Last month we were skeptical of all the touting regarding the Holiday season and the possibility that it would save the day. The final verdict is that sales were not as bad as we expected, but nothing to cheer about either. The MasterCard SpendingPulse data (one of many data points) adjusted by the extra shopping day this season indicates growth of about 1% YoY, or slightly negative in real terms. So much for a strong season!
After looking into the abyss and even with massive stimulus, we are only a few feet away from it. As the stimulus fades, the probability of a double dip increases.
Housing, Consumers and Credit Availability
A key function of banks is to screen and monitor borrowers, overcoming information and incentive problems. The present reduction of credit inhibits consumer spending and capital spending, lengthening the recession. If we assume a clear asymmetry of information by which bank managers know their truthful capital position, then the credit contraction is very telling. If we are right, then bank credit will remain tight.
The continued deterioration in value of available collateral is worrisome as it also leads to lower credit availability. This has been particularly painful for households as residential real estate has retraced about 30% since the peak, according to the S&P Case-Shiller index of the 20 largest metropolitan areas. Lately, prices have been inching up for five consecutive months, but still down 7.3% from a year ago.
House prices will continue dropping as failed industry-wide and government efforts only delayed repossessions skewing recent data. Federal programs to help homeowners stay in their homes, has had a marginal effect. The up to $8,000 incentive available to home buyers has created some demand, but it is clear that most would have bought the house anyways.
Even Mr. Case (one of the creators of the index mentioned above), said he believed ”the probability is very high of a serious double dip like in 1982”. In this context, bank’s mortgage portfolios will face additional write-downs. One in four mortgages is currently underwater, which leads to higher delinquencies and write-downs.
On Christmas-eve, the Obama administration pledged to provide unlimited support for Fannie Mae and Freddie Mac. This is a back door for additional subsidies for housing via lower-than-market mortgage rates. The government might need to inject additional cash to Freddie, Fannie and the FHA. All of them are now instruments of macro intervention. At risk of repeating, most of the government measures, only delay the adjustment process. We continue to make suggest a Brady-like program.
Looking forward, the household sector in the U.S. is still adjusting as about $12 trillion of household wealth evaporated. The new frugality which is a reflection of the need to save is a multi-year process. Do not get fooled by short-term price action in the equity markets.
The Fed and U.S. agencies have lent, spent or guaranteed about $8.2 trillion. Public intervention in the economy amounts to 30% of everything produced in the country this year. In other words, the U.S. is addicted to stimulus (monetary and fiscal). While we are aware of the cultural and demographic differences with Japan, we cannot avoid considering that we could face a similar pattern for a few years.
Stocks -- A Leading Signal
Third quarter earnings came strong compared to “low balled” expectations, however, earnings still fell by about 15% versus a year ago. Financials delivered a large increase in profits due to fuzzy accounting and the imagination of management.
During this recession management in general has been quick to reduce costs. The good news is that now many companies are well positioned for a recovery. The bad news is that revenues are not increasing. Sales tax receipts for instance, were down 9% in Q3 indicating clear weakness and conflicting with retail sales data.
Market action has been driven by the “casino mentality”, which produced a non-discriminating rally after March 9, 2009. During this process, solid corporations with high-quality earnings underperformed. As the market tops, choosing quality will be a great way to outperform.
Financials which peaked almost two months ago may be providing a leading signal to future market action. Please, stay in cash!
Interest Rates -- Up or Down
Rediscovered Keynesianism as practiced by the U.S. Government, is working under the premise that any level of interventionism is justified. In the present situation, it is a response to avoid the hangover from three decades of excess driven by debt and overconsumption. The solution as presented is to provide the elements for another bubble to clean the previous one!
It is difficult to disagree with bond vigilantes that spending is out of control. The issue is not the elevated deficit, but the fact that it is not wisely spent. The interventionist stance of the Federal government not allowing zombie banks and other institutions to go under (and cleaning the system), is only prolonging the economic malaise.
In this context it is our view that interest rates will come down as deflationary forces will override fiscal concerns. We are going against consensus on this one.
GDP Growth
Although it is ancient history now, let us make a brief comment on Q3 GDP. A 3.5% growth was initially reported, exceeding expectations. Fast forward eight weeks and the growth was just 2.2% of which about 1.4% came from motor vehicles (i.e. cash-for-clunkers program) and inventories added another 0.7%. In other words, the underlying economy is still in recession or stagnant at best if you strip temporary factors. The lack of a similar package in 2010 sets the tone for fiscal contraction!
Many optimists and TV hosts need to go back to the history books before they continue misleading the public. Growth as measured by the government does not mean the present recession is over. In the 1930s unemployment peaked at 19% in 1938, or about four years after the country started registering growth (1934). Nobody should think that the problems end when the government starts measuring anemic GDP growth.
The chance of a double dip is real and could materialize during 2010 as the fiscal stimulus fades.
Disclosure: Short Indexes
