2009Oct11 Week In Review
2009Oct11 Week In Review
October 11, 2009
WEEK IN REVIEW:
At this point in time, it appears that the first half of the year will have slight downward revisions to economic growth. The final quarter of the year is likely to be weaker than the third quarter giving way to concerns for a “W” pattern for our GDP. There are arguments for an “L” and “U” shaped recoveries but not for this update.
The Fed will have pressure to raise short-term rates if growth accelerates and inflationary pressures are resurrected. We do not expect that any time soon. As we move toward mid-2010, economic growth will have established a growth trend or not. Before then, the Fed is unlikely to change policy.
The bond market bulls expect inflation to drop to zero. Inflation is headed towards 1%, and there are deflationary pressures that continue to drive portions of our economy especially in real estate prices and rental rates. Existing home sales have been weaker than expected though new home sales leveled off in recent months. Whether that can be sustained without the Democrats’ wealth redistribution to first time home buyers remains to be seen.
Nonresidential construction and capital goods outlays are weaker than expected. Light vehicle sales fell more than expected in September in spite of the Democrats’ wealth redistribution to new car buyers. Payrolls and wage income remain weak with negative impact on consumer spending.
Private credit demand continues to fall resulting in declining rates. Banks refuse or remain reluctant to boost loan growth. Morgan Stanley’s analysis is the economy will revive next year and private credit demand will follow. However, wages have fallen another 0.5% which will not encourage consumers. In 2010 we will pass the peak of Boomers with adolescents at home and college expenses to pay. The normal “stage of life” transition is to less spending and more saving. With the current economic slump, general loss of asset values, job and wage uncertainty combined, we believe, are likely to cause Morgan Stanley to revise their expectation downward, again.
We have discussed the dilemma facing state budgets several times during our radio program. Spending cuts and tax increases which must continue to balance budgets at the state and local level have been offsetting the Fed’s stimulus efforts. In the past four months, state and local governments have shed 160,000 employees further eroding confidence in the consumer. This action is usually late in a recessionary cycle for governments which loathe firing anyone. Therefore, it is a positive indicator. However, budgets remain deeply in the red and more staff reductions are the fastest way to find balance – a negative for the economy.
Domestic demand for Treasuries has been strong and likely supported by asset re-allocation decisions by foundations and endowments to more conservative investment models. These decisions do not create repeat buyers for Treasuries. Once the allocation target is filled, available funds are directed to other assets. Therefore, demand for Treasuries is likely to wane even further as we move into next year. The market place will demand higher rates to continue funding our federal deficits. We expect the yield curve to steepen to a more normal spread of rates between short and long. If we get a “double dip recession” it will not be a problem for investors in intermediate and long-term fixed income. If not, the recently massive purchases of bond funds by investors will turn out to be a true contrarian indicator supporting carefully constructed equity portfolios.