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April 2009 Market Review: Brave New World

Posted by Larry Doyle on May 1, 2009 5:00 AM |

Does the economic activity in April 2009 represent a turning point in the recession which started in December 2007? Does the continuing rebound in the equity markets represent a bright light at the end of the tunnel or merely a rebound from a very oversold market? Have global risks abated or are they being masked by massive government intervention? Let’s get after it.

april-market-review

In my opinion, we are in the early stages of transition to a new global economic dynamic. That process includes:

1. Strict discipline in underwriting. Banks are forced to underwrite to own as opposed to underwrite to sell. The shadow banking system (loans originated to be securitized and sold) is dead as we knew it. Banks have certain assets marked way too cheaply while also carrying plenty of fraudulently underwritten loans worth far less than their mark. Growth potential for the economy as a whole will remain constricted by a lessened flow of credit. There will be a clear distinction in companies which are winners and losers in this process.  

2. Lessened consumer demand on a going forward basis.   

3. Challenges for companies relying on debt financing and opportunities for companies generating free cash flow. The model based on leveraged finance is dead and not soon to return. Automotive companies need a 13 million rate of unit sales to break even. Without a shadow banking system, I don’t see this happening.

4. Opportunities for consumers buying homes. Don’t expect a rebound in home price appreciation as foreclosures, which were forestalled by banks and Freddie and Fannie, will add supply to the housing market. Housing may stabilize, but I do not think it will improve given the glut of unsold homes. 

5. Continued increase in unemployment will keep consumers cautious.

6. Many analysts focused on inventory drawdown in the latest GDP report as being a positive for future growth. Why didn’t analysts highlight the fact that consumer spending was actually a positive 2.2%?  Does that statistic represent a return of the consumer? In my opinion, NO. The positive consumer spending was primarily focused on massive price discounts offered in January and February to move product after anemic holiday sales. Personal spending for March was released yesterday morning and came in at -.2%. March retail sales were a surprisingly weak -1.1%.

7. Government intervention in markets may be viewed as necessary in the short term, but a persistent government presence in markets and industries comes with unknown, and in my opinion, very high costs. We are seeing heightened challenges in banking, insurance, automotive, and soon health care, energy, and education. Companies, consumers, and investors will be forced to adapt to a regular presence of Uncle Sam. He is not a good business partner. 

8. There is a very distinct shift in economic power towards China and with it a shift in political power, as well. I believe it is a question of when – not if – in terms of a major European country defaulting on its debt and requiring a rescue from the EU and/or  IMF.

9.  I still see a steady dose of analysts and economists forecasting future economic activity based on past models. I think they are missing the big picture.  I believe we need to forecast economic activity based upon traditional bank lending. If the government persists in trying to fill a void which naturally is not there, the risk involved in that undertaking is hyperinflation. 

Again, I am happy the markets have rebounded from the lows of early March but in looking forward I see a dramatically different economic landscape than our recent past. People who are able to adjust to that will do fine. People who are trying to maintain a lifestyle predicated on the economy of 2003-2007 will be very frustrated.

As far as my market call, I remain very concerned about the prevailing level of interest rates. I think the market will test the resolve of the Fed to continue to effectively overpay for mortgage and government securities.

In regard to the equity market, we are only 3-7% away from the S&P and DJIA being unchanged on the year. If we do get there, I think it would be a good opportunity to sell positions. I believe the next 10% move will be to lower prices.

In short, I think the delevering process has been given a significant breather due to Uncle Sam’s checkbook but that it is not yet over.

What do you think? There is plenty here for everybody. Please share your thoughts.

LD

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  • Larry –

    The piece of this that I agree with you the most on is that analysts and economists continue to forecast future economic activity (and stock market direction) based on past models. We are currently sailing through uncharted waters in many different ways. The Federal Reserve’s actions over the last 18 months are a great example of that. That doesn’t necessarily mean that this is a worse situation than we have faced before, it just means that it is a different situtaion than we have faced before, and that no one really knows where we are headed. As you said, we are moving to a whole new and fundamentally different economic system and economic model. In my opinion, any forecast, for either the economy or the stock market, that is based on past historical models is not a credible forecast.

    Matt

  • TeakWoodKite

    There is a very distinct shift in economic power towards China and with it a shift in political power, as well. I believe it is a question of when – not if – in terms of a major European country defaulting on its debt and requiring a rescue from the EU and/or IMF

    LD, Was not the IMF itself 4 billion in the hole?

    Your analyisis extend to the global banking system I would venture that the points you make on the national level will manifest in “new models” in the global economy.

    In terms of China, does not the decline in consumer consumption effect China as well? China’s exports are likley to be fickle and their currency manipulation will continue. As an a side, I am wondering,
    in the evolution of world banking structure will other forms of banking gain an increase in funding levels in an effort to “get around” some of the current economic blood clots?

  • TWK….all great comments across the different posts. Always appreciated.

    No doubt the dynamics at work domestically will have to manifest themselves globally as well.

    China will clearly be impacted by our decline in consumer spending but the Chinese are operating from a much stronger initial position given their government surplus.
    Against that backdrop, their economy has benefitted much more rapidly from economic stimulus packages that have been implemented.

    In terms of other “forms of banking”, private capital will ultimately find a means to get through clogged arteries. However, from a global standpoint the ultimate answer is TIME. New economic growth will slowly absorb the current losses in the system.

    • TeakWoodKite

      Economic bypass surgery is required. Who will invest in a company when the government is saying the secured investment is not valid and if you don’t like it , the truck will be empty by the time it leaves JFK?






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