Well, at least August is finally over. The S&P 500 lost a bit over 5% on the month but that doesn’t begin to tell the whole story. It was one of the most volatile months on record with 15 daily swings of more than 1%. S&P downgraded US debt to AA. The European debt situation deteriorated, pressuring European banks. The global economy continued to slow with Europe and the US on the verge of recession. Gold soared to a new high while US Treasury yields – despite the downgrade – made new lows. Emerging market economies, which have provided the majority of global growth the last two years, continued to show signs of slowing. And just because all that wasn’t enough, nature threw an east coast earthquake and a hurricane at us. I don’t know what September has in store for us but if the first two days of trading are any indication, it doesn’t look like anything good.
The problems facing the global economy were not solved in August and they won’t be solved in September. It does appear though that events are coming to a head and markets may finally force decisive government actions. In Europe, Frau Merkel is facing a political revolt with her party getting trounced for the fifth time this year in local elections, this time in her home state. It appears to this observer that the end game in Europe is nigh and the implications for Europe’s banks – and the PIIGs – are dire. As I write this, European stocks, particularly bank shares, and the Euro are getting hammered. I have said from the beginning that the Euro cannot survive in its present form. Either the PIIGs will be forced out of the Euro, or Germany and its northern neighbors will exit. Which it is makes little difference except to holders of Euro denominated investments; if Germany leaves the Euro, it will give a whole new meaning to the term Eurotrash.
In the US, President Obama will be addressing the nation – and Congress – this week to unveil a new jobs program. After last week’s dismal report, one hopes he takes the opportunity to reverse course on some of his previous policies that have quite simply failed. From the beginning, the President’s economic policies and those of Ben Bernanke have been based on what Hayek called the fatal conceit. The fatal conceit is that the economy can be directed from on high by technocrats and politicians. It is the belief that economics is merely a matter of pulling the right monetary levers and investing in the “right” industries. It is the faith that the few hundred humans who occupy positions of power in Washington, D.C. can allocate our scarce resources more efficiently than the millions of individuals who make up our economy. It is the mindset that Ben Bernanke and his magic printing press can create prosperity by distorting the very prices on which markets depend. It is the arrogance that the economy can be forced to bend to the will of those in power.
The failure last week of Solyndra, a solar manufacturer favored by this administration with over $500 million in loan guarantees, and the ongoing destruction of capital at Bank of America – favored by the last administration with TARP funds – are evidence that this approach has not and cannot work to heal the US economy. The abject failure of QE 2 is evidence that monetary policy alone cannot heal the US economy. In fairness to President Obama, this approach to the economy did not originate on his watch and he should not take the blame for decades of economic folly. Monetary policy, rather then being the north star of economic policy, has become the last refuge of fiscal scoundrels since we left Bretton Woods in 1971. Fiscal and regulatory policies have become nothing more than the covert – and sometimes, overt – political corruption of the party holding the purse strings.
President Obama should be held accountable though if he doesn’t change course. John Maynard Keynes, held in high esteem by the President’s economic team, is often quoted as saying: “When the facts change, I change my mind. What do you do, sir?” Well, the facts have changed Mr. President. More accurately, what your advisers said were facts have been proven not to be facts at all except within the confines of their comfortable and predictable economic models. You can’t model the emotions of 300 million individuals. The Keynesian prescription has shown little efficacy and if it were a real drug, the FDA would pull it from the shelves and fine the manufacturers for false advertising.
The best thing – maybe the only thing – the President can do at this point is to make sure government policy isn’t impeding growth. As John Chapman points out in his latest commentary, this administration’s track record on that front is not good. It can only improve if the President acknowledges the truth of Hayek’s fatal conceit. Recovery does not come from Washington. Recovery doesn’t come from forcing companies and individuals to conform to the whims of politicians pursuing re-election. It comes from the decisions of millions of individuals pursuing their own ideas and goals. You can’t make it happen and you can’t predict its shape, but recovery does require faith. Faith in the ingenuity and persistence of individuals to succeed. Put your faith in the American people, Mr. President.
The economic data last week, despite the jobs report on Friday, was not terrible and didn’t change our outlook. Frankly, the jobs report was nothing special considering the pace of economic growth so far this year. Anyone expecting big job gains with an economy creeping along at 1% growth is dreaming or maybe consuming mind altering substances. The data merely reflects the current state of the economy and while it isn’t getting significantly worse, it isn’t getting any better either. At this point, we continue to believe the economy will avoid a new recession, but if the data continues to deteriorate, we may have to reassess.
Personal income and outlays were both a bit better than expected in July up 0.3% and 0.8% respectively. Both income and spending are up over 5% year over year which isn’t bad considering. The retail reports from Goldman and Redbook continue to show year over year gains of 3 to 4% confirming the trend in the official numbers. One caveat on the retail data though is that it might have been distorted some by the hurricane as people stocked up on supplies before the storm hit. We also have to watch this data closely as Consumer Confidence has recently plunged, especially in the forward looking expectations components.
Housing remains weak with pending home sales falling 1.3% in July after a big surge in June. Mortgage applications did tick up last week by 0.9% but from a very depressed level. Construction spending fell 1.3% after rising a revised 1.6% in June. There were some glimmers of hope though; single family outlays rose 0.1% and multi-family rebounded 1.4%. The downers were public construction (down 2.1%) and non-new residential (down 2.9%).
Manufacturing data was supportive. The Chicago PMI fell slightly but remains solidly above the 50 level that indicates expansion at 56.5. New order growth fell slightly but deliveries slowed substantially which is a sign of strong business activity. Hiring picked up a bit. The national ISM manufacturing index fell slightly to 50.6 but stayed above the magic 50 level. I fully expect to see a month soon under 50 as that is fairly typical in recoveries. In the past it has taken a reading under 45 to indicate recession. One good measure from both reports was a fall in input pricing pressure. The end of QE 2 has allowed commodity prices to fall and that should continue unless Bernanke does something stupid at the September meeting. Okay, maybe I should say until he does something stupid at the September meeting. Factory orders also rebounded in July, up 2.4%. The gains were primarily in the transportation sector with autos rising 14.8% and aircraft by 43.4%.
Of course, the big news on the week concerned employment or rather the lack of employment. ADP reported a solid gain of 91,000 private sector jobs and Challenger reported a drop in layoff announcements. New jobless claims fell after last week was revised higher but are still at 409k. The official Non Farm Payroll report Friday showed exactly zero jobs created in August. I have to say, that considering all that happened in August, that actually wasn’t as bad as it could have been. Private payrolls were up 17,000 but losses on the government side offset that exactly. Employment remains a challenge in this economy with headwinds like falling productivity and rising benefits costs but the real culprit is construction which lost 5000 more jobs last month. If we don’t get a pick up soon and manufacturing stalls due to the global slowdown, negative jobs numbers will probably be in our future.
The big question is whether the latest jobs figures will be sufficient to push Bernanke & Co. to “do something” at the September meeting. Since we don’t know what change they might make, if any, it is impossible to say how it would affect our portfolios but we feel comfortable in saying that whatever they do, the effect on the economy will not be positive. Monetary policy has been awful under Bernanke but just to cut him some slack, he hasn’t had the best fiscal policies to work with. The only way to get better monetary policy at this point is to get better fiscal policy. It is hard to see how the President or the fiscal committee can do much to make things worse, but it is equally hard to see them doing anything positive in an election year. Our best guess is that fiscal policy remains deadlocked and that makes the odds of another move by the Fed pretty high. We’ll make changes, if necessary, after we hear the details.
The stock market sold off over 2% Friday in the wake of the employment report but finished the week just slightly in the red, with the S&P 500 down just 0.24%. Our all stock model portfolio, Global Opportunities, managed a slight gain on the week. For August the portfolio was down but less than half the loss of the S&P 500 (-2.28%). Our global asset allocation model, World Allocation, also posted a gain for the week and a small loss for August (-1.65%). We remain defensive in both portfolios with larger than normal allocations to cash. In World Allocation we have nearly half the portfolio in cash, Treasuries and gold.
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