Impatient with Upcoming Recovery?

Have you been paying attention to the sports news? Over the past two weeks Toyota has withdrawn from Formula 1 and Subaru has just withdrawn from the World Rally Championship. Even Toyota has signaled Formula 1 cutbacks. Why should any investor care unless you were into that kind of thing? Because of the reason they withdrew!

"Our business environment has rapidly deteriorated. In order to protect the Subaru brand we were forced to make this decision," Ikuo Mori, the president of Fuji Heavy Industries, which makes Subaru cars, told a press conference.

"We, Honda Motor Co Ltd, have come to the conclusion that we will withdraw from all Formula One activities, making 2008 the last season of our participation," said Fukui. "This difficult decision has been made in light of the quickly deteriorating operating environment facing the global auto industry, brought on by the sub-prime problem in the United States, the deepening credit crisis and the sudden contraction of the world economies.

"Honda must protect its core business activities and secure the long term as widespread uncertainties in the economies around the globe continue to mount. A recovery is expected to take some time," he added.

"Toyota is currently committed to succeeding in Formula One and to reducing our costs. We are contributing to the FOTA activities which will achieve significant cost reductions whilst maintaining the spirit of the sport.” The Formula One Teams Association (FOTA) met on Thursday to discuss proposals to secure the future of the sport, and said agreement had been reached on "substantial cost-cutting for 2009 and 2010" as well as "additional initiatives to improve the show".

This reminds me of an event during the negotiations between America and the North Vietnamese to end the Vietnam Conflict. The negotiations were held in Paris. The American negotiators arrived and stayed at a hotel. The North Vietnamese negotiation team when they arrived signed a one year’s lease on a house. The negotiations concluded 5 years later with the Americans still living at the hotel, and the Vietnamese in their leased house.

Americans tend to have unrealistic expectations about how long things take to resolve. We are an impatient nation. This is not a bad thing as long as you recognize this is both a strength and a weakness. If you are too impatient, not only will you make decisions too quickly, but others will use this weakness against you.

I can tell you I have used this understanding of human nature for years. For a period of time, I was responsible for negotiating more contract value than the US government was negotiating. I negotiated with almost all nationalities. My negotiation weapon of choice with American companies was always time. They became impatient and capitulated.

The Japanese with their integrated government / business model are not viewing the current economic downturn in months or quarters – but years. In Asia, there is a significantly closer (spelled symbiotic) relationship between their governments and industry. Clearly, the Japanese government is telegraphing to business to batten down the hatches. This same message is being replayed all across Asia.

Americans want this crisis to end. The incoming government reads this loud and clear. Politically, they must be seen to be on top of the economy – and that tomorrow things will be better. Americans believe this as tomorrow has always been better for most of us. But for the ever diminishing number of Americans who remember life before and after 1929, they know that tomorrow does not necessarily bring prosperity.

Politically, it is suicide for the party in power to say our economic future is crap. This job is left to those who are not in power, the eternal pessimists who are on talk radio, or people like me who are pragmatists. Pragmatists try to find the truth, and are tormented that usually truths conflict, or that there is too little information to draw any conclusion.

My message remains the same, week after week. There is no evidence of any kind which points to a quick economic recovery, or how long this economic downturn will last. Impatience is not an investing virtue.

News of the Week

No financial event was bigger last week than the Fed’s Open Market Committee meeting. Besides lowering the effective target lending rate to between 0 and ¼ percent, they made all sorts of promises to buy and issue debt instruments. While others are worried about printing presses rolling (and they should be), I am starting to realize that the Fed policies are effectively taking the hyper-inflation scenario off of the table. After issuing all this debt at really low (try zero) interest rates, the debt (expressed as bonds) itself goes negative immediately when interest rates rise. At zero interest rate, the only way the economy works is to deflate.

OPEC announced a reduction of 2.2 million barrels of oil per day. The price per barrel dropped through most of the week. It appears the market believes supply will be higher than demand. The price of January contracts has now fallen below $34 per barrel. This actually is not good news as it destroys oil exploration and alternative energy at one time. This is a very deflationary sign.

Now extreme volatility has entered the currency markets. The dollar took a big exchange rate hit on the currency markets following the Fed’s interest rate announcement – especially against the Euro. The dollar declined 2.9 percent against the euro on December 17, the biggest drop since the Euro’s 1999 debut. On Friday, the dollar rose 2.5 percent against the euro. The Fed seems intent on debasing the dollar as one of their weapons to prevent a depression, so expect this kind of volatility to continue.

Summary of the Week’s Economic Fundamentals

I still see nothing last week to influence my asset preservation investment strategy. It is clear that the dollar is being debased, but fortunately so are the other major currencies. If you have some gambling money, I would try gold. There are some significant negative pressures on gold but as things are so unstable, it only takes one event for gold to go ballistic.

Markets and the economy remain volatile. I heard that in the 54 day period ending 12/03/08, the S&P 500 moved up or down 5% more times than it had done in the previous 53 years. With this kind of volatility, investing is gambling.

There is no indicator which would indicate a slowing of our economic freefall. Below is a list of news which happened last week which either reinforces or contradicts any investment strategy.

Interesting but Not Indicating Anything

• The St. Louis Fed released their January 2009 Monetary Trends. It is a picture book of graphs going berserk.
• The U.S. current-account deficit--the combined balances on trade in goods and services, income, and net unilateral current transfers--decreased slightly in the third quarter of 2008 from the second quarter according the BEA. There is no new trend or something clever to say about the new data.
• Home loan activity increased slightly last week. 77% of the mortgage applications were for refinancing.

Positive Leading Indicators

• None last week

Negative Leading Indicators

• The Conference Board released their November 2008 Leading Indicator which showed a slight fall in November. Over 55% of the index is money supply (M2) and average weekly hours (manufacturing). This leading indicator does not seem to be a reliable for the type of recession we are having, and I have been ignoring its results. It has, however, properly identified a contraction cycle beginning last year but continues to understate the severity.

• ECRI’s Weekly Leading Index continues to demonstrate deteriorating market conditions six months from now.

Positive Coincident Indicators

• None

Negative Coincident indicators

• The New York Fed released its Empire State Manufacturing Survey which showed little change this month. This kind of survey is for morons as the heads of companies know no more than you about future economic conditions. Even in August they were still seeing a positive future. And you will note that the future is always brighter than the present. These industry leaders are perma-bulls.

• And the Philly Fed also released their business outlook survey.which is at the lowest level since 1990. After falling significantly last month, this month showed only a slight drop. What is interesting about this survey is that 21% of the companies reported that they reduced the prices of their products. Also, unlike the New York survey, there is a negative forward outlook.

• The Department of Labor released their weekly Unemployment Insurance Claims Report. The advance figure for seasonally adjusted initial claims was 554,000, a decrease of 21,000 from the previous week's revised figure of 575,000. The BLS issued its November Mass Layoffs Summary which was bad (but not the worst ever). There were no surprises in the data.

Positive Trailing Indicators

• None

Negative Trailing Indicators

• The BEA has announced revisions to 2007 GDP. This news is interesting only to people who are building statistical tables.
• The CPI-U decreased 1.7 percent in November. The November level was 1.1 percent higher than in November 2007. Falling energy prices, particularly gasoline, drove the decline in the overall index. Excluding energy, the index was virtually unchanged. If you annualize this decrease, the decline was worse than any year period during the depression.

If you would like a summary of all government financial indicators, click here.

Quotes of the Week

From James Picerno in This Is What the End of the Line Looks Like discussing the Fed's monetary policy and quantitative easing:

The world has changed — radically, and it may change radically yet again. Exactly what does or doesn't suffice for monetary policy in the weeks and months ahead remains an open debate. No doubt there'll be definitive answers after all this is over. The playbook for monetary policy may be rewritten as a result. But for the immediate future, it's anyone's guess what happens (or should happen) next. No doubt we'll hear lots of policy recommendations from far and near. Making sense of it all, if at all, may be the toughest challenge.

From my friends at Bespoke Investment Group showing various pundits' predictions for the S&P 500 next year:

From OCED (hat tip to Paul Kedrosky for pointing this out) for those who wonder in which country to deposit their money:

A paragraph from a paper on deflation from this year’s Nobel Prize in Economics winner Dr. Paul Krugman (hat tip to Colin Peterson)

In short, if you really believe that deflation is now a global threat, you should also believe that only policies that lie outside the realm of what is conventionally regarded as responsible will contain that threat. And because unconventional thinking is not what one expects (or, in normal times, wants) from finance ministers and central bankers, there is now a real risk that deflation will indeed become a global scourge.

Disclosures: no positions

Comments

[Moon Kil Woong:]

100% on this article. The government is inflating money supply but every country is now. Clearly every country has learned that the loser is the country with the strongest currency making it unable to export their way out of their regional weakness.

And yet, at 0% fed funds rate, the US government is now also leading us down a path of massive deflation. Even though you would think lower interest rates would encourage more borrowing it clearly doesn't in historic context. Rather, it discourages saving in banks because you get no benefit/interest anymore, encourages hoarding because it is very very hard to get more of the precious money you have already, and when cash is king any other assets are secondary.

It is almost laughable that they should be so clearly contradictory in their actions. If they think people won't see the consequences I suppose they think everyone is as dumb as they are (we aren't).

I certainly hope a new administration will realize that a 0% policy is a recipe for failure, as is a ill timed and poorly allocated stimulus policy. This administration has amazingly done both. Simply, astounding.

2008 Dec 22 04:36 AM

[LilBob:]

Unfortunately I think deflation is inevitable. We had an economy that was based on hype and false promises. Remember not too long ago when the New York Times reported that Investment bankers were complaining their biggest problem was that the government was requiring them to report asset valuations based on market value? In other words, they had to tell people how much money they really had, not how much money they would like to have.

In this country we're in a state of shock because we've lost our sense of what things cost. The "Low Price Revolution," has filled our discount stores and homes with tons of cheap imported goods while the cost of everything that matters: education, health-care, durable goods-has gone through the roof. Now many Americans are waking up to what is important and they aren't buying so much of the cheap plastic crap. Higher national savings with a mind-set of focusing on those things that have become more expensive should be a good thing, but with an economy that's based so heavily on cheap plastic crap it's perceived as a nightmare.

2008 Dec 22 07:02 AM

[Ishortyou:]

the idea behind lowering fed rates is to avoid or prevent depression, they made retroactive observations on the depression of 1932 and one of their conclusions was that the slow and timid action by the fed in lowering the interest rates at that time contributed to part of it, the fed is now experimenting by making this aggressive move, this has its pros and cons like anything else but the benefit/risk ratio is calculated to be favorable to the economy.

2008 Dec 22 07:19 AM

[patio:]

Someone on one of the inumerable deflation/inflation debates and discussions said that while energy, housing, and commiodities were down, most other things weren't. I live in Austin, I think we're top three cities "unaffected" by downturn ( housing prices actually up 6% this year, unemploymnet 2% better than average, etc ).
Our local Randalls has food prices I haven't seen i years, Macy's had a sale the like s I haven't ever seen before Xmas ( the post Xmas sale will have to be insane ), cars are down 25%, etc.
Deflation is even as we speak is roaring through the economy, even on non-discretionary items.

2008 Dec 22 07:38 AM

[John Lounsbury:]

I have gotten a better picture of the economic outlook from Steven Hansen's articles than from any other single source. Many thanks, Steve.

I share the sentiments so far in the comment stream. I would ask one more question: Deflation for how long? Paul Krugman fears an entrenched deflation, lasting for some (unspecified) time. I just can't seem to forget the vast reservoir of newly printed dollars being accumulated as offsets against future losses from the still tangled debt pyramid. When that tangle starts to smooth out, I can envision a flood, as if a reservoir dam were breaking. Then deflation will become a memory and it's nemesis, inflation, will arrive with a vengence.

2008 Dec 22 09:41 AM

[Did U Think...:]

The fed is clueless. They think they can use this strategy or that to control the economy. This is hubris of the highest order. The fed and the treasury do not control the economy and they never have. Social mood controls the economy and the mood is not good. Fed intervention will just make things worse. Americans will sooner or later wake up to the wisdom of people like Ron Paul, but not until the very fabric of our republic is at stake. Not until all confidence is lost in the current government. Not until the banks completely loot the place and leave behind a smoking shell of an economy.


On Dec 22 07:19 AM Ishortyou wrote:

> the idea behind lowering fed rates is to avoid or prevent depression,
> they made retroactive observations on the depression of 1932 and
> one of their conclusions was that the slow and timid action by the
> fed in lowering the interest rates at that time contributed to part
> of it, the fed is now experimenting by making this aggressive move,
> this has its pros and cons like anything else but the benefit/risk
> ratio is calculated to be favorable to the economy.

2008 Dec 22 12:05 PM

[Jason Rines...:]

Excellent article as per norm Mr. Hansen. I'll comment on this snippet of the article:

"or people like me who are pragmatists. Pragmatists try to find the truth, and are tormented that usually truths conflict, or that there is too little information to draw any conclusion."

1) I have been called a pragmatist also. Forecasted 10% off our GDP in 2008 in March of this year. Anybody can do a search for my screen name here at SA to verify this claim. Also, forecasted another 10% drop off of our GDP in the next three years. Yes, this is classic deflation/depression scenerio, except it's moving faster then at other times in a global, interconnected technology world.

2) Knowing the truth but not being part of the top echelon to make a more immediate impact is frustrating. The top shut out the voice of dissent that had specific plans that could have made a difference, still can (to an extent). They looted the system instead.

Hence, those of us in the business class that wish to help restore the nation will have to do it bit by bloody bit and with less cash to work with to boot.

2008 Dec 22 12:26 PM

[fran:]

you could also add the violent whispers and tremors emanating in Charlotte's NASCAR garage suites as the thoughts of DETROIT'S potential demise struck home.

great advice on "long term patience"--for all[investors, job holders/seekers, plain ole folks, etc].

2008 Dec 22 01:37 PM