Dip in Confidence, Bad Job Numbers, Chinese Debt Holders: Invest Conservatively

by: John Eastman

We read from a recent survey of CEOs in the U.S. Business Roundtable that 92% of CEOs projected higher sales in 2011 Q1, up from 80% on 2010 Q4, 8% expected sales to stay flat, differing from 15% in Q4 2010, and 4% had projected lower sales in 2010Q4, now refined to 0%.

This would seem to be positive news.

However, their optimism regarding the economic climate and expansion for growth is less enthusiastic than from 3 months ago, a time when the U.S economy was reportedly turning the bend. It hasn’t made that bend yet. These are executives with a close watch on the pulse of their companies, and of the U.S. economic environment as well.

About 52% percent of those surveyed expected to add U.S. jobs in the second half of the year, while 62 percent indicated they would boost capital spending. CEOs now predict the U.S. economy will grow by nearly 2.9 percent this year, down slightly from a forecast of three months ago. An underlying factor reducing the respondents’ confidence is the cost of fuel, particularly in the consumer goods sector.

Increased capital spending directly affects job creation in many instances. But the job statistics have been disappointing of late. Unemployment is up to 9.1%, and Washington has been talking stimulus for more rapid job creation. The discussion of raising the debt ceiling is making everyone nervous and possibly reluctant to target a stimulus package anywhere, including towards faster job creation. The voices of the survey members are important as, on average, their economic clout is valued at about $3 trillion in revenues annually. Essentially - their pulse matters.

Sickly Employment Status

Unemployment is like the intensive care of economic indicators. It scares nearly everyone. It’s a grave situation and everything seems to be on hold until clear signs of recovery are established. In this case, everything is capital spending, and positive outlook by consumers which leads to consumer spending. Inflation is not really on the minds of many, as its outweighed by efforts at survival and looking for jobs. Payrolls (non-farm) increased only a third of what economists had predicted last month, to approximately 54,000. Government payrolls fell for a seventh straight month. Payrolls need to growth above 300,000 a month to make significant progress.

Not spoken aloud but whispered about is the infamous double dip - the economy being in a recession, temporarily coming out of recession for a few slow growth quarters, then contracting again into negative growth. This possibility is not often spoken, but still on the minds of many. Tentative, or perhaps skeptical, may be good terms to describe the state of the business CEO at this point.

Oil Is a Factor, Oil Is Factor and Lastly, Oil Is a Factor.

High gasoline costs at the pump and the slow upward spiral in the first quarter set everyone back on their heels, mostly hurting consumer spending. The affluent, non-affluent middle, and hourly worker struggling to get by, all pause in discretionary spending when it takes nearly $100.00 to fill up your gas tank just to get to work and go grocery shopping. At the end of 2010, economic growth was charted at 3.1 percent and looking up. First quarter numbers figure in at 1.8. Thus the evidence of living from check to check to survive is apparent.

A Game With Chinese Debt Holders

If employment numbers are the intensive care-like economic factor, than the nation’s massive and growing debt, and discussions of raising the debt ceiling, are outright Code Red. Ratings agency Moody's said that it would consider cutting the nation's credit rating if progress is not made by mid-July in talks to raise the $14.3 trillion debt ceiling. It seems that the Federal Reserve is frozen in its long shadow of analysis and decision making process. Its Fed Funds discount interest rates are still near 0. One wonders where that can go from here. Treasury debt prices and interest rate futures rose, generally a sign of economic weakness, furthering the pressure on the Fed to keep rates falsely low.

In the news are discussions of Republican lawmakers entertaining a technical default on interest loan payments in order to make a point: cut spending or else. The problem is that the “or else” involves someone else - Chinese debt holders – who could have a very negative reaction. China’s bankers are reportedly glued to their terminals awaiting the situation. A reaction by the Chinese could cause a crisis, in which the U.S. cannot go to the Chinese for more debt to bail them out. A destabilization of the markets (not just in the U.S.), the undermining of the U.S. dollar, and extreme tense relations could incur. China is the largest foreign creditor to the United States, holding more than $1 trillion in Treasury debt as of March, so its concerns equal a large and significant weight in Washington.

Congress has balked at increasing a statutory limit on government spending as lawmakers argue over how to curb a deficit which is projected to reach $1.4 trillion this fiscal year. The U.S. Treasury Department has said it will run out of borrowing room by August 2 of this year. A possible global economic panic could ensue, but many in the economic world believe the default would never happen.

A Backdrop of Overvalued IPOs Generate Press

Amidst the uncertainty, we hear of social media valuations of $100 billion for Facebook in early 2012, $25 billion for Groupon, and LinkedIn’s IPO skyrocket price a few weeks ago. They seem to be in outright defiance of the economic climate surrounding them, driven by the likes of investment bankers. (Unreal, overvalued, 100 times revenue, “not in touch with reality” has been said about these.) Many in the investment community are expecting a bubble like never before to happen. But investors are lining up to profit short term on the offerings, regardless of the basic underlying information regarding revenue, profits, diversity of the company, or management history. At the core, these companies manufacture nothing, and sell advertising based on the billions in Internet traffic that they drive, albeit they do contribute to employment of the nations workers.

What to Do?

So in these extreme uncertain economic times, what is the strategy of CEOs, institutional investors, and individual investors?

What does the U.S. government do?

Back to the CEO roundtable survey for a thought. Perhaps you voice a slight public optimistic approach, you ready your capital obtained from prior belt-tightening for investment if the light turns green or at least flashes green in the remainder of the year.

You invest in your own company, perhaps buy back shares, perhaps increase capacity with equipment improvements, but you add employees slowly and grow conservatively.

Perhaps institutional investors support their careful CEO plans and invest conservatively at firms that have solid business plans, are engraved in their industry, have a past track record of revenue streams, and net profits, dividends, and decent share price growth. Biotechs seem to be on a roll with potential cures for cancer and extended life periods.

Individual investors can take note of long strategies if they are patient. Assuming a series of domino-like catastrophic events does not transpire, conservative is the word to follow.

And the U.S. government? How are those IPOs looking to you, Mr. Bernanke?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.