The Perfect Storm: Even with Bailout, Economy Is Hurting 31 comments
James Picerno
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Surveying the financial and economic landscape looks increasingly like an exercise in watching the perfect storm unfold. Today's updates on durable goods orders and weekly jobless claims only strengthen the sentiment.
Durable goods first: They're down. Big time. The government reports that seasonally adjusted new orders for durable goods slumped 4.5% in August, the biggest percentage drop since January. As the chart below reminds, the trend looks equally troubling in actual dollar value as well.
It doesn't help that on a rolling 12-month basis, new orders for durable goods have fallen for six months running. Ditto for the fact that the back-to-back losses of nearly 5% in July and August for the 12-month change in new orders is the deepest loss for two consecutive months in six years. Let's not mince words: the trend is definitely not our friend here.
It's arguably even worse in this morning's weekly update on new filings for jobless claims. As our second chart below painfully shows, the labor market continues to suffer. For the week through September 20, fresh claims for unemployment benefits jumped sharply to 493,000, the Labor Department reports. The last time initial claims were reaching so close to the 500,000 mark was September 2001.
The message here is one we've been warning of for some time: The economic signals are weak, and they're getting weaker. Initial jobless claims are particularly troubling because they're a forward-looking metric. Joe Six-Pack asks for unemployment benefits today, which invariably means he'll be cutting back on spending tomorrow. And since 70% or so of U.S. GDP comes from consumer spending, it doesn't take an I.Q. of 200 to figure out where we're headed.
On top of all this is, of course, the implosion on Wall Street. Our duly elected representatives in Congress are working diligently on crafting legislative salvation as we write, a.k.a., putting together the mother of all bailout packages. We, for one, expect more government money is coming soon, and one could imagine some degree of relief will follow.
But let's not forget the trend on this front: Washington, through its various institutions, steps in with liquidity in one form or another. The initial reaction in the markets is positive, but investors quickly get cold feet and return to selling. Maybe it's different this time, but that's not yet clear. Nor is it obvious that the economy is set to recover, or even tread water.
The final capitulation in the investment realm may still be ahead of us, at which point even greater bargains in asset classes will arise. For what it's worth, we believe that to reach that point of maximum opportunity will require a broader, deeper and more comprehensive sentiment adjustment from even currently low levels. We're more than halfway there, or so we guess. Save for a catastrophic collapse, next year will be loaded with bargains. But we've not quite arrived at the station.
But remember that calling bottoms and tops in markets or economic cycles is inherently risky. So, yes, we could be wrong, which is why holding 100% cash is probably a bad idea--ditto for fully loading up on risk, for that matter. In fact, absolute extremes are almost never a good idea, unless the valuation levels are so extreme as to warrant taking a jump. More generally, as Tobin long ago advised, one needs to separate the risk portfolio from the cash portfolio and think intelligently about blending the two halves.
When it comes to designing and managing a risk portfolio, our strategic beliefs remain unchanged. As for cash, well, that needs no explanation.
The great question, as always: What is the appropriate ratio for weighting risk to cash? The answer depends on the individual (or institution), of course, although as a general observation we're not yet convinced that the cash weight should be minimal. But that's just a guess — an enlightened one, we'd like to believe. Or, if you prefer, a strategic outlook. But let's emphasize the word "guess" for now, since that's ultimately at the bottom line of every forecast, be it economic or financial. In the interest of full disclosure, it's refreshing to admit it every now and again.
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This article has 31 comments:
Simple guidelines:
1) NEVER take a risk which, in the worst case, will force you out of the game (unlike the banks now mired in the MBS debacle). Only take risks which will not cripple your ability to continue if the worst should happen.
2) Any opportunity which presents a poor reward for the risk taken should be skipped. Gambling for very small returns is a good way to bleed your account to death.
3) It's OK to sit in cash if there aren't any better opportunities. Patience pays.
4) Both risk and potential reward change over time. Be prepared to exit any position if the future reward/risk ratio deteriorates.
5) A big risk is acceptable in small positions if an immense reward is possible, provided you can stand to lose everything you risk. Sometimes you will hit a big winner and get way ahead of "market returns".
As with anything else that pays over time, investing requires an ongoing effort. If you expect to get ahead by not working at it some, you are deluding yourself.
As I write this the SPY is hitting its top again. It will try to take it out. Will it be a triple top (a worse omen than a double top)? Or will the market continue upward? From what I am seeing (and the news I am hearing), the longer term trend seems likely to be down for the near term, even with the bailout. Even if enacted, the bailout will take time to take effect. There will be more bad news in the meantime, and that is assuming the bailout works fairly well. Cash doesn't sound so bad at the moment. A few puts on specific stocks might be appropriate. PPC has gotten killed recently. There have to be other companies in roughly the same boat. It might be a good idea to look for them.
greed and unearned humongous pay and golden parachutes. Now they
all want Mainstreet to bail them out. How about all CEO'S and CFO'S and the rest of the bigshots give up for one year their bonuses and golden parachutes. They won't miss it. This should easily cover the $700 billion bailout fund and it will redeem Wall Street and Main Street will feel less pain.
Highly volatile durable goods orders zig zag down to levels last seen in the 2005/2006 boom years and I'm supposed to be worried?
Jobless claims zig zag upwards, but only on a chart starting at 2006 lows. How about showing the late 90's till now? How about the early 90's till now? This is reversion to a historical mean.
Meanwhile, we are being told that the great depression is right around the corner unless we increase the national debt burden on our children by thousands of dollars each. What suckers we are. We might as well be giving to Benny Hinn to avoid another hurricane!
A quick look at the earnings of companies who weren't neck deep in mortgage speculation will reveal no great depression on the horizon at all. Here's a starter list: WMT, USB, WFC. Don't let the talking heads scare you! The Japanese banks are already scavenging the bargain leftovers.
Thay take us for fools! Don't give them the bail out, no matter what happens to us. Wrong is still wrong! This is the only way to get at them, throught their wallets!
All after the same thing, OUR POCKET BOOK.
Suppose that the economy fails, the government runs into problems paying its bonds on time, then you still have your FDIC insured savings - right? Well, if you were the Secretary of the Treasury, which would YOU pay first - bonds so you could continue selling them to keep things afloat, or FDIC and let the U.S. Treasury collapse? You (presuming sanity) would pay the bonds first and put FDIC payments on hold until things improved, and pay FDIC later, probably with hyperinflated dollars. While FDIC is theoretically guaranteed by both their own fund AND the U.S. Treasury, in a collapse, T Bills would probably be better than FDIC-insured savings.
Unfortunately, no one (that I know of) is working this multi-scenario approach to figure out just how things might recover, slip, or "hit bottom" in a way that we can all live with.
Any thoughts?
Lucifer
Why not blame yourself for driving around too much with you Big Truck !!
If the bail-out plan fails, this could be a very long painful and drawn out late cycle contraction; with a bottom lying far below & several months away. While $700 billion is a small amount in the context of GDP of over $13 trillion, a credit default market of $62 billion and a derivative market of $1,300 trillion; with the multiplier effect it will over time generate several trillion worth of economic activity.
Once the financial services sector stabilizes, we can look forward to investment in productivity; this phase is typically led by technology. As employment rises as do incomes, consumer confidence improves; this phase is led by consumer discretionary. As the economy improves, in anticipation of strong demand from industrials, the basic materials sector prospers. As the economy goes from strength to strength, the next sector to prosper is industrials. As the engines of industry roar, the demand for energy rises; and yes, it is energy that outperforms. By now, the exuberance of the cycle has caused inflation; commodity prices are up, interest rates are rising to tame inflation and slow growth. Now caution prevails; the rotation into the security of health-care commences; when you get sick you need medical assistance, it is a safe-haven and the yield is nice; at the same time growth potential exists. As time passes, the caution spreads, the flight to safety continues as the economy contracts; now investors turn to the security of investing in necessities and essentials; the consumer staples sector prospers. The economy contracts further; unemployment is climbing, valuations in staples have risen reducing yield, valuations are stretched considering the sectors low growth potential. Value becomes fashionable, dividends are important considering rising unemployment; investors shift to utilities. Now risks to growth are elevated, inflation is past its peak, stimulative rate cuts are anticipated in the late contraction stage. In anticipation of better spreads and credit expansion, financials outperform. We have gone a full cycle; but each cycle remains unique - the lead sectors are beneficiaries of a strong secular trend.
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Exellent point related to one that I've made in my posts. The govt. depends on both foreign debt and taxes for its continued existence. The foreign creditors could flee at any moment. Taxpayers, on the other hand, can be coerced to pay. Which one controls the government then?
Might the answer to this question explain why the govt. is propping up the value of mortgage backed securities, owned by the same investors who support the govt. by buying treasuries, at the expense of taxpayers. You certainly didn't see tech stock investors (mostly taxpayers) being bailed out by the govt. when their investments lost money in 2000.
Assets = Liabilities + Owner's Equity
so...
Government = Foreign Creditors + Taxpayers' Equity
Like a bankrupt company, the government's decisions are no longer made for the benefit of the equity owners, they are made to make the liability owners whole. We let things get this bad when we let the national debt (liabilities) become so big that we lost control, just like bankrupt companies do. Now that we don't control or even own a majority stake in the government any more, we can expect more creditor-enriching decisions like this bailout, supported by both political parties.
Alan,
Agreed. The US produces far less than it consumes, and the service sector (public or private) does not make up for a loss of manufacturing dominance or utter energy dependence. Investment from foreigners has propped things up for a long time, but with the stable Euro, undervalued Chinese currency, and high-yielding Indian and Brazilian currencies out there, it won't last much longer. The US is basically GM.
1) Reinvest the billions into the American economy, forced restructuring of soverign debt, forgive a portion of all debt for all Americans or at least allow massive debt restructuring (household has multiple debt payments say totalling $3,000 a month debt payment for 15 years, consolidated into one payment for 30 years at $2,000 a month). In this scenerio, the USA accepts the large geopolitical fallout from forced retructuring of debt payments with soveign nations including repegging of oil to the Euro and $250 a barrel oil (which of course forces more domestic solutions but immense short term pain, SPR would need to be released).
2) Liquify the financial market, force taxpayers on an ever lifting and accelerating treadmill to pay off sovereign debt. Government confiscates properties from the middle class as they begin to fail en masse over a few short years and further sells real estate off as securities, US citizens revolt either physically or at the polls.
Neither option is good at this point. But I favor option 1 as does 99% of the US citizen while it appears the US citizen will receive option 2. Nations are opportunists.The US government in it's hubris and narcassistic practices will face economic collapse either way and restructuring of our nation can ensue. My personal philosophy is that of the Founding Fathers "give me Liberty or give me death". No, I don't want pain, chaos etc but this is preferrable to serving Russia and China the rest of my life. Hey, we pumped $4 B into the Russian economy in 1998 and forgave a further $100 B. Where is the Russian help now? Idiots in Washington, this crop of self-servers must go before the country has a prayer to recovery.
Agreed. Which would you rather own, companies that earn worthless currencies or companies that earn stable currencies of stable economies?
Jeff J.J,
Although inertia is a force to be considered, your points are backwards-looking. I'm wondering what the most trusted currency of the NEXT 60 years is going to be. The way things are going I'm suspecting it won't be dollars.