Insight & Commentaries
There is concern that after a stimulus-induced recovery in GDP and corporate profits, the domestic economy is slipping into a sub-par growth rate that provides neither job creation nor further material gains in profitability. How can this be, given the fact that nearly $11 trillion in government commitments (guarantees, loans, and investments) have been put in place? Could it be that too much of the monetary and fiscal pump-priming was squandered?
Global equity markets have recovered about half their losses since 2007 amid signs of slowdown in layoffs and improvement in earnings, as forecast by most analysts. However, most ordinary people have a different assessment of the economic environment. So while we welcomed improvement in financial markets in 2009, we do not see the economy as out of the woods.
Deflation has long been a concern of central bankers. After a period of falling prices, markets are pricing in a return to inflation. Our observations on credit and the economy confirm this expectation. However, quarterly data from the Federal Reserve shows that U.S. private sector borrowing is contracting at a $2.3 trillion rate. This trend is a significant risk to the outlook that needs to be monitored.
We believe that S&P 500 earnings have reached a trough and that recovery in earnings, led by cost reductions, is real and underway. Our most likely scenario calls for earnings to return to $65 by 2011 from the $40-45 in trailing-12 month earnings that are likely to be posted by the S&P 500 companies this quarter. We are marking this quarter as the trough point in that data series. Tactical asset allocations have been returned to “neutral” positions in response to improvements in our various indicators on credit, the domestic economy, and trade.
Since our last commentary, we have seen signs of improvement in a variety of economic indicators. We still have concerns about what the quality of the recovery will ultimately be, but believe it is appropriate to add some exposure to equities and broaden out portfolios to include foreign assets and corporate bonds, given recent improvement in our indices.
The magnitude of losses in equity markets have driven equity markets deep into what technicians would call “oversold” territory. The S&P 500, which used to trade at 2.4 times revenue in March 2000 now trades at 0.75 times revenue. At this level, our equity market has arguably reached a valuation level more typical of what the Japanese stock market has seen over the past decade.
The new stimulus plan is designed to replace the loss of private sector spending as that sector attempts to reduce debt and increase savings in response to excess mortgage debt, falling asset prices, and the nearing of retirement for the largest segment of the population. It also puts the government in the role of “borrower and spender of last resort” to complement the actions taken by the Treasury and the Fed to stabilize the money supply. According to The Wall Street Journal, the plan amounts to $1.4 trillion of new taxes, $5 trillion in additional debt, and $1 trillion in…
In our last commentary, we pointed to the ongoing slide in net new credit creation by households (the largest component of the private sector in the United States) as a historic event that signaled a dramatic change in the country’s financial inner workings. This raises two important questions. First, can government spending spur a sustainable recovery in the absence of private sector borrowing and spending? Second, will the Federal Reserve and the U.S. government be able to stimulate risk-taking as households, corporations, and investors seek to reduce leverage? The answer to these two questions will largely determine what kind of…
A quick look at the remarkable decline in consumer demand for money and credit through the lens of the Federal Reserve’s Flow of Funds Data released today. The data shows the first decline in household net new borrowing on record. This suggests the monetary transmission mechanism behind the Fed’s stimulative monetary policy efforts is not functioning well given de-leveraging efforts.
Action steps for the current market environment, and a thoughtful discussion about how this downturn differs from a traditional recession. The anatomy of the downturn is examined along with thoughts about how a bull market might eventually take hold.
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