UNCERTAINTY
While we are facing an uncertain economic future, there was certainty in last quarter’s stock market performance. In general, the popular market averages were down around 12%, one of the worst quarters we’ve had recently. But how can this be occurring amid forecasts of economic turnarounds and the constant drumbeat of the “better than expected” economic and earnings reports? And where are the banks and government market manipulators who have in the past kept stock prices elevated? Perhaps they are seeing something that the popular media has yet to see. It appears that many “crystal balls” are now broken. And the cause, in my view, is an uncertain economic future (at least for now).
So where am I seeing uncertainty? Here are a few bullet points:
· Housing – The housing sector is collapsing again. Existing home sales plunged 2.2% in May. This is the second worst monthly drop in history. Not to be outdone, new home sales fell 32.7% in May from the prior month to a seasonally adjusted annual rate of 300,000. This level of new homes sold was the lowest since the government begin compiling this data in 1963. In addition, home buyer traffic fell by 45% in May from April as measured by Campbell Surveys which conducts a monthly survey of 3,000 real-estate agents.
Foreclosed homes now accounted for 31% of all residential sales in the first quarter of 2010. According the RealityTrac, in a normal market, only one to two percent of home sales are foreclosures. The average discounts on foreclosure purchases increased from 21% to 27% in the first quarter of 2010.
Goldman Sachs (not my favorite source) says that U.S. housing values will fall 3% in the coming year, with the heaviest blows coming to Las Vegas, Portland, OR. and Seattle where values are predicted to fall from 4% to 12% in the coming 12 months.
I find it ironic that home buyers, who took advantage of the government’s $8,000 new home buyer credit, might have received a much better deal if they had waited until after the tax credit expired. If housing prices drop by just 3% over the next 12 months and you are looking to buy a $500,000 house, then you just saved $15,000, a much better deal than the $8,000 government tax credit. And you’ll get it without filling out a lot of paperwork.
· Jobs – In June, non-farm payrolls fell 125,000 after rising 433,000 last month. Both the rise in May and the collapse in June were attributed to the temporary census workers. Now, you might think that the census effect is now over, but you would be wrong. There are still approximately 350,000 temporary census workers that will come off the employment rolls in the coming months. That combined with the new layoffs occurring in almost every municipality in the country does not bode well for future jobs reports. Most municipalities run on a fiscal year from June to May and face extreme budget cuts for the coming year. While the federal government can continue to function by printing money and running deficit budgets, municipalities can not.
You may be wondering why the unemployment rate improved from 9.7% to 9.5% while there was a loss of jobs in June. The answer is that some 652,000 people are no longer looking for work and are not counted as “unemployed.” The real unemployment rate is very close to 20%. This is supported in the government’s own report that the percent of the population that is employed declined to 64.7%, the second lowest number ever posted in many decades of data.
Decreases were seen for the average work week and average hourly earnings. May factory orders came in at -1.4%, almost triple the dour expectations of -0.5%. And commercial construction spending is down 15.2% from a year ago. Where are all those shovel ready projects?
· Taxes – It is uncertain as to whether or not the so-called Bush tax cuts will be extended beyond this year. Unless Congress takes action and the President goes along, rates will go up for everyone, not just the wealthy. The current six rate brackets of 10%, 15%, 25%, 28%, 33% and 35% will be replaced by five new brackets with the higher rates of 15%, 28%, 31%, 36% and 39.6%.
Currently, the maximum rate on long-term capital gains and dividends is 15%. Starting next year, the maximum rate on long-term gains will increase to 20%. The maximum rate on dividends will skyrocket to 39.6% unless Congress and the President limit the rate to 20%. Right now, folks in the lowest two rate brackets pay 0% in long-term capital gains and dividends. Starting next year, those folks will pay 10% on long-term gains and 15% and 28% on dividends unless a change is made.
In addition, we may see a return of the marriage penalty, the return of the phase-out rule for itemized deductions, and the return of the phase-out rule for personal exemptions.
· Debt – How much larger will our national debt be and will we be able to amortize the debt and pay the associated debt service? The Congressional Budget Office has estimated that by year-end, the national debt will reach 62% of Gross Domestic Product. The budget office said the debt will reach its highest percentage of GDP since the end of World War II. By contrast, debt as a percentage of GDP has averaged a little above 36% per year over the past 40 years.
The co-chairman of the President’s Debt and Deficit Commission offered an ominous assessment of the nation's fiscal future by calling current budgetary trends a cancer "that will destroy the country from within" unless checked by tough action in Washington.
Other areas of uncertainty include the current unstable international situation, the negative impact to the economy from the Gulf oil spill, the impact from the recently enacted healthcare legislation and any cap and trade legislation that may be approved.
Verizon’s CEO Ivan Seidenberg who is also the head of the Business Roundtable stated, “By reaching into virtually every sector of economic life, government is injecting uncertainty into the marketplace and making it harder to raise new capital and create new businesses.” The bottom line is that at present the private sector is not using their capital to invest in plant, equipment or people mainly due to current uncertainties. Without jobs, consumers can not buy houses or goods and services. And the federal government can not spend its way out of our current economic woes.
Going into the next quarter, several factors are of concern:
· The Economic Cycle Research Institute registered negative growth for the fifth consecutive week coming in at -8.3. The rate of decline from the peak in October 2009 is unprecedented since the index was first devised in 1967. The ECRI weekly leading index has had a very respectable record for forecasting recessions and based upon its current reading, we are nearly there.
· An indication of potential global economic troubles can be shown via the Baltic Dry Index. This index tracks global dry shipping goods. Since May, it has been plunging like a rock.
· Technically, the major market indexes are struggling below their 200 day moving averages and the 50 day moving average is now below the 200 day moving average. Momentum is to the downside.
· Seasonally, by historical measures, the coming quarter has been a difficult period for the stock market.
Given current existing uncertainties and the headwinds the market may face this quarter, I believe that a prudent course of action is to maintain our defensive stance until the uncertainties become less uncertain and we enter into a more favorable seasonal investing period. Our defensive position, in general, has served us well particularly this last quarter. Nevertheless, while we need to be mindful of the potential risks that are now present, we also need to remember that present challenges may provide future opportunities to generate attractive stock market returns.
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