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06/10/2009
Where were we? Where are we? Where are we going?
By
Edward L. Snitzer
On June 1, 2009, the headline news was the GM bankruptcy, together with the Federal Government owning 70% of a post bankrupt GM. Of the 5.7 million jobs lost since the beginning of the current recession which began 18 months ago, making it the longest recession and still counting since the Great Depression, 1.6 million were lost in manufacturing, with almost 300,000 in the auto-makers and their suppliers. Continuing layoffs in this industry will push the current unemployment rate of 8.9% into the teens by year end.
Now one would think that would be bad news for the financial markets. No, the Dow soared 2.6%, 221 points, closing at 8721, almost 34% above its market low on March 9, 2009. Why? A survey by the Institute of Supply Management (ISM) showed the U.S. manufacturing sector contracted in May but at a slower pace than the month before. A government report showed U.S. construction spending in April had its biggest jump in eight months and rose for the second consecutive month. Consumer spending fell in April, slightly less than expected, despite the largest personal income increase in 11 months.
“(ISM)” was better than expected and I would put particular emphasis on the new orders component, which broke above 50. In my view this is more evidence that we’re getting closer to the end of the recession...” was the common Wall Street opinion of the day.
The S&P 500 has risen 5.3% in May for a three month gain of 25%, its biggest three month gain since August of 1938. Its rise of 38% since March 9th, 2009 has been the largest increase in seven decades over a similar period of time, validating PMA advice not to sell equities in a falling market during the very difficult days from September 2008 to March 9th, 2009.
Where were we? Where are we now? Where are we going?
The world-wide governmental response to avoid a collapse of the world-wide financial system has worked. The underlying fear of that calamity has waned, which we would argue is why the Dow Jones Industrial Average has rebounded from a low of 6500 to current levels of 8500, an increase of 31% or so, in line with historic market recovery patterns. There is also growing confidence that the economic collapse has ended. The worst is over and something better is coming.
That’s where we were and are.
Where we are going, of course, is unknowable. The effort of market participants to discern either with evidence or foresight is, has been, and will always be, beyond reasonable
certainty of prediction leading to reasonable certainty of behavior. The current ISM report sending markets higher, because right now conditions are not as bad as expected, or, that it portends the end of a recession, may be good news today. The question always is what is coming tomorrow. How strong will a recovery be? Is the GM takeover a good idea, or as we think, a bad idea? How will the United States pay for all of the ambitious, health care, green energy, cap and trade policies without increasing inflation, higher interest rates, and a weakening of the dollar. Are the government’s programs on the right track, or as we fear, many of them heading in the wrong direction. Let’s not forget the seven trillion or so of unprecedented Federal Reserve programs propping up the ailing financial system and the government’s ownership interest in that basic industry. How heavy a blow will the financial, housing, construction and consumer retailing businesses take and over what period of time? These are just a sampling of the problems coming down the road.
We think it reasonable to conclude that the effect of all these issues will result in slower growth of corporate earnings than usual; the financial system will be de-levered, de-globalized and re-regulated, consumer spending will decline while consumer savings will increase as will taxes on all Americans, not just the “rich.” Unemployment will be higher and will take much longer to get back to 2000 levels, and in many markets, price formation by market participants will be influenced by the legacy and in some cases the continuation of greater direct governmental regulation.
What we firmly believe is that the end of the story has not come for the United States economic system, nor for the basic ideas that have made it what it is. That being so, the governing rules are the same: the right stocks will do better than the right bonds, the right bonds will do better than treasuries and actively managing risk is doable and prudent. At our most recent PMA investment meeting on May 18th, 2009, we accelerated a program we had begun in January, 2008, to tilt to those equity managers buying companies with reasonable debt and pricing power, to maintain our short duration position for fixed income holdings and to tilt to corporate bonds relative to government holdings. We are in a time when those enterprises that make money by borrowing less to make things by selling to those who don’t have to borrow as much, will do much better than those who have wrecked their companies by borrowing too much and selling to those who also borrowed too much. As we view the facts in the coming months, we will continue to adjust our client portfolios accordingly.
Finally, there is no easy way out of our current predicament. Fiscal stimulus, at best, may stop further collapses in aggregate demand. It will not, regardless of the chatter of two million new green jobs as a result of government action, and other such talk, drive recovery. Recovery requires that battered banks behave like real banks; that risk premiums are properly priced; that risk takers want again to take risk and that the economy shifts towards whatever will replace construction, housing, finance and debt driven consumption, all with appropriate benevolent and not oppressive governmental intervention.
The next few years will not be easy but we believe we will work our way out of this mess. To believe otherwise is to believe that one can stop the world because it’s time to get off.
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