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I’m not sure what possessed investors to re-embrace the warmth of the bull market last week but it surely wasn’t good news on the US economy. Or good news from Japan. Or good news from the Middle East. Or good news from Europe. Or good news on the housing market. The ability to ignore the risks is a virtue at the bottom of a bear market. It’s probably more of a vice after a market doubles and the recovery is nearly two years old. This hasn’t exactly been a rip snorter of a recovery anyway and it is looking more peaked by the week.
Now I don’t know anymore about the future than the next market chatterer but I see the present and the past pretty clearly. What I see right now does not inspire a lot of confidence. The US recovery, such as it is, shows no sign of reaching a self sustaining pace. Housing is still in the dumps and companies aren’t investing or hiring. Consumption is still rising but wages are stagnant and households are still highly leveraged. Exports have been strong but growth in emerging markets is highly leveraged to commodity prices and there is a limit to how high they can rise before causing an economic slowdown or rising inflation or both. Besides, most emerging markets are already raising interest rates and that isn’t usually associated with an acceleration in growth.
The potential for production cutbacks in Japan may be a supply shock that accelerates the trend of rising prices. The European debt contagion is set to hit Portugal - maybe as early as next week - and Spain waits in the wings. And to top it all off, we just jumped in the middle of a civil war in Libya. Tomahawk cruise missiles cost an estimated $1 million apiece and we used 100 of them on the first day of enforcing the no fly zone. I suppose a Keynesian might see that as potential stimulus for Raytheon but unless we start using them on the jobless, the effect on the unemployment rate is nil. And it sure doesn’t help our already dire budget situation.
Gold just hit a new high last week while the US dollar continues to fall. That really tells you all you need to know about how investors see the future for the US economy. Investors pouring money into gold is the equivalent of burying it in the backyard; gold mining seems unlikely to be the growth industry of the future.
That covers the present and it isn’t a pretty picture. As for the past, I have a long memory and what hair I have is gray and growing in places I never expected. That means I remember the 70s and while I hold no nostalgia for that era of disco and stagflation, I am beginning to wonder if Ben Bernanke isn’t hiding a Saturday Night Fever white leisure suit in his mental closet. Inflation and inflation expectations are rising while growth estimates for the first quarter are falling by the day. We followed the UK in quantitative easing and Bernanke seems determined to make sure we follow them once again into the breach of stagflation.
Last but not least, we have the impending end of quantitative easing in June. That may also mean the end of the falling dollar but a rising dollar by itself isn’t the answer. It matters why the dollar rises. If there is increased demand for the dollar for productive investment and capital starts to flow back to the US from emerging markets and out of gold (and other commodities), then the recovery might actually become something of substance. If the dollar rises merely because the supply of new ones from the Fed dries up, it would still be good in the long run but the short run might get a lot dicier. I’ve said it many times and I’ll say it again; we need better economic policies here in the US that attracts investment. So far we haven’t gotten it and with the politicians squabbling over minutiae the prospects grow dimmer every day.
The economic data last week was just about uniformly awful, not that stock market investors noticed. Existing home sales fell nearly 10%. Supply rose to 8.4 months and prices fell again. And that my friends was the good news on the housing front. New home sales fell to an all time low, down 16.9%. Supply rose to 8.9 months and the median price fell 13.9%. In a country with 300 million people, we managed to sell all of 19,000 new houses last month. As I’ve said before, this is what is required to clear excess inventory but getting there is proving a long, long road.
Both the Goldman and Redbook retail reports are showing slowing growth or outright declines in same store sales. And no wonder with gas and food prices rising, consumer confidence is falling again. With the Fed intent on completing the full QE II menu, that doesn’t look to improve anytime soon.
Durable goods orders surprised to the downside, falling 0.9%. Ex-transportation wasn’t much better at down 0.6%. Even worse, non defense capital goods orders ex aircraft fell 1.3%. Companies are not in any rush to invest and who could blame them? Rising input prices already threaten their record profit margins. I don’t want to make too much about these numbers since durables are a very volatile series but in a robust recovery we would be seeing volatility around positive numbers, not positive one month and negative the next.
The US economy is not performing anywhere near potential right now and without a change in policy that seems unlikely to change. Globally, things don’t look much better. China and most of the emerging markets have an inflation problem. The UK has the worst of both worlds with inflation too high and growth too low. Europe continues to hope the debt fairy leaves a solution under the pillow of Jean Claude Trichet that solves their problem without any banks having to take a loss. In the meantime, Portugal is about to go hat in hand to the IMF and Spain can’t be far behind. As hard as I try, I just can’t seem to find the silver linings in all these clouds. How much longer can we go before one of those clouds opens up and rains all over the bulls?
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