Where Are We Now?

The question now is: Have the good times returned for the markets and the economy? In order to answer that question, I am going to borrow a story by Vitaliy Katsenelson which I believe is a good description of where we are today:

The economy reminds me of a marathon runner who runs too hard and hurts himself. But now he has another race to run. So he’s injected with some serious, industrial-quality steroids, and away he goes. As the steroids kick in, his pace accelerates, as if the injury never happened. He’s up and running, so he must be ok; this is the impression we get, judging from his speed and his progress.

What we don’t see is what is behind this athlete’s terrific performance – the steroids.

Of course, we can keep our fingers crossed and hope that the runner has recovered from his injury and what we see is what we get – the athlete is at the top of his game – but there are problems with this thinking. Serious steroid intake comes at a cost: it exaggerates true performance. Steroids can be addictive; once we get used to their effects it is hard to give them up. The longer we take them the less effective they are. Finally, there is a good reason why steroids are banned in sports: they damage the athlete’s body.

Our economy suffered severe injuries last year, and to keep it going massive amounts of steroids were and are being injected – they’re what economists call stimulus (or government intervention).

Let’s take a closer look at the extent of the steroidization.

In the US, things appear to be stabilizing and improving on the surface, but beware, there is a giant IV hooked up to the veins of the economy, through which billions of dollars are constantly being pumped in. The stimulus is everywhere:

• To help the auto industry taxpayers were subsidizing the price of autos through the “cash for clunkers” program.
• The housing market, the epicenter of this crisis, is propped up from different directions.
• The Fed set interest rates at near zero which allows banks to earn a healthy interest-rate spread.

Now let’s look at the side effects:

• Stimulus is a finite endeavor that comes with a heavy price tag. In most cases the stimuli have been financed with higher future taxes and rising government debt, thus higher future interest rates.
• Steroids and stimulus share addictive properties, and the longer we take them the less effective they become; but once we’re used to them it’s hard to give them up.
• Finally, stimuli result in long-term damage. For the most part stimuli just kick the can down the road and result in higher debt and higher taxes.

The stock market’s recent rally followed a typical, by-the-book, coming out of recession trajectory – it was cyclical, i.e., short term.

Source: Vitaliy Katsenelson, Advisor Perspectives, Inc.

Just because the Dow has broken 10,000 again doesn’t mean that our economic problems are behind us. Those of you who attended our recent seminar know that we are pleased with the market’s performance this year, but still believe we are, and will be, in a secular (long term) bear market for a number of years. The following is a list of some of the “headwinds” the economy and the market is facing: 

n      Rising unemployment (10.2%)

n      Rising deficits and massive government debt

n      Rising taxes

n      Rising interest rates likely

n      Slightly overvalued market

n      Low consumer spending

n      No “top line” growth

n      Likelihood of rising inflation

n      Possible deflation

n      Very slow to recover housing markets (High foreclosure rate)

n      Commercial real estate bubble looming

n      Medicare needs to be addressed

n      Weak $

n      Healthcare Reform

n      Iraq & Afghanistan wars

n      More than 120 banks have failed

n      FDIC is stressed – had to ask for 3 years of fees in advance

n      States are running at significant deficits

Optimism is bred into us Americans. In many ways, it is our unique strength. However, when it comes to the markets, if we anticipate only favorable outcomes, aren’t we being naïve?

I am convinced that we can make money in any kind of market. However, a secular (long term) bear market requires different strategies than the markets of the ‘80s and ‘90s. 

Sincerely,

• Five celebrities died in the past few weeks:  Michael Jackson, one of the greatest entertainers of our time; actress Farah Fawcett; pitchman Billy Mays; Johnny Carson’s famous second banana, Ed McMahon; and Karl Malden  I am continually amazed at how much coverage the media gives to the passing of entertainers and celebrities.  I think Bob Schieffer of CBS news said it best:  “Let’s not mistake American icons for American heroes.”
  
• Bernie Madoff, the individual responsible for the largest Ponzi scheme ever, was sentenced to 150 years in prison.  “Here the message must be sent that Mr. Madoff’s crimes were extraordinarily evil,” Judge Chin said.
  
• Iran officials confirmed President Ahmadinejad’s victory over challenger Mousavi after a recount of 10% of the ballots.
  
• Facing an unusual political trial, Federal Reserve Chairman Ben Bernanke disputed accusations last week that he pressured Bank of America to acquire Merrill Lynch in a deal that cost taxpayers $20 billion.

In a three-hour hearing of the House Oversight and Government Reform Committee, Bernanke denied threatening to oust Bank of America’s CEO Kenneth Lewis or the bank’s board members if they abandoned the takeover after discovering spiraling losses at Merrill.

Throughout the day, Bernanke faced often hostile questioning – unusual for a Fed        chairman, who typically commands deference in public settings.

Adopting the role of outsider, Republicans in particular have turned aggressive toward Bernanke, trying to link him to the Obama administration as advocates of government meddling in private industry.  Many Republicans are suspicious of the administration’s plan to expand the Fed’s regulatory powers.

 

It’s an odd shift, because Bernanke is a Republican appointee, and many of his key advocates are Democrats.  And it comes at a pivotal time:  Bernanke’s term expires early next year, and President Barack Obama will have to decide whether to pick his own Fed chief or reappoint Bernanke.

 

Why is it that we often see Congress spending inordinate amounts of time          investigating people and issues that do not appear to need investigating.  In my opinion, Mr. Bernanke was the key player in pulling our economy back from the brink of financial meltdown.

 

And just a few months ago Congress spent a full day grilling Edward Liddy.  Liddy had agreed to take the job of CEO of AIG for $1 a year to try to right the AIG ship, which was barely afloat.

• The life of two auto giants / Who will buy the first Government Made car?

General Motors (1908-2009) was founded on September 15, 1908 by William Crapo Durant (1861-1947), and it grew to greatness under CEO Alfred Sloan.  Peter Drucker centered his first great book, “Concept of a Corporation” (1945) around Sloan’s style of management at GM.  After World War II, GM eventually grew into the world’s largest industrial corporation, employing over 650,000 people and drawing on over 30,000 suppliers worldwide, with outlets in 190 nations.  Here is the arc of GM’s greatness, 1949 to 1988:

• • By 1949, GM reached #1 in corporate income in America, with net earnings of $656,434,232.
    
  • 30 years later, in 1979, GM was still the largest U.S. corporation, with annual sales of $63 billion. The next year, and from 1980 to 1984, Exxon eclipsed GM as the largest U.S. corporation.  But then:
    
  • In 1985, GM regained the top spot, with $96 billion in sales, eclipsing Exxon’s $86 billion.
  • In 1986, GM widened its lead, with $103 billion in sales, compared to Exxon’s $69.8 billion.
    
  • In 1988, GM swept the #1, #2, and #3 Powers Awards, given to the best-made cars for the price.
    
  • But then, in 2009, GM “died” of old age, resurrected by legislation, and referred to as “Government Motors.”

GM has cut its brand list from eight to four.  Gone are Hummers, Pontiacs, Oldsmobiles, and Saturns. (Perhaps the Cadillac division will lead GM to glory again, if regulators don’t emasculate the Escalade.) GM has sold its Hummer brand to China’s Sichuan Tengzhong Heavy Industrial Machinery Company and its Saturn brand and 350 dealerships to auto racing magnate Roger Penske’s Automotive Group.

 

Chrysler Corporation (1925-2009) is also on its last legs.  In 1920, Walter Chrysler walked out of a GM board meeting, vowing to start his own company, which he eventually did on June 6, 1925, his 50^th birthday.  The first Chrysler was a six-cylinder $1,500 luxury sedan.  Chrysler was taking a big risk.  Out of more than 1,000 car makers entering the business since 1905, only 15 survived to 1925, and only three made it through the Great Depression.  The 1925 auto market was dominated by the $375 Ford Model T, but Walter Chrysler, a former president of Buick and VP at GM, made a big bet that people would pay four times that amount for a classy car, in the customer’s choice of colors, and his big life-changing gamble worked.

 

Three years later, on July 7, 1928, after Ford finally ended its Model “T” era, Chrysler moved into the vacuum with the first Plymouth, inviting the press to witness the famous aviatrix Amelia Earhart sitting behind the wheel of their new “People’s Car.” Over 30,000 people came to the Chicago Coliseum for a look at the new Plymouth.  At an affordable $670, Chrysler sold over 80,000 Plymouths in its first year.

 

And now, this 84-year-old company has been reborn as Italy’s Fiat, in a deal    engineered by Washington DC.  According to The Wall Street Journal, internal Chrysler emails reveal that the Obama Administration rushed this shotgun marriage between Chrysler and Fiat.  Despite worries about Fiat’s financial health and its willingness to share technology, the Supreme Court OK’d the deal.

• Al Franken, the comedian from Saturday Night Live, has been awarded the Senate seat in the state of Minnesota.  This gives the Senate Democrats a 60 person super majority, and therefore filibuster-proof.
  
• California is in a state of financial emergency.  If the state goes bankrupt, it will have national repercussions.
  
• U.S. forces withdrew from Iraqi cities June 30^th, turning security responsibilities over to Iraqi security forces.  Some 130,000 U.S. troops will remain in Iraq, and some will remain at urban outposts to assist with security in cities if needed.  But the coming weeks and months will be a test for Iraqi security forces seeking to maintain relative calm in the country.
  
• Unemployment:  Nonfarm payrolls declined by 467,000 in June, up from 322,000 in May.  We are now at a 26 year high of 9.5%.  Even though unemployment numbers are a lagging indicator (i.e., the economy recovers before the employment numbers), this still indicates the economy is perilously week.

Consumer spending, which represents about 70% of GDP growth, will continue to be impaired by the high unemployment.  This could prevent a sustained recovery.  It is likely that the number will exceed 10% before turning around.

• North Korea fired seven ballistic missiles into the Sea of Japan on July 4th.  North Korea is using these tests as a means of reaching political and military goals.
  
  
• President Obama is headed to Moscow for a summit meeting with Russian President Medvedev.  From there he will leave for the G-8 meeting in L'Aquila, Italy, followed by a visit to Ghana.  These meetings hold special significance in our relationship with Russia.