DOW 12,000+ and Deficit $1.5 Trillion – an uneven score at best
On the same day that the DOW Industrials traded above 12,000 for the first time in more than two years (1/26/2011), the Congressional Budget Office released its estimate for the 2011 Federal Budget Deficit: $1.5 trillion… and counting. There’s an irony in this that ought not to be ignored. There will also be a price to pay.
In President Obama’s State of the Union speech he discussed the need to cut spending while at the same time make investments with federal resources. President Obama and his economic advisory team’s actions have evidenced in recent years that they clearly adhere to the Keynesian economic concept of a multiplier; suggesting that spending on the part of the government will create more output than it consumes. Without going into too much detail regarding Keynesian economics, lets simply note that Keynes proffered a theory wherein governments may spend their way out of high unemployment problems and lack of consumer demand as the millions spent are expected to create jobs; the wages of which are recycled through the economy via consumer spending, etc. Though some prefer not to recognize the validity of Keynes’s multiplier effect, it’s readily observable and like it or not, Keynes was right; he didn’t afford himself the luxury of having to consider the long term costs of such a plan.
Some argue that with real interest rates hovering just above 0%, such spending, even with borrowed money, has little long-term adverse impact. Add on the possibility that these debts may be repaid with inflated dollars makes the scenario yet less irksome for others. On top of that, many dismiss the debt issue by suggesting that since we’re not financing this debt ourselves, as we’re letting the Chinese and others loan it to us, it matters yet less. These are all good thoughts, but wrought with error nonetheless.
I should note here that I admire the work of John Maynard Keynes, his 1936 General Theory of Employment, Interest and Money is masterful and insightful, and as he predicted, it sparked a revolution in economics. What I find most interesting is how the foundation from which Keynes and his concepts rose. While discussing the underpinnings of his economic philosophies, Keynes offered the following:
The political problem of mankind is to combine three things; economic efficiency, social justice, and individual liberty. The first needs criticism, precaution, and technical knowledge; the second, an unselfish and enthusiastic spirit, which loves the ordinary man; the third, tolerance, breadth, appreciation of the excellences of variety and independence, which prefers, above everything, to give unhindered opportunity to the exceptional and the aspiring. The second ingredient is the best possession of the great party of the proletariat. But the first and the third require qualities of a party which, by its traditions and ancient sympathies, has been the home of economic individualism and social liberty. (From the collected works of John Maynard Keynes; Macmillan 1971-89, page 311)
Far from reflecting the rigidity of marginalist or neoclassical economics, such thinking appears to accept a blend of pragmatism and idealism – a combination that’s often difficult to maintain. For good or ill, it’s difficult for me to find fault with his observations; in fact, I find myself connecting to them on many levels, but in the end, reason must win out and popular or not, Keynesian or otherwise, adding hundreds of billions of dollars onto an already out of control debt burden smacks of irresponsibility. The long-term costs Keynes was unable to address are sometimes just too great to reasonably bear.
In the early days of his administration, President Clinton became one of the first national leaders to describe federal spending as investment. Though we later came to understand what he meant by the term, that such expenditures were to be directed towards infrastructure and other potentially meaningful projects, the economic climate, both domestic and global, was altogether different than that which we’re experiencing today. In the end, spending is spending, and while staring at a $1.5 trillion federal budget deficit, it’s hard to understand how seemingly responsible political leaders can advocate more of the same when we’re clearly mired with a debt burden unimaginable only a few years ago.
The Republican victories of last November could easily be erased if the newly elected House of Representatives supports anything short of iron-fisted wallet tightening. The trick is, how to decrease spending while protecting those in need and maintaining important infrastructure; how to differentiate productive expenditures from those that may be wasteful; or how to tell a generation of baby boomers on the verge of retirement that they may have to put off for another year or three or five, that which they’ve planned for over the last thirty plus years. It becomes a difficult task, but it is the type of challenge that requires leadership to address and through which leaders are formed and identified.
To add to the irony of higher market levels and deficit announcements, 2,500 of the world’s wealthiest met in Davos, Switzerland during the same week to address a variety of issues ranging from those referenced above to how to ease nearly a billion Chinese and Indian workers into the market. Ease is such a difficult term to use when speaking about a workforce roughly three times the size of the entire population of the United States, but it’s equally apt. China and India’s leadership are attempting to balance the needs of their poverty class with real concerns over inflation, infrastructure development, and environmental issues. Additionally, China is striving to keep the Yuan as closely pegged to the dollar as possible, while experiencing widely different rates of domestic growth; a strategy that has proven disastrous for other polities that have attempted to maintain similar currency policies. They’re not to be envied and anyone truly aware of the enormity of what they’re dealing with is anxious to see how such a policy plays itself out.
I do, however, find it fascinating to see how they dance around the issues of global competitiveness when there simply isn’t any music playing. The world is wise to pay attention and consider a future with a stronger China and India filled with resource-hungry consumers demanding higher wages and brighter futures.
With the DOW above 12,000
With 4th Quarter 2010 GDP coming in at 3.5%, we now have 6 back-to-back quarters of positive GDP growth and with each successive quarter, market makers and industry insiders become increasingly confident; to the point that their confidence may finally be making its way to consumers. The Consumer Confidence Board recently reported a 7.3 point increase in consumer and 12 point improvement in CEO confidence for January. As these are the groups that control spending, investment and hiring, the upward shift is significant, especially in the midst of a cold, wet winter.
The market’s resurgence since it bottomed out at just above 6,500 in April 2009 has been built on this growth in confidence, a return to reason and a string of impressive quarterly earnings reports from publically held corporations. Some suggest that a continuation of strong corporate earnings is less likely in future quarters as unemployment continues to hover near 10%, and they’re right. Others point to the ease of showing growing earnings after a period of GDP declines, and they’re right. Yet others contend that the US consumer, having shifted from a net savings rate of less than 2% to one of nearly 7% makes it difficult for demand to maintain levels supportive of ongoing earnings growth, and they’re right. But each of these voices have been heard before, while the markets have continued to improve on the strength of increased earnings. The consumer confidence element is critical as it’s consumer spending that drives increases in revenues and motivates corporate investment. It’s also consumer participation in equity markets that can fuel additional stock market gains necessary to reach new market highs.
Some analysts and asset managers are now calling for the DOW to break 14,000 by the end of 2011. A lofty goal by any measure for a market that has already retraced it movement back to the 12,000 level, but doable if the right sequence of economic, political and market events materialize. Though it’s hard to see how such optimism can be maintained in the face of a $1.5 trillion deficit and the need to one day account for our excesses.
And that becomes the challenge; how to balance the reality of current and future debt levels with optimism for the future. It’s a challenge with which our domestic market is familiar and one that requires hope (however audacious it may be), optimism and clarity.
A Personal Update
Readers of Signature Update may have noticed that it’s been a few months since we’ve published a new issue or offered commentary on economic and market events. It’s certainly not because there haven’t been any events in our economy worthy of attention, rather, many of you know that I’ve been engaged in a doctoral program in economics at the University of Utah that has kept me more encumbered than I had supposed it might. Between assisting in the operations of Signature Management LLC, fulfilling academic responsibilities, and striving to be a worthwhile husband and father, it’s been just shy of overwhelming. However, there’s too much going on in the market and economy to keep quite much longer.
With that said, I thought I’d take the time to comment on an issue of particular import in today’s marketplace and national agenda: the renewed debate over healthcare legislation.
I hope you enjoy the following issue of Signature Update.
A Future For Obama Care?
Many haven’t been terribly impressed with the Patient Protection and Affordable Care Act (PPACA, aka Obama Care) signed into law by President Obama in March 2010; while others see it as a remarkable piece of legislation. In fact, it’s likely neither. As the product of many legislative efforts between two passionate, but opposing political ideologies, the PPACA is cumbersome, burdened by bureaucracy, goes too far in some areas and not far enough in others, and in the end is very expensive while only dealing with some of the pertinent issues. But with that said, there are some basic considerations that we ought not to ignore.
US citizens and our economy suffer from the inefficiencies of the current state of healthcare, health insurance and the rising costs of both… so much so that we still need to solve some major problems. In 1993, when then First Lady Hillary Clinton took on healthcare reform, the nation’s policymakers simply couldn’t reach an agreement over what healthcare and health insurance should look like for the 21st century. Now, some 18 years later, after the healthcare debate has been put in front of the American people repeatedly, we’re coming to grips with what American healthcare coverage should look like and how it may efficiently and equitably cover the majority of US households.
Over the years, the makeup of the US House and Senate has changed and changed again, and with each successive rotation of legislators, voters have formed a congressional body prepared to tackle an issue that has grown from consuming barely 14% of US GDP in 2000 to almost 17% in 2008, with projections of more than 21% in 2011: remember, that’s a growing share of a growing number as GDP increased from $9.76 trillion in 2000 to $14.6 trillion in 2008. In virtually every measurable way, healthcare usage and healthcare costs have risen such that there is no longer any debate over whether or not the American system of healthcare is in need of dramatic change. The only debate is what those changes should be and how they might best be implemented.
The shift in political sentiment evidenced by numerous Republican House and Senate victories in November has now changed, for at least the next two years, the balance of legislative power at the federal level, so much so that the newly installed House of Representatives and more conservative-leaning Senate are seeking an outright repeal of the PPACA. In addition, the constitutional challenges against the Act have gained momentum and it now appears that the individual mandate, central to the Act’s success, may be stricken. Whether or not these efforts will prove successful for their supporters remains to be seen, but what is clear is that further change is in the wind and the outcome may be problematic.
Conservatives have offered open disapproval for many of the tenants of the Act, but have focused more narrowly on two issues raised through the healthcare debates: a potential public option and individual mandates. Both are seen as expanding the role of government and subjecting our citizenry to potential inefficiency and a fearful bureaucratic morass. While recognizing that a problem exists, they’ve been unsuccessful in gathering support for any proposal that is broad enough to deal with the issues at hand. Many in this cohort suggest that free-market competition should be allowed to deal with what they see as a market based issue, but objective observation shows that the healthcare market doesn’t conform to competitive market requirements and some level of regulatory intervention is necessary to provide for our nation’s collective health.
Leftward-leaning liberals have advocated a nationalization of the healthcare and health insurance system and many openly support a public option and single payer system. The PPACA stops short of providing such an option and system, but does include a sought after universal coverage requirement and its functional counterpart, the individual mandate.
Predictably, the two groups continue to be locked in opposition and appear to forget that our nation is a nation of centrists, most of whom simply want a more secure lifestyle without the wrangling of opposing political parties most heavily influenced by their vocal fringes. What appears to evade those seeking to overturn the Act is that our economy, current and future, as well as our citizenry is in need of a better system for providing and paying for healthcare. While the PPACA may not be perfect, its imperfection is the predictable product of compromise in a two-party system. It may also be the one thing keeping a public option or single payer system off the table.
The PPACA’s mandate and universal coverage provisions are interdependent; without the mandate for virtually everyone to be covered by health insurance it becomes unrealistic to require insurers to cover applicants without respect to their health status. The Act only allows for premium cost differentiation based on age, gender and whether or not the applicant is a smoker. The only realistic way an insurer can comply is if they can expect to benefit by having a normative mix of applicants, both healthy and less so. Absent the mandate, a public option becomes almost a certainty in order to cover the less healthy in our society.
The mandate’s possible unconstitutionality hinges on the federal court’s interpretation of the constitution’s commerce clause: is it lawful for the federal government to require the citizenry to purchase a particular good or service? If it is, then the mandate may stand; otherwise, a problem arises and the universal coverage provision will either drive insurers to financial ruin or force higher premiums; neither of which is preferable. Without the availability of reasonably priced health insurance, offered by financially viable insurers, the federal government is likely to have little choice but to intercede and offer a public option, almost certainly accompanied by a single payer system.
Additionally, if the mandate is deemed unconstitutional, but the political will to obtain health insurance coverage for all is strong enough, there’s another, perhaps even less advantageous way for the government to do so. Some legislators have already considered the possibility of having health insurance purchased through state or federal funds and funding the purchase by an increase in taxes. The argument is that the tax increase would be cash-flow neutral for tax payers as it could be accompanied by an offsetting decrease in insurance premiums paid by individuals or employers. A counter argument is that tax increases are a slippery slope and that such a plan would likely lead to a single payer system; which competes with tax increases for conservative disdain, but is highly favored among liberals.
So where does this leave us? We have an expensive piece of healthcare legislation that was signed into law almost a year ago, meaningful portions of which have already become active. We have an energized opposition seeking a dismantling of the law and a still-powerful body in support of it. We have a court system that may one day find parts of the Act unconstitutional, though through a lengthy process that isn’t likely to offer any definitive response until after even more of our healthcare complex has modified its structure to accommodate current regulations. We have a federal debt problem, exacerbated by recent economic conditions, that doesn’t need added pressure from implementation of the Act’s provisions. And, we have an electorate in need of relief from the effects of the recent recession and drawn out election year political battles. Maybe the fearful morass has become inescapable.
Whether the PPACA is repealed through legislative action or is dismantled via the federal courts, the void that might result is almost certain to be filled by future legislative bodies and the manner of fulfillment may be less satisfying to the architects of the Act’s demise than what was provided through the 2010 legislation. Twenty years ago, when our nation could better afford to solve a systemic problem, the political will to find a solution to the healthcare problem wasn’t enough to move the matter outside of the Whitehouse. A year ago, the issue was addressed and measures were placed into law in a hopeful attempt to affect a solution, however economically ill timed. What happens next is certain to disenfranchise some and placate others; hopefully, it will be in the best interests of our citizens.
Record High’s in the Gold Market
With the DOW Industrials closing above the 10,860 level on Friday September 24th, market observers should once again question the applicability of the phrase “Sell in May and go away”. For those investors who sold at the beginning of May 2010, when the DOW was above the 11,000 level, current levels marginally serve to support their late-spring decision. For those who sold later in the month, while the DOW struggled to remain above 10,000, there’s likely a lot of second guessing going on. Regardless, September is shaping up to be the best September in some 20 years, with a month-to-date return of 9.4%. While the month isn’t quite over and remembering that October can sometimes prove to be troublesome – my guess is that May sellers will once again be disappointed that they followed an outdated market idiom.
The price of gold breached the $1,300 level Friday without showing any signs of near-term weakness. Aided by a weakening US dollar and ongoing concerns over federal spending and growing budget deficits, possible tax increases and a decidedly uncertain business climate, it seems obvious that the precious metal has some room to go. With that said, it’s important to remember that buying at all time highs has never proven to be a winning investment strategy.
Though I’ve been skeptical of gold’s ability to remain at levels above $1,200 and have taken “Gold Bugs” to task more than once, it’s difficult to ignore what the gold market may be telling us. The global demand for gold is increasing as a global economic recovery continues, the US dollar continues to weaken against other currencies and US policy makers are likely to accept yet further weakness before structuring monetary policy support in favor of the domestic currency, and investors fearful of federal fiscal policy changes expect long-term inflation to become more meaningful than near-term deflation concerns. None of these come as a surprise of course, but gold’s movement in contrast to other economic pressures remains curious.
Typically, a weak dollar and increasing gold valuations (in US dollars) signal inflationary pressures on the horizon, and there are certainly some indications of this outside of the precious metals market. The price of corn and other agricultural commodities are once again on the rise and personal and household incomes have increased (albeit slightly) despite a less than optimal economy.
On the other hand, energy costs have remained relatively stable for many months now, the cost of housing and transportation have continued to decline, and average retail prices have steadily decreased. Increases in productivity and large scale buying opportunities have aided manufacturing and retail prices on the whole, even though some consumers still find periodic and sometimes surprising price changes at the grocery store.
In recent public statements, Fed Chairman Ben Bernanke has made it clear he remains concerned about deflation and is prepared to take additional aggressive action to keep price levels stable. In truth, he sees it as the most pressing threat to the economy. Were it not for the current weak dollar policy and ultra-low interest rates, deflationary pressures may have already become problematic. The trick central bankers will need to pull off is to tighten monetary policy and strengthen the dollar as deflationary pressures wane and inflation becomes more of concern.
Recovery is a Process and There’s a Long Way to Go
We continue to receive inquiries regarding the strength of the economy, both global and domestic, and questions regarding why there still seems to be economic uncertainty and pain in the face of widely reported economic recovery. The truth is that the US economy, as well as that of many other foreign countries, has now been in recovery mode for over a year. But being in recovery is very different than having recovered and this particular recovery will likely drag on longer than anyone might have hoped.
It’s going to be a while before the pain subsides and the marketplace returns to what might be considered normal. With unemployment remaining close to 10% and the US housing market continuing to struggle, we’re likely to see several additional years of less-than-optimal growth trends. Even then, it’s unlikely we’ll see the high growth rates of the mid-2000‘s. The reasons are many of course, but there is one factor beginning to become more readily observable than had been expected.
America is beginning to retire and the baby boom retirees are set to consume investment capital at a much faster rate than employ it. While the average retiree may only possess less than $200,000 in investment assets, the impact of millions of new retirees drawing from their investment accounts, rather than adding to them, is unmistakable.
Though this shift may not be the central cause of the housing and employment market difficulties, it’s certainly a contributor to prolonging them.
More retirees are turning to lower wage employment for supplemental income and as a means of staying occupied than ever before. Not only has this had an impact on younger workers seeking employment, it’s made it more difficult for recently unemployed workers to find short-term employment while seeking a more appropriate permanent position.
Many of those who purchased second homes in the last 10 years did so with the intention of retiring in the smaller of the two homes and as then sell the larger. Though the opportunity sell may not be as strong today as it was when these near-term retirees began to execute their plans, a large percentage choosing to sell what had previously been their primary residence. For many, this has become preferable to renting the larger home to others or waiting until higher home values are available and selling. Additionally, most retirees didn’t plan on the expense of supporting two residences, possible even two mortgages, during their retirement years. This has exaggerated problems in the housing market and aided in keeping prices low and inventories high.
To be certain, the effect of retirees on the investment, employment and housing market may not seem substantial, but in a nation of complex and interdependent markets even small changes form important outcomes. For those who doubt this, just consider the overall economic impact experienced by a 4% increase in unemployment or how significant it becomes to go from a surplus of 2% to a loss of 1% – it may only be a small move in relative terms, but in many cases it means the difference between winning and losing for households and businesses.
All of this adds to the numerous other factors supportive of a prolonged period of low growth and may cause governments, businesses and households to adjust the way they look at financing operations and where they turn for investments. We’re already seeing that states are reeling from budget issues at first thought to be temporary and businesses have sought capital-consuming productivity gains over bringing back displaced workers.
Though we’ve eschewed the concept of a “new normal”, it’s important to note that the effect of demographic changes, increased federal debt burdens and impending cost changes due to regulatory, tax and healthcare legislation have adjusted the landscape for businesses, households and governments.
What continues to be impressive is the strength and resiliency of the US consumer and domestic economy as a whole. Regardless of how daunting issues may appear to some, the bulk of decision makers are prepared to move forward and challenge fear in search of what comes… and that may be the important factor of all.
The recent malaise in the US stock market continues to reflect the same pattern of uncertainty discussed in the August 13, 2010 issue of Signature Update. So much so that it’s becoming increasingly difficult to ascertain if the difficulties in the housing and employment markets are cause or effect for the equity market’s fluctuations in recent weeks. What is relatively certain is that the markets are looking for leadership, of which there appears to be little on the horizon.
Though the markets are trading well off their late-April/early-May high’s of over 11,000 on the DOW, the markets are currently trading in the same range as late May and have a good chance of once again besting the “sell in May and go away” protagonists who regularly come to the surface in early summer.
It’s true that we can continue to argue that PE ratios make many US stocks look cheap and that there are numerous indicators suggesting we’re dealing with an undervalued market. There are also credible concerns being raised by knowledgeable market observers and there’s no discounting the impact 9.5%+ unemployment is having at the household consumption level.
On the brighter side, recent M&A (Mergers and Acquisitions) activity has provided excitement; not just because of the upside potential available to shareholders of targeted corporations, but because it signals that some of those with the greatest resources to invest see that there are some real bargains to be had in the current market. Among those deals sparking the most interest have been the Dell-3Par competitive bid against rival Hewlett Packard, the BHP-Potash hostile takeover bid and the Stryker-Gaymar acquisition announcement; each one offering excitement to an otherwise lackluster market. In the end, it’s going to take more than M&A activity to give legs to the current market; investors are looking for leadership and sustainable, increased consumer demand – both of which would appear to be in short supply based on current indicators and in light of uncertain economic conditions. But just how uncertain are they?
Clearly the trajectory of the mid-term 2010 elections has put into question what the fiscal and regulatory environment may look like in 2011-2012. Few but the most ardent supporters of President Obama are prepared to suggest he’ll succeed in a bid for a second term, but the markets have already discounted for potential, near-term outcomes – higher taxes, higher spending and more regulation courtesy of an increasingly larger federal government. As the summer winds down and the direction of early-November election outcomes become less vague, the markets appear poised to reward patient investors who stayed the course and resisted the urge to take on a more defensive portfolio.
