Optimists Could Use Some Good News

There was scant positive news this week offering hope to those still optimistic the US and global economies can avoid a recession. The government’s third and final revision of economic growth (GDP) for the second quarter was revised up to 1.3% from 1%, however still quite anemic. German lawmakers quelled short-term fears by approving an expansion of the euro-area rescue fund which allows European policy makers to focus on next to blunt their debt crisis. They will likely leverage the fund as the US did in its own crisis in 2008. 

But as some hold out hope of averting recession, the darker chorus grows louder. Lakshman Achuthan of Economic Cycle Research said there’s “a wildfire among the leading indicators across the board. Non-financial services plunging, manufacturing plunging, exports plunging.” He went on to say the combination of trends points to at least a couple of worsening quarters ahead.  

Equity markets which look to the future by a quarter or two may be suggesting the same. US stocks attempted rallies each day this week, but finished down three of the last four. The MSCI US Broad Market Index rallied by as much as 6.8% this week on the good news at home and in Europe, but gave up those gains over the past three days as negative data an sentiment seem to be winning out.

 In an historic retreat, according to the Wall Street Journal, investors world-wide during the three months through August pulled some $92 billion out of stock funds in the developed markets, more than reversing the total amount of money investors put into those funds since stocks bottomed in 2009. The withdrawals matched the worst three-month period during the depths of the financial crisis. Last week the Dow Jones Industrial Average suffered its worst one-week decline since October 2008. It is down 16% from its late-April peak.

Bond markets typically look much further than quarters. The bulk of bond buyers are not traders, but investors who are making commitments for years into the future. They carefully assess long-term risks such as inflation and credit quality in their due diligence. The US Treasury market has long been a safe haven for those fleeing the increased risks associated with stocks and has generally been a very good barometer of investor sentiment toward economic growth. Bond prices rise on increasing demand when investors think the economy (and inflation along with it) will slow.  

This time, however, the Federal Reserve in efforts to stimulate the economy and improve employment has dramatically impacted the behavior US Treasuries with its unprecedented purchases of the government’s debt. The first efforts QE1 and QE2 were focused on the short end - 0 to 5 years and the latest known as “operation twist” sells their short term bonds to buy bonds maturing between 6 and 30 years. The Fed’s balance sheet has expanded to the unprecedented level of $2.88 trillion.  

So if Treasuries don’t currently represent true investor sentiment on the economy, the next best thing is municipal bonds. Municipals are like Treasuries in that they are guaranteed by a state or municipality, not a corporation. If investors are worried about the economy, they by association worry more about corporations (stocks) than they do entities able to raise taxes to pay their debts.  

Despite problems at the city and state levels, investors are buying municipal bonds. According to Bloomberg, the $2.9 trillion municipal bond market is headed toward its sixth-straight month of positive total returns, the longest winning streak since 2002. Still, sales are well off of last year’s pace, so it may be difficult to draw much inference from the trend. This year’s municipal sales totaled $165 billion as of Sept. 23^rd, down about 40% from the period in 2010. The fact that Treasury yields are down so much (due in large part to Fed intervention) the tax-free yields of municipals are now all the more attractive by comparison. 

The week’s economic data was not very helpful for the optimistic case. New home sales remain at a nine-month low of a 295,000 annualized rate in August vs. 302,000 in July and 303,000 in June. New home prices dropped in August by 8.7% for both the median ($209,100) and the average ($246,000). On an annualized basis prices had been showing some slight growth, but new data show them down 7.7% at the median 8.5% on average.

The S&P Case-Shiller index is a broader index measuring all home prices across the nation. It showed prices holding steady for the third month through July, but summer is a traditionally strong period for housing demand. The index will likely be negatively impacted by the steep price contractions in new homes for August.  

Amidst declining stock and home prices as well as continued high unemployment, the consumer got some more bad news this week. Wages and salaries declined 0.2% in August after a 0.3% increase in July. Weakness was led by private services while the government component posted a modest rise.

Not surprisingly, consumer confidence is low and declining. According to the Conference Board, fifty percent of the sample say jobs are currently hard to get up 1.5% from August and compares with 44.8% in July and 43.2% in June. Same time, the Bloomberg Consumer Comfort Index dropped to its second-lowest level on record to minus 53 in the period ended Sept. 25^th from minus 52.1 the prior week. Ninety-three percent of those surveyed had a negative opinion of the economy as companies remain reluctant to hire and wages fail to keep pace with inflation according to Bloomberg. 

Worse, confidence in leadership is barreling downward. Global investor confidence in President Obama’s leadership now stands at 57% unfavorable, compared to 55% favorable last May. Perceptions of European leaders including German Chancellor Angela Merkel and French President Nicolas Sarkozy have also turned sharply negative. Scott Troxel, of the Tradition Group in Lausanne, Switzerland, summed it up well when he said “President Obama must get in front of the problems by taking real risk in achieving a bipartisan solution to long-term debt reduction, credible short-term job stimulus, and tax reform that is more clear and thoughtful than a tax on billionaires.” 

Bloomberg recently conducted a poll of 34 economists to determine their thoughts on the possible success of President Obama’s $447 billion jobs plan. On average they think it will help, but considerably less than Treasury Secretary Geithner and President Obama hope. Geithner estimates that the bill will increase GDP by 1.5%, and significantly lower the unemployment rate. According to the survey results, economists predict a median 0.6% growth in GDP next year, and 0.2% growth in 2013, should the bill pass. Median job creation predictions for the bill clock in at 275,000 next year, and 13,000 in 2013.  

A coalition led by Apple, Google, and Cisco Systems is lobbying for a tax holiday on more than $1 trillion in offshore profits. The one-time tax break is estimated to cost the US government $78.7 billion over the next decade, but proponents say the flood of cash has the potential to boost the faltering US economy. However, independent studies found that the last time the tax break was tried, in 2004, the repatriated offshore profits did little to spur hiring or domestic investment. Most of the money was used to buy back stock. Still, with some creative requirements, the idea might be worth a try. A trillion of fuel today for a cost of only $78 billion over 10 years sounds like a good investment to me. 

Barring a surprise from Europe, the next big thing happens on Capitol Hill when the president and Congress spar over the best ways to stimulate the faltering economy. Whether we wind up with the president’s bill, the House’s bill or the group of six’s stopgap bill, chances appear small that credible long-term remedies will result. With confidence low and uncertainty high, Mr. Obama and Congress could do infinitely more to boost this economy if they would turn their focus to reforming old, tired and bad habits, rather than continuing to waste billions or trillions of dollars in short term spending and tax breaks. Can a ‘problem’ fix itself?