January 27th, 2010 12:58 PM by Lehel S.
IN THIS ISSUE:
All eyes will be on this Friday's Gross Domestic Product report for the 4Q of last year. Pre-report estimates suggest the 4Q GDP number will come in around 4.5% (annual rate), as compared to 2.2% in the 3Q. There are a number of widely-followed analysts that believe the 4Q GDP number could surprise on the upside in the 5-6% range, but that remains to be seen.
Yet even if the GDP number comes in at or above expectations on Friday, there are increasing fears that the economy will fall short of earlier forecasts for the first half of 2010. Reasons for such concerns vary but the December retail sales report sent shivers down the optimists' spines. As I will discus below, retail sales for all of 2009 fell by the largest percentage decline on record, following a disappointing performance in 2008.
With consumer spending accounting for apprx. 70% of GDP, many economists are downgrading their 2010 forecasts. Previous forecasts of 5-6% growth in the first half of 2010 are being scaled back to 2-3% in many cases, and even that could be optimistic. This is consistent with what I have been suggesting for the last several months.
An excellent article appeared in the Wall Street Journal earlier this month that sums up our economic and financial dilemma as well as any I have seen. It is co-authored by three University of Chicago economists. If you want to understand why we likely face a year of anemic economic growth in 2010 – as opposed to 5-6% growth that some analysts predicted late last year – I suggest you read this article very closely; it is reprinted later on in this E-Letter.
Finally, there is word that Nancy Pelosi and Harry Reid are plotting a backdoor way to pass the Senate healthcare reform plan, even though the Senate no longer has the 60 votes to override a filibuster. If this is true, it is disgusting! I have included a link to this story as a P.S. at the end of this E-Letter. If you think healthcare reform is now dead, you need to read this.
4Q GDP to Rise - But by How Much?
The Commerce Department reported late last year that 3Q GDP rose by 3.5%, but later revised that number down to only 2.2% (annual rate). Even with the downward revisions, most economists proclaimed that the positive growth in the 3Q of last year marked the end of the worst recession since the Great Depression.
Here are the quarterly GDP reports for 2008 and 2009 (through the 3Q) as reported by the Bureau of Economic Analysis within the Commerce Department:
The Commerce Department noted that 3Q economic growth was fueled primarily by consumer spending, exports, private inventory rebuilding and federal government spending. Most analysts believe that these four areas of growth continued in the 4Q as well. However, as we will discuss later on, there are some reasons to question whether consumer spending continued to rebound in the 4Q – but I'm getting ahead of myself.
The government's first “advance” estimate of 4Q GDP will be released this Friday. As this is written, the pre-report consensus is for a rise of 4.5% in the 4Q. But some respected analysts believe that 4Q GDP likely rose by 5-6%, mainly due to inventory rebuilding. That remains to be seen. And don't forget that the “advance” GDP report this Friday, whatever it is, could be revised significantly lower (or higher) over the next couple of months, as was the case with the 3Q GDP report.
Retail Sales - Worst Drop on Record in 2009
Every year we hear conflicting reports during the holiday season as to how retail sales are going. Inevitably, some reports suggest that sales are running above expectations, while others indicate just the opposite. The real facts don't become clear until the following January when we get the official retail sales report for December.
The latest retail sales report for December was quite the negative surprise, marking the largest annual percentage decline on record. Retail sales fell in December as demand for autos, clothing, appliances, electronics, etc. all slipped more than expected to finish an already disappointing year.
The Commerce Department reported earlier this month that retail sales declined 0.3% in December compared with November. This was much weaker than the 0.5% rise that economists had been expecting. For all of 2009, retail sales fell 6.2%, the biggest decline on record, and it comes on the heels of a modest decline in 2008.
While a record decline in retail sales last year is bad enough, we must put it in a broader perspective. Retail sales typically increase every year, even during recessions, if only modestly. In fact, retail sales have risen every year since such records have been kept with the exception of 2008 when annual sales fell a modest 0.5%, and then fell again in 2009 as noted above.
The 0.3 percent decline in December was the first setback since September when sales fell 2%. Sales posted strong gains of 1.2% in October and 1.8% in November, raising hopes that the consumer is starting to mount a comeback. Yet for the year, retail sales fell by the largest amount since records have been kept.
The December drop in sales was a surprise given that the country's largest retailers reported better-than-expected sales during the last week before Christmas. But even with the late rebound reported by the nation's biggest chains, these retailers suffered their worst annual decline ever.
The weakness over the year reflected the battering that consumers have taken from the worst recession since the Great Depression, a downturn that has cost over 7 million jobs and left households trying to rebuild savings depleted by losses on Wall Street and a crash in housing prices.
Economists are worried about consumer spending in the months ahead given their forecasts that unemployment, currently at 10%, will keep rising until perhaps midyear. The growing worry is that GDP will slow significantly in at least the first half of 2010 unless consumers continue to spend at 3Q and 4Q levels, which is looking increasingly doubtful.
The trends in personal consumption spending are considered critical to any sustained economic revival, since consumer spending accounts for apprx. 70% of total economic activity (GDP). This explains why many forecasters are downgrading their predictions for 2010.
The Struggling Economy – Putting It All in Perspective
A big part of my job as a writer has always been to try and make complicated matters understandable for my clients and readers. I was advised many years ago to try and keep things simple, and that advice has served me well.
But occasionally I run across articles and research papers that do a much better job than I when it comes to handicapping our economic and financial situation and putting it all in perspective. Such is the case with the article below, which was published earlier this month in the Wall Street Journal by three noted University of Chicago economists.
If you want to truly understand the economic and financial pickle we are in, I suggest you read this article carefully.
Uncertainty and the Slow Recovery A recession is a terrible time to make major changes in the economic rules of the game.
by Gary S. Becker, Steven J. Davis and Kevin M. Murphy
In terms of U.S. output contractions, the so-called Great Recession was not much more severe than the recessions in 1973-75 and 1981-82. Yet recovery from the latest recession has started out much more slowly. For example, real GDP expanded by 7.7% in 1983 after unemployment peaked at 10.8% in December 1982, whereas GDP grew at an unimpressive annual rate of 2.2% in the third quarter of 2009. Although the fourth quarter is likely to show better numbers—probably much better—there are no signs of an explosive take off from the recession.
We believe two factors are behind this rather tepid rebound. An obvious one is the severe financial crisis that precipitated this recession, with many major financial institutions receiving large bailouts from the federal government. The confidence of bankers and venture capitalists has been shattered, at least for a while, and it will take time for them to recover from the financial turmoil of the past couple of years. The household sector also faces a difficult period of financial retrenchment in the wake of a major collapse in home prices, overextended debt positions for many, and high unemployment.
The second factor is less obvious, but possibly also of great importance. Liberal Democrats won a major victory in the 2008 elections, winning the presidency and large majorities in both the House and Senate. They interpreted this as evidence that a large majority of Americans want major reforms in the economy, health-care and many other areas. So in addition to continuing and extending the Bush-initiated bailout of banks, AIG, General Motors, Chrysler and other companies, Congress and President Obama signaled their intentions to introduce major changes in taxes, government spending and regulations—changes that could radically transform the American economy.
The efforts to transform the economy began with a fiscal stimulus package of nearly $800 billion. While some elements served the package's stated purpose and helped to soften the recession's impact, the overall package was not well designed to foster a speedy recovery or set the stage for long-term growth. Instead, the “stimulus” was oriented to sectors that liberal Democrats believe are deserving of much greater federal help. This explains why much of the stimulus money is going toward education, health, energy conservation, and other activities that would do little to soak up unemployed resources and stimulate the economy.
In terms of discouraging a rapid recovery, other government proposals created greater uncertainty and risk for businesses and investors. These include plans to increase greatly marginal tax rates for higher incomes. In addition, discussions at the Copenhagen conference and by the president to impose high taxes on carbon dioxide emissions must surely discourage investments in refineries, power plants, factories and other businesses that are big emitters of greenhouse gases.
Congressional “reforms” of the American health delivery system have gone through dozens of versions. The separate bills passed by the House and Senate worry small businesses, in particular. They fear their labor costs will increase because of mandates to spend much more on health insurance for their employees. The resulting reluctance of small businesses to invest, expand and hire harms households as well, because it slows the creation of new jobs and the growth of labor incomes.
The administration also indicated early on that it would take a different approach to antitrust policy, reversing a 30-year trend toward more consumer-based interpretations of antitrust laws. Likewise, the installation of a pay “czar” in Washington is scary, even though his activities are so far confined to companies that received substantial bailout assistance from the Treasury. Perhaps as a next step, Congress will decide that executive pay is too high generally and levy special taxes on bonuses, or impose other controls over executive compensation—as the British and French have done. Congress is also considering major new regulations on consumer financial products.
In its efforts to combat the financial crisis and recession, the Fed created over $1 trillion of excess reserves at banks through various bailout programs and open market operations. When banks draw on these reserves for loans to businesses and households, there is a potential for the money supply to grow rapidly, possibly producing a substantial inflation. How hard the Fed will fight inflationary pressures through open market sales and other actions that raise interest rates is a significant source of uncertainty about future inflation and about the potential for monetary policy tightening to choke off the recovery.
The uncertainty about monetary policy has important political dimensions as well. The Fed now faces greater political pressures than at any other time in the past quarter century, as seen from the grilling the Senate Banking committee gave to Fed Chairman Ben Bernanke in deciding whether to approve his reappointment. These pressures may intensify greatly if, and when, future Fed actions to restrain inflation conflict with politicians' desires to prop up housing and the major government enterprises enmeshed in housing finance.
Even though some of the proposed antibusiness policies might never be implemented, they generate considerable uncertainty for businesses and households. Faced with a highly uncertain policy environment, the prudent course is to set aside or delay costly commitments that are hard to reverse. The result is reluctance by banks to increase lending—despite their huge excess reserves—reluctance by businesses to undertake new capital expenditures or expand work forces, and decisions by households to postpone major purchases. [Emphasis added, GDH.]
Several pieces of evidence point to extreme caution by businesses and households. A regular survey by the National Federation of Independent Businesses (NFIB) shows that recent capital expenditures and near-term plans for new capital investments remain stuck at 35-year lows. The same survey reveals that only 7% of small businesses see the next few months as a good time to expand. Only 8% of small businesses report job openings, as compared to 14%-24% in 2008, depending on month, and 19%-26% in 2007.
The weak economy is far and away the most prevalent reason given for why the next few months is “not a good time” to expand, but “political climate” is the next most frequently cited reason, well ahead of borrowing costs and financing availability. The authors of the NFIB December 2009 report on Small Business Economic Trends state: “the other major concern is the level of uncertainty being created by government, the usually [sic] source of uncertainty for the economy. The ‘turbulence' created when Congress is in session is often debilitating, this year being one of the worst. . . . There is not much to look forward to here.”
Government statistics tell a similar story. Business investment in the third quarter of 2009 is down 20% from the low levels a year earlier. Job openings are at the lowest level since the government began measuring the concept in 2000. The pace of new job creation by expanding businesses is slower than at any time in the past two decades and, though older data are not as reliable, likely slower than at any time in the past half-century. While layoffs and new claims for unemployment benefits have declined in recent months, job prospects for unemployed workers have continued to deteriorate. The exit rate from unemployment is lower now than any time on record, dating back to 1967.
According to the Michigan Survey of Consumers, 37% of households plan to postpone purchases because of uncertainty about jobs and income, a figure that has not budged since the second quarter of 2009, and one that remains higher than any previous year back to 1960.
These facts suggest that it was a serious economic mistake to press for a hasty, major transformation of the U.S. economy on the heels of the worst financial crisis in decades. A more effective approach would have been to concentrate first on fighting the recession and laying solid foundations for growth.
They should have put plans to re-engineer the economy on the backburner, and kept them there until the economy emerged fully from the recession and returned to robust growth. By failing to adopt a measured approach to economic policy, Congress and the president may be slowing the economic recovery, and thereby prolonging the distress from the recession. [Emphasis added, GDH.]
Political Implications & How to Move Forward
You may or may not agree with the analysis and conclusions offered by the three economists above. Obviously, I think they hit the nail squarely on the head, or I would not have reprinted the article. But whether you agree or disagree, one thing is very clear:
President Obama and his administration made a conscious decision to pursue the most aggressive and politically charged elements of their agenda – healthcare reform, cap-and-trade and card check (pro-unions) – in the first year of his presidency. And they decided to enact the $787 billion stimulus package in ways that did not create a lot of near-term job growth.
We can argue about why this was the path they chose, but one reason has to be that they knew these policies would be unpopular, and thus they needed to pass them as quickly as possible before the president's enormous popularity faded (as it always does).
Now that Obama's key initiatives (namely healthcare and cap-and-trade) have failed to pass, at least for now, and now that the Democrats have lost their filibuster-proof 60-vote super majority in the Senate, it remains to be seen how the president will move forward. I would not even venture a guess at this point.
Obama's senior adviser, David Axelrod, said last week that the president intends to move full-speed-ahead with his agenda, despite what happened last week in Massachusetts. But that remains to be seen, and in my opinion, is quite doubtful. Without admitting as much, I expect President Obama will quietly move to the center, as so many presidents have done before him.
Of course, there are others who believe what Axelrod said last week – that the president will continue to press ahead with his controversial agenda, precisely with the goal of labeling the Republicans as “obstructionists” going into the November mid-term elections. Whatever the president decides, it will be very interesting to watch it all unfold.
Conclusions: Expect the Economy to Disappoint
Whichever political path the president decides to take just ahead, the US economy is likely to disappoint in at least the first half of this year. As noted above, many economists are now scaling back their estimates for growth in the first half of this year.
Consumer spending is not likely to rebound to pre-recession levels anytime soon. As a result, we may be lucky to see GDP growth of 2-3% for the first half of this year, with much of that the result of debt-financed government spending.
Oddly, I am seeing few, if any, suggestions for what growth may be in the second half of this year. That is partly because no one knows when the employment trend is going to pick up. As a result, consumers remain pessimistic and this mood could persist even in the second half of the year. The same may be true for businesses and plans for new capital spending later this year.
All of this does not bode well for a continued rise in the stock markets, which rose meteorically in 2009 after the March lows. The S&P 500 Index (see chart below) is approaching major overhead resistance at 1200 and above. With economic forecasts being revised lower, we could see stocks come under pressure just ahead, or simply move into a broad trading range. In my view, the easy money in stocks is behind us.
Given all the uncertainties and challenges facing us, I would suggest that this is a good time to consider some of the “actively managed” investment programs I recommend (and where I have most of my own money). Most importantly, these professionally managed programs include the flexibility to move to the safety of cash (money market) or hedge long positions should the market trends turn lower once again.
The primary objective of these actively managed programs is to minimize losses during down periods in the stock markets, while also participating in market gains during upward trending periods. The equity programs I recommend fared much better in 2008 than the S&P 500 Index, and some even made money in the bear market. (Past results are no guarantee of future results.)
For investors who held onto their equity positions through the nasty 2008 bear market, the stock market recovery last year served to improve their portfolios; however, buy-and-hold investors are nowhere near where they were at the peak of the bull market in late 2007.
If you'd like to learn more about the professionally managed investment programs I recommend, please feel free to give one of our Halbert Wealth Management Investment Consultants a call at 800-348-3601. You can also send us an e-mail at email@example.com, or obtain more information on our HWM website at www.halbertwealth.com. We look forward to hearing from you.
Wishing you profits,
Gary D. Halbert