Ben Bernanke told us last week that all systems are ‘go’ and that a pick-up in economic activity is in the air. Things may be slow on the employment front but we are not to worry and fret: the Fed has things under control and we can look forward with confidence. I hope that he is right because the numbers which are coming out – seemingly all over the globe – do not appear to justify his optimism. Indeed, the numbers which are coming out verify my long term forecast that the US economy cannot expand because of its unfortunate financial condition, like that of Japan after 1996, which does not allow for GDP growth to occur. The Fed has tried and tried and tried to stimulate new growth but what it has mainly achieved is a ton of speculation in commodities and stock prices. Dollar for dollar, it has only managed to achieve a tepid rebound back to its baseline GDP. The ratio of dollars pumped in relative to GDP output must be approaching infinity, unfortunately just as I had predicted way back in early 2009. The US solvency condition continues to erode the sandy base on which the American economy rests, and is eating away at the global ‘recovery’ as well.
It is, of course, not hard to understand why Ben would say the things that he does. He believes that economic resurgence depends on “confidence”, this elusive ‘feeling’ that he believes makes people go out and spend. Therefore, as Chairman of the Fed, it is important to instill this “confidence” among consumers: it’s a lot like the “élan” that the French leadership thought was important in World War I – if you’ve got, you will fight better, they thought. Never mind your inferior weaponry and tactics. We at SAC do not agree with this thinking. Consumers go into economic battle with their balance sheets, and when they don’t have a balance sheet that they can fight with, they stay at home. It is not surprising, therefore, that the US consumer is indeed staying home: not only is his balance sheet not strong and well-honed, it is still disappearing under his very feet as US housing prices continue their inexorable slide.
In Gary Shilling’s mid-year outlook, he noted that there are 5 major influences affecting the outlook going forward from here, all of which are working to slow things down, and even bring us to a (modest?) recession in theUS in 2012. Besides the housing issue (which has the further side effect of raising the savings rate and thereby slowing things even further), he observes that the same commodity prices that have givenCanada such a boost are flaying the American consumer alive. Gasoline costs alone are impacting travel and even going out for an evening.Canada is doing well, but the market where we sell well over 80% of our exports is limping. Associated with housing, US state and local governments are suffering horribly under the weight of declining tax revenues and rising pension and medical costs. Third, hyper-low interest rates are killing those who are retired and need income and forcing them to unsustainably dip into capital, and thereby retrenching their own spending plans. Bankruptcies remain on the upswing, both personal and business, not a happy and confident environment. None of this is “new” but all of it is slowly and steadily cumulatively working against whatever ‘good’ all of the Fed’s attempts at easing have produced.
Fourth, Shilling also sees that globally, the solvency problems in Europe, the PIGS, are becoming a potential drag. And finally, in the Far East, China has elected to try to ease its own inflationary challenges by slowing credit growth and hence its internal economic growth. He expects a ‘hard landing’ in the Chinese economy as a result. Adding injury to insult, the Japanese tsunami has crippled that country’s economic outlook and hence the world’s third largest economy is not contributing to recovery either. Not the greatest of timing for an Asian setback, he suggested.
And yet, Bernanke tells us that things are looking up and American consumers and businesses should be borrowing and spending. Actually, Americans are showing strong growth in spending in one area – ‘used merchandise sales’, a sign of the times, but not a sign of strength.
Since the market and economic “lows” in late 2008-early 20098, what we have seen so far is a rebound from an extreme condition, a rebound brought to us by easy money and low interest rates. It would be nice to think that things still work the way that they used to when the Fed could just ease the money supply and lower interest rates and growth would rebound and the economy head to new highs. But that is not the case any more: lousy balance sheets are in the way now and they have not even begun to be healed. We have seen a great market rally based on historical precedent, but somewhere along the line, real growth must begin. Right now that cannot happen.
The Fed has a couple of options. First, it can pursue more Quantitative Easing and at least keep some prices rising, if only stocks and commodities. Or it can do as it seems to be doing: halt the easing and see what happens. Given the massive Federal deficits and the political urgency to be seen to be getting things under control, Congress is a tough sell on the easing side of the ledger. However, I wonder how those same Republicans will be in 9 months from now if it looks as if a so-called ‘double dip recession” is underway as they had for re-election.
The market is not particularly cheap any more. The S&P 500 is currently trading at 14.6 times earnings, a 2% yield and a little short of 2 times book value. The NDX100 is trading at 16.4 times, a 1% yield, and has recently fallen just a bit below 4 times book. The TSX is no bargain either, trading at 18.5 times earnings, a 2.6% yield and 1.7 times book. In other words, a lot of the “improving outlook for 2012” is now ‘in the market’: an improving outlook had better transpire or there will be some largish downside risks in store. On an optimistic note, the Dow Transports remain above 2.5 times book, a stunning valuation for this group which I have not seen in the past 40 years.
In summary, in looking at the broad market averages, I see plenty of reason to be concerned, but – as yet – no solid reason to bail out.