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Welcome! Today is
2009 - Risk Trade Back On
Only with the benefit of hindsight can we make final judgments about what has transpired historically in our markets. Looking back on 2009, it would be an understatement to say we had a market of extremes-both down and up. Are we headed for a “V” shaped recovery as in past recessions, or is it different this time? First let us review where we have been.
We started out last year with a continuation of the bear market that had seen the averages down 37% in 2008. From January 01, 2009 through March 09, 2009, the S&P 500 with dividends was down another 26%. Investor sentiment was extremely negative, and the future looked bleak. Then, after an unprecedented round of monetary and fiscal stimulus kicked in, stocks rallied in response. The risk trade was back on in full force! The Federal Reserve (FED) vowed to keep the Federal Funds rate close to zero for an “extended period of time”. This policy forced many investors to shift their safe asset investment strategy from one of FDIC insured bank deposits and money markets to investments in the riskier stock and bond markets. The 10-year Treasury note stood at 2.20% at the beginning of 2009 and has moved up to 4.60% at year’s end; however, would one want to invest their funds for 10 years at either rate?
So, where are we now?
Those who believe in the “V” shaped recovery will point to last month’s jobs report where unemployment rose by only 11,000 jobs (the headline number). Productivity is up and the Index of Leading Economic Indicators has risen for six months in a row. Consumer surveys say that spending is up and Gross Domestic Product (GDP) for the fourth quarter looks to be in the 3%-4% range. All reasons to think we are out of the woods; but, we think one needs to examine the underlying data a little closer.
Challenges Ahead.
In our last newsletter we highlighted our concerns about unemployment, consumer spending and government intrusion into the private sector. These concerns still remain. The headline unemployment number stands at 10% (jobless number is a formidable 15.3 million people); while the true measure includes the involuntarily idled at 17.3% -- just under the all time high. The headline number on the just reported December employment report was 85,000 job losses. This number comes from the establishment survey, where larger businesses are called and asked about their employment. They also do a household survey (about 400,000 households surveyed). The household survey reports that last month 127,000 single women who are heads of households saw their unemployment soar. The number of employed men fell by 214,000. The total number of unemployed in the survey rose by a whopping 589,000. People classified as not in the work force (those not looking for jobs) rose by 843,000. In 2009, 3.5 million people were dropped from the potential labor force count because they were discouraged. When you add these people to the 15.3 million who are unemployed, you can see where the actual number is much higher than 10%. The unemployment numbers are “less bad” if you will, but still are a great concern going forward.
Consumer spending is up?
One way to catch this trend is sales taxes. When they are rising, consumer spending is rising. What are surveys of state tax offices saying now? Sales taxes are not up and most states are pretty downbeat on the subject. As we write, credit card lending dropped $17 million last month, the largest drop in history – and during Christmas! Where did the rise in consumer spending come from if savings are up and credit is down? Comparisons/surveys are being made with the horrible 2008 season. Same-store sales comparisons are for a time period when competitors such as Circuit City and Linens ‘n Things went out of business and Best Buy and Bed Bath & Beyond benefitted. Maybe consumer spending is not as robust as the headline numbers would suggest.
Let us now turn our attention to the states and the federal stimulus package. Coming out of prior recessions, municipalities have been a source of job creation. All indications are that this time it will be different.
$200 billion in federal stimulus was supposed to save the states from fiscal ruin. But, the stimulus enticed most state lawmakers to spend, instead of trying to reduce outlays, by adding on to already existing health and welfare benefits and child care programs. When the money goes away, those states that accepted the stimulus money must pay for these increases in their programs out of state funds at a time when many are facing huge and growing deficits--think near-bankrupt California and down-to-its-last –dollar New York. For example, the stimulus offered $80 billion for Medicaid to cover health care for unemployed workers and single workers without children. In 2011, most of that extra federal Medicaid money goes away, and the states have one million more people on Medicaid with no money to pay for it! A couple of smart governors turned down their share of the $7 billion for unemployment insurance. They had the foresight to know that once the federal funds ran out, increased benefits would be unpayable. There are more examples of egregious outcomes for those who took stimulus money. There are programs tied to environmental grants with state matching dollar requirements, and prohibitions on spending cuts on 15 programs from road building to welfare – all increases in expenditures that will have to be paid for when the stimulus ends. So, bottom line, when states should be reducing outlays to match a “new normal” of lower revenue collections, federal stimulus rules mean many states will have to raise taxes to meet their constitutional balanced budget requirements . Is this what they call unintended consequences?
Briefly, here are a few other challenges we are watching as we move into 2010:
Exit strategies. Central banks are starting to plan their exit strategies from the extraordinary fiscal and monetary stimulus put in place to avert this financial crisis. The timing of interest rate increases and the shrinking of the Federal Reserve’s balance sheet are crucial to normalizing our economy. The Fed has the tools, but is there the political will to carry it out? It will be tough to buck Congress and raise interest rates in the face of high un-employment numbers; but, it is imperative if they do not want to create new asset bubbles.
Sovereign Risk. Many countries are threatening to default on their debt – Dubai, Greece, Ireland, and Spain to name a few. This is a stark reminder that there is still much debt outstanding with either implicit or explicit guarantees from “friendly” nations. Will they stand behind the debt?
Populism. There is a movement afoot that blames banks/corporations /people of wealth for all of our current problems. If left to smolder and accelerate, these feelings could manifest themselves in greater government intervention in businesses/Wall Street/and banks. As we said in our last newsletter, government intervention in business adds another layer of cost which dampens corporate profitability and growth.
Protectionism. Washington-led China bashing could have severe consequences for our currency and interest rates. If trade sanctions were imposed, the Chinese would reduce their purchase of our dollar-denominated assets, forcing interest rates higher and endangering an already anemic recovery.
In Conclusion……..
Right now, we believe that we are indeed in a different environment coming out of this recession. We think unemployment and government intrusion will be troublesome and as a result, growth will be muted. There are many unknowns and unintended consequences with the proposed health care and financial regulatory proposals. We have been cautious in 2009 and remain so going in to 2010. But, we are starting a new decade, and we are excited about the future. It will take time, but with turmoil comes opportunity, and we hope to take advantage of those opportunities to put money to work as they present themselves.
Have a Happy New Year!!
As required by the Securities and Exchange Commission (SEC) regulation S-P (Privacy of Consumer Information), we are enclosing a copy of Occam Capital Management’s 2009 Privacy Policy.
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A copy of our current written disclosure statement as set forth on Part II of Form ADV and a copy of our current Abridged Business Continuity Policy are available for your review upon request.
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Please contact Occam Capital Management if there are any changes in your financial situation or investment objectives or if you wish to impose, add, or modify any reasonable restrictions to our investment management services.
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