It's Not All Bad News

Includes: DIA, JNJ, SPY, TLT, UN
by: Lee Eugene Munson, CFA

Co-written by Patrick Kirts

We were not pleased to hear the unemployment comments from the Fed this week, and the love-fest with tech and financials are giving us a headache. However, before you think all we see is doom and gloom, keep reading for some signs of hope. This means nothing in terms of the reality TV show based on the economy called the stock market, but it does show that eventually, things will get better. If you have an understanding of how the structural improvements are taking hold, your ability to spot the new leaders is greatly improved.

Among the many apparently hopeful signs sustaining this rally was the report on Thursday that the U.S. trade deficit narrowed in February to the smallest it has been since November of 1999. In fact, according to RRTNews, it "narrowed by 28% to $26.3B from January's revised $36.2B." BBC news claims that many of the reports focus on the fall in imports across all categories by 5.1%, the evident effect of decline of demand in America. There is, however, a silver lining to the Bureau of Economic Analysis' report: with the exception of services, which declined 1%, every category of exports rose in February, with autos and auto parts and consumer goods leading the charge. Even though we are still facing a lot of short and medium-term problems, this rise in exports is a very good sign of the long-term viability of the American economy, and could tell us something about the means for real recovery.

Americans are buying a lot less stuff right now, and a lot of the stuff they were buying was made in factories overseas; hence the decline in imports. The Asian economies are reeling from their corresponding decline in exports. Furthermore, prices of imported goods have risen slightly due to petroleum costs. However, many, if not most, Americans are acting completely rationally in buying less. There's evidently too much debt floating around, caused by too much easy money. The long-term trade deficit has been a signal that Americans are stretching beyond their means. It's a reflection of our net debtor-nation status. Some parts of the American economy need to accept their losses, so that people can be put back to work making things. While we would caution readers not to bet against the American consumer, a major dent in spending may not bounce back like it has in the past 20 years. When it does, an era of frugality may mean staples will stay in vogue longer than in the past; the reason we are not dumping out of positions like Unilever (NYSE: UN) and Johnson and Johnson (NYSE: JNJ).

Which brings us to the rise in exports. Over the very long term, a country's imports and exports must balance. Net borrowing forever is not feasible. A rise in exports of all goods can only mean one thing: more people in other parts of the world can afford things that are being made by Americans, in America. Even automobiles! Through a combination of increased purchasing power (they're always talking about how high the rate of savings is in Asia), and falling prices for goods in America, probably connected to the fall in American consumer demand, have made American goods more attractive around the world. This is great news!

It's not great news in the sense that we think the bottom in the market has been seen, or that we're in the rally to bring us back to health. A fake economy had hijacked the real economy for several years, and the financial system has yet to be cleaned out. But if we keep in mind that there is a real economy, that obeys real laws of supply and demand, the light at the end of the tunnel gets a bit brighter. Just remember the market is an historical novel based on the economy.

Source: Marketwatch (credit for Bureau of Economic Analysis report)

Disclosure: Long UN and JNJ.