Comstock Partners, Inc.July 07, 2011
Nothing Matters Until It Does
Once again, as in early 2000 and late 2007, the market is misreading the negative significance of domestic and global economic conditions. While the debt ceiling issue most likely will be settled under the pressure of a potential U.S. default, the optimistic interpretation of such an agreement is not warranted. The key is that whatever the details of the final agreement, it will result in a much more restrictive fiscal policy, and therefore will be negative for economic growth. Since this is happening almost simultaneously with the end of QE2, which was adding an average $3.8 billion daily into the economy for 7 ½ months, it is apparent that both fiscal and monetary policy will be tighter in the period ahead.
The problem is that as a nation we have serious problems with both economic growth and enormous debts, both private and public, as a result of the severe credit crisis. The U.S. economy faces significant head winds that go far beyond such temporary transitory factors such as Japanese supply-chain problems and higher oil prices. It is notable that the Fed recently reduced its economic growth forecast not only for 2011, but for 2012 as well. In his press conference on June 22nd Chairman Bernanke admitted that while part of the recent economic weakness was due to transitory factors, there were other long-term factors at work including the need for consumer to deleverage.
While reducing the deficit may be a laudable achievement, the economy is still likely to grow at a below-trend pace even if we are able avoid another imminent recession. The drag on the economy will continue to come from housing, unemployment, consumer spending and continuing credit restrictions. There are still excess inventories of about 2.0 to 2.5 million homes that will exert downward pressure on prices as they come to market. About 23% of all homes with mortgages are already underwater and any additional drop in prices will make this even worse.
As for unemployment, although the headline rate is 9.1%, the Bureau of Labor Statistics estimates the true amount as over 16%, when taking into account those who have just given up and those who are working part-time only because they couldn't get full-time jobs. Monthly payroll employment will have to increase by far more than 125,000 over a lengthy period to get this rate down significantly.
Consumer spending, too, is likely to remain tepid for some time to come. Households are being forced to limit spending in order to build up savings and reduce debt. The process of deleveraging has a long way to go. Although the ratio of household debt to disposable personal income has declined to 115% from 130% at the 2007 peak, the 1975-2000 average was only 75%----and even this was higher than in prior decades.
The global economy is rapidly losing momentum as well. The EU economy is now slowing in Germany and France while the EU's southern tier is still under pressure. Ten-year bond yields have soared in Ireland and Italy this week indicating that the EU may not have even been successful in "kicking the can down the road". Japan is in recession while China and other emerging nations are tightening monetary policy to fight inflation.
Even the oil price rise may turn out not to be as transitory as everyone seems to think. The prestigious Council on Foreign Relations recently wrote that "The Arab Spring Has Given Way To a Long Hot Summer". They stated that recent developments are producing a region that is far less stable than what existed previously. They concluded ominously that, "The world is only one major crisis in Saudi Arabia away from $200 per barrel oil".
Just as the stock market chose to ignore the obvious in 2000 and 2007, it is ignoring the obvious once again. In today's rapidly moving minute-to-minute market, nothing matters until it does.