The Bald Eagle belly flops?

The Dubai debt crisis has clearly garnering the attention of investors around the world but in reality the sums involved are small compared to those in the initial stages of the financial crisis and, in all likelihood, the surprises that still await us. More to the point is that the market reaction shows how nervous investors are at heart, with rapid economic recovery far from certain, particularly in the US.

While China is undoubtedly the star of the moment (although with serious concerns attached) the sustainability of its current rate of growth still ultimately relies upon its ability to export and the worlds biggest consumer continues to be the American public,  who make up 70% of what is still the world’s largest economy by some margin. As a result the US consumer remains the single largest contributor to world trade and is central to any global recovery. Indeed unless the US picks up strongly global growth will remain anemic at best and increasingly vulnerable to shock.

Strong Growth ?

However on the 29^th October the world received a much needed economic boost with news that the US economy had grown during the third quarter by 3.5% after declining for over a year. This has subsequently been revised down to 2.8% although of course this figure is annualised so the gain over the quarter was under 0.7%. We would humbly suggest though that those of an optimistic bent don’t spend too much time drilling down through the figures (made available in detail on the website of the Bureau of Economic Analysis – BEA – website. It’s laugh a minute).

Of the 2.8% it seems that 1.17% came from vehicles and recreational vehicles (cash for clunkers), 0.45% from residential investment (up to $8,000 tax breaks for first time buyers), 0.87% from inventory rebuilding (an expected and necessary rebound from the massive write downs in previous quarters) and finally an increase in Federal Government expenditure (by a government which is, oh so deeply indebted) of 0.65%.

That is 3.14% growth (so 112% of the total) largely on the back of unsustainable government spending, short term stimulus, promoting more consumer debt and by a rebound in inventories which was inevitable unless we were facing the mother of all depressions. There seems a fair chance that as stimulus is removed (which it must be, such is the parlous state of the governments finances) growth will fall away dramatically, if not back into outright recession.

Unemployment, Less Bad Apparently

The November US non-farm payrolls were well taken with the headline figures beating expectations and certainly far better than those seen earlier in the year. Unfortunately markets are so busy looking at the monthly numbers the key fact seemed to be missed by many and that was the total percentage of the workforce unemployed jumped to 10.2%. One of the problems with US unemployment figures is that if you stop looking for work for four weeks you are removed from the statistics. You are officially no longer unemployed. No, really.

It is thought likely that with a slight increase in optimism at the end of summer more people started looking for work and were then re-registered as unemployed. If those who are underemployed (those who want to work full time but have accepted part time hours) are also included it is estimated the true unemployment figure is over 17%

But US Retail Sales are pretty good!

Headline sales figures for October were slightly ahead of expectations, with same store sales up by 5% year on year, which followed on from good September figures, prompting some headlines to declare US consumer spending was on the up. Unfortunately sales volumes and money spent are two different things, a point made recently by the excellent Texan analyst John Mauldin (whose regular commentaries can be found at www.2000wave.com). As he points out, one way to really see how much is being spent is to look at sales tax figures as these are based upon actual receipts and many states posted significant double digit declines in tax received during October.

Overall sales volumes may be up but the amount being spent has clearly fallen. Furthermore combined with falling income tax receipts this is rapidly leading into another problem, apparently overlooked by many.

Fiscal Stimulus falters faster than anticipated

With sales tax receipts slumping and growing unemployment slashing income tax revenues some individual US states are facing huge budgetary problems. We all know that California is flirting with bankruptcy, delaying inevitable hard choices but other states face difficult decisions, with budgetary cuts of up to 20% expected in low profile Michigan for instance. Apparently some of the budgetary shortfall has been met by utilising federal aid for infrastructure projects, which in turn will dull the stimulatory impact of these measures.

Record numbers late on US loans

A headline in the FT on 20^th November, reported on how one-in-seven US mortgages are either in arrears or in foreclosure. The highest level since records began in 1972. Enough said?

Well not quiet, home sales have picked up lately (on the back of the first time buyers tax break) but prices are still falling in many states, which is likely to continue if foreclosed homes are pushed back into the market.

 US Insider selling

A slightly alarming figure we have recently encountered indicating that the ratio of corporate insider selling shares (legally and visibly) against buying stock in the market is now at 18-to-1. This hardly inspires us with confidence.

Strong third quarter results

The bulls are keen to point out how strong the Q3 reporting season in the US has been, although as we have mentioned before when forecasts have been slashed to the bone beating them shouldn’t be too difficult. Nonetheless across the US overall profits (in aggregate) surged by $123 Bln, or 13.4% which is pretty impressive. However if you drill down through the figures you find that $97 Bln of that (79%) of that came from the financial sector (which makes up about 25% of the market) which is in receipt of the massive stimulus injected into the markets and benefitting from nearly zero interest rates.

Average profits from non-financials were up 0.6%, which is pretty poor from depressed recessionary lows.

The end is not nigh

As we have stressed repeatedly; we are not all doomed, but the continued refusal of certain mainstream commentators (who did not foresee the trouble we have blundered into) and major investment banks (who had a large role in creating the hole we are in) to even examine the detail of our current position is alarming. The thought that we can simply take the massive government and central bank largesse as being normal, with no concurrent consequences, stores up likely future disappointments

How and when reality reasserts itself remains uncertain but perhaps our worst fear is that sufficient momentum will continue to generate superficial strength for sometime, all the while allowing the underlying problems to grow larger while simultaneously blowing new bubbles. Then when reality again bites there will be no ammunition left in the bag to respond.

This is not our base case but the risks grow the longer markets ignore them.

And finally……

Deep within a forest a little turtle began to climb a tree.

After hours of effort he reached the top, jumped into the air waving his front legs and crashed to the ground.

After recovering, he slowly climbed the tree again, jumped, and fell to the ground.

The turtle tried again and again while a couple of birds sitting on a branch watched his sad efforts.

Finally, the female bird turned to her mate.
"Dear," she chirped, "I think it's time to tell him he's adopted."