Monday, August 24, 2009

Billy Bernanke

Saint Bill of the grotto of the greenback has been beatified last week. That he performed the canonization on his own in Jackson Hole, Wyoming surrounded by some of the greatest scenery ever created gave it a certain holy gravitas. Herewith, the words of the rites.

“Our forecast is for moderate but positive growth going into next year. We think that by the spring, early next year, that as these credit problems resolve and, as we hope, the housing market begins to find a bottom, that the broader resiliency of the economy, which we are seeing in other areas outside of housing, will take control and will help the economy recover to a more reasonable growth pace.”

Ben Bernanke, Federal Reserve Chairman

The market cheered, the holders of short positions cringed, and the sun shone a little brighter. Wait, there must be a mistake. The keeper of the trillions said those words in 2007. Hmmm.....could it be he is plagiarizing himself. Considering those 2007 sentiments have to be among the least prescient ever uttered by a Fed Chairman maybe we should defer our accolades just a little longer.

I hope like everyone that he is right this time. But maybe first a prayer to Saint Anthony of Padua, the patron saint of lost items, soon to be declared patron saint of 401k's.

The consensus of economists now expect no recession next year. Unfortunately, the consensus has never accurately predicted a recession. So much for that comfort.

Given all the euphoria of last week, I have a feeling the animal spirits are nearing a neutering. It is always dangerous to reach a conclusion in the waning days of summer when junior traders practice and seasoned investors are on Martha's Vineyard or in the Hamptons, but things feel "toppy" and fundamentals no longer support broad valuations as they did in March.

John Barnyak

Watch This!

Any testosterone enhanced male knows that, "watch this!" are often the last words spoken before a trip to the emergency room. Last week central bankers across the globe were declaring the recession in retreat with the chest thumping certainty reminiscent of the last time I ever stood on a diving board. (yes it ended badly).

Level of consumer spending that gave us giddy investment returns is not likely to return anytime soon, if in our lifetimes. So we should expect sub par growth as personal balance sheets are repaired over the coming years.

The talking head debate now is about the shape of the recovery. "W"? "V"? or my favorite recent description "square root symbol", which is a quick rebound and then a long period of flat activity. One could argue that we are already in the long flat period as the market has gone nowhere (if a rollercoaster can be said to go nowhere) for ten years. Throwing up your hands and squealing with delight and just plain throwing up notwithstanding.

Historically, secular markets, those acting on major underlying economics last a generation. I would argue we are about half way through the current secular bear market and another decade of stumbling is very likely. Japan's Nikkei average last saw its historical high in 1990 at which point wild exuberance and real estate speculation brought market fun to an end. At the time Japan's broad market average was nearing 40,000. Today it is flirting with 10,000 after twenty years. Closer to home, from 1964 to 1981, the Dow Industrials rose an eye popping one point. Seventeen years with no return, excluding dividend yield.

Relative valuations matter. Alternative returns in other assets matter. We live in a different world of volatility encouraged by crazed derivative activity but the long term reality is the same. We remain in a time when giving up opportunity will have less negative impact than giving up capital.

This is an extraordinarily warped market as government intervention plays the tune. The fundamentals come out of Washington now, and as Keynes once said, "the market can remain irrational, longer than I can remain solvent."

John Barnyak

Eeek! Economics!

The biggest impediment to being right for an economist is the lack of fixation on time. Gary Shilling, Noriel Roubini and Nasem Taleb are all prescient economists who predicted the current deflation.....for years. In other words they were wrong until they were right. That is one of the advantages of being an academic. One can work in relative obscurity apart from occasional snickers during presentations of papers for years until reality turns to agree. Then you are a rock star....until you're not.

My economic based view has been tested the past several months. While being quite confident that March represented a buying opportunity, I have been much less assured since mid year while the market keeps moving higher. While the massive asset price lifting power of billions of public dollars has been demonstrated clearly the hangover that policy will produce has been largely ignored.

What has not changed is the massively important credit and debt aspects of the global economy and the U.S. economy specifically. The US debt to GDP ratio continues to rise with the public debt portion taking over an additional and substantial portion of total debt. Until debt declines we
are simply adding gasoline to the fire and eventually we will burn.

Those who see green shoots assume a typical "V" shaped recovery from a production/consumption recession. This is a credit and debt induced collapse and adding additional debt will not solve the problem. The public injection of capital allowing the banking system to continue to not recognize its insolvency and allow a market clearing event to take place rests on a misguided combination of fear and hope.

Schumpeter's creative destruction has been thwarted allowing zombie institutions to ultimately keep private investment to in check while ironically encouraging, once again, riskier speculation with the knowledge that public money would be made available to bail out failure.

If there is any rationale to the current public policy it is to buy time, keep the population placated and HOPE that a demographic tailwind rights the boat.

The US economy has been +70% driven by consumer spending and negative savings rates over the past 20 years. The is reasonable behaviour that will rekindle that irrationality in the near future.

The baby boom generation has seen its retirement savings decimated. Credit is no longer easily available. Unemployment appears to be structurally elevated for the foreseeable future.

Let's look at the green shoots. Housing. The good news is that there is some activity in housing. The vast majority of that activity is in foreclosure sales. That is in and of itself positive. It clears inventory, and inventory remains very high. Like the Cash for Clunkers program the government tax credit program may pull demand forward into 2009 from 2010.
This is another example of a buying time policy. Which in a normal recession would work well as spending returned. The housing stats reported last week are strong only if listening to spinmeisters. A suspicious increase in Northeast Condo sales was the only data that turned the numbers positive. Single family homes were still weaker.

The growth this past quarter seem largely limited to inventory rebuilding and cost cutting. Again, both positives for economic recovery, but with unemployment high and credit limited is it sustainable? Retail analysts continue to see very low store traffic and increasing pressure on rents by storeowners to landlords. Conversely real estate owners, i.e. landlords are facing severe financing problems of their own. Commercial real estate loans are the 1000 pound gorilla unless we begin to see a re-emergent consumer.