By The Curmudgeon
What most Wall Street pundits have not talked about (since last Friday's
jobs report) is the SIGNIFICANT downward revisions in non farm payroll
jobs in June and July. That downward revision -a combined 81,000
decline in the employment growth- was truly staggering. That on top
of the shocking loss of 4,000 jobs in August (over 100,000 additional jobs
were expected). The result? Job growth over the past three
months averaged 44,000, a pretty pathetic performance.
This unexpected loss of jobs could well tip the consumer sector into recession. In 2006, the economy generated an average of 189,000 new jobs per month. But as that once-strong economic momentum has faltered, job growth has slowed significantly.
Only Merrill Lynch economist David Rosenberg offered a true pessimistic take. "Today's employment report was very clearly the weakest of this cycle and vividly portrays a recession-bound economy."
It is doubtful that export growth can bail out the US economy. Hence, corporate profits should decline in the quarters ahead. This combined with rising oil prices and a declining dollar indicates that stagflation or an inflationary recession lies ahead. That does not augur well for stock prices. However, with US Treasuries yielding less then the inflation rate, and the Fed expected to cut short rates significantly, we wonder if capital will flow outside the U.S. causing the $ to crash?
The fact that the S&P 500 has delivered inferior absolute and relative returns over the last seven years can be attributed to the Fed’s failure to anticipate and prevent the “bubbles” of 2000 and 2007. To domestic investors, equities based on the S&P 500 have delivered returns of 3% (price appreciation
plus dividends) but to foreign investors, given the weakness of the dollar, the returns have been negative despite the above-average performance of US corporate profits. In the current setting, the Fed’s attempt to exude confidence is undermined by the growing suspicion that the American central bankers are dealing with the consequences of their own errors. The Fed has responded more quickly but also more excessively to recessionary/deflationary tendencies or fears but has failed to react to inflationary and exuberant behavior rampant in both the real and the financial sector of the US economy.
At the September 18th Federal Reserve meeting, it will become clear that the Bernanke led Fed is switching to a policy of “ease”. We hope they go at it slowly. The excesses and the shortfalls that have developed over the last 10 years, mostly under the non-leadership of Alan Greenspan. need time and patience to be worked out. The US dollar will be sacrificed to avoid a recession. But if it falls too fast it will cause havoc with inflation and interest rates.
In the words of Kenneth Galbraith, the countervailing” forces of a weak dollar and “sticky”cost-push inflation will prevail and prevent the Fed from capitulating, especially with all the "moral hazard" talk.
Maintaining some inflation-hedges in portfolios and continuing to be risk-averse towards lower quality long term bonds is advised given the increased probability of a major political shift “leftward”. We continue to recommend Gold coins/futures/ETFs, hard currency funds, and Euro ETFs. We like the Merk Hard Currency Fund, PIMCO Local Developing Markets Fund, and Prudent Global Income Fund. We are also short the US Dollar Index.
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.