Bernard Thomas'  Instablog

For the second time in the past few months I find my self in agreement with Pimco's Bill Gross. That I agree with Mr. Gross may not seem odd to many of my readers, but I have been very critical of his talking his book of holdings in the financial media while being portrayed as giving altruistic advice. I have not been especially critical of Mr. Gross's strategies, only that he is not the good-hearted soul dispensing free advice to the investing public he is believed by many to be.

However, Mr. Gross's letter to clients expresses opinions very much in line with my own. First: Mr. Gross is of the opinion that government efforts to achieve artificial levels of consumption are wasteful or in his words: (It)can be compared to flushing money down an economic toilet." Secondly: He states that deleveraging, stiffer regulations and protectionist policies create strong headwinds which hold back growth.He refers to the aforementioned conditions the "new normal."

I believe Mr. Gross is dead on. Consumers cannot and will not borrow as they did before. How much more can the Fed stimulate the economy than it has already has? Consumers are tapped out from over two decades of living through an almost a constantly stimulated economy. The amount of consumption required to achieve growth levels and unemployment rates seen during the past two-plus decades are fundamentally unsustainable.

Mr. Gross makes reference to Japan's perennially stagnant economy. Japan has had over a decade of rates down near 0.00% and still consumers save instead of spend. I do not believe U.S. consumers will go to the same extremes as their Japanese counterparts, but gone are the days of homes, cars and expensive appliances for anyone who can fog a mirror. Unfortunately, that is what it will take to create growth rates similar as to which we have become accustomed.

What about hiring? Balance sheets are strong, won't businesses hire? The will hire only if absolutely necessary. CEOs are being rewarded for doing more with less. Shareholders are pushing efficiency and productivity. It is not surprising that the one stronger sector in today's Durable Goods report was machinery. Still no signs of Luddites.

The Fed's Beige Book did not tell an encouraging story. The Fed's report on activity from its 12 regional banks stated: "Nearly all districts reported sluggish housing markets” since the home buyer tax credit expired last April 30th and several districts reported that manufacturing "slowed or leveled off. Growth is moving forward on the whole albeit at a modest pace.

The bond market is still on board with the modest growth story. Both yesterday's two-year treasury note auction and today's five-year treasury note auction were very will bid for, pricing at yields at or near record lows.

Disclosure: Long TBT, F, BAC, C, SIRI



Disclosure: Long: TBT, F, BAC, C, SIRI

Disclosure: Long: TBT, C, BAC, F, SIRI

Neither a borrower nor a lender be. The advice given by Polonius to Laertes in act 1, scene 3 of Hamlet is being taken by banks and consumers today.


In spite of record stimulus, banks are reluctant to lend and consumers and businesses are reluctant to borrow. Why? They there is little need for them to do so. Banks can make enough money via the carry trade. Consumers are still debt-laden. Businesses, without new demand on the horizon, do not need to borrow to expand.

Businesses rarely expand proactively preferring to see demand or at least consumer sentiment to become optimistic and stay that way for a period of time. When it comes to either expanding too soon or too late, later is usually better, or at least cheaper than sooner.

Consumer debt loads have been shrinking. According to the Wall Street Journal U.S. household debt was 122% of disposable income. Although this was down from 131% in early 2008, it is higher than the 100% seen as the highest sustainable level by most economists. With consumer debt loads still high and a lack of new products or service on which to spend (few ground-breaking, must-have big-ticket items or sectors), consumer demand will probably remain below trends to which we have become accustomed.


There has been much discussion of the possibility of a double-dip recession. Not surprisingly, these fears have been stoked by the financial media (the folks who brought you the can't miss "v"-shaped economic recovery). The double-dip is not the scenario most economists believe will play out. The more likely scenarios may be a protracted period of economic stagnation.

Nariman Behravesh, chief economist for IHS Global Insights told the Wall Street Journal:

"The risk here for a lot of countries is not a double dip but a protracted period of stagnation, which is bad news for creating jobs."

I believe Mr. Behravesh's concerns are legitimate. There should be enough economic activity in the U.S. to keep the economy in positive territory, but just. Although consumption is not necessarily a zero sum game, it is not infinite either. Any time sales are increased by stimulus programs or sale incentives we get more than sales which wouldn't have happened at all without incentives. We also get sales which would have happened at a later date moved forward (ask the Detroit automakers about this). Now we have consumers who, under normal circumstances, would have purchased vehicles and homes in 2010, 2011 or 2012 now out of the market because they have taken advantage of sweetheart incentivized deals. Not only has the ability to spend diminished the desire to do so have diminished as well.

Further slowing growth are the headwinds emanating from Washington D.C. Anti-business rhetoric does not instill confidence among business executives. Higher taxes and more restrictive labor practices have executives and business owners frightened.

Forthcoming economic polices are also helping to keep consumers on the sidelines. With debt averaging north of 120% of disposable income, consumers are reluctant to spend with the knowledge that they will have even less disposable income in the near future. One must question economic policies which will inhibit consumers' abilities to reduce debt to where it is at an acceptable ratio with disposable income. Consumers will be like a dog chasing its tail.

It is not like there are no historical precedents to which policy can refer before pulling the legislative trigger. One only need look back to the policy mistakes of the mid-1930s. At that time trade policy became more protectionist, tax rates where increased dramatically and the Fed tightened monetary policy. The rhetoric coming out of the Obama administration, tax increases and soon a more highly regulated business environment promises to slow economic recovery. The one saving grace is that Fed policy is unlikely to tighten any time soon. This will help prevent a double-dip recession.


Fed policy will also keep corporate profits high as borrowing costs will remain low and the carry trade will remain available for banks. With more restrictions on banks' ability to trade, take risk and lend, they will remain more dependent on the carry trade than the have in the past.

Individual investors are puzzled as to why corporate credit yields remain low. They are amazed that anyone will by a ten-year Verizon bond at 4.00% or a ten-year Bank of America bond at 5.00%. What they don't understand is that institutional investors determine value differently than retail investors.

Retail investors tend to view yield in absolute terms. They consider a good return and rate of return on which they can live. Institutional investors view value on a relative basis. five percent for a ten-year Bank of America bond may not thrill the hearts of mom and pop, but to an institution that 200 basis point spread over the ten-year treasury looks comparatively good. Because treasury yields are bound to remain low and because institutions will buy corporate bonds at these spread levels all day long, individual investors should reconcile themselves with this new reality and get out of cash. Laddering across the curve (overweight the 5 to 7 year "belly") of the curve is a good place to start when looking to invest in the fixed income markets. Investors should use caution when reaching for yield by investing in lower-rated bonds or far out on the yield curve. The reward may not justify the risk.

Disclosure: Long TBT, C, BAC, F, SIRI



Disclosure: Long: BAC, TBT, C, F, SIRI

Crossroads

 

I went down to the crossroads, fell down on my knees.
I went down to the crossroads, fell down on my knees.
Asked the Lord above for mercy, "Save me if you please."

 

 

~ Cream (Robert Johnson)

 

 

            Today’s employment data could be a crossroads for the economic recovery. On one side the private sector did add jobs and the unemployment rate fell. On the other side the economy shed jobs for the first time this year. Let’s tear through the data so we can avoid becoming road kill.

 

            Nonfarm Payrolls reported a decline of 125,000 jobs. Yes, the consensus was calling for a drop of 130,000 jobs but that estimate was changed yesterday from -125,000 jobs (which was changed from -115,000 jobs earlier in the week). Private sector jobs, the real growth engine of the economy (especially in the absence of insane amounts of consumer borrowing) came in with a gain of 83,000 jobs. While this was better than the prior gain of 43,000 jobs it fell short of the consensus estimate of 110,000 jobs. Manufacturing added 9,000 jobs, but that was far below the street consensus of 25,000 jobs and the prior revised 32,000 jobs. The unemployment rate fell from 9.7% to 9.5%, but that was because discouraged people answered that they were not looking for work and are therefore not counted as unemployed.  Where were jobs lost? Total government employment fell by 208,000 jobs. The construction sector shed 22,000 jobs.

 

            More bad news came in the way of a decline in average hourly earnings and a slight decline in average weekly hours. Although today’s data is not catastrophic it does tell us that consumption and economic growth could be much softer than expected and even softer than in the first half of this year.

 

 

            Truthfully, I do it know where all the optimism was coming from earlier this year. It appears as though many optimistic economists were pinning their hopes that improvement in the manufacturing sector would lift the economy and start the job creation machine. There is a problem with that. Manufacturing is responsible for less than 10% of the U.S. economy. The sector provides relatively few jobs, U.S. factories are highly automated and increased production could be sent overseas where labor is cheaper and customers are geographically closer. Also, we will probably see further government worker cuts, especially at the state and municipal level as shrinking tax revenues force governments to cut payrolls.

 

            The amount of economic growth we have experience during the past 25 years was the result of ever cheaper leverage and ever easier access to credit. This is not perpetually sustainable. It will take years to replace the jobs we have lost, but the overall job situation may not improve much. About 150,000 new jobs are required just to keep up with the growth new people entering the work force. This could result in an elevated unemployment rate for many years and subpar growth as well.

 

 

            The question being bandied about is: Will we experience a double-dip recession? The answer: Probably not. However, Americans have become accustomed to historically low levels of unemployment and the ability to spend at will for nearly any item. Those days are gone for a very log time (if not forever). Economists would be well advised to pick their heads up from their spread sheets and take a look at what is really happening in America and maybe, just maybe, look beyond or at least revise their models.

 

 

 

 

 

            Look for the Fed to keep rates low for a very long time and for long-term rates to stay low before rising modestly. The Fed is almost certainly on the sidelines for 2010 and possibly for most or all of 2011. Please resist the urge to cherry pick pieces of data to justify strategies, bullish or bearish. Leave that to the politicians and media talking heads.

 

            The markets are now filled with vigilantes. They are now voting no on government polices and the strength of the recovery. The Obama administration, if they value the good of the country over ideology, may want to reverse its views on tax policy and how it treats business, especially small and medium-sized business. On time tax credits or rebates do not result in long-term positive economic trends. Consumers want permanent or, at least, long term tax benefits. I am not holding my breath. Either are the markets.

 

 

P.S. Stop blaming Greece for our renewed economic malaise. This is home grown.

 

 

Disclosure: Long TBT, C, BAC, F, SIRI, FREprZ

 

 

Disclosure: Long TBT, C, BAC, F, SIRI, FREprZ