The U.S. Economic Glass Isn't Half Full - It's Cracked

by: Craig Taylor

Let me share with you a few survey results on how your fellow Americans feel about where they stand in life today.

  • 92% say the US is still in recession
  • 65% feared double-dip precession
  • 57% are fearful about running out of money in the next year
  • 44% could easily see their family slipping into bankruptcy if things get worse 42% say that they were their spouse has had wages or salary reduced
  • 34% say they or their spouse lost their job or has been laid off
  • 33% have taken on more hours or another drop to try and make ends meet

Disheartening, discouraging doesn't begin to tell the story about how Americans feel about their circumstances today; however the bigger problem is what they see on the horizon that is truly troubling-nothing but storm clouds. I'm often accused of being overly pessimistic (not realistic) and viewing the glass not as half-full but as cracked; however if one stands back and views not only the United States but developed economies as a whole, the crack in the glass is been forming for over 30 years. We all know how we got here: unsustainable/parabolic growth in personal debt/state/local/federal compensation and pension benefits…

Longer-term, I'm optimistic that the developed economies of the world will be able to repair their balance sheets sufficiently, that emerging markets will continue to develop (albeit not linearly) as engines of global growth; however what concerns me is the near term to medium term levels of growth in developed economies.

Let me explain:

In the United States, the tailwinds of fiscal stimulus - inventory adjustments, first-time home buyer credits, cash for clunkers, employed census takers - are behind us; we are now facing the headwinds of declining aggregate demand; consumption growth is less than 1%, declining state and federal spending is now increasingly a drag on the economy. Iventory adjustments are over, fixed residential expenditures are falling, nonresidential expenditures are falling, capital ex spending is slowing…

GDP forecasts are beginning to reflect an alarming slowdown in US aggregate demand - first-half GDP estimates were 2.5% growth; now second quarter GDP growth is looking to come in at 1.2%, with third quarter at less than 1% growth (consensus is still a 2.5% growth in the second half). Just remember that personal consumption is 71% of US GDP. Also remember that median US household income levels are now back to 1997 levels of $50,200. This means that close to 80% of Americans have been living with stagnant and declining incomes (masked by ever-increasing levels of personal/household debt) while trying to rebuild their balance sheets and pay down their remaining $6 trillion in personal debt. So, reread the survey results above and ask yourself if consumer confidence/spending is likely to increase in the coming quarters, knowing that the heavy lifting of rebuilding personal/government balance sheets is yet to come.

Additionally, ask yourself under what conditions that currently exist or might reasonably exist in the near term that will allow the US economy to reach escape velocity from the current recession/depression. More importantly, what is going to keep the US economy from reaching stall speed in the coming quarters?

In Europe, one half of the periphery countries are contracting (Spain, Greece, Ireland), Italy and Portugal are barely growing and France with close to 10% unemployment has minimal growth. Germany alone cannot carry the eurozone and looks to be slowing, although its exports have had a cyclical bounce due to the lower euro earlier this year.

Japanese growth is slowing and looks to be approaching a double-dip as its population decline has now reached a secular point, and will be decreasing going forward.

Emerging markets cannot escape the slowing growth in developed economies. Beijing, for example, has its own dilemmas of wanting to cut spending and rein in its voluntary monetary expansion, allowing more capital to seek more productive endeavors. This move, however, would mean slower growth, lower house prices, rising unemployment and potential civil unrest. On the other hand, it could continue to prop up real estate markets like the developed world, and keep kicking the can down the road hoping for a less painful outcome. Even Jim Rogers (who was the first to call a long-term bull market in commodities in 1998 and is the biggest bull on China) is short emerging markets for the near/medium term.

In summary, I continue to be of the opinion that the ability of global economies to continue to grow at levels recently experienced will come into question as developed economies struggle with a secular headwinds of demographics, personal/sovereign debt and stagnating incomes/government revenues. As events unfold, the realization that we are entering a secular global change in developed economies will increase (requiring restructuring), altering the global financial landscape.

Additionally, we must never forget that policymakers are reactive, not proactive, only responding when there is a full-blown crisis in process. Compounding this problem is the reality that policymakers globally, both in developed countries and in Asia, have limited playbooks to go by - most of which have reached their outer limits of effectiveness(certainly in developed economies). Increasingly, (the case in the US) the interest in and the effectiveness of additional quantitative stimulus measures both monetary/fiscal are rapidly dwindling.

As realization of lower growth rates in the developed world and the implications of this come into focus for market participants, expect:

  • Equities to be repriced lower (along with many risk assets), specifically: consumer discretionary, OECD banks (revenue growth slowing), certain asset managers (declining revenue flows) luxury good companies(significantly overpriced), autos and certain emerging markets, including Mexican equities.
  • US Treasuries to trade down in yield again.
  • Gold and silver to continue to move higher in price.

Disclosure: Author is long GLD, SLV, PHYS, TLT