Market Update: It's the 80's again

This morning we got another round of economic data whose best comparison resides in the early 1980’s. GDP (which measures the value of all goods and services produced inside our borders) declined at a 6.20% annualized pace on a Quarter over Quarter basis. The Bloomberg Survey estimate for GDP was a decline of 5.4% so the actual number was a fair bit worse than expected.

I’m aware that at this point some people are becoming afraid to open these market updates because of all the bad news, and I can’t blame you for that. It seems as if the only way to avoid the bad news lately is to turn off my computer and cell phone.

Today’s good news is that it’s Friday. Many of us will have two days away from the office that we can use to recuperate. I was just telling the guys here in the office that to get a break from the stress I might go fishing over in Arkansas…just drive up into the mountains, find a trout stream…throw my laptop and cell phone into it…and then go somewhere else to fish.

It shouldn’t be a huge surprise that consumer spending would slow down when you have over 600,000 people a week losing their jobs…and slow down it did. This is another bit of news whose most comparable print occurred in the early 1980’s. I actually hesitate to call this “bad” news. It certainly is bad from a GDP standpoint, but from a big picture perspective people that are spending more than they make NEED to slow down. They NEED to quit borrowing and living paycheck to paycheck. They NEED to pay down debt and fix their balance sheets. While this number is expected and is widely called “bad news” it’s actually something that if left alone will fix itself.

The chart below shows the long term trend in the Personal Savings Rate (1959 to year end 2008) along with the 6 month, 5 year, and 10 year moving averages. If you go back to the early 1980’s you’ll see that the Personal Savings Rate at the time was running around 10%. When hard times and recessions came people had savings that they could fall back on to make it through the storm.

Fast forward to 2008…the Personal Savings rate is almost zero. There are a myriad of causes for this, most of which are beyond the scope of this write-up. The important part is the exposure. It doesn’t matter why you’re not saving money, what matters is your exposure to unexpected events due to your lack of savings. The guy in 1980 might have been able to live off his savings for 6 months or so until he was able to find gainful employment. Nowadays people have been relying on credit cards and home equity lines for NORMAL purchases as well as for emergencies. When the recession hits they get in trouble very quickly because they have no savings and they can’t access their “normal” liquidity sources because credit card companies are raising rates and cutting lines, and they can’t get any more money out of their house because it’s value has fallen and their home equity line has been frozen. This has become a harsh reality for a lot of people. Relying on other peoples savings for emergencies is not a solid plan.

The graph below points out that people aren’t stupid all of the time. As the drumbeat of bad news turned into an avalanche of bad news toward the end of 2008 the trend of spending everything you make changed very quickly to one of hurry up and save. In a period of just a few months we went from saving virtually zero percent on average to saving almost 4.00%. The Personal Savings Rate popped up quickly to get above the 6 month, 5 year, and 10 year trailing averages. What this tells me is that people are smart enough to change their habits…it might take a depression to do it but change they will.

So in closing here is the good news. The stream in the picture below is out there…you have two days to find it…and it’s loaded with trout. If you find my cell phone or laptop while you’re there I’d appreciate them back.

Market Update: 2 23 09 _ Consumers aren't confident

Is there any good news?

A friend of mine called this morning and wanted some good news. I didn’t have any handy so I told him I’d have to get back to him. As I drove to work I thought about the issue the whole way…I really gave it some thought and it was difficult to find anything in the realm of business that I could spin as good news. As our economy shifts from a capitalistic structure where men and women used to accept risk in pursuit of reward to one where people get rewarded no matter how the risk pans out we’ve got some real problems. The government is now subsidizing bad behavior and punishing good behavior on a grand scale. Have no fear if you spent more than you earned…we’ll just tax those that saved more than they spent and it’ll all work out OK on average. From a monetary standpoint we’ll make everyone equal...they won’t all be happy but they’ll be equal. If I went home tonight and gave my daughter her allowance money even though she had messed up her room and forgot to set the table, and I took the money out of my sons piggy bank to do it, my wife would think I had started smoking crack. It makes no sense but it appears that many politicians are determined to do just this. So where is the good news that my friend was looking for?

Wisdom from the mouths of babes

My 9 year old son has been begging me to buy him a iPod Touch. For those that are unfamiliar with this gear it is essentially an iPhone without the phone feature. It gives you all of the multi-media functions…pictures, movies, music, web surfing etc. It costs in the neighborhood of $250. I imagine that all of the toys I owned when I was 9 years old wouldn’t add up to $250 combined so there’s not a lot of hope for the kid that I’m just going to drop that kind of coin on a toy. I dismissed the idea on the spot and I moved on…he didn’t.

Last night my little capitalist goes to his momma with a plan. He has a written proposal where he has outlined jobs that he can do to earn money, things he can quit doing to save money, and he has a timeline for making the purchase on his own with his current savings plus the capital he thinks he can raise under his plan. I couldn’t be any prouder of the kid. At NO TIME did he suggest that we tax Jim and Fay our next door neighbors to raise the money necessary to buy him an iPod. If a second grader can get this concept I don’t understand how so many people in America can miss it. The concept is simple…he can’t get what he wants by doing nothing so he comes up with a plan to WORK for it. He’s going to invest his time, his effort, and his emotions in this project…putting those items at risk in the pursuit of the reward that he wants. So that’s the good news…American kids still “get it”. The American Dream isn’t dead, it’s just that many of those that are supposed to be protecting it aren’t doing their jobs.

So with the good news out of the way…let’s look at the rest of the news from today.

Testify

First let’s look at some of Bernanke’s testimony from this morning. Those of you that have been getting my market updates for the last year will get very few surprises from today’s testimony. Last year I began writing that the government is fighting to avoid a Depression and I wrote a fair amount on Bernankes views on the subject. In Bernanke’s view, confidence in the financial system and maintaining access to credit for consumers and small businesses are paramount to recovery. Bernanke’s writings on the great depression state that the lack of these two factors caused what would have been the recession of 1933 to become the Great Depression. He is adamant that those two factors must be addressed and we are seeing strong action by the government to those ends. Large financial institutions are being given all of the help that they need to stay solvent. The government will not tolerate a crisis of confidence in these institutions. Despite the near hysteria in the media regarding nationalization of the banking system there is no talk from the current administration or from the Fed that this is in their plans. Nor is there any reason to believe that if they DID nationalize a bank that they would allow that bank to default on a bond. Allowing a bank to default on a debt obligation would cause a tidal wave of problems that run counter to everything that the government is trying to accomplish. As recently as this week Alan Greenspan was saying that even if some banks were nationalized that the government would have to protect the senior debt holders.

Based on everything that the government has said and done to date it is difficult to envision a scenario where a bond holder of one of these big financials in the TARP program takes a hit.

How Confident are you?

Consumer Confidence posted an all time low reading this morning. This data series began in 1967. It has seen all of the highs and lows that this country has been through since that date and today’s report shows that consumers are the least confident they have been since this series started in the late 60’s. I highlighted a few of the low points from this series since 1967 and I pulled a few random facts from the headlines of each period to give you a feel for what accompanied each low point.

The Richmond Fed index was released today. This is the latest in a long string of abysmal manufacturing data. Like the Empire manufacturing report and the Philly Fed index that were released earlier this month, this is a diffusion index which means any positive number indicates expansion in manufacturing activity and a negative number indicates contraction. The survey expected a bad number…a really bad number…and the Richmond Fed index delivered. The expectation was for a -49 and the actual release was a -51. You can see that this release was easily the worst since Bloomberg began reporting it.

The Case Schiller Home price index continues to decline on a Year-over-Year basis. There really isn’t much to say here…housing was a bubble and it’s correcting. Where she stops nobody knows.

There is still a lot of big news to come this week. Tomorrow we see Home Sales, followed on Thursday by Initial and Continuing Jobless Claims as well as Durable Goods. If you have any questions on this material please let me know.

Market Update: Jobless _ 2 5 09

Treasury yields are falling this morning as the market rallies on very poor Initial Jobless Claims data. Overall they are still higher than they were a month ago. It’s strange times when I can report that the short end of the curve is up significantly but that it still remains at an insignificant level. The 3-month bill was trading to yield 0.08% a month ago…it’s up 233% to offer 0.29% this morning. Not a tremendous amount of yield but certainly better than the negative yields at which it traded in late 2008.

Initial Jobless Claims were released this morning and they were far worse than even the very pessimistic Bloomberg Survey expected them to be. A quick note is in order on Initial Jobless Claims…this is a WEEKLY figure that tracks the number of NEW filings for jobless benefits. The Bloomberg Survey expected that 580,000 people would file for initial jobless benefits last week…in actuality 626,000 people walked in and filed. 626,000 people in a week. According to Bloomberg that is a 26 year high.

In the prior release the survey also fell short of reality as they expected 588,000 initial claims and we actually got 591,000. Since jobless claims surprised on the high side of an already terrible expectation in the prior week, it looks as though the survey thought things couldn’t get worse because they lowered their expectation for this week’s number. After being beaten on the high side the survey dropped the expectation from 588k to 580k…and then the market delivered this week’s 626k…beating the estimate by a much larger amount than it did on the prior release.

Here is a number that surprised everyone in this office…last MONTH 2.8 people filed for initial jobless benefits. That’s a lot of people on the street and there doesn’t appear to be a quick end to this process.

Below are two graphs to put the initial claims numbers in perspective. The first is a medium term graph showing the last 9 years of jobless claims. The second captures initial claims data stretching back to 1967.

A longer term look at Initial Claims shows that we are at 1980’s type levels of claims.

The graph of consumer credit below is a lagged series…the data is two months old when released. This index covers most short-term and intermediate-term credit extended to individual, excluding loans secured by real estate. The graph below shows how much the consumer began tightening up toward the end of 2008. The last data point on the graph below is from 11/30/08 and it’s among the largest drops in the history of the series. This isn’t entirely unexpected. As consumers begin realizing that times are going to get tougher, they save more, spend less, and clean up their balance sheet. This is a good news/bad news proposition for the economy. Americans with stronger balance sheets is a very good thing, but the process of getting to that point will involve a lot of friction. By definition the more the consumer saves the less he spends, and the consumer is 2/3’s of GDP. You don’t need as many people selling cars and TV’s if the consumer quits spending, so the economy sheds job.

Taking a look at the big picture we can use the Federal Reserve’s Total Consumer Credit Outstanding index that I’ve attached below. This index is also lagged by two months so the numbers do not reflect anything that has happened since 11/30/08. Total Consumer Credit Outstanding also shows signs of reduction. Some of this will happen as consumers clean up their balance sheet and some will happen as consumers go bankrupt.

The governments current plan is to get spending going again and to gets banks lending. They would love to see the line below keep moving up. But that begs the question…where does it stop? Eventually we’re going to have to pay back the trillions of dollars that are being spent to revive the economy. If the consumer is so saddled with personal debt when the payback period on the government debt begins, where will it leave us? How can the economy be expected to grow in the future if it’s burdened by tremendous amounts of debt and the higher taxes needed to pay it off?

The graph below shows that total consumer credit outstanding as of 11/30/08 was $2.57 Trillion. Even if you just do the minimum monthly payment the consumer is having to come up with a decent amount of cash every month to service that debt. Now throw on top of that consumer debt figure the additional debt that will be issued to fund the government spending over the next few years and you’ve got a very large obligation to deal with. Taxes will have to go up to fund the government spending, which will reduce after tax cash flow with which the consumer can pay back his personal debt or invest in prospects that would spur economic growth.

As it stands now the government wants to issue a few trillion dollars in debt, create a bunch of government jobs, and force the banks to make loans that will push total consumer credit higher at the same time. Conceptually I wonder what our prospects for growth will look like at the end of all of this. It would seem reasonable that once we get this apple-cart stabilized there will be so much debt to pay off that there won’t be much money left over to fund future economic growth. Could we be looking at years of GDP growth in the 0 to 1% range? As ugly as the current situation is, some of the answers under consideration look even worse.

If you have any questions on this material or if there is anything I can be doing for you just let me know.

Market update: Stimulus and bank closings_2 3 09

Recent activity

The headlines recently have largely ignored the economic data and bank closings and focused instead on the stimulus bill. The economic data continue to grind out disappointing numbers, although GDP was less negative than the survey expected, and there are a few encouraging signs amid the carnage. The stimulus bill is rightly taking center stage at the moment. There is a tremendous amount of taxpayer money being requested which on its own will force taxes to rise in the future and will serve as a drag on future growth. As this process moves further into the political arena it necessarily moves further away from the economic arena. I will attempt to keep all of my comments and analysis in the economic arena as:

A – I know how that world works, and;

B – my language will be better

One of the biggest concerns about the package is that there will be a lot of wasted expenditures. Depending on one’s view of the severity of our current economic problems you might view all of these expenditures as wasteful but that’s an argument for another day. Wasted expenditures are those that don’t address the problems at hand and will unnecessarily burden the taxpayer and the economy for years to come. At this point, those of us that actually pay taxes (and I’m confident that everyone on this distribution list falls into that category) are more concerned about the long term tax effects of the stimulus bill than those that are writing it…this makes perfect sense as it’s getting tough to find anyone in Washington that actually PAYS their taxes.

They took my job but left my bills

I’ve attached a graph below showing the long term trend in Personal Savings as a percentage of Disposable Income. In laymans terms this simply shows how much Americans save. The trend is pretty clear, since the late 1970’s Americans have been willing to operate with less of a cushion in terms of savings. As access to new and widespread forms of liquidity became available, from credit cards to home equity lines people spent more and saved less. This trend continued until very recently. This index actually went negative in August of 2005, an event we hadn’t seen since the Great Depression. The difference though is that during the Great Depression Americans depleted savings to survive the tough economic times…in August of 2005 Americans did it to buy stuff…generally stuff that depreciates in value.

So where are we now? Now we see this savings rates rising in a hurry. People are scared, and cash is king when people get scared. I think it’s a safe bet to say that at this point everyone in America knows of someone that has lost their job (or taken a pay cut to keep a job). You can’t go anywhere and not hear about someone getting laid off or fired. This conversation doesn’t go un-noticed by those that still have a job. They begin saving in case they lose their own job. It’s an unfortunate fact that when you lose your job you don’t lose your bills with it. You keep those you just have no way to pay them (especially if your savings rate has been close to zero). So people save. They build a cash cushion on which they can survive if the unthinkable happens. This is exactly how things should work…finally we are acting in a rational manner…it just took a trip close to a depression to make it happen.

The short term pain from this improvement in American savings is that consumers won’t be spending. Consumer spending accounts for roughly 2/3’s of GDP and if Americans are saving rather than spending then GDP can’t improve. The government at this point will increase it’s own spending to make up for the lack of consumer spending. This will clearly increase spending but the ironic part of this is that it will ultimately increase taxes which will depress consumer expenditures at some point in the future. This proves the old adage that there is no free lunch…but you CAN finance the lunch and pay for it a little at a time...with the minimum monthly payment.

In addition to traditional government spending programs the government is also pulling a lot of strings and re-writing a lot of rules to entice the consumer back into the game. They are making a Hurculean effort to reverse the savings trend. Despite the fact that saving is good, the government wants Americans to quit saving and start spending to get the economy out of the ditch. This is why you see such a hard push to get the refinance activity going. If every good borrower in the country get’s to refi to a 30 year 4.00% mortgage it will provide a lot of extra cash in the consumers pocket. This is cash the government expects will be spent, but at the moment it appears that the average American may be more inclined to save it.

Closing time, you don’t have to go home but you can’t stay here.

After a short break from closing banks, the FDIC got back to business this weekend by closing 3 institutions around the country.

Failed Banks:

Three financial institutions were closed over the weekend. Ocala National Bank in Ocala Florida ($235 million), MagnetBank in Salt Lake City ($300 million), and Suburban Federal Savings Bank in Crofton Maryland ($354 million). The reported asset sizes are as of 3Q 2008.

The most recent quote I’ve seen puts the FDIC’s troubled bank list around 170 banks. My contacts throughout the banking/regulatory/investment world seem to think the 170 number is far too low, and if I use history as a guide I tend to agree with them. To provide a bit of perspective consider the following quotes from the FDIC’s Sheila Bair:

- In 1989 at the peak of the S&L crisis the regulators had closed roughly 534 institutions

- In 1990 there were 1,500 banks on the FDIC’s Troubled Bank List

Given the complexity and scope of the problems we face today I would not be surprised to see the FDIC Troubled Bank list grow substantially from its current level of 170.

Will Mortgage refinance activity pick up?

There have been a LOT of different ideas considered in order to find a way to start the refi machine. I’ve written about many of them as they come up in the news. One of the most recent ideas is likely to hit the Senate floor during the debate over the stimulus bill this week:

Government insured and subsidized 30 year 4.00% mortgages. This plan would push banks to make these loans to qualified borrowers. Preliminary talk is that there would be some period of years on the front end of the mortgage during which performance is guaranteed by the government. Since mortgage rates are currently much higher than 4.00% the government will pay the difference…I say again…the government will pay the difference between the market rate and the 4.00% level. That is one option being considered. This is a great example of what we mean when we say don’t bet against the government…if they want it badly enough they will get it. Currently they want a refi wave and they have taken no options off the table. It is quite a plan to use taxpayer money to get homeowners an artificially low rate on their home…if they view this plan as workable I can’t rule anything out.

I’ve provided a link to the story where this was reported.

http://money.cnn.com/2009/02/01/news/economy/Senate_stimulus_housing/index.htm

If you have any questions on this material or if there is anything I can be doing for you just let me know.