One Misty Morning
Imagine a gray spring morning. The sun is rising ever so slowly but the thick marine layer is hanging around, still enveloping the city. Look for the sun, it will not avail itself to you. Yet, you can feel the warmth of its touch, fighting the morning tug-of-war against the breezy grip of the mist.
The US economy has had its running battle with the recessionary fog for the last two years. While the depression is at bay, its little brother, recession, is ever so resiliently present. However, hopes and positivity are starting to seep through the crack and some guarded optimism might be, well, justified.
Let’s recap; in 2007, our oh-so-mighty Greenspan claimed that the subprime mortgage problem would be an isolated event. By 2008, the world banking system blew up into pieces. In 2009, the world picked up those pieces and started the slow and agonizing rebuilding process, armed with exaggerated optimism and hasty money-throwing solutions. Last year, we are still toying with this recovery Rubik’s Cube.
Buyer (Optimists) Beware
– Average annual employment number is down from 470,000 to 410,000 in just about a year. Expect to see more decline as commodity prices go up and output to remain constrained which led corporations to continue their reluctance to staff-up.
– The economy is actually contracting despite of the growth shown by GDP. With the net money injection into the economy amounting close to $750 Billion (5% of notional GDP), the net contraction of the economy is at 2.3% (with the GDP clocked at 2.7%).
– Bond outflows are persistently high. While stock fund outflow has largely becoming an accepted fact, the bond flow is a bit disturbing. With the Fed’s quantitative easing version 2 (QE2) on the way, bond yields continue to falter along with investors’ confidence. Let’s put it in perspective: PIMCO’s Total Return Fund, a $250 Billion bond fund, has a net outflow of close to $2 Billion during the last two years. Munis are not faring any better. They just had a net flow of close to $9 Billion. Not a good indication.
– The US Government is struggling to get a favorable pricing on their highly advertised and planned $100 Billion monthly purchase of the Treasuries as part of the QE2 pledge.
– The US Government is on a heated battle to curb its budget. As the debt nearing its cap, the Congress has to decide to raise it and further complicate its long term recovery potentials, or to stay put and lose the world’s confidence (and possibly deliver a severe jolt to the weak global financial market). These are tough choices all around but someone is going to have to turn the wheel one direction sooner or later.
– Mortgage market and housing sector are still far from being out of the woods. Shadow housing inventory is still accounted for an additional 2 million homes which include serious delinquencies, foreclosures and real-estate owned properties (REOs), on top of the already massive unsold homes. The mortgage documentation debacle is certainly not helping the housing segment to recover anytime soon either. Let’s put it this way, there are about 12 million households with negative equity in their homes while an additional 8 million have a Loan-to-Value (LTV) of well above 90%. It ain’t looking good.
– Regulatory uncertainties are still looming large in many parts of the US financial market. While the rest of the world is still, perplexingly, looking at the US for guidance while the US is looking at itself in a murky mirror for a solution to the tangled financial system. The Volcker Rule, the Dodd-Frank Measures and Basel III are few of many unresolved regulatory issues that will only put additional hurdles in the way of hopes and aspirations for a quick and swift recovery.
– The European Union is deeply entangled with its own mess. With sovereign debt taking the center stage, the difference in policy, culture and tolerance will create headache for the EU (A.K.A Germany) to try to steer the old continent away from the economic iceberg. Thus far, I see three options for them: borrow more, default or break up. Anyone have any other options?
Anything is Better Than Nothing
I am going to try to avoid the temptation to fish for the beginning of the recovery; but, I believe that, a pre-cyclical recovery rally is on its way. Here’s why:
– Historically, employment figures are lagging indicators. The continued decline, albeit at a slower pace might foretell better news than what we are used to expect nowadays.
– Output is declining at a much slower pace and the initial stage of any economic recovery is always at its lowest point.
– Profit margin and P/Es are floating above their long term trend lines.
– Slow growth does not equal a recession. While businesses are still tiptoeing on the edge of the labor market, the hiring still continues and worker efficiency is increasing at a more sustained level.
– Household debt is leveling off to a new and lower level. Along with this, private sector savings is on an upward trend. All pointing toward a more responsible balance sheet structure. This might help the nation to compensate for the country’s borrowing binge.
Let’s be clear here; I am not trying to proselytize any baseless feeling of relief, especially against all the overwhelming problems that we are currently facing. However, I believe that a responsible awareness toward some rare bright spots in our economy can help us to be prepared for the still potentially stormy future. It is the here and now and how we respond to it that will determine how we will fare when that future is realized. It is cloudy, yes. But, it is the day young. How we navigate through the layers of the morning mist will determine where we end up at sunset. Thank you for reading.
NAVIQUS 