By Duncan Frearson, Smith Street Capital (via HedgeFund.net):
"Fool me once shame on you, fool me twice shame on me." This saying appears to be governing market behavior lately. Soft economic data has become the calling card for a market rout. Managers, fearful of another unforeseen collapse, have been selling down positions and de-risking their portfolios.
Why then should an investor buy what seemingly smart managers are selling? I believe the "rottenness" has already been purged from the system, to paraphrase Andrew Mellon, and the healing has begun.
Anyone who has kids knows when the lights go out, the boogey man appears. We are in the unfortunate position where problems in Europe, the end of some government stimulus programs, some large budget gaps and a growing oil leak have turned off the market's lights. The boogey man has entered the mind of the market causing some fearful behavior.
At the end of day the earnings power of a company is all that matters and thus understanding customer behavior is paramount. For the economy as a whole we should ask ourselves: are we currently spending beyond our means? Individuals are earning at record levels "“ around $10,103 for real disposable personal income for Q2 and we are only just beginning to push real spending beyond Q4 2007 levels leading to a savings rate in the 3.5% range, according to government data. The debt service coverage ratio and the financial obligations ratio both indicate the consumer is de-leveraging into a more stable financial foundation.
Source: Federal Reserve
The only real historical precedent for a double dip that is relevant happened in the early 1980s. A look at this prior period indicates a double dip recession is possible, but it requires action to make it happen.
The 1980s double dip came courtesy of a Federal Reserve that began to fear a pick up in inflation after the economy began to recover.
Of course their fear was warranted given inflation was the main reason for the prior economic malaise, but it would seem unlikely that the Federal Reserve will put any brakes on this time around (in fact they have stated they will not) and thus with a more stable consumer in the mix a collapse back to the late 2008/early 2009 level of economic activity appears highly unlikely.
On the corporate front, cash positions are at record levels for S&P 500 companies giving these firms confidence in their current operations and reducing the risk of sharp resource reductions.
U.S. states and EU nations are reducing budget gaps. They have provided liquidity and spending as the private sector reduced activity.
In the EU, the reduction in spending of the core nations will be slow allowing fears to eventually subside and any funding problems will be offset by ECB bond buying and the emergency SPE fund.
In the 1930s, U.S. government spending virtually doubled as a percentage of GDP creating an enormous economic dependence on this stimulus and thus a significant dip in activity when it was turned off. In the core EU nations no such boost has occurred and thus a reduction in economic activity from a cut in spending will be muted, at best, given their stable employment picture.
The longer the reductions are strung out and the longer stability is maintained, the more consumers will feel comfortable about increasing their spending. Ironically, U.S. states are increasing general fund expenditures in their FY 2011 budgets to $635.3 billion from $612.9 billion in FY 2010, according to the National Governors Association. Increased tax revenue from improving economic activity, the usage of remaining American Recovery Act Funds and "rainy day" funds will help stabilize a recovery.
Clearly, the U.S. received an initial boost from exports and government spending but this has provided a pathway for private sector restructuring. The Chinese have begun to talk down their economic activity somewhat but we should look to what they do as opposed to what they say.
Their interests are aligned with our interests, and their export sector needs a healthy global economy to continue to bring a few hundred million people out of employment. They maintain adequate gold reserves under the ground domestically and their willingness to backstop the U.S. dollar and their aid in keeping U.S. stimulus spending virtually interest free is a testament to their desire to move the global economy out of recession.
Confidence is slowly returning as employment stabilizes. Gallup polls suggest higher income consumers are beginning to spend more and this will filter down to middle income and eventually to lower income consumers even in light of the declining equity markets due to restructured personal balance sheets. Companies, in turn, will respond with increased production, inventory rebuilding and increased hiring.
Given this, I expect to see buyers enter the marketplace as interest rates drop and affordability increases. It is very unlikely we will have the same situation in 2010 that occurred in 2008 where no financing was available for purchasing activity.
We need to be patient as the healing occurs after such an economic downturn. The larger macro economic picture has improved and with global coordination among central bankers of the world we can get back to business as usual, albeit with a little less leverage this time around.
Duncan Frearson, CFA, is a co-managing partner at Smith Street Capital. He can be reached at dfrearson@smithstreetcapital.com. Please feel free to comment or visit our website at www.smithstreetcapital.com.
The views expressed in this guest column do not necessarily reflect the views of HedgeFund.net.
The content on this site is provided as general information only and should not be taken as investment advice. All site content shall not be construed as a recommendation to buy or sell any security or financial product, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of firms affiliated with the author(s). The author(s) may or may not have a position in any security referenced herein. Any action that you take as a result of information or analysis on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.
Post Footer automatically generated by Add Post Footer Plugin for wordpress.
I agree with this and with TPC’s view that it will be about 2012 for enough deleveraging to occur. It’s a process.
For those who think the market will crash below the lows of March 2009, I have only one question:
It is clear that that final plunge to the 600s was caused by hedge fund pure liquidation, but now hedgies are nowhere near as levered and are fairly liquid, so what will cause the same type of collapse this time around?
2 possible reasons for a drop to the 600s. 1) Multiple contraction due to the realization that future growth will likely be lower than past growth. 2)Collapse in Aussie/China/Canada housing.
Everyone seems to think 666 was completely unreasonable in March. At the time, we did not know where the banking sector would be alive in a few weeks. I don’t think 666 was much of an overreaction.
I just saw this on Mish’s website
http://globaleconomicanalysis.blogspot.com/2010/07/vancouver-home-sales-drop-30-percent.html
I live near the Canadian border and have good friends up in the Couve. They tell me real estate is insane up there and that it will crash like it did in the 90’s. They say it is all Asian (mostly China/India) money coming in and that most of the homes are vacant.
Is this a reflection of China slowing down? I don’t know, but we’ll find out in the next few months.
I believe the cheap money from our country made its way overseas and now we have the ultimate global economic top. The S&P could easily hit 500 at some point as profits in Coke and PG are cancelled out by losses at many financial institutions.
In the 1930s, U.S. government spending virtually doubled as a percentage of GDP creating an enormous economic dependence on this stimulus and thus a significant dip in activity when it was turned off. In the core EU nations no such boost has occurred and thus a reduction in economic activity from a cut in spending will be muted, at best, given their stable employment picture. Duncan Frearson
Non sequiter. If anything, the Europeans are so used to government spending that “austerity” will be devastating to them. Whistling past the grave yard this article seems to me.
Gallup polls suggest higher income consumers are beginning to spend more and this will filter down to middle income and eventually to lower income consumers even in light of the declining equity markets due to restructured personal balance sheets. Duncan Frearson
Ah, trickle down! Just how much can people who have everything spend? Did they get rich in the first place because of their “propensity to consume”?
I read that the government spending/transfer payments are barely even injected into the system as of this point so we still have that to factor in. And also, to all the US haters out there that claim Asia will overtake us, don’t forget that it’s our military bases that make trade there possible.
Exactly. And more Chinese and US stimulus is on the way.
Think hard on this, by way of default, I think the only US stimulus that can have a frigging prayer of getting through — is EXACTLY WHAT WE NEED!!!
I.e., tax cuts and corporate incentives.
How ironic would that be.
Notify me of follow-up comments via e-mail
© 2009 pragcap.com · Login.
By Duncan Frearson, Smith Street Capital (via HedgeFund.net):
"Fool me once shame on you, fool me twice shame on me." This saying appears to be governing market behavior lately. Soft economic data has become the calling card for a market rout. Managers, fearful of another unforeseen collapse, have been selling down positions and de-risking their portfolios.
Why then should an investor buy what seemingly smart managers are selling? I believe the "rottenness" has already been purged from the system, to paraphrase Andrew Mellon, and the healing has begun.
Anyone who has kids knows when the lights go out, the boogey man appears. We are in the unfortunate position where problems in Europe, the end of some government stimulus programs, some large budget gaps and a growing oil leak have turned off the market's lights. The boogey man has entered the mind of the market causing some fearful behavior.
At the end of day the earnings power of a company is all that matters and thus understanding customer behavior is paramount. For the economy as a whole we should ask ourselves: are we currently spending beyond our means? Individuals are earning at record levels "“ around $10,103 for real disposable personal income for Q2 and we are only just beginning to push real spending beyond Q4 2007 levels leading to a savings rate in the 3.5% range, according to government data. The debt service coverage ratio and the financial obligations ratio both indicate the consumer is de-leveraging into a more stable financial foundation.
Read Full Article »