Concerns that the global economy will continue to deteriorate, fatigue and complete uncertainty regarding incessant government action, talk of bank nationalization and another investment scam (returns are so much easier to come by if you just make them up) have put capital on strike.
Financials led the beat-down, tumbling 9.80%. Energy and utilities weren’t far behind, down 6.31% and 4.90%, respectively. You think utility stocks are safe? (After all, the group is a traditional area of safety.) You better make sure the one’s you own are good credits and haven’t over-extended the dividend – dividend cuts have smacked the group over the past week.
The lack of clarity makes it impossible to value anything for the near term – as we’ve touched on for some time, you can forget about fundamentals for now, it’s all about the government; the investor is held hostage by the whims of Washington. For the longer-term, looking out at least five years, we’re looking at a buying opportunity that comes along once every 35 years. Problem is you’ll need lots of patience and risk aversion is probably as high as it gets, and understandably so, likely delaying a sustained rebound.
Market Activity for February 17, 2009
Back to the Till
General Motors and Chrysler have come back for another $22 billion (little more than $16 billion for GM and nearly $5 billion for Chrysler). The goods news is GM is shedding programs and bloat that have sapped any inkling of efficiency. The bad news is now that they are on the government dole the high and mighty in Congress will direct what they automakers will produce – forget what the market demands, these central planners clearly know better.
Crude-Oil
Oil moved below $35 per barrel as the commodity is trading on GDP right now – that is, people are focused on very weak economic activity rather than supply/demand fundamentals. It’s not that supply is tight, U.S. crude supplies sit 15% above the five-year average, but I’m not sure this justifies $35 per barrel. (That said, these supply figures are probably not terribly accurate either. There is a lot of crude just floating around in tankers as the contango situation – prices for delivery in future months are higher than for earlier contracts, thus allowing buyers to profit from hoarding oil – is in place.) Still, the point is crude will probably not turn until we see some bottoming in GDP. While the lower GDP figures weigh on demand expectations, to this point world oil demand is just 3% off the peak hit in November 2007. During the 2001 downturn, for instance, demand fell 6% from the peak.
Looking out several months, we shouldn’t forget about a $600 billion stimulus package coming out of China (and our own $800 billion spending spree – even if much is entitlement programs and staggered three years out), which will boost energy demand. Government spending on parade along with the massive liquidity injections via the Fed that have not yet run through the economy should drive inflation rates to unwelcome levels.
One big disappointment is that we continue to allow enraged environmentalists (people who are completely unwilling to compare air quality today to say the 1940s) to block energy production via lawsuits and permit schemes. Oh, and by the way, CO2 levels follow warming trends, not the other way around; warming results from solar activity. Increased CO2 levels result from warming oceans; the solubility of CO2 falls when oceans warm and thus emit more of it.
If we can get our senses, we can take down two birds with one stone by putting in place a policy to drive energy production – this would help to create the supply that will be needed to absorb the money that will explode through the system 6-12 months out – tamping inflation -- and create high-paying technical jobs at the same time. While we watch oil tank for now, I’ve got a feeling we’ll wish we had begun to put such a plan in place when we look back a year from now.
On the Economic Front
The New York Federal Reserve Bank’s survey of the area’s factory activity (known as the Empire Manufacturing Index) fell to -34.7 in February (lowest level since records began in 2001) from -22.2 for January. In ISM terms (as longer-term readers know ISM is the nationwide factory activity index), Empire improved a bit to 40.2 from 40.0 – still quite depressed but not the substantial deterioration headline Empire printed. The headline reading on Empire is based on sentiment, not the weighted average of new orders, shipments, delivery times, inventories and employment like ISM.
While the new orders and employment sub-indices of the report declined, inventories, shipments and delivery times improved.
The decisive point is that New York-area manufacturing activity remains very weak, surely due to weak housing-related production as the area is hit hard by the financial sector woes, to put it mildly. But when we properly weight the major components activity was not as bad as the headline figure showed.
The question, since the weighted reading was boosted by a meaningful improvement in the inventory index is whether or not this is a fake out or manufacturers are actually feeling much better about inventory levels. If so, we could begin to see sustained factory activity improvements a couple of months out. We’ll get the Philly Fed index later in the week, and since this a better indication of what is occurring on the national level it will help to provide evidence as to whether we’ve seen bottom in factory activity or not.
In a separate report, the Treasury Department showed international demand for longer-term U.S. financial assets rose in December (quite a lag to this data) by more than expected. Total net purchases of stocks and bonds rose $34.8 billion in the final month of the year after posting one of the rare declines in November – net selling of U.S. assets was $25.6 billion that month.
Demand for corporate debt drove the increase as spreads widened, making these securities more attractive after five-straight months of decline. Demand for U.S. stocks was upbeat, rising $3.9 billion.
Net purchases of U.S. longer-term assets have risen $520 billion over the past 12 months. Some say the difference between the trade deficit and this measure of foreign investment inflows is what determines the value of the dollar. That is, if the trade deficit is larger than the investment inflow, the dollar will fall in value, and vice-versa.
But this hasn’t proven to be the case, as we’ve talked about within this letter for a few years now. While the dollar was declining 2003-2007, the inflow of investment to U.S. assets was outpacing the level of trade deficit, yet now that the trade deficit has outpaced the investment inflows, the dollar has strengthened. This is the opposite of what the so-called pundits state should occur.
The fact is there are a number of variables that go into currency fluctuations – for now the dollar is benefiting from the safety trade as global investors rush into the Treasury market. Overall though, there are two simple things to remember for those that desire a strong currency, which should be a goal: One is sound monetary policy; the other is low tax rates, especially on capital. An economy that remembers these two things will have both a strong currency and rising levels of prosperity.
Signed
The stimulus bill was signed yesterday. Too bad -- and I say this in jest because personally I would rather they had scrapped it for something that incentivizes the private-sector -- the spending doesn’t occur as quickly as the boondoggle was passed. More than $200 billion will be spent after 2010 (so much for what Keynes called “priming the pump”), $584 this year and next.
And speaking of the impact on growth, one thing we did not touch on yesterday was what is termed as the “crowding out” effect. Normally, I don’t give much credence to this argument, but at the level of budget deficits we’re now sowing there may be something to say about this thought. One would think bond yields to eventually rise as the Treasury market is flooded with supply, and as this occurs it will have an effect on mortgage rates, corporate borrowing costs and of course dampen any nascent housing rebound just as it may begin to materialize.
I have to say, instead of stimulating, this legislation just may actually depress economic activity. I use the word “may” out of kindness. I do not believe it is a likelihood, but rather a certainty that any actual stimulant that is in the plan will be completely offset by this effect, at which point we are left with only the debt. It may not be long before the Hope Express runs out of track.
Have a great day!
Brent Vondera, Senior Analyst
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