Comstock Partners, Inc.July 16, 2009
Less Bad is Not Good Enough--Part 2
Six weeks ago we wrote a comment titled "Less Bad is Not Good Enough", meaning the worst is over, but that recovery was some time off. We also mentioned numerous times that the massive stimulative actions undertaken by the Fed and the White House had averted a global financial and economic collapse, but that the deep and prolonged recession would have to run its course. We also stated our view that the recovery would be extremely subdued as a result of the poor financial state of consumers and the need of the economy to pare down debt. None of that has changed. Indeed the strong market rally off the March low has already reflected a huge sigh of relief that the global system has not collapsed and that the economy was no longer falling off a cliff. Since those factors have already been discounted, it is unlikely that. the market would discount them again despite this week's market gain. Although it's possible the recession could be over in six months, the recovery is likely to be so weak that it will hardly be noticeable in the real economy.
Furthermore, better-than-expected earnings by some prominent companies is no sign of renewed economic strength. Hardly noticed in the celebration is the anemic revenue growth (or non-growth) reported along with the earnings. For instance Google's revenues were up a mere 3%, its lowest since it became a public company, while IBM's revenues were down 13% and Intel's 15%. In fact sluggish or declining revenues has been a hallmark of 2nd quarter reports so far. That is hardly a harbinger of strong economic growth. On the contrary, it indicates severe cost-cutting efforts that pose danger to the economy as a whole, although it helps the individual firm.
For anybody who doesn't think that the economy is still quite weak, don't take our word for it. We doubt that many have read the full version of the Fed's late June minutes, but the underlying tone is far more negative than the headlines suggest, and, to a large extent, belie the Fed's own conclusions. Following are some quotes from the review.
"The information at the June 23-24 meeting suggested that the economy remained very weak."
"...most participants saw the economy as still quite weak and vulnerable to further adverse shocks"
"Although financial conditions have improved, credit was still quite tight in many sectors...Credit was tight with some banks quite reluctant to lend. Worsening credit quality, especially for consumer and commercial real estate loans, was seen as an important reason for reduced lending and tighter terms, and banks could face substantial losses in their loan portfolios in coming quarters. Many participants noted that obtaining financing for commercial real estate projects remained extremely difficult amid worsening fundamentals in the sector."
"Most participants judged that consumer spending would continue to be subdued for some time...Participants also observed that while personal income had expanded briskly of late, those increases had been boosted by special one-time factors such as fiscal stimulus and large cost-of-living adjustments for Social security recipients."
"indicators of single-family starts and sales suggested that housing activity may be leveling out, but most participants viewed the sector as still vulnerable to further weakness...others noted that foreclosures were continuing at a very high rate and could push house prices down further and add to inventories of unsold homes, holding back housing activity, and weighing on household wealth."
"labor market conditions were of particular concern to meeting participants...Reports from district contacts suggested that workweeks were being trimmed and that total hours worked were falling signigficantly. The large number of people working part time for economic reasons and the prevalence of permanent job reductions rather than temporary layoffs suggested that labor market conditions were even more difficult than indicated by the unemployment rate."
All in all, that is not a pretty picture, and it makes us wonder how many people have really read the minutes rather than a spun version in the media. We continue to believe that the market rally has already discounted the slowdown in the rate of economic decline, and that further substantial upside requires more proof of actual strength that we still believe is a ways off.