Comstock Partners, Inc.October 29, 2009
Economy Getting an Artificial Boost
If the economic recovery is as solid as the 3rd quarter GDP implies, why are the governmental authorities desperately acting as if it needs more life support? Congress is about to pass an extended version of the first-time home buyers credit in addition to allowing a $6500 credit to current homeowners until next April 30th. The White House is talking about a possible tax credit for companies hiring new employees and has proposed giving every social security recipient $250 to make up for the absence of an annual inflation adjustment this year. Further additional stimulus programs are only on the backburner for fear of increasing the deficit before final passage of the health-care bill The Fed is promising a near-zero fed funds rate indefinitely while it is reluctant to put any kind of time-table on withdrawing its massive stimulus program.
Let's face it--there's good reason for all of this talk. The economy remains extremely fragile, and almost all of the progress seen to date is the result of massive stimulus programs that are pouring funds into the economy. Take today's report of 3.5% growth in the GDP as an example. This percentage reflects an increase of $113 billion in total GDP from the 2nd to the 3rd quarter. A reduced rate of inventory decline accounted for $30 billion of the total, resulting in a final sales climb of $83 billion. Of this amount, consumer spending accounted for $76 billion and residential sales $18 billion, more than accounting for the entire increase in final sales. But a good chunk of the consumer spending increase resulted from the 'cash for clunkers' program that goosed auto sales in July and August and has since expired, while the housing number was mostly a result of the $8,000 first-time home buyer credit that expires for home sales closed by November 30th. Therefore, it appears that very little of the 3rd quarter GDP growth was organic, and that it was mostly induced by artificial programs with a finite end.
Even then, the efficiency of both the 'cash for clunkers' and the home buyer credit are subject to question. According to Edmunds the government's cost for every additional car sold was $24,000. As for the home buyer credit, Calculated Risk, using the NAR's estimate of an additional 350,000 homes sold, estimates that the government paid $43,000 for each home sold. That is optimistic compared with Goldman's estimate that only 200,000 additional homes were sold, costing the government $80,000 for each marginal sale.
Now Congress is proposing an extension and addition to the housing tax credit, although its overall impact on the economy is questionable. If prospective buyers really need this money to purchase a home, it is doubtful that they can afford it anyway. And if they don't need the incentive, they would probably buy a house without it. As for the 'cash for clunkers' program, all it probably accomplished was pushing forward sales that would have been made within the next 12 months. In fact, auto sales slumped as soon as the program ended.
Other than artificial programs there is little to drive future economic growth. The economy is being battered by a malfunctioning credit system, a jobs crisis, declining wages, commercial loan problems, another wave of coming residential foreclosures and a massive overhang of vacant commercial properties of all types. Banks are not lending, preferring to build up capital. Consumers are trying to pare down debts and bring their savings rates up to previous norms. They are, therefore, limiting spending mostly to basic necessities. Businesses are cutting debt, conserving cash, and restricting capital spending in the face of record amounts of excess capacity.
It seems to us that the stock market surge since the March low is based on the actions of two broad types of investors. First are those who believe that the economic recovery will follow the V-type trajectory of most post-war cycles. Second are the momentum players who either ignore fundamentals or do not believe in a robust recovery, but are willing to follow the trend until it ends. In our view the chances of a V-type recovery are exceedingly slim. When the stock market stalls and starts an inevitable decline the momentum players will run for the exits, resulting in another waterfall decline.