BlackRock's Weekly Investment Commentary from Bob Doll, Vice Chairman and Chief Equity Strategist for the week of Aug. 30.
There was some positive economic news last week, including initial jobless claims, which were less than expected. That number fell to 173,000 from 504,000 the prior week. Additionally, signs have been emerging that lending standards are easing somewhat. The Federal Reserve’s senior loan officer opinion survey showed that overall standards have been becoming less stringent and small bank lending has been increasing — a necessary ingredient for a broadening recovery.
The economic highlight last week was a speech by Fed Chairman Ben Bernanke, who provided a fairly dovish outlook in his comments. Chairman Bernanke made it clear that more easing would be in store unless the economy improves. His statements should help ease some fears among investors who remain concerned about the possibility of a double-dip recession. His reasons for optimism included ongoing monetary policy accommodation, the improvement in consumer balance sheets, the stabilization of bank lending standards mentioned above and a general improvement in financial conditions that are becoming more supportive for growth. To be sure, there are a number of downside risks and the economy remains quite fragile. In particular, one aspect of the economy that remains troubling is the lack of business, consumer and investor confidence. On the whole, we believe that the economy is continuing to go through a deleveraging phase (particularly on the part of the consumer), but we maintain our view that the US economy is unlikely to experience a double dip and that the global economy will not slide back into recession.
To us, one of the more interesting features of the current economic and market landscape has been the continued resilience of the corporate sector in the midst of weak economic data. The growth in corporate profits and the ongoing decline in corporate credit spreads are forecasting economic strength. In fact, corporate profit margins as a percentage of GDP are near 40-year highs. During a normal economic cycle, such levels would encourage companies to spend more on capital expenditures and/or ramp up hiring plans, but most companies have remained reluctant to reduce their cash levels. We have seen some increases in capital spending, but a lower amount than would normally be expected given current profits, and, of course, private sector hiring has remained anemic. Some of this reluctance to spend can be attributed to uncertainty surrounding potential legislative and regulatory changes coming out of Washington, but we believe that we are at a point where companies will need to either accept slower growth levels or begin to put more of their capital to work.
For the past several months, stocks have been caught between the crosswinds of a range of positive and negative forces. On the bullish side, strong corporate profits, increases in merger and acquisition activity, high levels of corporate debt issuance and some renewed spending on capital expenditures show that the corporate sector remains a source of strength. Additionally, the Fed has made it clear that it will continue to do what it can to remain accommodative. Outside of the United States, economic data also continues to be somewhat stronger than expected through most of Europe and Asia.
There are, however, a number of bearish forces that warrant mentioning as well. A lack of overall confidence has been depressing markets, which is not surprising considering that the most visible aspects of economic growth — jobs growth and the unemployment rate — have continued to be disappointing. Additionally, the housing market remains an important source of weakness. There are also the real and ongoing threats of deleveraging that have to be considered. The consumer still has some work to do on this front, and we have seen sovereign debt spreads widen in Europe recently.
The critical issue for investors remains the question of whether the economy will experience the much-dreaded double dip. We are on the optimistic side of this debate and would point out that while the recovery has been slow, we have made significant progress. On a real basis, US gross domestic product has regained 70% of what was lost during the recession and on a nominal basis, GDP has regained all of it, meaning that the United States is in a nominal expansion.
In any case, investors in US stocks can expect continued volatility ahead. The S&P 500 Index has remained in a rough trading range of between 1,020 and 1,120. We do not expect to see a dramatic breakout of this range at the current time, but do believe that as economic conditions slowly improve, the positive forces should win out.
Summary of TrimTabs Weekly Liquidity Review – August 30, 2010
We remain neutral (0% long) on U.S. equities. Our macroeconomic indicators and demand-side indicators are sending very different signals, so we are content to have no net equity exposure.
Washington insiders have been congratulating themselves on saving the U.S. economy from a depression. Mark Zandi and Alan Blinder released a study on July 27 entitled “How We Ended the Great Recession.” About a week later on August 2, Treasury Secretary Timothy Geithner penned an editorial in the New York Times entitled “Welcome to the Recovery.” We suspect these writings will come to be regarded much like Irving Fisher’s statement in October 1929 that “[s]tock prices have reached what looks like a permanently high plateau.” Almost all of the macroeconomic data we track is grim:
Private sector job growth is anemic at best. Growth in online job postings was flat in the past eight weeks, and the four-week average of initial unemployment claims rose to a nine-month high of 486,750 in the latest week.
The housing market is a disaster. On the demand side, new and existing home sales plunged to 4.1 million at a seasonally adjusted annual rate in July, by far the lowest level in this decade, and mortgage purchase applications in the latest week were only 4% above their record low. On the supply side, millions more foreclosures will hit the market in the next couple of years. Foreclosure filings are still running at a rate of nearly 1 million per month, and about 10% of mortgage borrowers are behind on their mortgages.
The manufacturing sector, which had been a bright spot for the economy earlier this year, seems to be losing steam. According to Federal Reserve surveys, manufacturing in the Philadelphia, Richmond, and Kansas City areas all deteriorated in August. Manufacturing in the New York area improved slightly, but new orders fell into contraction territory.
The only apparent positive sign comes in our income tax withholdings data. Adjusting for our estimates of tax changes, withholdings rose 3.8% y-o-y in the past three weeks, higher than the 2.4% y-o-y growth in the past three months. We do not think the acceleration in growth in withholdings means wages and salaries are rising sequentially. We suspect COBRA withholding tax reimbursements last year were higher than we are estimating, which would push year-over-year growth up now.
In contrast to our macroeconomic indicators, most of our demand-side indicators are favorable:
Retail investors are gloomy, which is bullish from a contrarian perspective. U.S. equity funds have lost an estimated $12.0 billion (0.3% of assets) in August, putting this month’s outflow on track to at least rival the estimated outflow of $14.0 billion (0.4% of assets) in July. Also, the American Association of Individual Investors reports that 49.5% of investors were bearish in their latest survey, more than double the 20.7% that were bullish.
One reason for caution is the continuing optimism of day traders. Leveraged long U.S. equity ETFs issued 4.9% of assets in the past week, even higher than the inflow in the previous week.
Corporate liquidity flows have been pretty neutral lately, which is one more reason for us to play it safe. Corporate buying and corporate selling were both below $2.5 billion in the past week, and announced corporate buying (new cash takeovers + new stock buybacks) has been only $9.4 billion higher than corporate selling (new offerings + net insider selling) in August.
Until our demand-side indicators turn less favorable, we are reluctant to be net short even though the economy is sputtering and companies are not shrinking the float much. In our model portfolio, we remain 25% short XLE (SPDR Energy), 25% short IWM (iShares Russell 2000), and 50% long XLV (SPDR Health Care).
Ben Bernanke’s Latest Speech Signals Federal Reserve Will Print as Much Money as It Believes Necessary to Try to Support Economy and Asset Prices. Key Question: Will Money Printing Work?
In a speech last Friday, Federal Reserve Chairman Ben Bernanke outlined options the Fed might take to support the economy: money printing, changes in communication, a reduction in the interest rate paid on reserves, and an increase in the Fed’s inflation target.
Mr. Bernanke has demonstrated through the years that he is above all a money printer. Therefore, it was no surprise that he came out clearly in favor of debt monetization. He said, “I believe that additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions.”
While some analysts were disappointed that Mr. Bernanke did not provide as strong an endorsement of additional money printing as they had expected, we think Mr. Bernanke made it absolutely clear that as far as it depends on him, the Fed will hold nothing back. He declared, “[T]he FOMC will strongly resist deviations from price stability in the downward direction. . . . if deflation risks were to increase, the benefit-cost tradeoffs of some of our policy tools could become significantly more favorable [emphasis added].” He also noted, “[R]egardless of the risks of deflation, the FOMC will do all that it can to ensure continuation of the economic recovery [emphasis added].”
We regard this latest speech as the clearest signal yet that the Fed will go all out to try to support asset prices. In the next couple of years, we expect the Fed to print trillions of dollars to buy everything from Treasuries to mortgage-backed securities to credit card securitizations to corporate bonds. We think Mr. Bernanke will print as much as he feels is necessary—whether that amount is $2 trillion, $5 trillion, $10 trillion, or $20 trillion.
The key question is not whether the Fed will print lots of money but whether the money printing will work. Money printing could support asset prices for a time, but higher asset prices and even lower long-term interest rates will do little to improve the economy. The economy is not struggling because asset prices are too low and interest rates are too high. Indeed, the prices of almost all assets are lofty, and interest rates are extremely low. The economy is struggling because final demand is weak. Consumers have been forced to live on their incomes rather than on ever greater amounts of borrowed money.
We do not see how monetizing even more debt can solve a problem caused by too much debt. Moreover, we think the eventual impact of massive money printing on the credit and currency markets will be even nastier than the problems the Fed is trying to address.
Viewpoint: Why Another Fiscal Stimulus Won't Do from PIMCO's Mohamed A. El-Erian
The great hope a few months ago was for a "recovery summer," with the economy responding favorably to various policy initiatives. Yet the recovery has lost momentum, and while the end of the year will not be as gut-wrenching as the final 3 1/2 months of 2008, when the global economy suffered a cardiac arrest, it will be as consequential in affecting the welfare of millions of people.
Throughout the summer, data signals have become more alarming. Despite all the rhetoric about job creation, unemployment remains stubbornly high and the problem is becoming structural in nature (and, therefore, harder to solve). Consumer credit continues to contract while small companies find it difficult to access new bank lines of credit. Housing activity is falling, and home values are poised for further declines as foreclosures increase. The trade balance has taken an ominous turn, with exports stagnating and imports surging. More Americans are falling through the large holes in the country's safety net.
The equity markets are again under pressure while yields on Treasury bonds have collapsed, reflecting that market's growing concerns about the weak economic outlook. With such fragility, households and companies have become even more cautious, undermining the "animal spirits" needed for economic expansion.
Meanwhile, the United States has received little help from the rest of the world. Yes, German growth is up, but a significant part reflects its well-functioning export machine. The beneficial spillover effects have been immaterial. And despite the political narrative to the contrary, market concerns with debt solvency in some eurozone countries (Greece, Ireland, Portugal and Spain) remain high.
Even a steadily growing China is proving to be of limited help. While Beijing is implementing additional structural changes to reorient its economy toward domestic consumption, the pace remains measured; what is understandable from a Chinese national perspective does little to help sustainably rebalance the global economy.
In sum, the current policy approaches here and abroad are unlikely to deliver a durable and robust U.S. recovery and, critically, create sufficient growth in jobs. Yet the main debate in Washington is whether to do more of the same -- namely, another fiscal stimulus and another round of quantitative easing by the Federal Reserve. This clearly conflicts with evidence that a broader and more holistic response is needed.
These realities will fuel debate among economists, who already hold unusually divergent views, and reignite the discomforting notion that economic unthinkables and improbables—such as a double-dip recession and a deflation trap—are more of a possibility.
What is critical to keep in mind is that this situation is part of a broad, multiyear process driven by national and global realignments. It's a secular phenomenon that needs to be better understood and navigated -- by recognizing its structural dimensions and by urgently broadening the excessively cyclical policy mindsets that abound. Unfortunately, the approach in too many industrial countries has been to kick the can down the road, seemingly hoping for a series of immaculate economic recoveries.
Policymakers must break this active inertia by implementing a structural vision to accompany their current cyclical focus. Measures are needed to address key issues, which include the change in drivers of growth and employment creation; the high risk of skill erosion and lost labor productivity; financial deleveraging in the private sector; debt overhangs; the uncertain regulatory environment; and the unacceptably high risks facing the most vulnerable segments of society.
Specific measures would include pro-growth tax reform, housing finance reform, increased infrastructure investments, greater support for education and research, job retraining programs, removal of outdated interstate competition barriers and stronger social safety nets.
That, of course, is what is desirable; how about what is likely?
With the recovery's visible loss in momentum, more people are coming to appreciate the importance of structural issues. Indeed, some elements of the package are visible. Yet, to my dismay, the prospects for a sufficiently bold policy reaction are doubtful. Post-financial crisis, it is no longer just about the "unusually uncertain" economic outlook and related challenges for a policy approach that remains too reactive and ad hoc. The politics of structural change are now a material impediment.
An already polarized political environment is becoming even more fractured by real and far less substantive issues. There is virtually no political center that can anchor consensus and enable sustained implementation of policy. Meanwhile, as anti-Washington sentiments rise, interest in a national agenda is increasingly giving way to the election cycle. Internationally, the impressive degree of cross-border coordination seen during the global financial crisis has been reduced to inconsistent—and at times contradictory—national responses.
This worrisome trio of increasingly ineffective national and global policy stances, intense political polarization and growing social pressures speaks to the risk that the economy's recent soft patch will evolve into something even more troublesome and sinister.
I hope that sober policy responses will accompany the coming cooler temperatures. Given the proximity of the November elections, however, I worry they may not.
U.S. Trading Focus Commentary from Joseph Lavorgna of Deutsche Bank
The economic data over the past four months—and the last few weeks in particular—have been much weaker than we projected. As a result, we have removed the upside risks to our H2 growth forecast, which we highlighted as recently as July, and we sharply reduced our near term estimates of output.
We see current quarter growth at just 2%, and full year growth slightly below 3.0% following the downward revisions to Q2 GDP which we expect to be reported this morning. Some analysts see even weaker output this quarter, which in turn will extend into both Q4 and 2011. We are more sanguine even though the risk to the next batch of economic data is to the downside.
There are several compelling reasons why we believe the economic recovery will continue: First, income growth is rising. Employee tax withholding receipts are rising at over 7% year-on-year. This data series is useful, because it is both timely and not susceptible to revisions. While the official data do not yet reflect this, employment income growth is rising at an impressive pace based on tax receipts.
Perhaps this will show up to a greater degree in the July personal income data, which are reported on Monday. Second, the household savings rate is poised to level out. At 6.4% in June, it is up over 5 points from its low of 0.8% in April 2005 and also above its 30-year trailing average of 5.8%. A rising savings rate diverts a substantial amount of household income away from consumption, thereby depressing overall growth. Likewise, a drop in the savings rate could provide an important tailwind to consumer spending. Third, corporate profits are growing at a solid pace.
Over the past four quarters, corporate profits are up 38%. With the exception of 43% y/y growth in Q4 of 2009, this is the fastest rate of profits growth in over 25 years. The Q2 profits data are reported this morning along with the GDP revisions. Currently, profits per worker are at an all-time record high. In the past, when profits per worker rose above the long-term trend, employment gains ensued; hence, solid Q2 profits should bolster the case for acceleration in private sector job growth—something which has largely proved elusive to date. Fourth, interest rates and energy prices are both stimulating activity. Borrowing rates across a host of categories, ranging from 30-year mortgages to new car loans to corporate bonds, have declined substantially. Additionally, energy prices have also moved lower. CPI energy is down -4.5% year-to-date (annualized). Retail gasoline prices are currently running below their Q2 average, and natural gas prices are unchanged over a similar period. Every recession in the last 75 years, including the most recent one, experienced some combination of rising rates or rising energy prices either ahead of time or in the midst of the downturn. Remember that headline CPI was rising nearly 6% on the back of $147 oil in the months immediately before the Lehman bankruptcy.
Monday, Aug. 30:
Personal Income and Outlays
Tuesday, Aug 31:
S&P-Shiller HPI; State Street Investor Confidence Index
Wednesday, Sept. 1:
ADP Employment Report
Thursday, Sept. 2:
Monster Employment Report; Pending Home Sales Index
Friday, Sept. 3:
ISM Non-Mfg Index
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