So, What Happened?
November 2, 2009
Good morning. Despite a solid advance of 2.1% last Thursday on first estimates of third quarter GDP, the week showed a fairly large decline in the SPY of 4.64, or 4%. The close Friday in the SPY of 103.56 represents a 6.1% decline from the 110.31 high set on 10/21. Last Friday was particularly troublesome in that the market more than gave away a solid advance on Thursday, an advance based on a strong economic number. The preliminary GDP number of Thursday morning of plus 3.5% annual growth exceeded both the consensus estimate of 3.2% and the Goldman estimate of 2.7%. Even taking out the auto piece, heavily influenced by Cash for Clunkers, the GDP advance was estimated to be 1.9%, “officially” ending a recession that had seen GDP drop for four consecutive quarters and five out of the last six.
So what happened? For one, the market has seen a very strong advance since the March lows. The gain from the low of 67.10 on March 6 to the “so far” high of 110.31 on October 21 is over 64%. That sort of rally, in effect, assumes a lot of good things happening in the economy, and has priced in some strong economic numbers. The problem then becomes judging exactly how much “good” has been priced in and when some “disappointment” might occur. Clearly the number on last Thursday was a good one, and probably did “surprise” the consensus market estimates, hence the solid rally. Friday, however, brought the economic news that consumer spending in the month of September was down. In fact, the whole report indicated that personal income was almost exactly flat (not exactly a good indicator for a supposedly now growing economy), savings was up .5%, and spending was down .5%. So the numbers say quite plainly (for the month) that income is not going up and people are still retrenching a little. What you would have liked to see is that August was a little better than July and September a little better than August. What we probably did see was a good July and August due to cash for clunkers and maybe some tax holidays for back to school, then September slowing down again. Obviously, the government has many programs designed to jump start the economy, and everyone is very keen on observing whether the program “works” by creating increased activity (like cash for clunkers and the tax credit for first time home buyers) only to have the numbers plummet again at the completion of the incentive program. The idea is for the incentive to create something that will become sustainable on its own, otherwise you just shift production and demand around at great cost to other people. What is even more ominous is that the total cost of the various incentive plans is becoming unsustainable in itself, meaning that if the programs do not work there might not be the ability for another attempt.
I, for one (and have many clients feeling the same way), am getting pretty nervous about this whole direction we are heading. In full disclosure I voted for the current administration, and still am hanging to some hope for them to do a good job, but am getting less confident by the day (maybe hour). The fact is these programs are costly, and generally end up costing way more then preliminary estimates, and the last time I checked we do not have any money to be wasting. Take, for instance, the cash for clunkers, which is now causing a big war of words between the White House and the Edmunds.com website (Edmunds??). The White House has taken huge credit for the jump-start in automobile sales in July and August, citing the up to $4,500 cash the government paid to people trading in old and inefficient cars for new and more fuel efficient models. The government, of course, took credit for every car sold that received the $4,500 rebate. Edmunds, on the other hand, did an analysis more like I would do (I was a financial analyst in a previous life, and rumored to be a pretty good one). They estimated, by the normal ratios of non-qualifying cars to those qualifying, how many qualifying cars would have been sold anyway during the time period. They then took the total amount of qualifying cars sold and subtracted those that probably would have been sold anyway, coming up with a number of 125,000 cars sold in excess of what you would normally expect. Dividing that 125,000 number into the total program cost of $3 Billion, and you get a number of $24,000 per car, not $4,500. Essentially all you did was give $4,500 to over 500,000 people who would have bought anyway, and maybe people that just happened to have a qualifying car around to trade, quite possibly people who did not need any of our help to buy a car. I would hope that the White House would look at a simple (but powerful) analysis like this and consider, in reflection, whether the program was worth the cost, instead of lashing out in defense. I am going to agree with Edmunds and say the program was too costly for what it did, not to vilify, it may have been a nice idea and nice try, but it did not work out efficiently. You (yes, you, Mr. President) need to learn by his. I suspect the same thing is going on in the tax credit for first time homebuyers program (along with massive amounts of fraud), and it would not surprise me at all that when it is over and someone logically figures out how many would have bought anyway the program will be way more expensive than advertised, and we will have given money to millionaires who paid cash for a second home and got away with it.
I think what Washington is missing, and missing big time, is that regular people are tired of fraud on every level. In addition, their definition of “fraud” is different from the absurd attitude towards fraud present in government and many corporations. They do not want, in times of stress on all levels, a large bank to get other people’s money and pay it to the hacks who work there instead of lend it. They also do not want their neighbor to get a check for buying a car he would have bought anyway, or a tax dodge for buying a second house in his wife or child’s name as an investment. Is the IRS even looking at the beneficiaries of this program? Our President wants to take credit for every car and house sold under these programs, whether legit or not. I say start using your head and thinking straight (I suppose talking straight might be too much to ask). Otherwise we are in for an even bigger mess, with mid-term elections swinging the other way, even more finger pointing, and another whole new group of people with no clue. That condo on the Isle on Man is looking better and better, maybe I could get used to the sideways rain while golfing (my game is awful anyway).
What about the market, and how do we benefit? For one, I think we have a chance that the market is overextended. It is currently priced at about 20 times current earnings, a historically high number. However, the market does not price for the present, it prices (or should price) for the future. The trick is to figure out what the world will look like next March or April and judge the market versus those numbers. It looks to me, even with the relatively strong GDP numbers of last Thursday, that the recovery is sputtering a little, and that the market has priced in a much smoother recovery. Again, I want to protect against a double dip but still participate if we advance, a tough assignment in any market. It is even harder now because the returns to any extra cash are close to zero (not helping at all) and because the market has been in a funk for so long. A lot of retired people that have looked at their retirement accounts see a lot of stagnation, and really little ability to draw out the amount they need to live on (the reason for the account in the first place). The current deal of not much income on any level (forget the part about the big rally for six months this year, we are still are only even with last year with several traumatic events in the meantime) is clearly not what people were promised. The collective “we” were promised 7-10% in the market any 5-6% risk free by legions of talking heads, and the “we’s” are nowhere close to that. Those in the Protected Index Program (PIP) for the last 10 years have not seen the catastrophes that have befallen the majority of investors, and have maintained a 5%+ average over that time, but I will be the first to admit we have had to work real hard to provide that return. All of us could really use a few years of markets up 1% a month, new job creation, a raise once in a while over cost of living increases, etc. I just don’t see it anytime soon.