November 2009 Investment Commentary

The third quarter of 2009 showed positive economic growth for the first time in over a year.  Gross Domestic Product was reported to have increased 3.5% in the quarter ending September 30th.  However, most of the reported “growth” could be attributed to government stimulus.  It is estimated the “Cash for Clunkers” program contributed to approximately 1% of the growth.  The $8,000 tax credit for first-time home buyers was responsible for another .5%.  Almost another 1% was a result of companies increasing inventories after paring them drastically earlier this year.  Without government stimulus, the U.S. economy would have experienced minimal growth, if any.

Interestingly enough, the last time this country experienced positive growth was in the second quarter of 2008.  That was also a result of government stimulus.  If you recall, President Bush sent checks to virtually every U.S. adult citizen in the first half of 2008. That was enough to eke out slightly positive growth in the second quarter of 2008.  The ensuing recession, already the worst since World War II, might actually have been much worse.  The artificial stimulus is creating economic activity….activity that may or may not continue after the stimulus is withdrawn.

The government appears worried the economy is not yet ready to stand on its own.  After seeing auto sales decline 10.4% in September, the first month after the Cash for Clunkers program ended, they are taking action to ward off the same fate for housing.  Although home sales have shown small signs of life, the Administration is proposing to extend the tax credit for first-time home buyers through April 30th.

Because GDP increased 3.5%, the recession is officially declared to be over by the people responsible for making such declarations.  The announcement of the death of the recession on October 29th sent the Dow Jones Industrial Average soaring almost 200 points.  Giddiness over our new prosperity faded quickly as the DJIA declined over 251 points the next day.

Clearly, the government stimulus is creating economic activity.  However, it may not lead to REAL growth…..as the Administration is hoping. With unemployment approaching 10%, we need to have sustained economic activity to realize job growth.  Companies don’t begin to hire until they believe that increased consumer demand is not just a temporary phenomena.  And, of course, sustainable increased consumer demand is less likely with double digit unemployment.

So here is the dilemma: Do you put your foot on the accelerator and INCREASE government stimulus in order to ensure job growth takes hold and we can get back to full employment (which will take years)?  Or do you halt additional government stimulus and hope that actions taken are jump-starting the economy already and that it will continue to grow?

The first choice would no doubt reduce unemployment.  Sending federal government funds to states, cities and counties for projects all over the country would certainly spur economic activity and job growth.  However, with this year’s budget deficit approaching 13% of GDP, borrowing additional funds to create economic stimulus will only make the deficit more daunting.  Increasing the deficit is becoming less  popular and would likely cost the Democratic Party some votes in the next election.  Obama will possibly face opposition from his own party if he attempts to get additional stimulus dollars approved.  Let’s face it, most congressional delegates are primarily concerned about one thing…. getting re-elected.

Other problems with the first choice are that it will almost certainly be inflationary and it will increase the amount of debt that the U. S. taxpayers are eventually required to repay.  This will merely deter economic growth sometime in the future.

Our economic and financial problems took years to create and are going to take years to fix…..and that assumes we make the correct moves to fix them.  What we are getting are short-term fixes which are not in concert with long-term solutions.

We dedicated billions to bailing out financial institutions that took the greatest amount of risk and we have done virtually nothing for the financial institutions that were run prudently and properly.

We dedicated billions to bailing out inefficiently run automobile manufacturers and we have done virtually nothing for businesses which have been run prudently and properly.

We are dedicating billions to re-structuring mortgages for people who bought homes they could not afford and we are doing nothing for the people who have chosen to live within their means.

The message is that it is okay to take excessive risk.  If the risk works out in your favor, you will be handsomely rewarded.  If it does not, you may not have to suffer the consequences.  Meanwhile, the Federal Reserve continues to cause investors to price risk incorrectly.  Keeping interest rates artificially low creates cheap money and causes the prices of assets to become artificially high.

Short term interest rates plunged close to 0% a year ago during the global financial panic as investors around the world poured money into short term treasury bonds.  This “flight to quality” drove rates down temporarily.  The flight to quality has been over for months, as evidenced by the drastic decline in the value of the U.S. dollar.  Yet, short term treasuries are yielding almost nothing.  Why?  Because the Fed is continuing to hold the Fed Funds rate at 0% – .25%.

Although the economy appears to be in recovery mode, the 937,840 families who experienced foreclosure on their home this past quarter might see it differently.  According to a spokesman for RealtyTrac, that quarter was “the worst three months of all time”.

Speaking of bad mortgages, on October 11th, Fannie Mae and Freddie Mac announced some drastic measures to get rid of the homes they now own because of the massive foreclosures.  They are offering to potential buyers up to 3.5% of the selling price to help cover the closing costs.  In addition, they are offering mortgages to the buyers of foreclosed properties that only require a down payment of 3% with no PMI (private mortgage insurance).  Doesn’t this sound kind of familiar?

Why might you be optimistic?

• GDP growth of 3.5% in the 3rd quarter.
• Initial claims for unemployment are at the lowest level since January.
• Retail sales were positive in September (barely).
• Inflation is not yet evident.
• Exports have been increasing due to the falling value of the dollar.
• China’s growth was 8.9% in the 3rd quarter.
• On my monthly bicycle ride, the number of “for sale” signs dropped to 17 from 26 just a few months ago.
• Orders for durable goods increased 2% in September.

Why are we still concerned?

• The U.S. budget deficit for the fiscal year that ended September 30th was $1.4 trillion.  The previous year was $459 billion.
• Foreclosures are still occurring at an alarming rate.
• Credit card companies are continuing to experience additional charge-offs and delinquencies.
• The “too big to fail” financial institutions are actually much bigger than they were prior to the crisis.
• New home sales declined 3.6% in September, the first decline since March.

At Boyer & Corporon Wealth Management, we have not lost our healthy respect for market bubbles.  Although we have increased our equity allocation over the past 3-4 months, we are inclined to decrease it if the “bubble” gets more inflated.  A stock market that declines 50% and increases 50% in a twelve month period is not a safe place to play.  We remain cautious.

This information is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.