The Financial Commentator on the Economy

E. James Welsh has published an excellent monthly letter (by subscription) since 1988. Jim is a Registered Investment Advisor in Carlsbad, CA. I always find Jim's letters to be very insightful, and have discovered a number of valuable concepts from them. The article "The Declining Usefulness of Debt" (here) was inspired by one of Jim's letters earlier this year. The newsletter goes under the banner The Financial Commentator, and it lives up to its title spectacularly.

Jim has agreed to make his September newsletter available to Seeking Alpha readers. It is temporarily available here (pdf warning).

I asked Jim to share this letter because I felt it gave a particularly insightful view of some of the challenges faced by our economy moving forward.

Jim discusses some of the headwinds we face in a very balanced way. The discussion is divided into two categories:

Secular Headwinds

1. The burden of debt.
2. Constrained availability of debt.
3. Subdued consumer demand and reduced spending.
4. Increased consumer savings rate (and debt reduction).
5. Reduced state and local tax revenues.

Cyclical Headwinds

1. Low employment and increasing unemployment.
2. Expiring unemployment benefits.
3. Housing prices that have not bottomed.
4. Declining commercial real estate values and increasing debt defaults.
5. Increasing government program costs meeting reduced tax revenues.

These headwinds are skillfully woven into a very readable narrative. One section that I find very quotable, deals with the concept of the stock market as a discounting mechan ism for future earnings.

The stock market bottomed in March, and it would appear the economy bottomed in July. The sequence of the stock market bottoming before the economy will perpetuate one of the great falsehoods on Wall Street, which says the stock market anticipates and discounts the future. In this case, the sages state that the rally off the March low is discounting the coming earnings rebound. Myths are maintained because there is just enough truth to convince the unsuspecting. The irony in this case is the unsuspecting are the same people spewing this nonsense. What the Wall Street sages will fail to mention is that the rallies off the lows of March 2008, July 2008, October 2008 and November 2008 were all heralded as signs the economy was about to turn for the better. They also won’t explain what wonders the NASDAQ was discounting when it traded above 5,000 in April of 2000, or when the DJIA reached 14,200 in October 2007.

I find Jim's admonition quite amusing, because it thoroughly debunks the value of mythology based on selective use of historical data. It might be said, using Jim's analysis, that the stock market has discounted the future earnings of five of the last one recoveries. And, Jim doesn't say this, but we still have to prove the existence of that one recovery.

Again, read Jim's newsletter here.

Comments

[Kimball Corson:]

And of course some of us do not believe that on its most fundamental trend line the economy has even bottomed yet, as Jim might be implying.

Oct 08 09:13 AM

[inthemoney:]

Market and economy are too different things. Market is driven by immidate available liquidity and perception of the risk ( i.e. physcology). Economy is also driven by liquidity , i.e. availability of finance and perception of the rsik, but with several months lag, but in addition economy has to take into account global situation, taxes, supply/demand.
Economy is much more complex but because it shares some drivers with the market it appears that they are closely related. However, when the drivers most influencing economy are different from the market's like right now , eveonoy and market can diverge significantly.

Oct 08 01:56 PM

[Old Trader:]

John,

Mr. Welsh appears on a fairly regular basis as a guest on the Noon Business Hour on CNN radio, here in Chicago, and I always look forward to his appearances. From his last appearance, it seems he's moved over into the "W" camp from the "L" camp, which makes more than a little sense to me, fwiw. I'll definitely have to check out his newsletter. Thanks!

Oct 08 05:14 PM

[Steven Hansen:]

John,
i am in more of inthemoney's camp.

i would like to make a point which we all seem to forget. if the economy permanently reset 2% or 3% down, and your margins were 2% or 3% - does your profits go to zero???

of course not. once the business rationalizes based on the new environment profits return to normal - the pain is in the rationalization.

once the market sensed the economy was bottoming, it is logical that it anticipated a return to profits. the difference in this downturn from the previous is that business realized its business model had changed permanently and needed to restructure. this restructuring - depending on the industry - occurs over varying lengths of time.

it is not logical that business profits will not return.

Oct 09 01:52 AM