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 Budget Wars: Now beginning

Morris Segall      bailout, budget deficits, democrats, financial Armageddon, fiscal wars, national debt, national economic philosophy, new fiscal discipline, obama, politics, republicans, U.S. government default, U.S. government shutdown

Last week’s melodrama leading up to the eleventh hour avoidance of a Federal government shutdown is just the beginning of the new fiscal wars over the U.S. budget for this fiscal year and beyond. The discussion of U.S. fiscal policy has now turned from stimulus, bailouts and economic recovery to debt reduction and redefining the role of the Federal government in the economy. Starting with the release of the Republican led House Budget Committee’s aggressive plan for deficit reduction, followed by steadfast demands for major reductions in federal spending  to avoid the government shutdown, the Republican party has now shaped and defined the fiscal discussion and taken the lead from the President and the Democrats in Washington. The President, on the defensive, will reveal tomorrow evening his plan for reducing projected federal deficits going forward and lowering the level of the national debt as a percentage of our GDP.

In arriving at their compromise last week on nearly $39 billion in spending cuts for this fiscal year, the President was fortunate in being able to utilize a number of “one time” program reductions, cost cuts already approved by Congress and unused funds from previously adopted appropriations. This “low hanging fruit” may be as much as $20 billion of the $38.5 billion compromise. The President and the Democrats in Congress will not be so fortunate going forward. The President knows he must propose a credible deficit reduction program in an attempt to get Republican cooperation in raising the federal debt ceiling by early May. Such a plan will likely include tax increases as well as significant spending reductions. The President and his party will try to salvage as much of their fiscal and social agenda as possible.

Given the strong philosophical differences between the parties, we believe the President’s submission tomorrow evening will be rejected as insufficient and inclusive of unwelcome taxes by Republican hard liners in the House of Representatives. Another period of gamesmanship between the Republicans in the House and the President and the Democratically controlled Senate will ensue between now and early May, when the government will run out of money, to attempt a budget compromise and avoid a federal government default. The parties will use this period to blame each other for taking the country to financial Armageddon. We are optimistic neither party want to be held responsible for that and last minute concessions will avert disaster.

We have long warned of deteriorating federal finances, long before the recent recession, and been critical of the burgeoning federal debt, unsuccessful fiscal “ bailout” and excess liquidity programs to the extent we have been steadfastly pessimistic in regards to the long term U.S. financial and capital markets outlooks. We are in the process of examining the federal financial situation and the proposed solutions in an upcoming website article. However, the current chain of events and resulting dialogue represents a sea change in our national economic thinking and philosophy. The potential economic changes resulting from a new fiscal discipline in Washington will have profound impacts on all of us, our children and grandchildren.

Morris R. Segall

January Unemployment: Are we there yet?

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

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

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

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

Morris R. Segall, CFA, CIC

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

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

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

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

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

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

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

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

Morris R. Segall

I’m Mad As Hell (Part 5): Long Term Implications Of The Recession

Morris Segall      economics, economy, fears, politics, recession, social implications

In a recent article published March 23 for SPGTrend.com subscribers, we examined the social and political toll of the current recession and their longer term impacts on the U.S and overseas economies.  Over the course of several blog posts, we will take you through the content of this piece and put what we’re going through into context.

In part one, we outlined an introduction for this series.  Part two discussed the first four trends and developments.  Part three discussed public anger.  Part four discussed the declining economy causes spiraling stress.  Today’s entry discusses the long-term implications for the recession:

We believe the current trends and developments have longer-term significance and implications for the U.S. and overseas countries, politically, socially and economically.  From an intermediate term economic outlook perspective, we believe the current recession will “bottom out” in the second or third quarters of this year. We believe the worst of the recession is now being experienced in the first quarter. We do not expect an economic recovery to be measurable until the fourth quarter of this year, at the earliest, and possibly the first half of next year.

Assuming a recovery from the current recession gets underway next year and builds through 2011, 2012 and 2013, we expect such a recovery to be cyclical and quite robust given the pent-up demand that is accruing from consumers and businesses over the past 5 quarters. The economic recovery will be led by the U.S and extend overseas late in 2010 and more pronounced in 2011, 2012 and 2013.

However, longer term, we see the following resulting implications from this recession:

1.       Americans will be more circumspect in assuming risk going forward. They will not embrace the unbridled use of credit as they have in the past. First, the availability and cost of credit in the future will restrict credit to consumers. Second, many consumers will eschew the use of credit to maintain lifestyle given the difficulty they have faced in meeting debt obligations.

2.       Americans will be more conservative in their investment programs after the cyclical rebound expected over the next 2-3 years in worldwide equity markets. For one thing, Americans will be older and less inclined to take risk with their remaining and/or rebuilt capital, particularly in retirement plans. Second, Americans’ faith in the equity markets has been shaken by two market declines of 50% in the past 9 years plus the scandals also attendant with these declines. We believe Americans will retreat to a more basic and conservative investment profile that emphasizes intrinsic and transparent value and predictable future prospects. In addition, we expect a more highly regulated environment for financial firms and capital markets which should result in less leveraged and speculative investment products and strategies.

3.       Americans will have to work longer before retiring as a result of the huge losses in savings, net worth and retirement accounts. However, many of the current generation of middle aged and senior workers will be suffering deteriorated health as a result of the current emotional and physical stress they are currently experiencing. These workers will have aged faster than otherwise due to the emotional and physical stresses of this recession. This will result in many workers having to retire earlier than planned which will add to the cost of Medicare, Medicaid, Social Security and private pension costs. These increased costs will be in addition to the enormous increase in Federal entitlement program costs from the retirement of the “Baby Boomer” generation of workers who begin to turn 65 in 2011 and will reach age 70 in 2016.

4.       As a result of the wealth and job destruction in this recession and the impending retirement of so many workers, the demand for increased government services to handle a burgeoning aging and retirement population will put enormous strain on the U.S. Federal budget. This will be in addition to the huge strain on Federal finances that is now being incurred from the massive “bailout” programs that are being initiated to stabilize the banking system and end the current recession. It is likely the annual Federal budget deficits will range from $500 billion to $1 trillion or more over the next 5 years.  Clearly this will put upward pressure on interest rates and price inflation in the U.S. and downward pressure on the U.S. Dollar in foreign currency markets. Indeed, we and other economists have raised the threats of these developments presently and they are already of concern to foreign governments and investors that own U.S. Treasury bonds.

5.       Unemployment in the U.S. will be historically high even with a cyclical economic recovery projected over the 2010-2013 period. There simply will be no job opportunities for many of the former Wall St. and banking managers, executives and traders and automobile and related managers and executives, particularly over the age of 50.

6.       The increasing population of aging and retired workers will not have the financial resources anticipated for this population segment at the beginning of this decade when the stock market bubble at that time had created so many retirement plan millionaires. As a result, the projected retirement population will live more frugally than earlier projected and will not be the economic stimulus many had planned on. Indeed, for the reasons stated previously, they will be more of a drain on the U.S. economy than help. In addition, they will not provide the spending for increased foreign imports or overseas travel as previously predicted.

7.       We expect international trade agreements to be less liberal here and abroad, as the infatuation with globalization becomes a casualty of the massive unemployment in the current recession.

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