Blog: chris-rhim.blogspot.com Email: crhim@greenviewadvisors.com
Still feeling the effects of the European debt and banking crisis, US investors continued a four month trend of pulling billions out of stocks and buying bonds, exactly the opposite advice of many fee-only, investment advisers. For the quarter, the S&P 500, Dow Jones Industrial Average and NASDAQ stock indices all increased 10-11%, foreign stocks were up 16%, investment-grade bonds were up 5% and US Treasuries up almost 3%. Why this occurred is due in part to a disconnect in the outlook between businesses and consumers.
Large corporations lead our economy in many ways. Companies that do business nationwide may be dominant in their industry, have thousands of employees and contribute to the local economy. Our leading corporations also sell goods overseas which buoy sales during domestic downturns. As the recession deepened, companies slashed payroll, reduced overhead costs, closed less-profitable units and shifted work to cheaper regions while streamlining processes. This has an immediate impact on their bottom line as cash has piled up. Businesses profits are up 4% from the first quarter and over 26% from a year earlier. While they have rebuilt inventory, they have been hesitant to resume hiring. Businesses need clarity before committing resources to new initiatives. Opportunities present themselves when a combination of factors come together making the risk worthwhile. Muddling the picture even more, the government will have to decide to either extend the soon-to-be-expiring tax laws or create new potentially punitive ones. In this environment, it is understandable why large corporate balance sheets look relatively healthy. Economist Ed Yardeni says it typically takes about two years after a recession for business spending to pick up once the economy has stabilized. It also explains why there is a lack of drive to change, innovate, acquire and take on risk in the face of such uncertainty. As a result, balances sheets look healthy, companies have been buying back their stock, refinancing their debt, and their stocks have been surging.
The consumer has not realized as much improvement. Unemployment is stuck around 9.6% with not enough companies hiring. Consumers feel poorer due to plummeting home values which reduces the equity in their homes. All types of consumer borrowing including credit card, home equity, and auto loans have dropped significantly. Wages have either dropped or remained flat. While government transfer payments such as unemployment insurance, Social Security, Medicare and Medicaid have increased, the growth of these payments, as a percentage of Federal spending, remains troubling. These fixed payments along with new health care regulations, defense spending and the like present a growing burden for current and future tax payers. While inflation is currently muted, there is a real threat of much higher rates which would not only mean more expensive mortgages and consumer loans but could further threaten those on fixed pensions. Given this backdrop, it is understandable why consumers remain a bit shell-shocked and have been buyers of bonds. Unfortunately, extremely low yields on bonds and the risks of higher rates have made many bond investments a higher risk than the stock market.
Business should pick up once new tax laws are passed and companies sort out how the new health care rules apply to them. Banks and lenders must also work much harder to resolve personal and commercial bankruptcies and foreclosures that continue to add uncertainty in the real estate market. Once these losses are realized, proper property valuations can be made and lending will pick up to those waiting to buy, sell, refinance or take out equity. The recent freeze on residential foreclosures hurts both homeowners and banks, delays the repricing of foreclosed homes and neighborhoods and adds greater uncertainty to the market as we approach 2011. Until some of these things happen, the disconnect between consumers and the stock market will continue.
As always, please contact me at (301) 655-4970 should you have any questions or concerns.
Chris
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