Capital Markets Update: Economy

Notes from the August 23, 2010 issue of “The Punch Line…”, published by Abraham Gulkowitz

Headlines and data appearing in The Punch Line came from widely available publications including national and international newspapers, trade journals, economic and industrial bulletins and news websites.

Curves in All the Wrong Places

Much of the economic data has been coming in weaker than many experts had expected, even as companies appear to have made an impressive recovery from the Great Recession. Talk of a double-dip downturn is spreading. We argued from the midst of the downturn that the recovery from such a unique recession was going to be complex and difficult to categorize with the traditional nomenclature of previous recoveries. Bottom line--the economy that emerges from this recession may not resemble the pre-recession economic fabric. Even in recovery, key drivers of the economy would remain disoriented, crippled or run way below potential, at best. That has been underscored in these pages again and again. Households, in particular, will continue to be constrained. Limitations come from feeble employment growth, new borrowing guidelines, ongoing risks to home prices and severely impaired household balance sheets that call for a multi-year deleveraging process. The need to rebalance budgets at the state and local level is also an ongoing drag on growth. Such weakness even jeopardizes corporate earnings as massive cost-cutting and ample capacity in most industries mask weak sales prospects. On the international scene, Europe will follow austerity programs for years, and China’s boom centered economy is in need of downshifting. Ultra loose macro policy has also come with some awkward consequences. The liquidity infusions plus the reserve status of Treasuries has created a thorny set of circumstances, with yields on government securities at absurd levels. And policymakers can’t let go of easing. The acceleration of the sovereign crisis in Europe plus the disappointing turnover in the macro data helped shift market expectations regarding the exit strategy from ultra easing to talk of actually expanding support (through extending quantitative easing). Such expectations were accelerated with the recent FOMC announcement of reinvesting mortgage pay-downs, rather than letting them just roll off. Perhaps such supports can counter some of the slowing already evident. But in total, the wide range of troubling issues seem to have no obvious solutions, thereby challenging the growing belief that the business cycle will naturally conquer all its multiple threats.

U.S. Jobs Problem Looking More Structural

Laid-off census workers were the main cause of the July tumble. But the private sector added
just 71,000 jobs, suggesting struggles to absorb new workforce participants. New hiring is
seriously lagging that of previous recoveries. A new market inefficiency could be forming.

From the section titled: The Return to Normal!

Federal Reserve Official Sees Chance of a New Boom-and-Bust Cycle

Thomas M. Hoenig says the Fed needs to avoid the monetary policy that followed the recessions of 1990-91 and 2001.

This year’s federal deficit will exceed $1.3 trillion, Congress’ official budget analysts
projected Thursday in a report underscoring election year perils both parties face as they
struggle to balance conflicting demands to trim budget shortfalls, spark the economy and cut
taxes. The nonpartisan Congressional Budget Office said this year’s budget gap would be $71
billion less than last year’s red ink, thanks to a reversal of recent trends that have seen years
of steadily rising government spending and falling federal revenues. Even so, that would
leave this year’s deficit as the second largest ever in dollars, trailing only last year’s $1.4
trillion. To put those numbers in perspective, the shortfalls for 2009 and 2010 are each three
times as big as the government’s annual deficit had ever been previously.

From the section titled: Credit Matters

Accounting Change Set to Burden Companies

According to the FT, “retailers, airlines, and ship operators can expect to assume billions of dollars more liabilities on their balance sheets as the result of a radical overhaul of lease accounting proposed by US and international standard setters.” Some companies fear they might breach their loan covenants as a result of the new rules. Under the new rules, the liabilities of companies would rise as they are forced to put rented assets like planes, ships, shops, and even photocopiers on their balance sheets. According to PWC, these moves could increase a company’s debt load by almost 60%. The rules are subject to further consideration until a
final standard is released in 2011.

Asian credit growth (outside of China) is growing rapidly at a 15% QoQ rate as of June, even
as exports moderate.

China’s loan crackdown may have unintended penalty…

Beijing has ordered banks to bring loans made to trust companies back onto their books. Closing the loophole will help reduce financial risks. But the move could also leave make it harder for banks to meet existing lending limits, restricting the supply of credit.

From the section titled: Real Estate and Construction Outlook

Was that the recovery? Judging by the latest round of reports from European property companies and tracking services, growth in property values is rapidly slowing as rents and demand for property show signs of declining in some markets. The latest data published by research group Investment Property Databank show that property values in the U.K. have grown 15.4% since August 2009 and about 7% this year. But the growth in property values has been slowing for the past four months; in July, U.K. property values barely budged, rising just 0.2% from the previous month.