Comstock Partners, Inc.October 04, 2012
Betting On Monetary Policy Is A Risky Gamble
After the massive Fed easing moves since 2008 economists have worried about what would happen if another economic slowdown developed with interest rates still near zero. We are about to find out and the results may very well be ugly.
In the U.S., growth continues to come in under 2 percent with no rebound in sight as consumers, accounting for about 70% of GDP, are restrained by excess debt, low savings rates, weak job gains and minimal wage increases. Average real hourly wages, a leading indicator of consumer spending, is down 1.7% over a year earlier. August consumer spending was up a paltry 0.1% and has increased by an average of only 0.1% a month over the last six months. The savings rate has declined back down to 3.7%. With demand so weak it is no wonder that businesses are reluctant to spend and to hire more workers. Core capital goods orders are down a substantial 9.7% since year-end, a signal that production will remain weak in the period ahead. In addition, keep in mind that earnings estimates have been coming down and that the third quarter earnings reports season will start next week. A decline into renewed recession is a strong possibility.
The weakness in foreign economies adds to the malaise and threatens a global recession as well. EU manufacturing activity has fallen to its lowest level since early 2009 and has been below the critical 50 level for 14 straight months. A number of EU members are already in recession with others on the cusp. Europe's sovereign debt crisis has gone through successive periods of serious concern interspersed with periods of temporary calm, but with no lasting solution. As we expected from the beginning, the ECB's proposed bond purchase program has proven difficult to put into place as sovereign governments are caught between rioters in the streets protesting austerity measures and financial leaders who insist upon them. Unfortunately Europe is running out of time.
The situation in Asia is also cause for concern. Chinese economic growth has been slowing down for six months and their PMI has contracted for the last two months----and these are the official figures. Some who know China well say that unofficially the economy is actually much worse. In Japan the "tankan" survey of business sentiment indicates that growth will weaken between now and at least the end of the first quarter. The Korean PMI has sunk to its lowest level since early 2009 and new orders are down 8.5% from a year earlier. In addition economic growth in India has dropped sharply in recent months.
With most of the globe slowing down at the same time, individual nations will find that their exports are also shrinking, putting the burden on domestic spending. At the same time, the Fed and a number of other central banks have already used much of their ammunition to fight the recession of 2008-2009 and will find it difficult to stimulate their economies. We believe that investors in the U.S. and elsewhere are engaged in wishful thinking if they insist that monetary policy alone can cure all of our ills.