The United States are for Sale
11/30/07
Schizophrenia, from the Greek roots schizein ("to split") and phren, phren- ("mind"), is a psychiatric diagnosis that describes a mental illness characterized by impairments in the perception or expression of reality, most commonly manifesting as auditory hallucinations, paranoid or bizarre delusions or disorganized speech and thinking in the context of significant social or occupational dysfunction. In other words: Just another day on Wall Street, where perception becomes reality as long as enough people believe in it. Case in point ...last Wednesday:
Well's Fargo disclosed an additional $1.4 Billion write off which was somewhat expected but still a nasty reminder that even conservative lenders like Wells Fargo are not immune. That same day, the beige book, which surveys economic conditions between meetings of the rate-setting Federal Open Market Committee, noted that in October through mid-November, seven of the Fed's 12 districts reported slower growth. Not good. Fed Vice Chairman Donald Kohn piled on that afternoon by stating that recent credit market turbulence could increase the possibility of further tightening in financial conditions for households and businesses. That's even worse. But wouldn't you know it, the schizo's on Wall Street loved it. The Dow Jones rallied by over 350 points. Everybody in the asylum thought that bad news was good and that worse news was even better. Of course I am exaggerating. The point however is, that the economy now truly is deteriorating in a worrisome way and that even further rate cuts may not be able to improve it's health meaningfully. Let's look at some charts: One is bad, one is not-so-bad.
The first chart comes courtesy of the Economic Cycle Research Institute (ECRI). The Institute issued on Friday it's latest Recession-Recovery Watch: "The Weekly Leading Index (WLI) fell to 138.1 in the week ending November 23 from 139.1 in the prior week, as did its smoothed growth rate to -1.8% from -1.2%. With WLI growth at its worst since just before the Iraq war, U.S. growth prospects have deteriorated further." That is the bad chart.
The next chart comes from the Institute for Supply Management (ISM). The chart shows the business activity of the service sector, ISM calls it "Non-Manufacturing Business Activity Index". The grey area denotes the 50% line below which the sector contracts. The service sector according to the ECRI is still in expansionary territory and if the "New Orders" sub-index is any guide, it will stay there for a couple of months longer. Nevertheless, by Friday, Goldman Sachs' economists had nudged the likelihood of a U.S. recession up to 40% to 45% (from 30%) and Merrill Lynch increased it to 60% from 50%. I go with the guys from Goldman Sachs – 40% to 45% seems about right. These, however, are not great odds because the economy is vulnerable now. All it takes is one outside shock (oil, terror, etc.) and we might be tipped into a recession. Aggravating the situation is the state of the American consumer. Personal income increased just 0.2% in October and data for past months were revised down by $41 billion. October's 0.2% gain did not match the 0.3% gain in inflation, which means that real disposable income actually fell 0.1% in October. "Continued readings such as these would translate into economic recession" says Tony Crescenzi. When he gets worried, I get worried. He continues "The 0.2% income gain was half of what was expected. The miss was because of weakness in private wages and salaries, which increased just $1.5 billion in October, much smaller than September's gain of $35.3 billion, which has been typical for most months. There is risk of a repeat of these data, owing to signs of weakness in the U.S. labor market, which has been especially apparent in recent data on initial jobless claims and consumer confidence." The U.S. labor market will be the most important story next week. Friday, the labor department will publish the state of this nation's job market. Mr. Crescenzi sees reason to worry: "Jobless claims have been above the one-year average, now at 320,000, for the past seven weeks, the first such occurrence since 2003 when job growth averaged just 9,000 per month. This is a worrisome trend. The rise in continuing claims validated this concern in a big way. Continuing claims measure the number of people continuing to receive jobless benefits, a figure that rises when initial filers have difficulty obtaining a job." But not all needs to be gloom and doom. There are many positive factors that work in the stock markets favor right now. Bull runs rarely end with a labor market this tight, and with sentiment as negative as it was for the past couple of weeks in the stock market. Valuations also are hardly exorbitant. Also, the dollar for instance, foreign investors in other words, are discounting the worst for this old bull. Look at the charts:
Clearly, foreign investors have been discounting lower or falling interest rates for some time in the case of the Euro and for the last 3 months in the case of the yen. Consequently, U.S. assets can be had 20% cheaper today than last year in November. This also means that the Dutch concern Philipps acquired lighting manufacturer Genlyte at a huge 50% premium, despite Genlyte's housing-centric business, because they could afford to. After all, 20% of the premium was paid for by the currency markets. Opportunistic non-US. buyers seem likely to accelerate their acquisition of our currency-depressed assets through year-end and into 2008. This should support our markets and help us rally into year end. It also should highlight the one fact that some euro-bulls seem to forget. The U.S. economy still constitutes about 30% of world GDP and is attractive to global companies for many reasons. Barron's wrote this week: "So far in 2007, Asia-Pacific buyers have accounted for more than $702 billion worth of deals, including many that have given them large equity stakes in companies, according to Thomson Financial. That's a 69% increase from the level in the comparable 2006 span." I believe that many Europeans have fallen in love with the Euro as the new world currency, but they might be disappointed shortly. I believe that the dollar will stage a rally in the first quarter of 2008 and ultimately reflect rising interest rates due to improving economic prospects. Remember that it is always darkest just before dawn.
Hermann Vohs
"A wise person does at once, what a fool does at last. Both do the same thing; only at different times."
John Dalberg Acton
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
