spring the European debt difficulties moved to crisis stage with the imminent debt default of Greece. The financial crisis that began that spring has continued virtually unabated with a series of financial “band aids” that have staved off world financial disaster but done nothing to provide a permanent solution to Europe’s financial distress. In the meantime, the ratings agencies have downgraded both sovereign and bank credit through much of Europe and the ill advised austerity programs (See our website articles of March 15, 2011 and December 17, 2010), adopted by the members of the European Union have “choked off” economic growth in much of the continent, threatening the region with existing and imminent recession. During this period, world financial markets have been in turmoil and capital markets have been depressed.

Without a firm solution to the spreading sovereign debt woes, panic spread to the continent’s banking system that forced world central banks to add liquidity to the European banking system. This new calamity necessitated a summit of European leaders to fashion a long awaited permanent solution to Europe’s debt crisis. The summit was held last week and as we expected, failed to produce a bona fide solution to the debt crisis. Once again, a summit of European political and financial leaders was long on rhetoric and short on tangible solutions. After a reflex rally in the world capital markets last Friday on the news of increased unity and collaboration of EU members, the absence of substance in the summit became evident on examination over last weekend and the capital markets reacted accordingly on Monday.

We have been pessimistic about the future of the European union since its financial woes became unmanageable in 2010 and the sequence of events since then have only borne out our concerns. The fact is there is no machinery within the European Union framework that will accomplish what is needed to alleviate Europe’s financial distress and satisfy world financial markets that Europe is creditworthy. The principal entity that should be able to provide a conduit for Europe’s sovereign debt financing and shore up its banking system, the European Central Bank, is not empowered nor does it have the resources to do both. Therefore, the members of the EU face totally revamping their union with new treaties, subordinating their sovereignty to the European Commission, or creating some ersatz organ to provide the financial resources to do so. Again, there is not enough consensus among EU members to do what is necessary and not enough resources within the European Community to fully engineer a financial solution to both the sovereign debt and under-capitalized banking system. So the angst over Europe’s financial future continues as does the continuing threat of credit downgrades by the credit rating agencies, exacerbating an already tense situation. At this point, the austerity programs have created a negative economic situation for Europe, both Western and Eastern, that is threatening world economic growth for 2012-13. Europe represents approximately 20% of world trade and is a major market for U.S. and emerging market exports. Its economic stagnation has negative implications for GDP growth here and abroad. If Europe’s financial woes degenerate into a world financial crisis threatening the banking systems globally, it could precipitate a worldwide recession. This is the principal reason why forecasting world economic growth for the next 2-3 years has become so difficult.

That difficulty has been compounded by the current significant economic growth slowdown in the emerging market leaders in Asia and Latin America, notably China, India and Brazil. Emerging markets have been the locomotive of world economic growth before the recession and have led the world economic recovery since the recession ended. Economic deceleration in this key segment of the world economy coupled with economic stagnation in Europe cannot help but depress prospects for economic growth in the U.S. The impact of overseas events on our economy, our financial system and capital markets has never been greater and is unprecedented in the post war era. Unfortunately it is part of a secular change in the world economic order where global interdependence has replaced economic independence and where global economic growth leadership has passed to the newly industrialized economies of Asia and Latin America.

Morris R. Segall

August Employment: There is None

Morris Segall      Capital Markets, consumer sentiment, Economic stagnation, economy, employment, employment report, future trends, government, government stimulus, manufacturing, private sector investment, recession, slowdown, unemployment

Today’s employment report for August continued a worsening trend in the job market we have noted in our blog and website articles since June. Rather than another month of paltry job growth seen since May, job creation in August was zero. The last time the monthly employment report recorded an absence of job creation was last September. In addition, job creation for the months of June and July were revised downward a combined 58,000 jobs. Thus, over the last three months, job creation has averaged 35,000 jobs versus an average of 153,000 over the first five months of this year. Even the private sector, which has been creating a moderate level of jobs so far this year, dropped to nearly zero in job creation in August. More distressing is the event we have feared since the economy and employment faded through the second quarter. That is the shift by employers from reduced job hiring to job layoffs. In the August report, a number of industries recorded job losses including: manufacturing; construction; retail trade; transportation and information technology. The latter includes striking Verizon employees but that does not account for all of the job loss in this sector. The government sector also shed another 17,000 jobs in August. Year to date, the government sector has reduced employment by over 260,000 jobs.

As bad as these numbers are, other data in the employment report for August are even more negative. The already weak average workweek declined to 34.2 hours from 34.3 hours in June and July and is at the low level of last August. Average hourly earnings declined from July levels and are less that 2% above year ago levels, well below nominal inflation. The number of involuntary part time workers increased by approximately 400,000 to over 8.8 million workers from July and is at the highest level since last August. As we reported in prior employment report articles, the number of unemployed 5-14 weeks had been expanding in recent months. Now those people are unemployed over 15 weeks and that category has expanded to almost 59% of the number of unemployed persons.

Combined with the very weak manufacturing data reported yesterday showing major declines in orders, shipments, backlogs and employment and the plummeting levels of consumer confidence in recent surveys, and we have an economy that is “stalled out” and on the verge of sliding back into recession. We have previously cautioned about such a prospect in previous blog articles if economic data over the summer did not improve materially and fast. It hasn’t.

The private sector is doing what we expected in a weakening economic environment-cutting back. The President is expected to announce new economic stimulus measures next week to help create jobs. They will not turn the economy around. The Fed will inaugurate a QE3 program to add more liquidity if recession is imminent. The impact will be similar to that of QE2- a temporary respite but damaging to the bond market and the value of the U.S. Dollar. Without the full participation of the private sector to invest heavily into the economy and hire workers, the current economic trends and pessimistic outlook will not change. This also does not augur well for U.S. and overseas capital markets.

Morris R. Segall

July Employment: Not Good Enough

Morris Segall      business retrenchment, Capital Markets, Economic Growth, economic recovery, employment report, GDP, job creation, recession, unemployment

July’s employment report was hailed with a sigh of relief. Total new job creation was over 100,000 with private sector job creation in excess of 150,000. This was the highest level of private sector job creation since 241,000 jobs were created in April. In addition, May and June employment was revised upward by a total of 56,000 jobs. Revised job creation for the two months amounted to 99,000 rather than the 43,000 previously reported. These numbers were interpreted to allay fears the economy was about to recede into recession.

While the July employment gain and previous months revisions were encouraging, in our opinion, the gains were not much more than statistical and change little in our view of the weak current employment environment.  In virtually all of the key measures of the job market, the July data continued the picture of a diminishing and discouraged work force, working stagnant hours and suffering from diminished employment.

According to the Household Survey, the civilian labor force contracted by almost 200,000 in the month of July and is 400,000 persons lower than year earlier levels. The employment/population ratio has fallen to 58.1% from 58.4% in July, 2010 and is at a 28 year low. The number of people not in the labor force has risen to 86.4 million, an increase of 374,000 from June and 2.1 million higher than year earlier levels. The unemployment rate for July was 9.1%, virtually unchanged from the May-June levels and only fractionally lower than the 9.5% of July, 2010. In addition, 2.5 million people could find only part time work in July, an increase of 116,000 from June and over 200,000 higher than year earlier levels. The average workweek continued to be an anemic 34.3 hours, virtually unchanged for a year.  The average duration of unemployment in July rose to 40.4 weeks, up from 33.0 weeks in July, 2010. The total number of unemployed plus all persons marginally attached to the labor force and those working part time involuntarily, remained over 16%, virtually unchanged since April of this year and only fractionally lower than the 16.5% of July 2010.

On a more positive note, the important Professional and Business Services segment continued to show important progress with further gains in Computer systems design, Management and technical consulting services and Administrative jobs while temp jobs actually declined from May levels.

In summary, private sector job growth accelerated in July from weak levels of May and June. The job creation in the private sector continued to be offset by large job losses in the government sector, averaging 39,000 over the last three months. In fact, even with the increased job growth in July, net employment growth over the last three months averaged 111,000, down from an average of nearly 180,000 over the first four months of this year. This just isn’t good enough to foster increased economic growth or business expansion. While we do not believe we are currently in recession, an absence of improvement in recent economic data, including employment, will in our opinion, lead to further business retrenchment. This business retrenchment will be intensified by the recent downgrade of the U.S. sovereign debt rating and the resulting deterioration in worldwide capital markets. This has raised the possibility of a recession later this year and next.

Morris R. Segall

In addition

The June Employment Report: Now we are getting pessimistic

Morris Segall      business spending, Capital Markets, consumer sentiment, consumer spending, debt default, deficit reduction, democrats, Economic Growth, economic recovery, future trends, inflation, job creation, June employment, obama, recession, Republican Party

Today’s employment report for the month of June is unequivocally a blow to expectations that May’s weak report was an aberration.  Instead of rebounding from May results, the June report deteriorated in virtually all key aspects  of employment. Nonfarm payrolls increased by a neglible 18,000 jobs, the weakest level of job growth in nine months. To make matters worse, the Labor Department revised downward its previous readings on job creation in April and May by a combined 41,000 jobs, including a 29,000 job reduction in May to 25,000 from an already weak level of 54,000 jobs. The June report and the April-May revisions reveal a virtual absence of job creation since April. Of the 18,000 jobs created in June, 57,000 were created in the private sector, offset by a reduction of 39,000 jobs in federal, state and local governments. Of the 57,000 private sector jobs the vast bulk of these, (34,000),  were in the Leisure and Hospitality sector- low paying, seasonal and tenuous given its sensitivity to the economy. According to the Household survey, the unemployment rate reached a year to date high of 9.2% in June despite a contraction in the labor force of over 270,000 from May levels. In addition, the June Household survey showed an increase of 173,000 in the number of unemployed workers and an increase of nearly 450,000 persons not in the labor force. Other statistics from the June monthly report include: a recessionary employment/population ratio of 58.2%; a $.01 decrease in average hourly earnings resulting in no increase in average hourly earnings since April; a decrease in the average workweek and factory overtime; an increase of 100,000 in the number of discouraged workers from May to nearly 1 million persons; an overall increase of 474,000 in those categorized as marginally attached to the labor force from May to a level of 2.7 million people; and an increase of over 400,000 from May in the number of unemployed less than 5 weeks to over 3 million persons. In June, the percentage of workers unemployed, those marginally attached to the labor force and those working part time because they can’t find full time work amounted to over 16%, the highest level this year. Two years after the recession ended, these numbers are unprecedented in post-war economic recoveries.

In our June 7th website article on May unemployment data, we concluded that the May data had been suppressed by the severe storms in the south and mid-west in April and May and the supply dislocations in Japan. We saw reassuring data in the May report that encouraged us to believe we were not on the verge of a double dip recession. Unfortunately, the June report contained none of those positives and should be relatively unimpeded by exogenous events. We believe  the June data confirms our fears that the business sector has retrenched in its spending since March, insecure in the outlook for consumer and customer end demand given the high levels of inflation and pressure on incomes and profit margins and deteriorating economic conditions in major markets overseas. This is confirmed in the underlying weakness in the June ISM manufacturing survey ( See our website article on the June Manufacturing Survey), and the weakness in the June ISM non-manufacturing survey, both released earlier this week. This retrenchment now appears to include a reduction in hiring.

This business spending retrenchment will have enormous implications for economic growth for the remainder of this year and into next if not reversed. An economy that does not provide job growth cannot grow. We have long focused on business and consumer spending as the drivers of economic recovery in the absence of contributions from housing and the government sector. Business retrenchment in spending and hiring will remove both of those drivers from the economy. The absence of private sector job creation will soon be reflected in reduced consumer sentiment and spending. Reduced consumer spending will slow business sales and pressure corporate profits causing businesses to retrench further. The net result is an economy that does not grow and one that could easily fall back into recession. We commented in our last website article how important the June employment report would be for the future direction of our economy. With the June numbers showing such employment weakness, we are now pessimistic the second half of this year will show renewed economic growth and the outlook for 2012 has become decidedly less sanguine. We expect to revise downward our expectations for GDP growth for this year to the bottom of our 2%-3% range and we may have to reduce our projections further if current economic trends persist.

We expect the weak June employment data to complicate if not preclude an agreement on raising the nation’s debt ceiling. The weakness of the June report will, in our opinion, harden the resolve of Republicans to reject revenue raising measures advocated by the President. The same employment weakness will, in our opinion, also strengthen the resolve of Democrats to avoid stringent federal spending cuts, particularly in entitlement programs. The current weakness in the economy will widen the ideological chasm between the political parties. Thus, we are not optimistic a far reaching deficit reduction program will be reached in the next two weeks. Rather we now believe a stopgap measure to avoid government default, possibly through the end of the current fiscal year, will be the only agreement that can be fashioned.

Clearly these events and the current economic environment are not conducive to stock market appreciation. In view of the recent rally in stock prices at the end of June and the first week in July, we believe the equity markets have increased downside risk and less upside potential. We would advise a more defensive and risk averse capital market strategy in light of present circumstances.

Morris R. Segall

Osama Bin Laden is Killed and Risk Tolerance Rises For the Moment

Morris Segall      Al Queda, Capital Markets, consumer spending, debt ceiling deliberations, economic realities, Fed's QE 2 program, geopolitical changes, inflation, kudos to U.S. intelligence and military, obama, Osama Bin Laden, President's reelection, risk aversion, stock market

Last night’s news that U.S. military forces killed Osam Bin Laden is another unexpected geopolitical development in a year that is already seeing huge changes in the world’s political landscape. The news of Bin Laden’s death is causing an immediate reaction of relief and exultation which is seeing large gains in U.S. equity futures which will translate into large gains in U.S. stocks at today’s open. The very short term reaction in U.S. stocks will see a reversal in recent surges in safe haven investments led by gold and oil which are already trading down in Asian and futures markets. This reversal of risk avoidance will last in the very short term but economic and geopolitical realities will reassert themselves in fairly short order.

First, the U.S. markets will still have to deal with U.S. budget contentions that threaten to stall a rise in the U,S. debt ceiling that must be done to avoid a potential U.S. debt default. We continue to believe an eleventh hour agreement on raising the debt ceiling will occur but the cost in the form of higher taxes and decreased federal spending will be significant.

Second, the rise in inflation through the first quarter and extending into the current quarter threatens the growth of personal consumption and business profitability. Already more companies are announcing price increases necessary to pass along higher commodity, manufacturing and distribution costs. Unless, commodity prices collapse on an extended basis through the second half of this year, inflation will continue to be an economic headwind, not just for the U.S. but more importantly, for most economies overseas.

Third, the Fed’s QE 2 program will end at the end of June. What will the effect on the U.S. Treasury market be once the Fed stops absorbing the continuing large issuance of Treasury debt to finance this year’s large deficit.

Fourth, while the killing of Osama Bin Laden is a huge psychological victory over Al Queda, the reality is Al Queda has been operating independently of Osam Bin Laden for some time as witnessed by the vibrancy of the Al Queda operations in Yemen and Africa. The killing of Osama Bin Laden will not change that fact or the threats from local Al Queda chapters. In fact, these factions may intensify their threats in order to offset the psychological loss of Bin Laden.

So after a near term robust rally in U.S. and overseas equity markets, we expect euphoria to be tempered with economic realities. The impact of Bin Laden’s loss may have more mileage in the Arab world where people may feel a sense of relief and increased security that will empower them to further their fight for economic and political change in North Africa and the Middle East. In the dizzying pace of international events, it is difficult to forecast with clarity how political and economic developments will be shaped but major changes in both are underway and the status quo around the world is being altered.

Finally, we have been critical of President Obama in his handling of foreign policy including our recent website article on the Middle East. Despite critical diplomatic setbacks, we must congratulate the President and the counterintelligence agencies and the military for what appears to be first rate work in intelligence and military operations and decisive action on the part of the President to secure the prize. This will undoubtedly be a huge boost to the President’s reelection chances and deservedly so.

S & P Joins the U.S. Budget Debate

Morris Segall      austerity programs, bailout, business confidence, business landscape, Capital Markets, consumer sentiment, consumer spending, Economic Growth, economic recovery, federal deficits, future trends, GDP, national debt, politics, recession, tight credit

This morning, Standard and Poor’s downgraded the U.S. credit rating outlook from stable to negative. The rating agency cited the high level of public debt as a percentage of GDP and the uncertainty that adequate actions to significantly reduce the U.S. debt level and maintain it at manageable levels would be undertaken in the forseeable future. The negative outlook and the reasoning behind it portend a “one in three likelihood of a lower long-term credit rating on the U.S. within two years” according to the text of the S & P release. Standard and Poor’s states the leverage on the U.S. balance sheet and accumulating annual deficits are higher than other countries with sovereign debt ratings of AAA.

We are not surprised by the S & P action. Indeed, in our website article of September 8, 2008, “Stocks, Recession and the Bail Out” we cautioned that the massive federal bailout of the housing and banking industries would add billions to annual deficits and the national debt. We further stated “The cumulative effect of ballooning annual federal deficits, the secular pressure on the federal budget from increasing entitlement spending and the continuing balance of trade deficit may lead to a downgrade in the U.S. government credit rating and a further aversion to U.S. dollar denominated assets longer term”. The extended decline in the U.S. dollar versus other currencies has reached historical proportions in the first four months of this year, even against the financially questionable euro. 

While we are not surprised by the S & P action, we are surprised at the timing of the ratings outlook. Why now in the heat of the budget debate between Congress and the President? Why didn’t Standard and Poor’s wait until mid May after some decision on the federal budget and increase in the debt limit would have been forthcoming? It is our opinion that by releasing this downgraded credit outlook now, it would have a significant impact on the budget deliberations and possibly tilt the argument in favor of more draconian spending cuts as advocated by the Republicans in Congress. It is not unreasonable to believe that outside credit analysts, rating agencies and economists have come to the conclusion that the U.S. must adopt an austerity spending program similar to those adopted by the European Union as a solution to its excessive debt burden. By using a time frame of three years (similar to that employed in the European austerity programs) to measure progress, S & P makes the same mistake such a short time period has created on the countries in Europe. It is simply too short a period of time to deleverage sovereign balance sheets without stifling critically needed economic growth to provide the means to paydown debt (See out website articles of December 17, 2010 and March 15, 2011).

Today’s ratings outlook release by Standard & Poor’s misses important differences between the U.S. economic situation and those of Ireland, Greece, Portugal and Spain. The U.S. economy is in recovery led by manufacturing, exports and more recently consumer spending. Employment gains have accelerated since last November. While the recent surge in inflation has slowed U.S. economic growth coming out of the first quarter of this year, the recovery trend is not aborted. It will be if the Federal government is forced to make drastic spending cuts which will reverse its role as an economic stimulant to an economic depressant at this sensitive point in the U.S. economic recovery. We argued in our economic articles on Europe and once again, that longer periods of time are required to deleverage these balance sheets. A longer period of time will allow the national economy to grow at a rate to raise tax receipts and pay down debt. We have long been advocates for greater fiscal discipline by the U.S. government that includes large spending cuts and higher taxes. However, a nation in recession cannot reduce its debt to GDP ratio.

By releasing its downgraded U.S. ratings outlook today, Standard and Poor’s has entered the political debate and abandoned its role as a neutral and impartial arbiter of credit conditions. Furthermore, the surprising timing of this release has caused capital markets here and around the world to decline significantly, further eroding asset values and wealth and business and consumer confidence already battered by overseas events in Japan, the Middle East and Europe. Declining capital markets and consumer and business confidence will lead to tighter credit conditions at a time when credit was just beginning to “loosen up”. This in turn will lead to investment and spending retrenchment, threatening the nascent economic recovery here in the U.S. The worries of a deteriorating U.S. financial condition in 2012 and beyond could be self fulfilling as a result of what we believe is an ill timed alarm. We will have to see in the coming days if the S & P action is transitory or longer lasting in its impact. 

Morris R. Segall

The Japanese Disaster and the Capital Markets

Morris Segall      Capital Markets, deflation, Economic Growth, Japanese reconstruction, nuclear meltdown, reflation, stock market, stock market correction, stock market volatility

What was already a cataclysmic catastrophe in last week’s earthquake and tsunami in Japan has become a calamity of potentially worldwide proportions. On the heels of the tsunami has been a series of hazardous nuclear system failures at the nuclear power complex at Fukushima Daiichi. These failures have been caused by the destruction of water cooling systems that are essential to maintaining the safety of nuclear power plants. The loss of this water cooling apparatus has resulted in dreaded nuclear fuel overheating and potential meltdowns that would release deadly radioactive gas into the atmosphere. What appeared to be a containable situation last Friday has become a seemingly out of control nuclear nightmare, rivaling the nuclear tragedies of Chernobyl and Three Mile Island. 

This ongoing nuclear misfortune has exacerbated the Japanese disaster into one of world consequences. World capital and commodity markets have declined substantially since the proportions of the nuclear threat increased.  The declines have been severe and precipitous as concerns that the impact of the Japanese national destruction would curtail world economic growth and cause another international financial crisis. After concerning ourselves with the rising tide of inflation in our March 7th website article, the Japanese crisis threatens to unleash deflationary forces, temporarily, from diminished demand from the world’s third largest economy. In addition, the spread of nuclear radiation to Asia and the Pacific Basin would impair economic activity in the important emerging industrialized countries in that region, further reducing worldwide growth.

In the long term, the rebuilding of the Japanese economy will stimulate demand for industrial commodities, raw materials and capital goods resulting in reflationary trends and accelerated worldwide economic growth. This should be reflected in rising capital and commodity markets after the near term corrections in these markets. However, the recent severe declines in equity prices threaten to derail the stock market recoveries began last September if they continue. As we publish this post, Asian markets are stabilizing from Tuesday’s sharp declines and we expect this will spread to European and U.S. markets on Wednesday.

If equity market recoveries are to continue, the Japanese nuclear threat must be removed so reconstruction can proceed. The disposition of Japan’s nuclear problems will determine the direction of capital and commodity markets in the short term. Those problems have become unpredictable and the uncertainty of that situation is causing public and investor consternation. At this time, we are maintaining our economic and capital market outlooks and allocations (See our website article of January 6th, “Great Expectations”),  but we are watching the Japanese situation closely to see if reevaluation is necessary. The recent public market declines and volatility from adverse overseas developments fortifies our capital market strategy emphasis on private equity investment in transaction and hard asset themes and cyclical recovery emphasis on the U.S.

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

Today’s Economic Landscape and What’s on the Other Side – Significant Economic Presentation

Morris Segall      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:

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

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.

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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 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