Breaking News – Retail sales disappoint. No surprise here
Retail sales at U.S. retailers unexpectedly fell in July,
declining by .1%, as a boost from the cash-for-clunkers
automobile incentive program couldn’t even overcome cuts in
other spending. Purchases excluding automobiles fell 0.6
percent, also more than anticipated. This report is critical
because consumer spending accounts for over 70% of the
nations GDP and no recovery can occur with significant
consumer. Today’s report was a big surprise to the market,
but not at all for us here. Read more below.
Market Update – There’s nothing like being in love
The market continues to take a dreamy view of the
“recovery”, firmly believing that it is fully underway. The
economic #’s have been pretty good as we have been expecting
from massive government spending. People clearly expect this
recovery to be like all the others with a surge in business
activity with the unemployment level lagging behind. A surge
in productivity is typical at this stage in the business
cycle as the economy transitions from the bottom of a
recession to the start of an economic recovery. Businesses
generally see a modest pick-up in demand for their products,
but are reluctant to add workers or boost
production/services until this increased demand shows itself
to be consistent and is expected to continue. Subsequently,
as the economy strengthens, workers are added, production is
ramped up and output rises. Another important component of
rising productivity is it helps keep inflationary pressures
down. In effect, businesses are able to absorb rising costs
via increased output per worker.
So, stocks are rising because they believe they are
anticipating better economic conditions ahead.
Interestingly, the same news that made investors bearish a
year ago is making the market rally. The third quarter is
likely to be positive, especially given the success of the
"Cash for Clunkers" program which Congress extended with
another round of spending which taxpayers (our kids) will
get to pay off, or more likely pay $50 million per year for
decades in interest. Essentially, we are moving up car sales
today which would have been made later, except that if you
can get someone else to make your down payment, why not make
that purchase today? A very great deal for the consumer.
Given all the government spending, it will be hard for GDP
to not show a modest gain.
For the short term, the market is acting like it is in love
with those dreamy eyes, either ignoring reality or simply
believing (sometimes believing in something is just
believing) that this recovery will be like all the
others. It will not! However, I am not ready to call an end
to the current rally. I went positive on March 11th largely
because sentiment was so incredibly negative and I want to
see more positive sentiment before selling. Although the
market has rallied almost 50% from the bottom, there is
still too much pessimism for the rally to be over. However,
we are getting close. The AAII sentiment figures went to 50%
(Last Sunday’s Barron’s), the first time at this level since
the rally began. Read more in the strategy update below.
Economic Update – We won’t be fooled again
Will the market turn up and stay up from here, bringing joy
to the world? Or will it take another nosedive fooling “us”
again? Well, don’t let yourself get fooled again because
it’s coming. First let me clarify that when I say “we”, I
mean the collective we, the general public who was caught
with their pants down last fall when the market crashed.
Luckily we gave our readers a heads back in February of
2008, well before the crash in our Economic Tsunami: How
to prepare for this perfect storm special report
(ET
Link). This report is as pertinent today as when it was
written, so go back and read it again. I now have it in pdf
format now to email, so let me know if you need another
copy.
The report discussed in depth how the demographic
landscape of the United States is rapidly changing: A
generational change that happens every 40 years with
devastating consequences every other generation or every 80
years. In very simple terms, the country is aging. The
biggest segment of the population, the 78 million Baby
Boomers, is rapidly passing their peak spending years,
turning from net spenders to net savers. For a country to
grow, it needs more spenders. That’s what drives an economy.
Spending patterns are very predictable. From cradle to grave
we know how people spend their money and we know that peak
spending occurs at 48 years old. At that point, the kids
have left the nest and we spend less on everything from food
to gas to housing. 1957 was the largest birth year on
record. Add 48 years and you get 2005. What happened in
2005? Housing peaked. What a surprise! 1961 was a close
second in births. Add 48 years and what do you get….? You
got it, 2009. There is no avoiding this and there are no
exceptions. Once a nation turns into a nursing home, growth
stalls and reverses. That’s what happened to Japan. That’s
what’s happening here. No amount of stimulus can alter this
track.
The Macroeconomic picture is no less alarming. The 2
major hindrances continue to the massive deleveraging
process and lack of consumer spending. As I have been
discussing, the current process of deleveraging is
massive, bigger than what economists understand and bigger
than the administration wants to admit. When a process like
this begins, it takes years to wind down and is devastating.
There is an estimated $2 Trillion in cash in our economy and
now $50T in assets (already down). That leverage is going to
shrink dramatically, removing an enormous amount of money
out of the economy. Repaying debt will be attractive to many
Americans in future years as they shun spending after their
huge losses in stocks throughout this decade and their
shocking setbacks in real estate. A number will want to be
less leveraged as slower economic growth makes employment
less stable and unemployment more likely. Lenders, pressed
by regulators, will be pushing individuals to lower their
leverage by repaying debt. This massive destruction in
assets will keep prices down, regardless of government
spending, generating deflation, not inflation.
The consumer spending obstacle is real and it is not
going away. The consumer is dead. And with 70% of GDP
generated from consumer spending, it doesn’t take a genius
to know what’s going to happen. When you add in
psychological distress of consumers from their loss of money
on investments, the huge number of unemployed and the rising
savings rate which was zero and is on its way to 10+% to the
natural cycle of aging people who are changing from spending
to saving, and you’ve got a dramatically slowing economy.
Not until the echo boomers, the next generation that is big
enough to make a difference, reaches their peak spending
years will the economy have a sustainable growth phase.
The recent consumer spending report occurred in the face of
gargantuan fiscal stimulus and leaves wondering how this
critical 70% chunk of the economy is going to perform as the
cash-flow boost from Uncle Sam's generosity recedes in the
second half of the year. Imagine, government transfers to
the household sector exploded at a 33% annual rate, while
tax payments imploded at a 33% annual rate and the best we
can do is a -1.2% annualized decline in consumer spending in
real terms and flat in nominal terms? The government simply
cannot keep up this pace of spending. If you remove the
massive government spending, consumer spending would have
shrunk at a 10% annual rate last quarter! Nonresidential
construction action sagged at an 8.9% annual rate and this
was on top of a 44.0% detonation in the first quarter. The
same goes for equipment & software spending; also down at a
9.0% annual rate and this too followed a 36.0% collapse in
the first quarter. Residential construction slumped sharply
yet again, this time at a 29.0% annual rate. These are the
guts of private sector spending and collectively, they
contracted at a 3.3% annual rate -- the sixth decline in a
row. So while there are many calls out there for the
recession's end, it remains a forecast as opposed to a
present-day reality.
Slower spending will only exacerbate commercial real
estate’s woes, which aren't so much the result of
overbuilding, as is the case with residential. Rather, the
problems are due to aggressive refinancing and pricing in
earlier years as well as current slumping demand. As
retailers must close stores or fold completely, mall space
becomes vacant. Warehouses are empty as consumer
retrenchment curtails goods imported from Asia and
elsewhere. Excess space and weak busiess and leisure travel
is axing hotel room rates and occupancy. Layoffs result in
sublease office space competing with landlords for tenants.
Furthermore, a great deal of real estate debt must be
refinanced soon amidst falling occupancy, rents and sales
prices as well as tight credit markets. Estimates are that
$155 billion in securitizations are coming due by 2012 and
two-thirds won't qualify for refinancing as prices drop 35%
to 45% from their 2007 peaks. Meanwhile, $525 billion of
commercial mortgages held by banks and thrifts will come due
by 2012. About 50% won't qualify for refinancing since they
exceed 90% of the underlying property value. Lenders prefer
loans of no more than 65%. Excess house inventories were
built up in the 1996-2005 boom and still number about 1.5
million new and existing houses above normal working levels
despite the collapse in housing starts and recent
stabilization in sales. Excess inventories are the mortal
enemy of prices in any goods-producing industry, especially
housing.
Housing: it will take several years before excess
house inventories are reduced to levels that no longer
depress prices. More importantly, not until the echo boomers
begin their buying of starter homes in 2012-2015 will real
estate make any meaningful recovery. The boomers are done
buying homes, period, and there are just not enough people
to absorb all the homes that boomers live in, never mind the
ones they speculated on. I first said that in my initial
warning to sell real estate in 2006 and in my Economic
Tsunami report. The same holds true today. You should sell
any real estate that you do not want to hold regardless of
price.
Investment Strategy – Pray for peace…prepare for war
The market continues to rise, climbing a wall of worry and
leaving. Although the longer term picture is very scary, the
current “Hope” rally looks to have some more legs. Not until
more people become believers, throw in the towel and get
back in, will the rally be over. However, the current rally
is still considered as taking place within the context of a
longer term bear market. At this point, investors must
consider the risks. What is the upside potential vs. the
downside risk? I believe it is far outweighed to the
negative. But, we all possess that greed factor to capture
that last nickel, as well as an overstated confidence in
ourselves to know when to get out.
This is just a bear market rally and should be treated as
such. When this markets turns it will turn fast and
leave the majority of investors’ in pain. Everybody
thinks that they will know when to get out…but they won’t.
Our strategy of investing in real returns through high
yields on stocks and corporate bonds, often exceeding 10%,
and tax-free bonds where necessary. I am very proud to say
we had a great year last year and are also having a great
year this year.
Our proprietary process for building tax-efficient
portfolios for high net worth individuals has been extremely
successful. If you’d like to see if it can work for you,
just give me a call at 916-925-8900. I’d love to share with
you some of the exciting things we are doing with our
clients.
Cheers –Keith
916-925-8900
P.S. Be sure I am in your address book so my weekly email
newsletter: Keith Springer's critical economic and market
commentary, do not get blocked.
Keith Springer is President of Capital Financial
Advisory Services, a registered investment advisor,
providing Wealth Management and Mortgage Consulting
Services. For more information on how to build and
maintain a solid retirement plan, please contact Keith
at
916-925-8900 or
Keith@KeithSpringer.com |
