May 12, 2013

Dow Jones: Stratosphere…or Troposphere?

by Hal Gershowitz

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Or more succinctly, are we headed for the stars or back to earth?  Frankly, we don’t know (and neither does anyone else).  But as we look at the data, certain realities emerge.  Most indicators are pretty positive, some robustly so, and some barely so.  And some realities just seem to be there to spoil the fun.  But let’s drop in on the party and see why, at the moment, it rocks.

One very robust indicator has been the impressive jump in American automobile sales.  Last month Detroit racked up sales of nearly 2.0 million cars and pickup trucks.  That’s a whopping 8.5% increase over sales in the same month last year.  That’s very impressive and a strong sign that the American auto industry is back and back for keeps.   Chrysler’s Ram pickups jumped nearly 50% and Ford’s F-Series trucks spiked by 24%.  GM enjoyed a consolidated 11% increase in sales, as did Chrysler while Ford’s overall sales jumped 18%.  As the above increases indicate, truck sales led the way, which is a pretty good indicator that business is increasing among contractors.  This is born out by increases we are seeing in-home sales, which drives activity by remodeling contractors and new home contractors.

We watch the Case-Shiller index, which tracks home prices in twenty cities.  Prices, of course, go up as demand increases and home sales generally result in demand for contractor services.  The index rose nearly 10% for the year ending in February.  This represents the largest increase in seven years. Eighty percent of the cities tracked in the Case-Shiller Index showed accelerating growth.  That’s nothing to sneeze at.  It is clearly a good sign. However, we’re not home free by a long shot. Many cities still have a substantial inventory of houses for sale, which will serve as a drag on prices until those inventories are substantially reduced.

The job market also improved more than expected.  These statistics from the Bureau of Labor Statistics are a little more muddled given the large number of people who have given up and left the labor force or finagled themselves onto the disability income roles, and, therefore, are no longer counted as unemployed. Go figure. Nonetheless, nearly all predictions of anticipated job increases in April were between 140,000 and 150,000, but US businesses wound up adding 165,000 jobs.  This resulted in a slight diminution in the unemployment rate from 7.6% to 7.5%.  While not a rip-roaring decline in the unemployment rate, it is the lowest level of unemployment, as measured by the Bureau of Labor Statistics, in four years.  The unemployment curve, at least for now, is clearly bending down.

And as unemployment slowly turns down, personal income seems, at last, to be inching up.  According to the Bureau of Economic Analysis, personal income perked up about 0.2% in March. Unfortunately, the inordinately cold winter caused utility bills to soak up most of the increase in personal income.

Investors who have been on the sidelines are now clearly chasing the pepped up stock market.  While no one wants to be in the last car on the gravy train, investors who have been keeping their powder dry have started to rush back into the game.  More money flowed into mutual funds and exchange-traded funds ($52 billion to be exact) in the first quarter of 2013 than in any quarter since the first quarter of 2004.  That’s only the third positive quarter in the past four years.

And given the mess in Europe, with nearly every country firmly in recession, European citizens and institutions with money to invest are pouring money into American equities.  By this time last year the Treasury department had reported that a record $4.2 trillion of foreign investment had made its way into US equities.  Considering the continuing deterioration of European economies (think Cyprus) we can presume that European money is continuing its flight to America.

So while we are seeing great exuberance on the part of investors (hopefully not of the irrational sort about which Mr. Greenspan once warned), the ghost of George Santayana keeps hovering, reminding us that those who forget the past are condemned to repeat it.  Remember, it was only about five and half years ago that the Dow soared through 14,000 for the first time ever. It stayed there for about two weeks, and then, rather abruptly, headed south.  A year-and-a-half later it was trading at about half that level.  Of course, that coincided with the financial meltdown from which we still suffer.  We’re certainly in better shape now than we were then.  But we’re not home free.  Not by a long shot.

Travel to main street in almost any town in America and you’ll still see too many vacant stores to suggest we’ve entered a new period of boom.  Okay, North Dakota doesn’t count.  There are, however, few Henry Bakken’s digging holes and finding oil as he did in Tioga North Dakota.  For most of America, economic recovery is going to be a long, hard slog.

Financial analysts report that most corporations are scaling back the guidance they are offering to the Street.  This is troublesome because we must assume that these people know their markets and their customers and they, apparently, see uncertain sailing ahead.  The economic slowdown in Europe, which constitutes America’s largest export market outside of North America, is troubling and may spell trouble for our manufacturing sector.

Ernst and Young, the international public accounting and consulting firm, in their economic outlook for April to October 2013 wisely balance their view of positive developments with an understanding of the uncertainties that lie ahead.  In their view, the really robust economic activity going forward will center on the newly emerging markets especially in the Asia-Pacific area. Conversely, they note that although North America and Europe’s middle class populations will stay roughly constant, their share of the middle-class population of the world will be drastically reduced — Europe’s by more than half, to 14% by 2030.

This redistribution of middle class growth will have an enormous impact on global wealth distribution.  Those businesses that are prepared for this shift will prosper at the expense of those that are not.

We return in our essays, again and again, to our concern over the uncharted waters in which the Federal Reserve is navigating our ship of state.  Certainly, the Fed has provided tremendous buoyancy to our economy with its unprecedented intervention in the capital markets through its colossal purchases of government debt.  This has kept interests rates near zero for years now, forcing many investors into riskier investments, generally equities.  The question many are asking (we included) is what happens when the Fed ends its support? Might this be another bubble in the making?   Europe is, after all, still in very precarious straits both financially and politically, and we continue to be mired in a period of slow growth and corporate caution.  Even ever-sprinting China seems to have lost economic momentum.

As we have frequently noted, the Federal Reserve has forced many cautious Americans to dance at a party they have traditionally avoided, the higher risk stock market.  With interest rates hovering around zero, Americans can’t keep up with inflation by saving or investing in traditionally safe fixed-income bonds.  Bond prices, which move in the opposite direction of interest rates, have nowhere to go but down once the Fed allows interest rates to rise.  So count us among those who see Fed support as a double-edged sword.  Our concern is that everyone will continue dancing as fast as they can until the music stops.  Then the rush for the exits might be something for the books.

While the Fed can mitigate concern about a precipitous drop in the market as long as it continues to pump money into the system, each time the Fed has even hinted that it was thinking about ending its unprecedented intervention, the market has run south.  So, what happens when the Fed pulls out as, sooner or later, it must?  That’s the question.

So while there are clearly encouraging signs regarding the recovery, we’re wise enough to know that everything that glitters isn’t gold.  Strong corporate earnings today are more the result of strong management controls than strong product sales (automotives excepted).  The velocity of money throughout the system isn’t keeping pace with the accumulation or supply of cash.  More money in the hands of consumers is a good thing.  Money wisely changing hands would even be better.

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One response to “Dow Jones: Stratosphere…or Troposphere?”

  1. mark j levick says:

    Perhaps Paul Krugman is right and deficit spending does not lead to inflation and can be continued as long as necessary to simulate a stagnant economy. What happens when the economy recovers and businesses start investing and expanding? Can the FED continue to pump money into the economy without fear of inflation? What happens when Government debt is 120% or more of GDP and the FED is the only buyer of our paper? What happens when millions of seniors get wiped out when the pros sell and the stock market declines to customary levels. Perhaps the answer is to make sure the economy never recovers by redistributing the wealth of our Country to those who have become entitled to leaving the American dream by staying home and sleeping or creating even more dependents when awake. That still doesn’t answer the question of how we pay unfunded government employee pensions and what happens when Obamacare uses what was disposable income to those who are between 22 and 35 and are working to fund medical insurance for those who have none and have no means of purchasing same. Perhaps I just answered my own question. The economy will never fully recover so long as we drain funds from it to pay pensions and insure the uninsurable.

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