Stocks rallied this week as the Senate neared completion of the economic “stimulus” package and the Treasury Deparment finalized the details of the bank bailout plan. While I find myself wondering how $900 billion worthof politically motivated spending and even more billions to prop up poorly managed banks will stimulate the economy, other market participants seemed less concerned. The economic statistics offered a few glimmers of hope but overall presented a fairly bleak picture. Of course, its always darkest right before the dawn and hope springs eternal on Wall Street so traders put on their blinders and ignored another lousy employment report to cap the week with a pleasing, broad based rally on Friday.
The week started with the Personal Income and spending report which showed another drop in spending and a rise in real income. The result was another rise in the savings rate as Americans continued to shirk their patriotic duty to spend every nickel they can scrape out of the couch cushions. The ISM Manufacturing Report offered one of those glimmers of hope as it rose to 35.6 from 32.9 last month. As I’ve pointed out before the ISM is a great coincident indicator for stocks so any rise is welcome. The housing market provided another glimmer as Pending Home Sales rose 6.3%. The ISM reported its Non Manufacturing survey on Wednesday and it also showed an increase.
Jobless claims rose again to 626,000 foreshadowing the full employment report on Friday. Between the two reports, the BLS reported another gain in productivity. Productivity has typically fallen during recessions, but this time has continued to rise throughout. What that portends for the recovery I’m not sure but it doesn’t seem a positive for job growth, at least in the short term. Factory orders clocked their 5th consecutive monthly decline and even I couldn’t coax anything positive from the report. Friday’s employment report was just plain ugly; the only sectors showing growth were healthcare and government which always seems to grow. The good news? Well, its slim but average hourly earnings were up and the total hours worked fell at a slower pace.
The stock market put in a good week despite the bad economic news, but the S&P 500 has yet to make any significant technical headway:
The S&P remains around its 50 day moving average and while last week’s action was encouraging, there is still much work to be done before this can be called a sustainable rally. There are positive factors though that could cause this to turn into something more. Sentiment is still very negative with the AAII poll of individual investors still showing the bulls at less than 25%. This market is all about sentiment at this point; the economic stats are not likely to turn positive for quite a while. If the public starts to believe the “stimulus” plan and the bank bailout will work to turn things around, the market could make a significant advance as bears turn into bulls.
Big gainers on the week were technology and biotech, which goosed the NASDAQ, homebuildersand the materials stocks. But all the attention was on the financials again; the week started withthem resuming their downtrend and ended with them leading the advance as the Geithner bailout plan details started to leak out. The bailout better really be comprehensive and logical when released next week or there will be disappointment galore.
The bank bailout and the stimulus plan are both intended to induce economic activity and I suspect they will be successful to some degree. The stimulus plan will apparently include incentives to buy houses and the bank bailout is primarily about relieving banks of the obligation to recognize their previous bad loans. Putting taxpayers on the hook for those loans will allow the banks to get back to their job of making more bad loans for the taxpayer to absorb in the future. So, while the plans may produce activity, they don’t seem designed to induce productive acitivity.
Between the massive monetary stimulus and the impending fiscal stimulus, it would almost seem impossible for activity not to pick up. The markets will anticipate that activity and indeed there seem to be signs that is happening already. Foreign markets that are particularly sensitive to US economic activity are showing signs of life. Latin American and Chinese stocks are well up from their lows and I expect they will outperform the US market if we start to see more concrete signs of recovery:
These markets are, to a large degree, early cycle indicators for the US economy. Latin America provides the raw materials and China provides the manufacturing for the US consumer economy. If the Fed is able to revive the bubble economy, even for a while, these countries’ economies will feel it first.
The larger question for long term investors is whether the Congressional orgy of spending will produce anything of lasting value. Based on the details I’ve read, I have serious doubts about that. The US economy is deep in debt and nothing proposed to date addresses that underlying problem. There was once a time when we might have been able to grow our way out of our debt addiction, but that day seems long past. The US needs to save more, invest more and spend less. In a globalized world that will require changing the incentives to attract investment to our shores for something other than financing government debt.
Ultimately, I believe that our current efforts to reduce the pain of a recession will just result in anemic growth and increased inflation. I see no way for us to finance the amounts appropriated for the stimulus package and the bank bailout without the Fed monetizing at least part of the tab. The Chinese appetitefor US Treasuries is finite and besides, they have their own stimulus plans to finance. With oil prices down, the oil producing nations do not have excess dollars to purchase the debt. The bottom line is that we cannot finance the new debt internally so the only alternative would seem to be inflation.
The gold market continues to reflect this inflation fear, although it did pull back a little last week:
While I remain bullish on gold for the long term, the sentiment is overly bullish at this point and a correction of some kind would not be surprising. If economic activity revives somewhat, the fear that has driven investors to gold will lessen. The wild card to watch is the dollar. Gold has been able to rally over the last few months even as the dollar has remained relatively strong. If some of the flight to safety bid moves out of the dollar and it resumes its previous downward trajectory, it would be unusual for gold not to respond by moving in the opposite direction.
In my lifetime, there have been three periods of significant dollar weakness. The first was in the mid to late 1970s and that produced consumer inflation and disco. The second was the mid to late 1980s and that produced the crash of ’87 and heavy metal hair bands. The most recent was from 2003 until this year and that produced…well, today’s economic environment and Kid Rock. It seems that the only thing a falling dollar produces is economic turmoil and bad popular music. I don’t know about you, but I could use a little less of both.
Disclosure: Alhambra Investment Management and/or its clients have positions in the S&P 500 (via various ETFs), (IBB), (IYW), (BAC), (V), (PBR), (EFA), (ILF), (FXI) and gold (via IAU).