July 2008 |
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According to the Federal Reserve's statement following the last Federal Open Market Committee meeting on June 25th, the downside risks to the economic growth "appear to have diminished somewhat". The statement goes on to say that "overall economic activity continues to expand, partly reflecting some firming in household spending" and that "the substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time". In other words, they seem to be saying that the worst of the slowdown is behind us so don't worry, be happy. We would like to believe that but that rose-colored view just doesn't jive with what we see happening in the real world.
For example, on June 26th (the day after the Fed's meeting) Brunswick Corporation, the manufacturer of boats, marine engines, and other leisure products announced plans to close 12 plants and layoff 2,700 workers after U.S. boat sales fell to a 40-year low. Also, on the same day LCA-Vision Inc. an operator of 74 Lasik eye-surgery centers in 33 states said their business was down 40% from last year.
And that's not all. A Wall Street analyst and a bond rating service warned that General Motors and Chrysler may be facing a severe cash crunch into late 2009 as $4+ gasoline prices erodes demand for the more profitable pickup trucks and SUV's. GM's U.S. sales are down 16% this year through June as the stock price tumbles to levels not seen since the 1950's.
Obviously these examples of consumers pulling back on spending are for big-ticket items. There are also numerous instances of retail and restaurant businesses commenting on a drop in store traffic. Many small business owners in northern Michigan who depend on tourism are already seeing signs that sales this summer will be less than last year.
It is also interesting to note that the day of the Fed's meeting the Conference Board, a business research group, reported that consumer confidence fell to its lowest level since 1992. They also said that consumer expectations of the economy six months ahead plunged to the lowest level since 1967. Even the tax rebate checks that are being sent out to 130 million families could not lift their spirits.
One reason for this decline in confidence and expectations for the future could be the fact that Americans experienced a $1.7 trillion decline in their net worth in the first quarter of this year after a $500 billion drop in the prior quarter. Real estate values were down about $300 billion in the first quarter and financial assets tumbled $1.3 trillion.
We don't think Americans' mood or confidence levels are going to improve soon. It looks like they took another hit in their net worth in the second quarter as stocks, bonds and real estate continued to fall in price as gas and food prices continued onward and upward. People don't tend to spend money on discretionary items when they are not feeling good about their financial future.
While rising gasoline and food prices have been the recent headline concerns not only in this country but around the world, we think the most important problem confronting the U.S. economy is the severe credit crunch that has continued and intensified since last summer. The fact is the average person has much less access to credit.
Over the last year banks have concentrated more of their efforts on getting the money back that they had already lent out than making new loans. Home equity lines of credit are being cancelled because of falling home prices. Even credit card companies are reducing the borrowing limits they had previously approved. When was the last time you were offered a new credit card in the mail?
Most banks in this country are suffering the consequences from their past aggressive lending practices. Loan losses are rising at alarming rates and not just for mortgage loans. Losses are up for all types of loans from all kinds of borrowers.
These loan losses are reducing banks' capital and thereby their ability to make new loans. Despite the Federal Reserve's efforts over the past year to reduce short-term interest rates and provide liquidity for the U.S. financial system, the end result up to now has been much less than what is needed. The falling stock market in the second quarter was evidence of that fact.
We have a difficult time seeing how the U.S. economy that has been built on the extension of massive amounts of credit can be characterized in its current state by the members of the Federal Reserve (with straight faces I might add) as having diminished downside risks. That seems ludicrous to us.
We realize that the Federal Reserve is in a precarious position with a slowing economy and rising inflation expectations. Higher energy and food prices can become a more widespread inflationary problem if wages begin to rise to compensate workers for these rising everyday costs. The Fed does not want to let that happen, which is why they kept interest rates unchanged instead of lowering them again in the face of these continuing problems in the credit markets. Maybe their rose-colored statement following that decision was necessary to ward off criticism for not doing more to help the ailing economy.
We believe that there will not be a quick turnaround in the economy and that the second half of the year will be weaker than is currently assumed by investors. We have structured our clients' portfolios very defensively with a light exposure to stocks, some hedges and a lot of cash as we wait for the stock market to better reflect our concerns. We are ready to buy stocks when we think the time is right.