Market Insights – June 7, 2011
“Because if it didn’t work out, I didn’t want to blow the whole day” —- Paul Horning, (Hall of Fame running back for the Green Bay Packers), on why his wedding ceremony was before noon.
Dear Clients and Friends,
The unemployment report for May was a big disappointment to be sure, but to listen to FOX, CNN, CNBC and MSNBC tell it, you would think that we were on the verge another economic disaster. The “hours worked during the week” component of the report actually rose dramatically in May. Employers clearly responded to uncertainty by working existing employees harder and longer,rather than hiring new workers. Most certainly the debate will now heat up with regard to whether the “soft patch” is really another round of recession that requires more monetary easing in the form of QE3. Brian Westbury, senior economist for First Trust argues rather convincingly that because of a number of one-off events that occurred simultaneously this spring, the economy is experiencing only a temporary slowdown (click here to see his article). As with all things of an economic nature, the reality of the situation lies somewhere between a soft patch and recession. Clearly manufacturing had slowed in the first quarter as companies allowed inventories to build. Whether they were spooked by high raw materials costs, lack of parts from Japan or the pending end of QE2 and its economic impact, companies have slowed their rate of expansion and unfortunately…… of payrolls as well. Some of the explanation for this behavior can be found in the consequences of the financial crisis of 2008 where the fear of, no credit, is still fresh in the memories of corporate CFOs. The crisis revealed that the availability of financing for future business needs is far less certain than previously imagined. The frozen and inaccessible credit markets during the fall of 2008 made it virtually impossible to finance payroll and inventories and greatly increased the value of holding cash. In the next credit crisis, having cash on hand could make the difference between survival and failure.
The pessimists will argue (with good reason), that the economy cannot recover and begin to generate jobs as long as residential real estate remains in a full blown depression. According to Calculated Risk, using 2010 Census data, the current excess housing supply is approximately 1.5 million units. Re-financing applications continue to fall even in a low rate environment because, according to the Mortgage Bankers Association, “to many potential refi borrowers have little or no equity remaining in their homes.” The pessimists say that the government can and has been generating economic growth “at will” by borrowing money and spending it. All of that liquidity looks to be going away all at once and all at the wrong time with the Republicans playing hard ball on the debt ceiling negotiations and the June 30th end of QE2. The new assumption is that the real economy is not strong enough (without a QE3), to create the 200,000 jobs per month necessary to have a self sustaining recovery.
The optimists will argue (with good reason), the economy is still expanding. The ISM index of national factory activity for May came in at 53.5, down from 60.4 in April (any reading above 50 is considered expansionary). New orders fell by 10% but were still positive. Prices paid for materials fell by 8% and that is good. Tom Graff, fixed income manager at Brown Advisory Service says, “Don’t confuse slowing with declining. Today’s non-manufacturing ISM report should reinforce that thought. So we gained only 54,000 jobs, which is not good at all. But it isn’t declining. Until the economy looks like it is sliding into zero growth/recession, there will be no QE3. Consider today’s non-manufacturing ISM number of 56. That is expansion at a decent level.” Further analysis of the ISM report shows that this is the 22ndconsecutive month of expansion. New orders grew by 4.1% and more importantly, the Employment Index within the report gained 2.1% and appears to be accelerating. The ISM summarized the report by saying, “Respondents are mostly positive about overall business conditions. There is a sentiment that there is a degree of stability in the economy; however, a continued concern exists over fuel costs and various volatile commodities.” Jamie Dimon, CEO of JP Morgan, seems to echo those comments when at a June 2ndSanford Bernstien conference on economic conditions, he said that “The economy is getting better, not worse, that charge-offs continue to decline as asset quality improves. The consumer is stronger and the housing leading indicators are not bad.” Whoever you believe and whatever side of the economic debate you lean towards, the stock market will move in the direction of earnings expectations. Bad numbers and the expectations decline. Good numbers and the expectations rise. Until we settle into a more consistent direction for the economy, I think we will have a volatile market that moves between 1250 and 1350 on the S&P index. Not a lot of risk, not a lot of reward for the time being.
I agree with the very accurate and very savvy hedge fund manager Doug Kass when he says, “Our investment world is not coming to an end. In all likelihood, short-term interest rates will remain anchored at low levels for as far as the eye can see. Moreover, most credit metrics, such as swaps and spreads (as well as the positive sloping yield curve); argue in favor of a relatively hospitable economic and investment backdrop. However, for those of a more conservative nature, stay underinvested until there is more economic clarity and less economic ambiguity.”
It could be a long and hot summer.
Sources: Real Money, CNBC and First Trust
Articles of interest:
Ken Beach, President of Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.