The major indices reversed course after starting the session lower when news broke that BB&T Corp. stated they have seen declines in past due loans regarding some portfolios. The positive headlines that ensued help to lift investor sentiment. (We’ll note that BB&T’s CEO Kelly King also mentioned they expect “continued increases in nonperformers in this difficult environment” and one can be sure we’ll see delinquencies and defaults rates rise in commercial real estate loans and credit card accounts.)
We’re closing in on the top-end of the five-month trading range of 666-935 on the S&P 500 and it will be a big test this week as we get something like 35% of S&P 500 members reporting first-quarter profit results. I’ve got a feeling we’ll have a tough time extending this weekly winning streak to seven as the industrial and tech sector profit reports will mirror the plunge in sales and business spending that occurred last quarter. The fact that the broad market has jumped 30%, even if it is off of what was clearly an oversold low, in just six weeks will make extending this streak tough enough on its own.
Financial and consumer discretionary shares led Friday’s advance. Telecoms and information technology shares were the only losers on the day. Telecoms have had a rough two weeks, falling 3.4% as the broad market is up 3.15%.
Market Activity for April 17, 2009
We’re without a major economic release until Wednesday so this gives us time to talk about some things on the policy front – namely the flawed economic models that will engender a harmful bout of inflation over the next year to 18 months, if government policy even allows the economy to bounce back. We’ll deal with this caveat tomorrow; for today the flawed models.
The Prevailing Economic Thought and Its Effect on the Business Cycle
Policy makers continue to insist that deflation poses the largest risk to the economy. This view is giving them (in their minds) the green light to engage in an economic philosophy that has proven to be quite harmful with regard to the duration of business cycle expansions, the level of employment, real wages and the economic distortions that result from intense government involvement.
And indeed, one doesn’t see the present current of economic thought changing anytime soon. Many economists, and importantly those who receive much attention from the press, continue to cling, however precariously, to their Keynesian/Phillips Curve/Output Gap models. That is, for economists within the Obama Administration and throughout academia, there is the overt belief that the federal government (via fiscal policy/government spending) and the Federal Reserve (via monetary policy) can continue to put the pedal to the floor without concern of sparking a nasty inflationary event. FOMC Vice Chairman Donald Kohn, New York Fed Bank President William Dudley and the White House’s chief economist Larry Summers were all out this weekend attempting to explain why high levels of inflation will not become a problem
Why are they so confident? Because there is a lot of excess capacity out there (plant and equipment and also within the labor markets – although not true for highly skilled labor) – ie. the “output gap.”
This way of thinking surmises that because excess capacity remains, right now at least, we can jack any level of money into the system and have little fear of inflation rearing its ugly head. However, this is a terribly flawed concept because it ignores that inflation is a monetary phenomenon, as a plethora of empirically evidence has shown. One would think this abundance of historical evidence over the past 30 years would have changed minds within the Keynesian camp – alas, they remain lost in the wilderness of their Phillips Curve/Output Gap textbooks. (And this was very obvious by way of Larry Summers’ appearance on Meet the Press yesterday morning. Mr. Summers is living in a fantasy world.
As they wander aimlessly (and we mustn’t forget that this type of economic thought is conducive to a big government agenda, which is why pedal-to-the-medal spending types love it) they forget that production has contracted substantially over the past seven months. In the meantime money supply growth and government debt-driven stimulus has (and will continue to) skyrocketed. This sets up for the classic situation of too much money chasing too few goods – the result of which is inflation, and based upon the level of money pumping activity that policy is exacting this inflationary event could be very large.
While no one can predict what will occur in the future, the chances of very high inflation rates, and thus the economically crushing monetary tightening that would eventually be applied to quash this event, are running high.
The main focus of this discussion is not a lesson in Keynesian economic thinking but to caution investors from becoming too excited after this significant move higher in stock prices; there will be additional economic challenges to address even when it initially appears we’re out of the proverbial woods. The way we are dealing the current situation is not favorable to sustained economic growth.
When the business cycle does turn up it will act as the spark to this inflationary event and the monetary tightening that will ensue, although it will be delayed as the Fed is not currently independent of the political class (as they should be) and will be pressured not to act on this inflation right away for fear of shutting down what may be a nascent housing rebound, will act as another economic problem that will very likely keep stocks in a trading range. That tightening process will cause the economy to contract again – I’m not smart enough (or dumb enough) to attempt to predict the timing --, and maybe profoundly, and thus investors should not be taken to move further out along the risk curve in an attempt to quickly make back the losses of the past seven months, in particular. It’s a natural human reaction to try and do so.
The caveat to this inflationary event occurring is that government screws up so royally that the economy does not rebound in a meaningful way. When Washington gets increasingly involved with regard to the allocation of resources this does cause the private sector to hold back. We can talk to this topic tomorrow, specifically what the administration wants to do regarding interest-rate ceilings on credit cards and regulations within the energy sector that has power plant companies holding off on building new plants until they see what Congress does in this regard. My view is the economy will rebound and that inflation event will occur, but this is the caveat… more on that tomorrow.
Have a great day!
Brent Vondera, Senior Analyst
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