Monthly Market Observations
February 2001
Make It One For My Baby
Eco-Tours...Don't worry, this one's self guided. A little journey through the current economic ecosystem. An ecosystem that is in a bit of trouble, although to many observers of the landscape, current visual health is no real cause for alarm. We caution you, keep your hands and legs inside the car at all times. Monetary ooze is bubbling up from the ground virtually everywhere. Although innocent in appearance, the ooze is known to cause serious financial side effects in humans who have had prolonged and substantial exposure to the substance. Enjoy your tour.
The current deceleration in the domestic US economic environment is happening at one of the most rapid rates experienced in the last two decades. For what appeared to be the cornerstone of "prosperity" so few months ago, the economic sky has turned to a much deeper shade of blue. Daily, thunderheads roll across the horizon. Microbursts have engulfed sectors of the economy such as manufacturing. Kicking and screaming all the way, the technology and service sectors are being sucked into the economic twister that seems to grow in power with each passing week. For the financial markets, what was once an economy characterized as a positive reinforcement mechanism for the upward trajectory of financial asset prices, the tide has turned. The economy is now public enemy number one, threatening to rob common stocks of their function as new age savings vehicles.
During the fourth quarter, the US domestic economy grew at one of the slowest rates in almost half a decade. If it were not for the strength of the services component of GDP, 4Q GDP would have surely been negative. The deceleration over the last five quarters is nothing short of striking.
We take the recently reported US CEO Business Confidence Index as extremely important, given its historical role as a leading indicator. In decades past, the CEO Business Confidence Index has plunged to an ultimate bottom well ahead of consumer confidence, corporate earnings, and other primary economic indicators. The following chart needs very little explanation. The index stands at a twenty year low. If history is any guide at all, this chart says the news regarding the macro economy gets worse, before it gets better.
img src="http://www.contraryinvestor.com/images/busconfidindex0101.jpg">
In addition to the CEO Business Confidence numbers, new orders as a component of various economic statistics (NAPM, Chicago purchasing managers, Philly Fed, etc.) also foretell of further weakening to come. The following is the unfilled orders number from the recent Philly Fed survey:
The Philly Fed orders component looks like a picnic compared to the broader and more meaningful NAPM (National Association of Purchasing Managers) results. The new orders component of the January NAPM fell to a 20 year low. The new orders component of the NAPM carries the heaviest weight in the index. Roughly 30% of the total. The current total NAPM reading coincides with virtually every recession of the last 25+ years.
As you know, in the early 1970's the oil shock swept across America as a chilling wake up call (unfortunately forgotten in meaning in subsequent years). In the early 1980's, NAPM bottom as the US grappled with double digit interest rates. In the early 1990's, not only did we briefly revisit the global geopolitical hot potato that is oil, but were wrestling with junk bond blow ups, the S&L bailout, and a US banking system shaking under the cold blanket of balance sheet credit concerns. These prior period characterizations were times when the NAPM was as bad as it stands today. Humble question: What's the current crisis to cause this type of economic performance? Could it be a decade of credit and monetary expansion leading to excess capacity in manufacturing and ultimately a US consumer staggering under a bloated left side of the personal balance sheet? Just a thought.
The Boomer Consumer...One of the keys to the economy ahead will surely be consumer confidence. After all, it has been the US consumer who has so obligingly levered their personal balance sheets to consume real estate, consumer goods and financial assets during "the longest US expansion in history" (a record soon to come to a grand finale in the quarter(s) ahead).
During past economic bottoms seen in the early 1980's and early 1990's consumer confidence bottomed below 50 on the index. As we have shown you in the past, consumer leverage in prior economic downturns was much less than we find today. As we mentioned, CEO business confidence which leads and already reflects levels seen in the early 1980's and early 1990's suggests consumer confidence has the potential to plunge from here, assuming, of course, that there are no new eras.
Set'em Up Joe...The economy has not needed to waste any of its rescue flares declaring distress to those otherwise distracted. The Fed rescue team has already plunged into action well ahead of any hint of the academic definition of recession. Remarkable action considering the history of the Greenspan tenure. After raising short rates from 4.75% to 6.5% over the last 19 months, the Greenspan Fed has already taken more than half of that back in the last four weeks. Another 75 basis points and we'll be back to ground zero in terms of interest rate policy. The newly elected Bush contingent should be attempting to shore up the economic levee in the months ahead with a little $1.6 billion tax package. Lastly, the Fed is allowing monetary go-juice growth to accelerate at a rate rivaling historic highs. M3 (broad money supply) is growing at an annualized double digit rate at the moment.
Suffice it to say that all the stops are being pulled out.
Make It One More For My Baby And One More For The Road...There is more monetary ease ahead. Fed funds futures predict another 50 to 75 basis points of rate decline between the second and third quarters of this year. There has been recent talk of another inter-meeting Fed Funds rate cut prior to the official March FOMC soiree, given the weakness shown in the NAPM figures. Not so fast. The Fed had the NAPM figures in hand prior to the January month end half-point action. There will need to be some eye opening economic stats ahead to move the Fed to inter-meeting antics. Clearly an avalanche in stock indices from here could also do the trick.
After fighting financial fire after financial fire over the last 13 years with the same old solution (liquid solution, that is), will another round of rate cuts, money injection and soon to be newly minted personal tax breaks be enough to get consumers and businesses spending again? It's nothing short of the key question ahead. The key question not only for the economy at large, but for corporate profits (and, theoretically, stock prices). Although Greenspan is setting up shots of monetary elixir at the bar, has monetary toxicity already set in? From the charts and discussion above, it's more than safe to say that the manufacturing sector in this country is in a recession. Although differing from the consensus soft landing mantra of the Street, it's also a pretty safe bet that the rest of the economy is about to follow down the slippery path the manufacturing sector has already trod. If so, the traditional quick fix of monetary expansion, now coupled with the soon to be unleashed fiscal "payback" (tax cuts), will run headlong into this:
During the last two recessions in this country, the personal savings rate was positive. People actually had money in the bank from which to draw in "hard times". At the current time, most consumer "savings" is either registered as common shares, or involves a refinance to access (as opposed to a bank withdrawal slip). The last time consumer confidence saw present levels, the saving rate in the US was actually positive. The last time CEO business confidence saw present levels, the US savings rate was at our near positive double digits. A clear choice for those many now caught in announced layoffs is to sell their stocks for food and home heating. Who knows, maybe Safeway will agree to swap you a bag of groceries for a share of Cisco. Before they report earnings, that is. One last comment, in approximate terms, every one percent change in the US savings rate equates to about $90 billion in consumer spending (in either direction of, course). God forbid the US consumer actually starts saving. It's no wonder Fed Governor Robert McTeer implored consumers to "go out and buy something" in a speech on February 2nd. And here we thought he was just warming up for Valentines Day.
The other little roadblock of monetary and fiscal policy success in achieving a 180 is this:
During the prior two recessions in the US, we simply were not "borrowing" $1-1.5 billion per day from our more than generous global compadres. Like any borrower who falls on hard times, are that borrower's lenders usually more or less willing to lend the borrower even more? You know the answer. As a matter of fact, that answer is often highlighted in the following chart:
Without the help of his global central bank brethren, Greenspan faces a crossroads ahead. Recently the ECB (European Central Bank) and the UK central bank have passed on lowering interest rates in their respective economic arenas. As Greenspan lowers while his peers stand pat, the dollar will continue to come under pressure relative to global currencies. Simply put, not a good thing for a nation so dependent on "foreign aid", as is the US at the moment. We do expect foreign central bankers to ease to some extent ahead as the US trade deficit is one of the primary reasons their own economies have been able to hold. It seems that never in economic history has the global economy been so reliant on interdependent relationships. The dollar, being the global reserve currency of the moment, is clearly a linchpin or hub in that interdependency. The global dollar and bond vigilantes will clearly be watching and reacting to the Fed's every move ahead.
This is a particularly interesting juncture for the US economy. An economy that has been a partial support mechanism for the global economy over the last half decade. An economy who has been so willing to lever to achieve/maintain positive GDP growth. An economy that now faces its first "digital downturn" in the last decade.
We would once again stress that domestic consumer confidence is a big key here. Simplistically, the US economy is largely driven by consumer spending. That spending has allowed corporate America to do its fair share of capital spending over the last half decade. An about face by the consumer will ripple backwards through corporate America (and global entities exporting consumer goods to the US). The virtuous circle of consumer and corporate spending could find that the domestic economic hot rod has a fifth gear called "reverse". Clearly it's a gear that has not been used for quite a while in an economy subjected to monetary turbo-charging in recent years. From afar, this is simply a replay of the ebb and flow cyclical nature of a capitalist economic landscape. A landscape revolving around the changing nature of human decision making concerning savings, investment and consumption. Nothing new.
Hanging On In Quiet Desperation?...The confidence of the US consumer is important not only for drawing inferences regarding the potential depths of an economic downturn, but also for gauging equity market strength over time. As we have shown you in charts past, domestic inflows into equity mutual funds were positive throughout almost the entirety of 2000. Year end 2000 did see some outflow attributable to both capital gains distributions (counted as outflows) and possible above normal tax loss selling on the part of individuals. After the first week of January (which encompasses a portion of year end 2000), inflows to equity mutual funds have been positive in each and every week. The consumer may be reorienting his/her outlook regarding the real economy, as measured by the consumer confidence numbers, but there is no significant concern regarding equity holdings. This despite a meaningful drop in the ultimate symbol of the new era, the NASDAQ. A drop that rivals financial market tops that legend is made of.
Clearly corporate earnings growth is questionable over the next few quarters. Significant and rapid layoff announcements are now daily routine. Although we live in a digital decision making world, employee cost reductions will not be captured by corporate America until into the second quarter of 2001. Due to legislation passed after the last recession in the US, corporations are mandated to give their employees 60 days lay off lead time. Declining aggregate demand (revenues) will meet with relatively stable to rising cost pressures in 1Q 2001. First Call estimates now put S&P profits up .3% in 1Q. Certainly that is a moving target over the next eight weeks. The question of the moment for the equity markets is, "will US equity holders be confident enough to hold common stocks through what is certain to be an earnings downturn for corporate America, without flinching?" Likewise, will foreigners still flush with US dollars and dollar denominated financial assets forgo capital repatriation during the first US economic downturn in a decade? It all comes down to confidence.
In The Long Run...As we have said many times, confidence destruction as well as confidence acceleration is a "process". The Fed will do its best to bolster economic confidence vis-à-vis monetary ease. The Bush Administration will do its best to bolster confidence through the fiscal realignment mechanism. As we have witnessed in action many times during the past few years, the stance of being a "long term investor" is quite easy to espouse during a bull market. Given the trajectory of corporate earnings over the next few quarters, we have the feeling investors in US equities are about to experience what it really takes to be a long term investor. Given the fast motion digital world in which we find ourselves, do investors have the patience and perseverance? Maybe more importantly, given the speed with which corporate P&L reconciliation (layoffs, cap-ex cut backs, expense reductions) is now occurring, set against the backdrop of heavily levered corporate and personal balance sheets, do investors have the financial wherewithal to go the distance? As we've heard it said, "we'll find out in the long run".
so far, so good
proxi
February 2001
Make It One For My Baby
Eco-Tours...Don't worry, this one's self guided. A little journey through the current economic ecosystem. An ecosystem that is in a bit of trouble, although to many observers of the landscape, current visual health is no real cause for alarm. We caution you, keep your hands and legs inside the car at all times. Monetary ooze is bubbling up from the ground virtually everywhere. Although innocent in appearance, the ooze is known to cause serious financial side effects in humans who have had prolonged and substantial exposure to the substance. Enjoy your tour.
The current deceleration in the domestic US economic environment is happening at one of the most rapid rates experienced in the last two decades. For what appeared to be the cornerstone of "prosperity" so few months ago, the economic sky has turned to a much deeper shade of blue. Daily, thunderheads roll across the horizon. Microbursts have engulfed sectors of the economy such as manufacturing. Kicking and screaming all the way, the technology and service sectors are being sucked into the economic twister that seems to grow in power with each passing week. For the financial markets, what was once an economy characterized as a positive reinforcement mechanism for the upward trajectory of financial asset prices, the tide has turned. The economy is now public enemy number one, threatening to rob common stocks of their function as new age savings vehicles.
During the fourth quarter, the US domestic economy grew at one of the slowest rates in almost half a decade. If it were not for the strength of the services component of GDP, 4Q GDP would have surely been negative. The deceleration over the last five quarters is nothing short of striking.
We take the recently reported US CEO Business Confidence Index as extremely important, given its historical role as a leading indicator. In decades past, the CEO Business Confidence Index has plunged to an ultimate bottom well ahead of consumer confidence, corporate earnings, and other primary economic indicators. The following chart needs very little explanation. The index stands at a twenty year low. If history is any guide at all, this chart says the news regarding the macro economy gets worse, before it gets better.
img src="http://www.contraryinvestor.com/images/busconfidindex0101.jpg">
In addition to the CEO Business Confidence numbers, new orders as a component of various economic statistics (NAPM, Chicago purchasing managers, Philly Fed, etc.) also foretell of further weakening to come. The following is the unfilled orders number from the recent Philly Fed survey:
The Philly Fed orders component looks like a picnic compared to the broader and more meaningful NAPM (National Association of Purchasing Managers) results. The new orders component of the January NAPM fell to a 20 year low. The new orders component of the NAPM carries the heaviest weight in the index. Roughly 30% of the total. The current total NAPM reading coincides with virtually every recession of the last 25+ years.
As you know, in the early 1970's the oil shock swept across America as a chilling wake up call (unfortunately forgotten in meaning in subsequent years). In the early 1980's, NAPM bottom as the US grappled with double digit interest rates. In the early 1990's, not only did we briefly revisit the global geopolitical hot potato that is oil, but were wrestling with junk bond blow ups, the S&L bailout, and a US banking system shaking under the cold blanket of balance sheet credit concerns. These prior period characterizations were times when the NAPM was as bad as it stands today. Humble question: What's the current crisis to cause this type of economic performance? Could it be a decade of credit and monetary expansion leading to excess capacity in manufacturing and ultimately a US consumer staggering under a bloated left side of the personal balance sheet? Just a thought.
The Boomer Consumer...One of the keys to the economy ahead will surely be consumer confidence. After all, it has been the US consumer who has so obligingly levered their personal balance sheets to consume real estate, consumer goods and financial assets during "the longest US expansion in history" (a record soon to come to a grand finale in the quarter(s) ahead).
During past economic bottoms seen in the early 1980's and early 1990's consumer confidence bottomed below 50 on the index. As we have shown you in the past, consumer leverage in prior economic downturns was much less than we find today. As we mentioned, CEO business confidence which leads and already reflects levels seen in the early 1980's and early 1990's suggests consumer confidence has the potential to plunge from here, assuming, of course, that there are no new eras.
Set'em Up Joe...The economy has not needed to waste any of its rescue flares declaring distress to those otherwise distracted. The Fed rescue team has already plunged into action well ahead of any hint of the academic definition of recession. Remarkable action considering the history of the Greenspan tenure. After raising short rates from 4.75% to 6.5% over the last 19 months, the Greenspan Fed has already taken more than half of that back in the last four weeks. Another 75 basis points and we'll be back to ground zero in terms of interest rate policy. The newly elected Bush contingent should be attempting to shore up the economic levee in the months ahead with a little $1.6 billion tax package. Lastly, the Fed is allowing monetary go-juice growth to accelerate at a rate rivaling historic highs. M3 (broad money supply) is growing at an annualized double digit rate at the moment.
Suffice it to say that all the stops are being pulled out.
Make It One More For My Baby And One More For The Road...There is more monetary ease ahead. Fed funds futures predict another 50 to 75 basis points of rate decline between the second and third quarters of this year. There has been recent talk of another inter-meeting Fed Funds rate cut prior to the official March FOMC soiree, given the weakness shown in the NAPM figures. Not so fast. The Fed had the NAPM figures in hand prior to the January month end half-point action. There will need to be some eye opening economic stats ahead to move the Fed to inter-meeting antics. Clearly an avalanche in stock indices from here could also do the trick.
After fighting financial fire after financial fire over the last 13 years with the same old solution (liquid solution, that is), will another round of rate cuts, money injection and soon to be newly minted personal tax breaks be enough to get consumers and businesses spending again? It's nothing short of the key question ahead. The key question not only for the economy at large, but for corporate profits (and, theoretically, stock prices). Although Greenspan is setting up shots of monetary elixir at the bar, has monetary toxicity already set in? From the charts and discussion above, it's more than safe to say that the manufacturing sector in this country is in a recession. Although differing from the consensus soft landing mantra of the Street, it's also a pretty safe bet that the rest of the economy is about to follow down the slippery path the manufacturing sector has already trod. If so, the traditional quick fix of monetary expansion, now coupled with the soon to be unleashed fiscal "payback" (tax cuts), will run headlong into this:
During the last two recessions in this country, the personal savings rate was positive. People actually had money in the bank from which to draw in "hard times". At the current time, most consumer "savings" is either registered as common shares, or involves a refinance to access (as opposed to a bank withdrawal slip). The last time consumer confidence saw present levels, the saving rate in the US was actually positive. The last time CEO business confidence saw present levels, the US savings rate was at our near positive double digits. A clear choice for those many now caught in announced layoffs is to sell their stocks for food and home heating. Who knows, maybe Safeway will agree to swap you a bag of groceries for a share of Cisco. Before they report earnings, that is. One last comment, in approximate terms, every one percent change in the US savings rate equates to about $90 billion in consumer spending (in either direction of, course). God forbid the US consumer actually starts saving. It's no wonder Fed Governor Robert McTeer implored consumers to "go out and buy something" in a speech on February 2nd. And here we thought he was just warming up for Valentines Day.
The other little roadblock of monetary and fiscal policy success in achieving a 180 is this:
During the prior two recessions in the US, we simply were not "borrowing" $1-1.5 billion per day from our more than generous global compadres. Like any borrower who falls on hard times, are that borrower's lenders usually more or less willing to lend the borrower even more? You know the answer. As a matter of fact, that answer is often highlighted in the following chart:
Without the help of his global central bank brethren, Greenspan faces a crossroads ahead. Recently the ECB (European Central Bank) and the UK central bank have passed on lowering interest rates in their respective economic arenas. As Greenspan lowers while his peers stand pat, the dollar will continue to come under pressure relative to global currencies. Simply put, not a good thing for a nation so dependent on "foreign aid", as is the US at the moment. We do expect foreign central bankers to ease to some extent ahead as the US trade deficit is one of the primary reasons their own economies have been able to hold. It seems that never in economic history has the global economy been so reliant on interdependent relationships. The dollar, being the global reserve currency of the moment, is clearly a linchpin or hub in that interdependency. The global dollar and bond vigilantes will clearly be watching and reacting to the Fed's every move ahead.
This is a particularly interesting juncture for the US economy. An economy that has been a partial support mechanism for the global economy over the last half decade. An economy who has been so willing to lever to achieve/maintain positive GDP growth. An economy that now faces its first "digital downturn" in the last decade.
We would once again stress that domestic consumer confidence is a big key here. Simplistically, the US economy is largely driven by consumer spending. That spending has allowed corporate America to do its fair share of capital spending over the last half decade. An about face by the consumer will ripple backwards through corporate America (and global entities exporting consumer goods to the US). The virtuous circle of consumer and corporate spending could find that the domestic economic hot rod has a fifth gear called "reverse". Clearly it's a gear that has not been used for quite a while in an economy subjected to monetary turbo-charging in recent years. From afar, this is simply a replay of the ebb and flow cyclical nature of a capitalist economic landscape. A landscape revolving around the changing nature of human decision making concerning savings, investment and consumption. Nothing new.
Hanging On In Quiet Desperation?...The confidence of the US consumer is important not only for drawing inferences regarding the potential depths of an economic downturn, but also for gauging equity market strength over time. As we have shown you in charts past, domestic inflows into equity mutual funds were positive throughout almost the entirety of 2000. Year end 2000 did see some outflow attributable to both capital gains distributions (counted as outflows) and possible above normal tax loss selling on the part of individuals. After the first week of January (which encompasses a portion of year end 2000), inflows to equity mutual funds have been positive in each and every week. The consumer may be reorienting his/her outlook regarding the real economy, as measured by the consumer confidence numbers, but there is no significant concern regarding equity holdings. This despite a meaningful drop in the ultimate symbol of the new era, the NASDAQ. A drop that rivals financial market tops that legend is made of.
Clearly corporate earnings growth is questionable over the next few quarters. Significant and rapid layoff announcements are now daily routine. Although we live in a digital decision making world, employee cost reductions will not be captured by corporate America until into the second quarter of 2001. Due to legislation passed after the last recession in the US, corporations are mandated to give their employees 60 days lay off lead time. Declining aggregate demand (revenues) will meet with relatively stable to rising cost pressures in 1Q 2001. First Call estimates now put S&P profits up .3% in 1Q. Certainly that is a moving target over the next eight weeks. The question of the moment for the equity markets is, "will US equity holders be confident enough to hold common stocks through what is certain to be an earnings downturn for corporate America, without flinching?" Likewise, will foreigners still flush with US dollars and dollar denominated financial assets forgo capital repatriation during the first US economic downturn in a decade? It all comes down to confidence.
In The Long Run...As we have said many times, confidence destruction as well as confidence acceleration is a "process". The Fed will do its best to bolster economic confidence vis-à-vis monetary ease. The Bush Administration will do its best to bolster confidence through the fiscal realignment mechanism. As we have witnessed in action many times during the past few years, the stance of being a "long term investor" is quite easy to espouse during a bull market. Given the trajectory of corporate earnings over the next few quarters, we have the feeling investors in US equities are about to experience what it really takes to be a long term investor. Given the fast motion digital world in which we find ourselves, do investors have the patience and perseverance? Maybe more importantly, given the speed with which corporate P&L reconciliation (layoffs, cap-ex cut backs, expense reductions) is now occurring, set against the backdrop of heavily levered corporate and personal balance sheets, do investors have the financial wherewithal to go the distance? As we've heard it said, "we'll find out in the long run".
so far, so good
proxi
