Betting on American Recovery - It's Gonna Happen

The world is in the midst of a very serious economic problem. However, we have survived lots of other very serious economic problems and we will survive this one. There is little doubt the next few quarters will be ugly for GDP, corporate profits and employment. For this, there is plenty of blame to spread around.

We are rightly concerned with the last $350 Billion of TARP and with the mockery that is this “stimulus package”. However, we must not ignore the substantive gains achieved by the Federal Reserve, nor should investors forget the propensity of markets to discount recovery and move higher while GDP and employment numbers remain weak.

The annualized rate of GDP contraction in Q4 will likely be revised slightly lower. Q1-2009 GDP will most certainly be negative, but likely less negative than Q4. I see 2009 as period of negative or flat growth of the industrial economy. However, unemployment (a lagging indicator) will likely rise and remain elevated into 2010. In fact, job loss reports over the next few months will be substantive.

The Clinton administration’s push to expand home ownership and George W Bush’s “ownership society” coupled with the excessively leveraged balance sheets of Fannie Mae (FNM) and Freddie Mac (FRE) were major contributors to our current woes. The Federal Reserve left interest rates too low for too long. Low interest rates and poorly executed regulation allowed companies to leverage their balance sheets to unreasonable levels. There were irresponsible borrowers too. Greed of private sector institutions with puppet boards are also to blame.

The Fed is what will bring us out of this mess. The Fed was slow to recognize the problem but has since acted with great force. The government in all its forms has committed up to $7.8 Trillion dollars to fight this problem, but spent less than 20% of that.

Type Committed _____Spent

Insurer $3.1 Trillion $100 Billion

Investor $3.0 Trillion $650 Billion

Lender $1.7 Trillion $617 Billion

Total $7.8 Trillion $1.37 Trillion

Thus far I see very little risk of loss on any of the US commitments. That may change but only modestly as the second half of the TARP assets are invested. The Fed will have a record year and its profits will be remitted to the Treasury, which is required to remit its profits to the Treasury who must:

supplement the gold reserve held against outstanding United States notes, or shall be applied to the reduction of the outstanding bonded indebtedness of the United States.

The House just passed an $800+ billion fiscal stimulus and the Senate pushed it through with a few tweaks. This is little more than a hollow mockery. It has a whisper of stimulus in it and a lot of special interest legislation, none of which will get us out of the recession. It contains nothing in the way of fiscal responsibility promised by President Obama. There is much more effect that will come from what the Federal Reserve has been doing. A central campaign theme of 2012 will likely be President Obama giving credit for the recovery to this ridiculous spending boondoggle.

Massive fiscal deficits are inevitable in the short run, even with responsible fiscal stimulus. Fortunately, our debt to GDP ratio heading into this is low when compared to other industrialized economies.

To be sure, the economy will stumble for the next couple of quarters but financial markets in general and equity markets in particular will head up well before the recession ends. Many people are calling for a prolonged ten year slump in economic activity or even a depression. Our history is full of periods in which very real obstacles to growth have been successfully overcome. Recalling the generally accepted view that the US could not compete with Japan causes one to rethink the consensus view of India and China destroying our manufacturing sector. Remember when robots and automation would make human labor obsolete? How about the view that the internet would replace bricks and mortar retail? We have survived credit crunches, wars and oil shocks before. If one just steps back and looks at the demographics of the US it’s hard not to be optimistic about her long term prospects.

I have no compelling opinion on the direction the next 1,000 point move in the Dow (DIA), nor do I know exactly when new home sales will equal the 900,000 or so required to serve our natural population growth, but they will. (More than double today’s level) I don’t know for sure when our banks will be declared healthy, but they will. I do however believe in the return to growth for the most innovative economy the world has ever known. As such, I patiently wait for recovery and invest in those areas likely to perform well when recovery comes.

Owning the S&P 500 through iShares S&P 500 index fund (IVV) is the most reasonable pure play on American recovery. With a dividend yield that exceeds that of the thirty year treasury and is expected to grow over the next decade, it’s hard to imagine anything less than rich rewards between now and then.

More adventurous investors should consider IShares US Home Construction index fund (ITB). Clearly not trading with a hint of irrational exuberance in its price, this beauty allows investors to patiently wait for this sector’s recovery over the next couple of years without taking dangerous single stock risk.

For those volatility tolerant income investors, I’d suggest looking to the IShares High Yield Bond Fund (HYG). High Yield has gotten so cheap the asset class is priced for a depression and a level of defaults that simply won’t happen. When pessimism subsides, (it will) spreads will narrow. Historically, investing in High Yield when spreads were this wide has paid richly.

I Shares Preferred Stock Index Fund (PFF) is another way investors can bet on recovery. Preferred stocks, most of which are issued by financial companies, have gotten very inexpensive as fears of bank nationalization have spread. After Fannie Mae, Freddie Mac, Lehman (LEHMQ.PK) etc. it's no wonder investors have dumped the asset class. In my view, nationalization is not an option and this diversified portfolio represents a reasonable risk to patient investors.

Comments

[market ace]

The only way the Fed can contribute to any recovery is if it is abolished as called for by Ron Paul. With the morons in congress aided by the thieves on Wall Street there will be no hope until trillions in debts are extinguished and having the gov't pay for and guarantee all of this sinful garbage is all wrong. I think the economy will recover someday, but it will in spite of the Gov't intervention and the Fed acting in a detrimental amnner.

2009 Feb 11 11:50 AM

[User 143167]

Are you kidding me? In one paragraph, you said too much leverage and Fed fund rate being too low for too long are the causes to the current woes. Then in the paragraph right next to it, you said that the current Fed with its ZIRP and 100x leverage is what will get us out of this mess? Just amazing to know how come The cause of the problem will be the solution of the problem?

The current US government debt to nominal GDP ratio is 75%, but considering the huge funding requirement and huge deficits ahead of us (Obama said he would run trilllion dollar deficits for a couple of years), that ratio will be around 100% in no time. That will be one of the highest among industrial countries. And don't forget that the US has way higher deficit and way lower tax rates than most of other industrial countries do, so the ability of the US government to pay back its debts by taxes are very questionable. Plus, the saving rate in the US is zero.

Borrow and spend out of the problem is the reason that we have this economic crisis and how can you expect it will work this time. I think that is just a way to create bigger problem ahead.

2009 Feb 11 11:51 AM

[Marcap]

I really do not think the author has any real grasp on just how bad the current economic situation is, nor does he have any viable solutions on how current problems can be rectified. In fact from reading his article, I think that it will become very clear to many, that rather than offering solutions to the problems at hand, those with such a mentality as the author, are actually the root cause of such problems.

2009 Feb 11 12:01 PM

[Teak]

I agree. He is in the same boat as our governmental "leaders" who neither have a real grasp of the situation nor have any viable solutions. USA 2009.


On Feb 11 12:01 PM Marcap wrote:

> I really do not think the author has any real grasp on just how bad
> the current economic situation is, nor does he have any viable solutions
> on how current problems can be rectified. In fact from reading his
> article, I think that it will become very clear to many, that rather
> than offering solutions to the problems at hand, those with such
> a mentality as the author, are actually the root cause of such problems.
>

2009 Feb 11 06:22 PM

[gebby]

problems were created by industry and the government acted swiftly to arrest the downward spiral in economic activity. dont blame clinton , 1992, blame bush and his free market principles which do not and have never worked. all markets must be regulated all the time to avoid excesses like we just experienced in housing financial markets 2003-2007( gw bush was president) live with the reality.

2009 Feb 12 09:06 AM

[st]

Interesting post. Fed commitments vs. what is spent was very enlightening. Shows how much they can deliver on confidence still. Laughed when I saw the call to end the Fed. Same group that wants a gold standard and probably stocks weapons in their basement (sorry).

This downturn has been interesting. It is a middling recession by all measures I have seen. Something similar to 1982. Considering that the US used to go into recession about every 4 years in the 40's, 50's and 60's it has been interesting to watch the hyperbole on this one.

The other piece though is harder. Banks truly convinced themselves we would never enter another recession. The effect of 1982 did not destroy banking because banks were well capitalized, with managements schooled in recessions. This recession actually has had a lower foreclosure rate (surprised?) than 1982, yet banks are going under at a rate I cannot fathom. In 1982 banks held 12% equity and this one they had less than 3%. Stupidity. Yes, but the bailouts are critical in this instance. Credit has to flow. Fed is doing a great job.

As far as stimulus, your are just plain off. Stimulus is not rocket science and will contribute dollar for dollar minimum to the economy in 2009 and retain the level of jobs they are claiming. The interesting thing about politics vs. economists is that one group does in fact carry a component of compassion. Keeping jobs actually does matter to a politician. So retaining two or three million jobs may not matter to you, but it does to a great number of families out there, and we should actually care about things like that. The stimulus was brilliantly assembled with short and long term, with some of the modernization and efficiency and green agenda. Brilliant. AND you have a number of business groups, and state governors livid at the Republican congressional leaders. Obama played a masterful strategy.

2009 Feb 12 12:10 PM

[st]

I could not agree more. The period from 2000 to 2008 will likely be viewed as the lost decade and I have already seen numerous references that the Bush years were lost years. Obama has said as much in two speeches I have seen. A tremendous surplus was squandered and lost into ever deepening deficits, tax cuts were given to the rich who lost it all in hedge funds that did nothing but move paper around. Innovation was actively shut down. The telephony advances were destroyed for ATT to hold their hegemony, internet 2 was stopped by the Bush administration, stem cell research was shut down, basic science research was gutted. Capital was shifted from research and innovation to building stick houses, and not even with any efficiency standards. Thrown up as they have been the last fifty years. I can't think of a worse use of capital. We flushed a trillion dollars down the Iraq toilet, and managed to destroy countless families both here and abroad in the process. CAFE standards were gutted which stopped all innovation in the auto sector and led to the highest gas prices since the late 1970's. The US became a nation that tortures and kidnaps, that taps phones and cowers in fear and self doubt, that hid information, and let religious fanatics make science and policy decisions. It was lost, all lost. The lost decade. It is like we wasted ten years. Can you identify a single major innovation? Everything was status quo, incurious, how can we be surprised in the absence of any future thinking that we wallowed in a decade of nothing.


On Feb 12 09:06 AM gebby wrote:

> problems were created by industry and the government acted swiftly
> to arrest the downward spiral in economic activity. dont blame
> clinton , 1992, blame bush and his free market principles which
> do not and have never worked. all markets must be regulated all
> the time to avoid excesses like we just experienced in housing financial
> markets 2003-2007( gw bush was president) live with the reality.

2009 Feb 12 12:19 PM

[Tony Daltorio]

The comment about how the best way to invest in the upcoming "recovery" by buying the S&P 500 index should tell readers that the author is your typical clueless,never think outside-the-box financial advisor. How well has the recommended strategy worked over the last decade??

2009 Feb 12 01:17 PM

[Green Beret]

CDO,s They were a major innovation. Oh and don't forget the Bush Doctrine of preemptive self defense another huge success.


On Feb 12 12:19 PM st wrote:

> I could not agree more. The period from 2000 to 2008 will likely
> be viewed as the lost decade and I have already seen numerous references
> that the Bush years were lost years. Obama has said as much in two
> speeches I have seen. A tremendous surplus was squandered and lost
> into ever deepening deficits, tax cuts were given to the rich who
> lost it all in hedge funds that did nothing but move paper around.
> Innovation was actively shut down. The telephony advances were destroyed
> for ATT to hold their hegemony, internet 2 was stopped by the Bush
> administration, stem cell research was shut down, basic science research
> was gutted. Capital was shifted from research and innovation to
> building stick houses, and not even with any efficiency standards.
> Thrown up as they have been the last fifty years. I can't think
> of a worse use of capital. We flushed a trillion dollars down the
> Iraq toilet, and managed to destroy countless families both here
> and abroad in the process. CAFE standards were gutted which stopped
> all innovation in the auto sector and led to the highest gas prices
> since the late 1970's. The US became a nation that tortures and
> kidnaps, that taps phones and cowers in fear and self doubt, that
> hid information, and let religious fanatics make science and policy
> decisions. It was lost, all lost. The lost decade. It is like
> we wasted ten years. Can you identify a single major innovation?
> Everything was status quo, incurious, how can we be surprised in
> the absence of any future thinking that we wallowed in a decade of
> nothing.

2009 Feb 13 03:57 AM