Posts Tagged ‘US economy’
After having been blissfully unaware of any economic and market news since the end of March I am back in Boston, and it’s time for me to get back into the game. I’m still in the process of catching up, but here’s what I think the key developments over the last few months were:
1. The market hit a (temporary) bottom in early March. The Dow Jones is back at around 9,550, roughly 45% above its March 9 low of 6,547.05. Similarly, the S&P500 is somewhere north of 50% above its March low. At the same time, 30 year Treasury yields are back in the neighborhood of 4.35% after having hit a bottom at 2.55% in late December 2008.
2. Both Chrysler and GM declared bankruptcy; the two firms emerged from bankruptcy after no more than a few weeks each. In addition to the troubled automakers there were 84 bank failures in 2009 through August, a full 63 of which occurred in between the end of April and now. 24 of those bankruptcies occurred in July, another 15 in August.
3. The US economy seems to recover, albeit slowly. Unemployment stands at 9.4% but negative GDP growth slowed to -1.0% over the second quarter and durable goods orders were up. Re-appointed Fed Chairman Ben Bernanke suggested in his speech last week that we have the worst behind us in this “most severe financial crisis since the Great Depression.”
But do we really? Is the rally in the stock markets actually sustainable, especially without analogous interest rate increases? What happens if the dollar crashes? What if inflation picks up? The futures markets do not seem particularly worried at the moment: implied probability has the Fed Funds rate steady at 0.25% through the end of 2009 and then suggests and increase to 1.0% towards the end of the first quarter of 2010, suggesting steady progress on the course towards economic recovery.
My own conclusion at this point is simple: I’m at a loss. I don’t see what should justify a stock market rally of the magnitude that we have seen. I do see optimism that isn’t based on any real data (if you disagree please let us know!), and I believe that there’s a systemic problem lurking in the financial system that we prefer to ignore: all the money that has been printed over the course of the last year. When you look at the US monetary base and the level of excess reserves of depository institutions, the picture doesn’t look much different from seven months ago when I first wrote about it.
Bernanke suggested last week that “the continuing provision of liquidity and a tightening of the regulatory framework are key” to keep financial markets functioning properly. It’s blatantly obvious that the provision of liquidity remains a top priority of the Fed at the moment, and our monetary base and excess reserves are still at levels that are barely different from the end of 2008 when the crisis was in full swing. Looking at these charts doesn’t make me confident that we have the worst behind us. Or maybe we do, and what we are looking at is a systemic change in the financial system. What do you think?
Two days ago President Obama signed the 2009 stimulus package into law, committing an additional $787 billion to supporting the American economy. A number of banks – JPMorgan, Citigroup, Bank of America and Wells Fargo among them – have agreed on temporary moratoriums on foreclosures. Weekly mortgage applications jumped 46% last week, and (as noted in my last post) a variety of indexes seem to be slowing their decline. Credit Suisse recently suggested that the much-bemoaned US debt to GDP ratio might not be in as bad a shape as commonly assumed. Yet the S&P500 lost -4.6% the day President Obama signed the American Recovery and Reinvestment Act, and the Dow Jones gave up -3.8%. As of February 18, the Dow Jones has lost roughly 14% for the year. I have no idea when equities are going to see a bottom or when the economy is going to reach a turning point. I do believe, though, that there are certain prerequisites to be met before a lasting recovery can begin:
1) We need some signs that the stimulus package is working.
In their January meeting, the minutes of which were published yesterday, the Federal Open Market Committee once again reduced their 2009 growth projections. The consumer confidence index stood at 37.7 in January, its all-time low since inception of the index in 1967. I think that consumer and investor confidence will only tick up again as the tax cuts and spending programs of the $787 billion stimulus package (hopefully) prove their effectiveness over time – per the Congressional Budget Office’s estimates the stimulus will add somewhere between 1.1 and 3.8 percentage points to real GDP in 2009, and have an effect of similar magnitude in 2010.
Take a look at the charts below for a breakdown of the stimulus package, and an estimate from JPMorgan showing the sizing of tax breaks and spending quarter by quarter. Please note that the JPMorgan graph dates to the first week of February and is thus not a fully accurate reflection of the stimulus package that was passed on February 13.
2) Systemic threats on both the national and international level need to be resolved.
Temporary calm returned to the US markets in December of 2008 after the government committed to “doing all that it takes” to thaw credit markets, stabilize the financial system and revive the economy. Talk of an impending collapse of the US financial system subsided as it became clear that the government would do everything possible to prevent another Lehman disaster. I believe that we need a similar commitment from the EU regarding the escalating situation in Eastern Europe, and from the US government and banks regarding the prevention of potential systemic shocks such as a large-scale municipal default (think California which just managed to corral the last vote needed to resolve the budget impasse) or a spike in mortgage defaults triggered by a wave of simultaneous interest rate resets.
3) We need to recalibrate our expectations regarding homeownership, leverage and GDP growth.
It seems that by now both Wall Street and Washington and have understood that we can’t go back to “business as usual” – i.e. our pre-crisis reality. For a while to come, banks and hedge funds won’t be as leveraged as they were over the last decade. American automakers need to revamp their business models. I personally don’t believe that almost 70% of households in the US can afford owning a home (stay tuned for a post outlining why). I don’t think that a personal savings rate in the zero to three percent range is sustainable. And I don’t see how increasing reliance on debt – both private and public – can continue to drive GDP growth going forward.
The charts below show the US debt to GDP ratio (the revised version from Credit Suisse) over the last 100 years, the growth of GDP compared to the increase of productivity in the US since 1965, and the development of homeownership over the same period. Looking at these long-term trends, I believe that we’re in for a prolonged period of pain – after all, the stimulus package addresses the symptoms of the crisis and not its causes: leverage is shifted from private to public, instead of being reduced; homeowners who can’t afford their homes are receiving support to avoid foreclosure.
What do you think needs to happen in order for things to get better?