Why We’re Buying In This Market: Part Six

The rest of this series can be found here.

What Happens Next

The manufacturing sector of this country is improving faster than the rest of the economy, and in the macroeconomic sense, it is buying time for everything else to catch up. It, too, produces confusing economic data points, and it certainly won’t go straight up forever, but core capital goods data (riveting!) indicates that businesses will continue to invest strongly the rest of this year. In the aggregate, corporate profits right now are high – and increasing. This gives firms the ability to invest and hire. That will eventually improve job growth, which will, in turn, improve “consumer confidence” – a slightly more pleasant turn of phrase than “people will go to the mall,” but basically meaning the same thing.

Because the Federal Reserve will continue to keep interest rates very low, access to credit for small businesses will improve as banks earn their way out of their past sins. Once housing prices truly hit bottom, even more credit will flow. The recovery will then be able to sustain itself without being dependent on government stimulus. Then, we’ll be really growing. No training wheels or nothin’.

This will take time, though perhaps not as long as you might think. And it won’t be the kind of recovery that will knock your socks off. Again, job growth will probably be anemic, and housing will remain ugly for a few more quarters. But things should soon start to feel better than they do right now.

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.
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One Response to Why We’re Buying In This Market: Part Six

  1. Kirk Kinder says:

    Good series of posts. I always subscribe to Lou Holtz’s statement that things are never as good as they seem and things are never as bad, it is somewhere in the middle that reality falls. I think that is probably true about the economy. Prechter is preaching doom to sell books. For the Dow to hit his 1,000 level the Dow would sell at 1/4 of its book value. Just can’t see that. Not impossible to get to one times book as most secular bull markets start there and that is where Japan is now, but below that seems impractical. Krugman just loves guv spending and will say what it takes to get more socialism. By the end of this period, I hope they take his medal away.

    I think talking double dips is being too short sighted. We are in for a period of adjustment that will take years. The less the government does, the quicker we get through it. Here is my Austrian take (economist, not Schwartzenegger). Since the 1980s we have increased debt faster than GDP or income growth. This can go on for quite some time just as a family can rack up credit card debt to spend beyond their income. Eventually, you reach a point where the debt is no longer manageable. At that point, one has to spend less to manage the debt or default on the debt. Both are bad for the economy in the near term. We, as a nation, have 3.7 times as much debt as GDP. This is clearly untenable and is 25% higher than the ratio reached at the height of the Great Depression. Japan tapped out in 1989 at about 2.9 times GDP.

    If you look at Japan’s GDP figures over the past two decades, it has been positive in 4/5 of the quarters. But, many of the positive quarters were just shallow numbers. They have yo-yoed with government stimulus for years. After each instance, the markets tumbled when the stimulus wore off. For all this stimulus, they sit precisely where they did in 1989 as far as Debt to GDP. Consumers and corporations delevered while governments levered up. Krugman wants the US to lever up to stop a debt deflation or deleveraging, but is this really a good idea. Japan’s market is 80% from its peak and real estate sells for values last seen in the 1970s. Plus, they are no closer to getting out of their mess than they were when it started.

    Even if we delever we won’t experience the 1930s so long as we don’t get a Smoot Hawley protectionist trade war. The 30s saw trade wars and drought. The drought was especially damaging because many families still lived on the family farm back then. We were still 1/3 agrarian. Plus, the 30s had zero safety nets like unemployment. So put away the MREs and shotguns.

    But, we will experience muted growth, and subsequently volatile markets, until our debt levels are more manageable. What scares me though is the level of unfunded liabilities on the horizon. The big advantage the US had in the 30s is once the debt levels receded after the war, the economy was set to flourish. Even if we can get healthy in the near term, we have a level of unsustainable debt on the horizon.

    However, I agree with Cale that finding good companies with a margin of safety is the only thing you can control. This goes for looking at countries with better balance sheets (think emerging). It is time to be an investor and not a speculator. If you can’t handle volatility, just roll jumbo CDs and deal with lower returns.