Today's Market WrapUp 04.29.2003 Mon Tue Wed Thu Fri Puplava Archive
The
Recovery
BY
JAMES J. PUPLAVA, CFP
Now that the war is over the economy can begin growing again. Businesses will start spending money and the consumer will once again go back to borrowing and spending. The consumer accounts for close to 70 percent of the U.S. economy. Therefore, what the consumer thinks, his state of mind and what he does is of major concern to policy makers. Today was good news for economists because consumer confidence jumped from 61.4 in March to 81, the biggest increase in 12 years. The jump in confidence is attributed the end of the war in Iraq, a drop in energy prices and a rising stock market. Now economists believe the consumer will go back on a borrowing and spending spree and help jumpstart the economy.
The jump in confidence is probably attributed to the end of hostilities in Iraq and no accompanying terrorist attacks here in the U.S. However, the confidence numbers may not mean much. In 1991, confidence also jumped after the Gulf War ended. The postwar rise was short-lived. Back then, corporations were downsizing and firing workers to cut costs. A recovery had begun in the economy, but it was a jobless recovery. The jump in confidence was short-lived and by February of 1992 the index was back in a slump along with consumer spending. Confidence matters but a job is even more important. It is hard to maintain spending patterns and confidence if you just received a layoff notice from your employer.
During the first quarter the Labor Department said that labor costs rose at the highest rate in 14 years because of rising benefit costs for employers. The employment cost index increased 1.3 percent, almost double the cost during the fourth quarter. Benefit costs for employers rose 2.2 percent. The jump in benefits was mainly due to health insurance and pension costs. That is why companies are laying off more workers. They have very little pricing power so they are trying to improve margins by reducing costs, mainly labor. Today Ericsson announced plans to cut 7,000 jobs and Alcatel would also reduce its workforce. At this point, given the jump in weekly unemployment, claims and the rise in the unemployment rate, how do unemployed workers maintain their spending power? Economists are still forecasting an increase in consumer spending of 3.3 percent this year. Where does the money come from? How many times can a homeowner refinance a home and how much equity can they extract before bankers begin to feel uncomfortable with the collateral value that is left unencumbered in the property?
These are questions that need to be answered if one is to believe that a major recovery within the economy is going to take place later on this year. The economic numbers in manufacturing, service and the unemployment numbers speak of weakness, not strength, in the economy at the moment. Capex spending has also been restricted as companies try to conserve cash.
Even if the consumer once again embark on a borrow and spend spree, where does that money flow to? Much of today’s consumer spending has been directed towards imports. Just go into a Best Buy or a Circuit City, stores that sell merchandise based on discretionary spending, and what do you find? The TVs, DVDs, cam recorders, stereo receivers, speakers, car stereos and other electronic equipment is made by overseas companies. Foreign manufacturers make most of the merchandise you’ll find for sale in these stores. Finding a label made in the U.S. these days is very rare unless you get into high-end audio and video equipment. If you look around your neighborhood, what kind of new cars do your neighbors drive? Here in Southern California most of the cars you see on the road are foreign. Even with zero percent financing in our neighborhood, I see plenty of new Mercedes, BMWs and Lexus.’ On the economy side there are Hondas and Toyotas.
The sale of these foreign goods may produce profits for the car dealers or retailers that sell them, but it doesn’t create high-end domestic manufacturing jobs. Economists and analysts in the U.S. fail to make the connection between a $40 billion a month trade deficit and the two million plus manufacturing jobs that have been lost in this recession. The U.S. has lost 12 percent of its manufacturing jobs in this recent recession. Now companies are transferring service jobs overseas. Computer technicians, architects, client service centers, and research and development centers are in the process of being transferred to India and China. Even if a tech recovery takes place it will take place overseas in China or perhaps India where U.S. companies are building large manufacturing facilities. As these new factories are built and brought on stream, it will add more manufacturing capacity globally and contribute to rising trade deficits here in the U.S.
The Keynesian economic models of debt and consumption are leading to the U.S. consuming all of its seed capital. It is one reason why if there is a recovery it will be shallow and short lived. How do unemployed workers or new consumption that goes overseas build a lasting economic recovery? If you follow the economic logic it doesn’t add up. Companies fire workers to help contain costs. They then transfer new plant and equipment overseas to find cheaper labor. Then fired workers go deeper into debt through equity extraction from their homes used to finance the purchase of foreign made goods. What does this line of reasoning do for domestic employment or for the trade deficit? In order for this plan to work interest rates will have to continue to decline, home prices continue to rise, consumers to go deeper into debt, and fired workers to get equivalent paying jobs.
In
addition the stock market continues to go up as giddy fund managers
and investors pay even higher prices for already high-priced stocks.
Does anyone find a problem with this line of reasoning? Perhaps the
Fed can continue to monetize Federal debt in order to keep interest
rates down. Perhaps they can successfully continue to intervene in the
stock market to put a floor underneath stock prices and encourage fund
managers and investors to speculate in the market. However, I can’t
help but see where this kind of intervention or economic policy avoids
an eventual day of reckoning.
The U.S. may have the strongest military in the world, but our Achilles heel is our economy and financial system. The U.S. economy runs on credit. It must be constantly fed with ever-increasing amounts of debt or the economy shuts down. Right now, it is government deficit spending, housing and mortgage financing keeping the economy afloat. The Fed is buying government debt and running the printing presses at full throttle. The only problem is foreign investors are beginning to get nervous. As the graph of the dollar below shows, the dollar is in danger of breaking down. In fact it has received very little benefit from the stock market’s rally. Normally when U.S. financial markets appreciate the U.S. dollar benefits. The fact that it hasn’t tells me the dollar could be headed for trouble.
The next graph provided courtesy of Ned Schmidt shows how rapid the dollar’s depreciation has been since 2001. The fall in the dollar means foreigners are losing money on their U.S. investments. In addition to a falling dollar, America’s burgeoning trade deficit is putting more dollars and U.S. debt in foreign hands. What foreigners think and do will become more important to what happens to our economy and financial markets since they own a major portion of our bonds, government and corporate, stocks, and real estate.
© 2003 Ned Schmidt
"Weapons of Monetary Destruction"
With foreigners now accumulating more and more dollars as a result of our trade deficits it can’t be assumed that they will always hold on to and invest those dollars. There are now plenty of alternatives to the dollar. There are plenty of alternative paper currencies for them to invest their trade surplus. There is also gold and silver. Asian investors and central banks, Middle Eastern investors and governments are now accumulating gold and silver. A process of diversification out of the dollar has begun which explains much of the weakness in the dollar chart above.
Too Many Holes in the Dike
The Fed and U.S. policyholders have their hands full. They have to contend with a weakening economy, rising unemployment, rising government deficits, record trade imbalances as well as a volatile and unstable stock market. The Fed is now actively monetizing debt in an effort to keep interest rates in a narrow range. However, with bigger government budget deficits and a weakening economy, they must keep the credit machine flowing and interest rates low or risk major defaults in the financial system. They now have their fingers in all segments of the financial system. It is apparent that conventional monetary tricks, such as lowering interest rates, have failed to create an enduring and lasting recovery. The economy is now in danger of slipping into recession again. Given the numerous Fed speeches made recently, it appears that unconventional measures are being taken which includes intervention in the financial markets. The Fed’s problem is what happens if foreigners start to exit the system. Furthermore, John Q. and the smart money isn’t buying stocks. The amount of insider selling recently should be a warning to those who believe in pro forma earnings. The company insiders now understand the GAAP numbers, which tell a completely different story. That is why they are taking advantage of stock rallies to sell off shares.
As for John Q., he is putting his money in real estate and bonds, not the stock market. This explains the falling volume in the stock market and the weak momentum in recent rallies. This rally doesn’t have the strength and power behind it. Without constant interventions as seen in miraculous rallies that take place on rumors, this market wants to head south. Sentiment indicators show a turning point, volume suggests weakness, stochastic and on-balance volume indicators are flat or falling, and the VIX and the VXN are dropping to levels where market corrections have begun. What the authorities will need to do is pull off a Robert Rubin, which is to keep intervening in the markets all the way up and drive all the bears and shorts into permanent hibernation, a feat considered to be unlikely unless they can find Saddam and Osama on the very same day. If they are going to give us a rally that goes beyond resistance levels and above the neckline of a major head and shoulders pattern, they better do so soon. We are about to head into the summer months, a time of market weakness that lasts from the end of April all the way until late October. Seasonal market patterns are about to take over, so a market catalyst is immediately required, which is why I humbly suggest they find Osama and Saddam.
Now for today’s casino results, the markets spent most of the day in and out of positive territory until about the final hour of trading. Miracles occurred once again in the futures pit that drove stock prices higher. All three indexes finished in the green with advancing issues beating out losers by a 19-14 margin on the NYSE and by 17-15 on the Nasdaq. Volume hit 1.5 billion shares on the Big Board and 1.6 billion on the Nasdaq. Today’s gains were attributed to companies beating pro forma estimates and a rise in consumer confidence. Analysts were encouraged today by the continued drop in oil prices, which fell for the sixth consecutive day. Things also looked good on the earnings front if you ignore expenses and look only at pro forma numbers. Companies have been able to beat estimates after pro forma estimates were lowered just before reporting season. Actual numbers and what companies are cautiously saying about the next few quarters still doesn’t give us a second half recovery. That is why the President is pushing so hard on a half a trillion-stimulus package. If the economy is to avoid a recession or get rolling by election time, something needs to be done now. Of course it is going to take enormous political capital to pull it off. The opposition would prefer a weaker economy and stock market to run against in 2004.
Overseas
Markets
Asian stocks
rose, led by Cathay Pacific Airways Ltd., Shangri-La Asia Ltd. and
other travel-related shares, after some countries reported progress in
controlling the spread of severe acute respiratory syndrome. Hong
Kong's Hang Seng Index rallied 3.7 percent to 8744.22 after the city
yesterday reported its fewest new cases this month. In Singapore, the
Straits Times Index added 3.5 percent as no new cases were announced
for two days. Japanese markets were shut for a public holiday.
European stocks fell on concern economic growth won't be sufficient to justify this month's rally. Royal Dutch Petroleum Co. and Total Fina Elf SA sank amid speculation they will struggle to increase earnings after the first quarter. The Dow Jones Stoxx 50 Index lost 1.1 percent to 2326.07. The Stoxx 600 Index shed 0.5 percent to 195.08. Both indexes have advanced more than 10 percent this month amid optimism an end to the war in Iraq would boost spending by businesses and consumers. Eight benchmark indexes fell in Western Europe's 17 national markets.
Gold and silver short positions coming tomorrow for April.
Copyright
© 2003 Jim Puplava
April
29,
2003
Charts courtesy of www.stockcharts.com
and Ned Schmidt
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