Here’s the news of the week – and how we see it here at McAlvany Wealth Management
1. Tipping of the scales?
In the ongoing battle between the private and public sector, socialism has been the clear victor for many years on end. Along those lines, here are a few observations worthy of note. For at least three decades we have seen U.S. government spending and “carry trade” dynamics (stemming from the Fed) cause multiple expansions in productive assets that exceeded the expanse in that of the U.S. GDP, and for a while it worked per se. Put in simple terms, borrowers have flourished in a world of declining interest rates and coinciding asset bubbles while savers have been punished seemingly without end. But that may be changing, albeit it be subtly for the moment – new trends always have small beginnings. In Tuesday’s news, Bloomberg ran an article entitled “Buyout Firms Beaten in Takeover Auctions by Cash-Rich Companies” (link provided below). The title just about says it all, implying that as inflation rises and the economy contracts, over-leveraged entities are feeling the pinch perhaps more than anyone, and those who have governed their finances conservatively are being favored.
Municipalities in a similar way are experiencing the same issue. In a study by Meredith Whitney, state finances are worse than previously estimated. The report indicates that since 2003, state governments have raised annual outlays by $700 billion (to $2.2T), yet tax receipts have risen only $400 billion (to $1.4 T). In fact, spending surged throughout the recession while income from sales, personal income and corporate taxes went totally flat as early as 2007. The load is rising quickly, as unfunded pension burdens have jumped 50% in the past year. Long story short, municipalities will be forced to shed a record 110,000 jobs once the new fiscal year begins July 1.
The same can be said about the U.S. government, who has shouldered the “recovery” as the lender and spender of last resort. In Washington, the debate rages on over whether or not to raise the debt ceiling another $2 trillion (to $14.2T) so the bills can be paid. Moody’s and S&P have the U.S. on credit watch, ready to downgrade if politicians don’t raise the ceiling – if that makes any sense. But with government spending approaching a record 28% of GDP and total national debt approaching a record 93% (not including the proposed ceiling) of GDP in 2011, it’s not likely we will see a solution anytime soon. Taxing the rich for example, of ALL of their income ($800B), solves the budget deficit for maybe one year at best, while crippling the job creators – and then what? Cuts and or “austerity” measures as they call them overseas will need to be implemented – either by divine intervention or more than likely, political self preservation. The Republicans may have it right this time.
This may be making a big deal out of nothing, but it appears that the dominant cash-rich corporations may be the only ones remaining with the financial power to hire those now in the category of the unemployed. Garnering the corporate confidence to do so will require a restoration of pricing power, and that will require further consolidation across most industries – remember the “nifty fifty”?
2. Fed Slow to “Greece” the Wheels.
Bernanke and stocks seem to be caught in the same trap. Following Bernanke’s downbeat comments (in Atlanta) on the economy, and with no hint with respect to stimulus, stocks slipped with the S&P 500 down by 2.24% along with the Nasdaq Composite which fell 3.26% for the week. Treasuries, to Bill Gross’s chagrin – and ours to some degree, continued to be the port in the storm, with yields now off nearly 60 basis points from highs set in February this year. Commodities had modest gains with the CCI index up .32%. Oil was flat, supported by OPECs decision to halt output growth, and the metals were off a bit, with silver down .16% and gold off .66%.
U.S. economic news was light this week. Jobless claims and continuing claims rose again in the back half of May. The trade deficit narrowed (to $43.7B from $46.8B), deemed a positive in Thursday’s trading action, but only reflected the reduction of bloated imports from previous quarters and Japanese shocks.
Texas Instruments announced it will miss growth estimates for the second quarter in both profits and sales. Similarly, McDonald’s missed May same store sales targets, recording a 3.1% increase instead of the 4.1% expected. The latter may be an indication that the consumer is reaching an end in the search for lower cost food substitutes.
Overseas, the usual debate over Greece continued. The Greeks are still in need of $45B from ECB and IMF sources to keep the lights on. Uncertainty over the loan raised Greek CDS spreads to an all-time high. Austerity measures and unfavorable mandates to investors holding Greek debt again prompted riots in the streets. The ECB now has nearly €444B worth of uncollateralized exposure to the PIIGS. Also in response to economic weakness in the Eurozone, the ECB, U.K. and some Asian countries have put rate hikes on hold, indicating that further hikes may be needed later this year.
Market volatility peaked on Friday. Judging by the action, investors were disappointed that QE3 did not commence ASAP. The “risk off” trade (predominantly into Treasuries, German bonds and cash) continues, but at a moderate pace so far. Rumor has it the Fed may wait until August (Jackson Hole) to announce further stimulus efforts – if any. The crux of the matter is that the Fed may need the markets to fall a bit further before gaining the political backing necessary to escalate printing efforts. In the meantime, the metals may be range bound in the waiting. However, no matter how you slice it, printing or no printing, the economy is contracting, placing default pressure squarely on the world’s bloated debt markets, which, theoretically, could ignite the metals upward – at any time.
Have a great weekend.
President and CEO
VP Investment Management