Targeted, timely and temporary. That was the clarion call of the Keynesians during the debate over the stimulus plan enacted at the beginning of President Obama’s current term. Stimulus was reckoned to be most effective when these three principals were embraced. We all know now that timely wasn’t much of a consideration in the structure of the stimulus and even President Obama has acknowledged that there is no such thing as “shovel ready”. Even if the stimulus had been targeted at infrastructure and other projects with a theoretical long term investment return, getting it done in a timely manner is impossible unless you are Walmex and willing to grease a few palms.
In any case, the spending wasn’t aimed at long term government investment (an oxymoron if ever one existed) with most of it spent on transfer payments to individuals or states. Never mind, the Keynesians told us; transferring cash from bond buyers to those more inclined to spend it would create a virtuous circle of higher spending that would somehow lead to sustained growth. And now, with the release of the recent GDP report, we find the flaw in this tripartite ponzi scheme. Having failed so miserably in the targeting and timeliness, our politicians succeeded in adhering only to the temporary part of the equation. The biggest drag on “growth” in the GDP report was the drop in government spending.
The latest reading on US growth starkly demonstrates the limits of Keynesian policy as it was practiced by the current administration. The transfer payments – along with a drawdown in savings – have certainly propped up consumer spending. What it hasn’t done is lead to investment by the private sector; the rise in private investment was a paltry 1.4% in the first quarter. That is down from a 6.3% rise in the previous quarter and 13% the quarter before. One area of fixed investment that is rising is residential investment but it is from such a low level that the effect on the economy is muted, adding just 0.4% to overall GDP growth. The continued rise in inventories added more to growth than any other type of investment, adding 0.59% to GDP. I know of no economic theory which posits that inventory accumulation is the path to long term growth.
The Keynesians have, of course, been foiled by their own rhetoric. It isn’t as if the only people who knew the stimulus was temporary were the politicians and lobbyists who wrote the bill. Companies and individuals were let in on the secret and not surprisingly – at least to me – they haven’t been keen to invest their hard earned capital to expand capacity based on temporary demand measures. Why expand now just to be forced to contract later on when the stimulus ends? The lack of job creation is a direct result of the measures taken to limit the depth of the downturn. Once again, the free lunch promised by politicians proves elusive.
Now some will certainly say that Keynesianism hasn’t failed but has rather not been tried; if the stimulus had been targeted better, we would have gotten a different result. Others will say that if the “stimulus” is running out – and with interest rates so low – we should just borrow and spend more, that Keynes will eventually be proven correct. Given the success of Solyndra, the first argument leaves a lot to be desired. Given the results of Japan’s 25 year spending binge, the second fares no better. In any case, any stimulus funded through continued deficits is by definition temporary. Contrary to Dick Cheney’s voodoo economics, deficits do matter. There is a limit to how deeply in debt bond markets will allow governments to get, as Europe is discovering now.
So the economy continues its ragged recovery and absent an inexplicable surge of investment appears headed for, at best, a continuation of PIMCO’s new normal. At worst, one of the many challenges facing the global economy – from a slowing China to a fresh round of debt denouement in Europe – causes a return to outright recession. With an election and another debt ceiling debate on tap, further government spending measures seem highly unlikely and as we’ve just seen, ineffective in any case. Those who make their living punting on the stock exchange seem to be placing their faith in further emanations from the Fed’s printing press but betting on further impoverishment of the lower classes is so declasse as to earn one the dreaded moniker of speculator.
The difficulties facing the investor – as opposed to the evil speculator – are myriad. Bonds, while hated by the professional investing class, are the darlings of the mutual fund investor, the so called dumb money in case you’ve forgotten. At current rates of interest and inflation, bonds of all types are overpriced with corporates and high yield priced for continued economic expansion and Treasuries a lottery ticket that only gets cashed in Depression. Cash, as Doug Terry points out in his commentary, is a depressing alternative at zero return but at least offers the comfort of minimal duration. Stocks, on the other hand, are cheap – assuming growth accelerates and profit margins remain at generational highs. If not, well the best that can be said is that the aforementioned dumb money – which hasn’t looked too dumb recently – is avoiding them like the plague. Lest that give you some comfort in holding a portfolio of equities, it should be remembered that the folks who love stocks are the same ones who brought us the real estate bubble from which we’ve yet to recover.
The other available asset classes offer similarly distorted ratios of risk to reward. In a global economy dominated by central banks, hard assets such as commodities and real estate offer only mild comfort to the asset allocator. With the Fed and other central banks caught between the rock of slow growth and the hard place of inflation above their target, further easing seems unlikely until after any deflation becomes evident. That condition, as 2008 amply demonstrated, is devastating for real asset prices, and provides no diversification benefit at exactly the time it is most needed.
Faced with such choices, investors are best served in my opinion by investing in the most overlooked asset on Wall Street – patience. Cash, as I said above, offers no current return but what it does offer is an option on future asset prices. As we’ve sold positions over the last few months we have been faced with the option of buying overpriced bonds, overpriced stocks, overpriced REITs with yields that are only attractive relative to the paltry payouts from bonds, commodities whose future price is tied to Chinese growth and further Fed easing or low risk cash. As long time readers know, we’ve chosen cash. That decision may carry some career risk if the market keeps rising and clients become frustrated with our intransigence with regard to value but I’ll happily accept that risk in exchange for a clear conscience and an opportunity to buy cheap assets in the future.
As this is running long already, I will not bore you with the details of the other economic reports last week. Suffice it to say that the recent pattern of less than expected continues. The majority of reports, like GDP, came in less than consensus. Next week brings a plethora of reports including the ISM surveys and a jobs report Friday. It will be interesting to see how the market reacts if the reports continue to show a slowing of growth. Will stocks move higher in anticipation of more Fed easing or fall due to fears about growth? In hopes of exercising our cash option, I have to admit to wishing more for the latter than the former.
For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: firstname.lastname@example.org or 786-249-3773.
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