Comstock Partners, Inc.February 20, 2014
Looking Beyond The Weather
In our view the economy is disappointing, even allowing for the bad weather. We’ve been saying for some time that, following major credit crises, economic growth is sub-par for many years to follow, and that is, indeed, what has been happening. For the last few years growth has generally trended at about 2% annualized, sometimes a bit more and other times a bit less. Every time growth exceeded 2% the pundits believed that the economy was achieving “escape velocity” only to see it drop back into renewed weakness.
Before the bad weather hit, the economy was already sputtering. Real disposable income was increasing at only a 0.6% annual rate, and consumers were able to increase spending only by reducing their savings rate to the lowest point of the recovery. Second half GDP was goosed by a jump in unwanted inventories that had to be worked off in coming periods. The year-over-year increase in payroll employment was within the same range it had been in for the prior three years. The housing industry had also turned down. Existing home sales for November were down year-over-year for the first time in three years, and the mortgage purchase index was declining----all before the bad weather settled in.
Granted, the weather has been a factor and has slowed the economy down even more. When conditions return to normal, it is logical to believe that there will be some snapback. However, when that happens growth is likely to return only to the same tepid pace it was on before the winter began.
Let’s take payroll employment as an example. Employment in November, prior to the poor results in December and January, increased 1.82% year-to-year, compared to recovery peak of 1.88% in March 2012. In January the rate dropped to 1.65%. In order for the year-to-year growth rate in March to return to the November level, the economy would have to add 652,000 jobs, an average of 326,000 for each of the next two months. And if February is also disappointing, we could actually see a big catch-up in March on the order of 400,000 or 500,000 jobs. Even then, however, that would only be enough to return to the November annual rate, which is in the inadequate range of the last two years. Keep in mind, too, that in prior post-war recoveries, employment typically rose by 3.5%-to-5% annualized for many months, far above anything seen in the current cycle.
In addition, the global economy is faltering as well. The IMF has stated that the world economy is still weak and that “significant downside risks still remain”. Europe is barely growing while China is showing signs of slackening growth even by the government’s suspect official numbers. Even more disturbing are reports we've been reading about problems in their shadow banking system. China has about $1.8 trillion invested in so-called “trusts”, and a large portion is apparently in danger of default. Over 40% of these trusts mature this year. A few have already defaulted. We don’t know any more than that, but any continuation of the trend could have exceedingly ominous consequences for the Chinese economy.All in all, it seems to us that investors are viewing both the U.S. and global economies through rose-colored glasses, and that the risks to the market are unusually high.