FYI | Sep 21 2009
(This story was originally published on Wednesday, September 16, 2009. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere).
It is not our aim to be bullish, or to be bearish. It is simply our aim to be correct – FNArena.
“We face an economy with substantial slack, prospects for only moderate growth, and low and declining inflation” – Janet Yellen, President and CEO of the Federal Reserve Bank of San Francisco.
The first statement above sums about up what we at FNArena try to achieve. Many readers who only started taking note of our existence since mid-2007 (or our writings and analyses in addition to the broker stories we publish) might have been surprised while reading our more recent musings, as we at times proved even more bullish-minded than some of the market bulls we frequently read. Fact is, however, we have little doubt that natural separation between FNArena and those bulls will again take place eventually, if only because most bulls cannot help but do what they always do best – no matter what the circumstances, while we will simply change our tune in line with the change in underlying trends.
I thought it was apt to open this week’s editorial with the above reminders. This week the age-old Dow Theory has provided investors in the US share market with another Buy-signal (this happens when a movement in the Industrials is being confirmed by a similar movement in the Transports, or the other way around), while Fed Chairman Ben Bernanke (sort of) declared the end of the US economic recession and Warren Buffet has been quoted as saying he’s happy to buy more US equities.
No wonder thus the Australian share market surged beyond 4600 on Wednesday, like a high speed train at full speed, on its way to a new eleven month high, even despite some foreign selling orders in the background because FTSE decided to rebalance one of its regional indices, leading to less representation for Australia.
Maybe this is as good a time as any other to remind investors that nothing ever lasts forever. Or to put it in the words of the sage King Solomon:
“This too shall pass” (eventually).
The first time I referred to Solomon’s words of wisdom was during last year’s relentless downturn. It goes without saying Solomon’s words will prove equally well-chosen this time around.
As anyone would have concluded from my recent writings and analyses, I am not buying into any of the all-doom-and-gloom scenarios that continue doing the rounds, be it from Elliott Wave-analysts predicting a retest of the March lows will soon be upon us, be it from worrybeads and bear-commentators elsewhere who see the US financial system yet collapsing and the economy eaten alive by a gargantuan deflationary back hole.
In the same breath, investors will do themselves a big favour by not getting fully sucked in by the unbridled market euphoria that is currently dominating everything else.
It is for this reason that this week’s speech by the President and CEO of the Federal Reserve Bank of San Francisco, Janet Yellen, deserves your attention. Yellen’s speech to the San Francisco Society of Certified Financial Analysts won’t provide investors with any insight into timing, but it does give a stern reminder that those words passed on with Hebrew legacy over many centuries will eventually prove their value, again.
Yellen’s speech in full is available as a Special Report on the FNArena website (alternatively: see the website of the San Francisco Fed). What follows is a selection of the standout paragraphs in this week’s speech by Yellen.
Janet Yellen: “I believe that we succeeded in avoiding the second Great Depression that seemed to be a real possibility. Much of the recent economic data suggest that the economy has bottomed out and that the worst risks are behind us. The economy seems to be brushing itself off and beginning its climb out of the deep hole it’s been in.”
“That’s the good news. But I regret to say that I expect the recovery to be tepid. What’s more, the gradual expansion gathering steam will remain vulnerable to shocks.”
Your editor: Yellen, speaking on her own account, not as a spokesperson for the Fed, is convinced the US unemployment rate will remain “elevated” for years to come, while she describes the US economy overall as a very ill patient who has been kept on “essential life support” through interventions and support programs initiated by governments and central banks around the world. What we are experiencing right now, says Yellen, is the economy is little by little starting to breath again on its own.
Janet Yellen: “I’m happy to report that the downturn has probably now run its course. This summer likely marked the end of the recession and the economy should expand in the second half of this year. A wide array of data supports this view…Importantly, consumer spending finally is bottoming out.”
“A particularly hopeful sign is that inventories, which have been shrinking rapidly, now seem to be in better alignment with sales… Recent data suggest that this correction may be near an end and firms are now poised to step up production to match sales.
“In fact, I expect the biggest source of expansion in the second half of this year to come from a diminished pace of inventory liquidation by manufacturers, wholesalers, and retailers. Such a pattern is typical of business cycles. Inventory investment often is the catalyst for economic recoveries. True, the boost is usually fairly short-lived, but it can be quite important in getting things going.”
“Improved financial conditions have played a vital part in stimulating greater activity… The fiscal stimulus program passed by Congress in February also deserves credit for helping the economy turn the corner… Much of the stimulus money remains to be spent and will add to growth as the year proceeds.”
“The all-important question is how strong the upturn will be. With unemployment at 9.7 percent of the workforce and capacity utilization at its lowest level of the post-World War II period, the economy has an enormous amount of slack. That gives us plenty of room to grow rapidly over the next few years…”
“At first glance, history suggests that a vigorous expansion could very well take place. Following previous deep recessions, the United States typically saw V-shaped recoveries. For example, the economy grew at an average rate of nearly 6 percent during the two years following the severe recession in 1981-82.”
Your editor: So far so good. Up until this point Yellen is citing similar experiences from the past similar to many optimistic market commentators and experts elsewhere, only to spoil it with the following paragraph:
Janet Yellen: “This time though rapid growth does not seem to be in store.”
“My own forecast envisions a far less robust recovery, one that would look more like the letter U than V… It is consistent with experiences around the world following recessions caused by financial crises. That seems to be because it takes quite a while for financial systems to heal to the point that normal credit flows are restored.”
Your editor: The following two sentences in particular will cause many less-exuberant economists and analysts across the globe to nod heads in full agreement:
“In an attempt to improve credit quality and reduce risk, banks have now tightened business and consumer lending standards. They have been doing so at the same time that rising unemployment and falling house prices have fed additional credit losses.”
Your editor: Consider, for instance, the following chart which might as well be regarded as the key reason why so many experts remain skeptical about what lies ahead for the US (and the global) economy:
Janet Yellen: “Unfortunately, more credit losses are in store even as the economy improves and overall financial conditions ease.”
“In the face of continuing credit losses, moves by lenders to shrink assets, reduce leverage, and conserve capital are restricting the provision of credit in the economy.”
“Here’s the bottom line: Financial conditions have clearly eased compared to the darkest days of the financial crisis. But the financial system is still far from healthy and tight credit is likely to put a damper on growth for some time to come.”
“The chances are slim for a robust rebound in consumer spending, which represents around 70 percent of economic activity.”
“Over the long term, consumers face daunting issues of their own. In fact, it’s easy to draw a comparison between the financial state of households and that of financial institutions.”
“It may well be that we are witnessing the start of a new era for consumers following the traumatic financial blows they have endured.The destruction of their nest eggs caused by falling house and stock prices is prompting them to rebuild savings.”
“An increase in saving should ultimately support the economy’s capacity to produce and grow by channeling resources from consumption to investment. And higher investment is the key to greater productivity and faster growth in living standards. But the transition could be painful if subpar growth in consumer spending holds back the pace of economic recovery.”
“My business contacts indicate that they will be very reluctant to hire again until they see clear evidence of a sustained recovery, and that suggests we could see another so-called jobless recovery in which employment growth lags the improvement in overall output.”
“Unemployment, job insecurity, and low growth in incomes will undoubtedly take a toll on consumption. When the array of problems facing consumers is considered, it is hard to see how we can avoid sluggish spending growth.”
“The slow recovery I expect means that it could still take several years to return to full employment. The same is true for capacity utilization in manufacturing. It will take a long time before these human and capital resources are put to full use.”
Your editor: Towards the end of the speech Yellen notes the fierce debates that are taking place across the globe about whether we should fear uncontrollable inflation or the exact opposite danger of price deflation in the coming years. Yellen is firmly on the side of the deflationists, believing:
“the more significant threat to price stability over the next several years stems from the disinflationary forces unleashed by the enormous slack in the economy.”
In case anyone still has any doubts: “With slack likely to persist for years, it seems likely that core inflation will move even lower, departing yet farther from our price stability objective.” (Our = the Federal Reserve’s)
Time for the final message (after all, she is President of the Federal Reserve Bank of San Francisco):
“We are, as always, steadfast in our determination to achieve both of our statutory goals of full employment and price stability.”
“I can assure you that we will be ready, willing, and able to tighten policy when it’s necessary to maintain price stability. But, until that time comes, we need to defend our price stability goal on the low side and promote full employment.”
Your editor: Don’t expect US interest rates to move higher anytime soon.
Enjoy the good times, but don’t assume all this will last forever. A sustainable bull-market will require consumers in developed economies (not just in the US) to actively participate in the economic recovery. At this point we have production realignments and inventory corrections, which are both necessary and welcome, but we will still require consumer spending to pick up in a big way to make this a solid and lasting recovery.
Don’t be surprised if we will see a few dips and retreats along the way.
With these thoughts I leave you all,
Till next week!
Your editor,
Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab Team at FNArena)
P.S. All paying members at FNArena are being reminded they can set an email alert for my editorials. Go to Portfolio and Alerts in the Cockpit and tick the box in front of Rudi On Thursday. You will receive an email alert every time a new editorial has been published on the website.
P.S. II Those who want to read the full speech can download it in pdf format via the Special Reports section on the FNArena website.
P.S. III Consider also the following two charts, both with special thanks to BTIG:
(Apologies if you are reading this through a third party channel and the charts are not included. Technological limitations are to blame).
