October 21, 2009
2009 Q4 Newsletter
It is pretty amazing how quickly sentiment changes. Looking at the headlines today, it almost seems like the world has completely forgotten the small financial crisis we had last year. There is even talk now that maybe everybody overreacted and things really were not as bad as we thought back then. So we thought that reviewing the fundamentals of some of the most important economic drivers would help shed light on whether things had really gone back to the good old days. We will look at the raw numbers around unemployment, retail sales and capacity utilization hoping that this would give us some clarity on the euphoria in the markets. One of the key indicators to watch during this economic downturn is the unemployment numbers. Consumer spending accounts for over 2/3rds of our economy so it is imperative that the consumer stay gainfully employed and bring home income. The pundits would like you to believe that the employment situation is getting better because on a weekly basis we are losing fewer jobs than we used to. Taking a look at the recently released September report from the Bureau of Labor Statistics shows something a little different. The headline increase in September for the number of unemployed was 263,000 workers1, however we like to look at the actual number of people who are EMPLOYED since it is the Employed x Wages = Personal Income. Taking a look at that number we actually lost 785,000 income producing workers from August to September.1 The reason that the two numbers do not add up is that workers who have not looked for a job in the last 4 weeks are removed from the labor force so they are not counted as being unemployed. According to the September report on The Employment Situation, we have lost 7.6 million jobs since the beginning of this recession bringing the unemployed total to 15.1 million. If you count all the discouraged and marginally attached workers then the total number of unemployed workers grows to 23 million.1 This along with the length of unemployment has produced results that are unprecedented as you will notice in the chart below. |
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Chart #1
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The chart clearly illustrates that we have never had workers stay unemployed this long since this data has been available. One of the main problems with having people out of work for such an extended period of time is that they start to lose their skills over this period of time and/or their skills can become obsolete. That is why we believe that to create an economy with strong long-run prospects then this problem of structural unemployment needs to be addressed as quickly as possible. Inversely, as long as the employment situation is continuing to get worse, economic growth will be subdued. |
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Chart #2
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Retail sales are another strong indicator of the state of the economy and provide a good gauge on the consumer’s state of mind. The more confident consumers are with their employment situation and the overall state of the economy the more willing they are to spend. The Cash for clunkers program provided a nice boost for retail sales in August, but September sales are still down 6.6% from a year ago2. The large drop in auto sales in September gives the impression that auto sales were merely pushed forward and new sales were not triggered from the program. |
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Chart #3
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In total dollars Retail Sales are currently running $293B behind 2008 cumulative total through September2. If we do not lose any more ground for the rest of the year this $293B is still a 2% drag on GDP. This is with the massive amounts of fiscal and monetary stimulus that has been injected into the economy through the year. Retail Sales is at ground zero when it comes to measuring the health of the US consumer. Clearly in light of the high levels of unemployment and lack of credit availability the consumer has had to retrench from their previous shopping habits. The valuations in the markets currently suggest that long-term economic growth is expected to be 4.5%, but we believe that it is highly improbable that this economy can sustain this rate of growth with the current headwinds. The last item that we wanted to address is Capacity Utilization and especially in regards to what this signals about possible inflation in the short-term future. Take a look at the chart on the right that shows Manufacturing Capacity Utilization since 1970. We are currently at the lowest levels this nation has experienced in nearly 40 years. What this means is that our economy has a lot of slack to absorb before we come across supply constraints that may lead to pricing pressures. | |
Chart #3
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Two distinct ways inflation can take hold is from a wage led spiral of too much money chasing too few goods. With unemployment and capacity utilization at the current levels it seems unlikely that this type of inflation could take hold in the next 18-24 months. The other type of inflation would be a commodity spike from a crash in the dollar. This is the more likely scenario of how inflation could take hold, but what we learned from last year is that demand is the overwhelming price-setting mechanism in the commodities markets. The decrease in demand from the recession brought oil prices down over 70%. A major decline in the dollar (40%+) would, in our opinion, cause a major disruption to the world economy and we would expect the demand destruction to cause commodity prices to still fall in dollar terms. That is why we still believe that inflation should stay muted in the near-term and we will continue to focus on buying assets at attractive prices. At this time the stock markets around the world are not looking so good. Thank you, Excelcia Financial Group | |
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