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Column by Jim Flinchum, Inside Business, Hampton Road, 7/10/2009
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For the stock market,
the second quarter was great. For the economy,
the second quarter was only “less bad.”
The Dow was up 11 percent, the best quarterly
performance since 2003. The S&P was up
15 percent, the best since 1998.
Significantly, the tech-heavy Nasdaq roared
to life with a 20 percent improvement in Q2.
This is significant because technology and
small company stocks usually lead the way
out of bear markets. Small cap stocks were
up 45 percent since their lows on March 9.
However, on a year-to-date basis, the S&P
was up a mere 1.8 percent, while many foreign
stock markets, especially the more volatile
emerging markets, did far better:
| China |
+60.5% |
 |
| Russia |
+55% |
| India |
+49.5% |
| Indonesia |
+47.2% |
| Israel |
+41.4% |
| Taiwan |
+39.0% |
| Argentina |
+43.2% |
| Brazil |
+32.3% |
| Chile |
+28.2% |
| Columbia |
+28.3% |
| Venezuela |
+23.6% |
Our ailing U.S. economy decreased 5.5 percent
in Q1, but this is an improvement over Q4
of last year, when our GDP decreased at a
6.3 percent rate, the worst six-month economic
performance for the U.S. in over 50 years.
Estimates for Q2 range from flat to 4 percent
down; still not pretty but relatively better.
The most overused phrase of the second quarter
of this year has to be “green shoots,”
an expression used by Fed Chief Ben Bernanke
to describe the earliest signs of economic
recovery, and there were many. For example,
personal incomes were up 1.4 percent in May,
far exceeding expectations of only 0.3 percent.
The all-important consumer spending was up
0.3 percent. Orders for durable goods also
increased 1.8 percent, for the second month
in a row.
Targeting the dollar
Since early March, the dollar has lost 11
percent of its value against the euro and
17 percent against the British pound.
With a federal budget deficit at a whopping
13 percent of GDP, the highest since World
War II, there are not many rosy outlooks for
the Greenback.
As you can see from this chart of the Dollar
Cash Index, the general trend over the past
five years has been down, except for the panicked
flight to the dollar during the crash last
year. However, the dollar has now clearly
broken the moving average to the downside,
which is significant.
When the dollar became the primary or “reserve”
currency for the world, it increased demand
for the dollar and therefore increased the
value of it. One of the most important long-term
events of the past quarter was that serious
debate has now begun as to whether the dollar
should remain the world’s reserve currency.
China has asked for another discussion on
this during the G-8 conference in Italy this
month. It won't happen now, but we think it
certainly will happen.
Green shoots or dream shoots?”
The World Bank said the crisis was far from
over and revised its 1.7 percent original
estimate of global GDP decrease this year
to 2.9 percent, a big change in the wrong
direction.
While consumer confidence dropped in May from
54.8 to 49.3, it is way up from the low of
25.3 in February, when many still feared “the
end of the world.” A green shoot?
The 20-City Case-Schiller Index of housing
prices shows a 33 percent decrease since their
high in the second quarter of 2006, but recent
monthly reports are showing smaller decreases.
Another green shoot?
6,500,000 – That is how many people
have lost their jobs since this recession
began in December of 2007, including the 467,000
who lost their jobs in June alone. Economists
were expecting only 322,000 to be that unlucky.
Nobody should expect much improvement in this
until next year. Unemployment is a lagging
indicator, which means it will continue rising
after the economy bottoms out. The green shoot
is that average monthly job losses in the
first quarter were over 600,000, compared
to about 400,000 in the second quarter. That’s
good, right?
The rate of unemployment rose to 9.5 percent,
the highest in 26 years. Another 5.8 percent
of the workforce is under-employed, working
part time while seeking full-time employment.
In other words, over 15 percent of the workforce
is financially stressed, and, since consumer
spending is two-thirds of the economy, who
will do the spending?
Economics 102
The most interesting piece of data that nobody
noticed was the fifth consecutive monthly
decrease in China’s exports, down 26.4
percent in May from the previous year, while
business investment in the U.S. was up 4.8
percent, the biggest jump in five years.
Every country wants to maximize their national
income, which is usually measured by GDP or
Gross Domestic Product. It is the total of
consumption spending (C), business spending
(I), government spending (G), and the net
gain or loss from international trade (E).
The basic formula looks like this:
GDP = C + I + G + E
The U.S. is currently a consumption-based
economy, with spending by consumers reaching
about 70 percent of our GDP. Because people
from emerging economies don’t have the
money to buy all the things they want, they
invariably start as an export-based economy
to get that money. China has amassed an enormous
cash reserve by exporting and has now begun
encouraging the Chinese to consume more. Their
C will become larger, while their E becomes
relatively smaller.
In the U.S., we can deal with our massive
debt burden by raising taxes, which reduces
our national income or GDP because it reduces
C or consumer spending. Or, we can “inflate
it away” by allowing inflation to reduce
the value of the fixed amount of debt, which
is probably the “ethical thing”
to do for the next generation. Doing so would
decrease the value of the dollar, which would
increase our exports, because our exports
would then be cheaper to foreign buyers. Our
C will become smaller, while our E will become
relatively larger.
This is a huge transformation, probably taking
a decade or more, and presents several investment
challenges.
How we are managing it
Because we are convinced serious inflation
is coming in another year or so, we are gradually
increasing our exposure to commodities and
consumer staples. Because that inflation will
hasten the erosion of the dollar, we are also
adding foreign currencies, especially those
of commodity-rich countries.
Because we think globalization has benefited
the rest of the world so much, we will continue
to invest outside the U.S. Because unemployment
falls faster in emerging markets than in developed
ones, we are partial to those markets.
As mentioned, we have been increasing exposure
to small cap stocks. Some interesting recent
research by Russell Investments found the
best time to “load-up” on small
caps is 3-6 months before the bottom of the
economic cycle.
Yes, there are indeed green shoots! But, we
think those shoots are very slow-growing.
Jim Flinchum, a financial planner and economics expert, is the managing principal of Bay Capital Advisors, an investment advisory firm in Virginia Beach. He can be reached at www.baycapitaladvice.com.
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