Thursday, August 27, 2009

Cash Now, Suffer Later?

By Taesik Yoon - Yesterday’s stronger-than-expected new home sales data was encouraging. But the stock markets barely reacted to it. Perhaps, more investors are becoming as skeptical as I am of any sales data that is currently benefiting from some form of federal subsidy.

In this case, I’m referring to the $8,000 tax credit for first time home buyers the government is providing. That, in and of itself, is a strong motivator for any potential home buyer still on the fence. But there’s also the added benefit of alleviating the initial cash burden of ownership. This is because the FHA has allowed qualifying homebuyers to monetize the credit and apply it towards the down payment. This last point should not be minimized, especially now with many buyers required to put up a down payment of at least 20%.

This would also apply to the strong sales enjoyed by automakers in recent months, which has benefited from the highly visible cash-for-clunkers program. In fact, I’m even more skeptical of these numbers due to the magnitude of the incentive. A credit of $3,500-4,500 is nothing to balk at. Coupled with additional incentives and promotional offers by automakers and dealerships, the actual savings to the consumers were far greater.

While the stock markets have reacted mostly favorably to the performance of these programs so far, I don’t believe this reaction is deserved. One of my concerns pertains to just how much stimulus (if any) these programs will actually create.

Economist and Noble Laureate Gary Becker and respected judge, economist and law professor Richard Posner recently posted highly critical opinions on the cash-for-clunkers program on their coauthored blog. Of all the comments, I found this statement by Posner to be the most compelling and concerning:

"It is true that people who participated in the "cash for clunkers" program couldn't pocket rather than spend the money they received from the government, as they could with the other transfer payments included in the stimulus program; they had to use it to help them buy a new car. But that is different from paying a road contractor to build a new highway. The contractor as I said has to go out and hire people to build it, so unemployment falls (on the assumption, correct with regard to construction, that there is a high rate of unemployment in the industry). The purchase of a new car merely reduces a dealer's inventory, and whether the reduction leads to new production will depend on estimates of future demand."
What makes me even more skeptical are the lackluster results stemming for other tax credit/rebate programs implemented in recent memory designed to stimulate consumer spending—specifically, the tax rebate checks that were sent out last year. Like the current programs, these checks boosted consumer spending levels over the near-term. But the benefits over the longer-term were minimal.

This is not to say these tax credit programs won’t work. As my colleague, Sam Ro, pointed out in a recent post, many consumers used the tax rebate checks to pay down debt. But these programs reward only those who spend. As his post implies, a key benefit of cash for clunkers (or any program that encourages spending) is the multiplier effect that spending has on the economy. I agree that these programs will be more effective than the stimulus checks at creating more overall spending over the near term. My concern is what it will do to future demand.

As Becker writes:

“Unfortunately, that the subsidies are popular is no measure of its public value, and I am afraid there is little to be said at any level in defense of a cash-for-clunkers program. Hundreds of thousands new cars will be purchased under the program, but many of these purchases would have occurred later in 2009 or in 2010 instead of during the five week window of the clunkers program. There is little value to the economy in subsidizing consumers to buy cars a few months earlier than they would have bought them anyway.”
If Becker and Posner are correct in their assessment that these programs will simply pull potential sales forward—that is, induce those would have bought eventually into buying sooner—then you’re just sacrificing future growth for growth today. As such, there is a real risk that the programs could actually retard the current economic recovery efforts in future years.

There are beneficiaries of these programs to be sure—car buyers, automakers and dealers, home buyers, homebuilders, and even the environment. But I wouldn't put the economy on that list quite yet.

Tuesday, August 25, 2009

What Trillion Dollar Deficits Mean

By Jeff Diamond - The OMB now projects a deficit of $9 trillion by 2019, but if you really want to understand what that means just consider that 80 percent of the deficit in 2019 will go to interest expense! Yes, 80 cents of every tax dollar will be going to service our debt... As the excellent blog ZeroHedge points out, "We are now officially a vassal state of China."

No doubt that the wars in Iraq and Afghanistan have contributed to our national debt, but it was really the reckless banks overseen and egged on by a reckless Federal Reserve that caused the financial crisis and the gargantuan bailouts.

Enjoy the stock market rally while it lasts... We have paid dearly to engineer this pop in the markets... But, hey, at least Ben Bernanke gets to keep his job!

Sunday, August 23, 2009

Financial Jenga

By Jeff Diamond - So, the improbable stock rally of 2009 continues… Kudos go to the Federal Reserve and their global cohorts. They have implemented all kinds of previously unimaginable liquidity facilities and other monetary props so as to once again levitate global stock markets. The rally has been parabolic in nature, and alas, unsustainable in the long run. In the meantime, however, the financial media is closing ranks in order to spread Ben Bernanke’s and Wall Street’s message far and wide: “The recession is over!” The only problem is that the recession may be ending for the ivory tower economists who devour government economic statistics with little doubt to their accuracy, but for the rest of us who live in the real world all we can see is the economic ruin left by the bursting of the last central bank induced bubble(s)…

If we set aside the smoke and mirrors of Ben Bernanke’s green shoots for a moment, then it is apparent that credit is still contracting, retail sales are still weakening, global trade is still declining, real estate foreclosures are still rising (though not as much as they should since banks are reluctant to swallow the costs and admit the losses associated with foreclosure these days), and sadly, unemployment is still worsening… All this is occurring in the face of the largest global fiscal and monetary money-pump in the history of mankind.

The recent history of cheap money and bubbles seems completely lost on central bankers. Their only answer to one burst bubble is to create a new bubble that is even bigger than the last. I must admit that I lack the imagination (and the chutzpah) to ever succeed at the current game of central banking. Back when Greenspan was chairman, he started off modestly when he engineered the bailout of Long Term Capital, but then cranked things up when his Y2K money pump induced the dotcom bubble. I didn’t foresee the real estate and credit bubble that he was going to foment back in 2002 as the stock market was bottoming in October . It wasn’t long, however, before I realized that the securitization markets were removing risk (supposedly) from lenders and freeing them to pursue business with little concern for the borrowers’ ability to ever repay. What baffles me is central bankers’ complete inability to foresee the consequences of their reckless behavior. So, here we stand in 2009 as the Jackson Hole powwow concludes with these same men patting themselves on the back for acting decisively in averting financial meltdown over the last 12 months while refusing to admit their role in creating it in the first place.

Again, I did not foresee a new global initiative among these men to once again bail themselves out with something even bigger than the housing and credit bubbles. Not only do we have the central bankers creating money at warp speed and shoveling it into what should be failed financial institutions, but we have deficit spending by politicians around the world hellbent on saving their own behinds from the wrath of their economically displaced constituents. But, a funny thing happened on the way to economic recovery. All this newly minted money was highjacked by the same gang of market operators who brought us the last asset bubbles in stocks, bonds, real estate, commodities, artwork, etc., etc… No wonder the real economy isn’t recovering!

So, just in case a central banker or high government official cares, let me say this as clearly as possible… We cannot print and deficit spend ourselves to prosperity. So why would anyone think that zero percent interest rates, government monetization of debt, “too big to fail” bailouts, and government stimulus might work this time? I do not know when the current rally will collapse. It may continue for weeks or months to come. Heck, maybe it could continue longer! It will, however, end in tears just as the last one and the one before that ended, because it is not based on a healthy, wealth-producing economy, but rather a game of financial Jenga that grows ever taller even while the building blocks are disappearing from the foundation.

Update 8/25: It's official... President Obama does not blame central bankers for the current financial crisis. Otherwise, why else would he nominate Ben Bernanke, one of the main architects of easy money since 2002, for a second term as Chairman of the Federal Reserve? It's the safe move politically for the President today, but I guess we'll just have to see how it plays out...

Saturday, August 22, 2009

Cash For the Credit-Worthy

By Sam Ro - Cash for clunkers will not generate major incremental sales for automakers like Ford (F). Some of the 489,000 cars sold under the program were made by consumers who were already in the market to upgrade their vehicles. Some represent future sales that have been pulled forward. This sentiment is shared by J.D. Power and Associates, who recently boosted their 2009 auto sales forecast by 300,000 units, but cut their 2010 forecast by 100,000 units. This reflects a net gain of 200,000 over a two year period, during which 21.8 million cars are expected to be sold.

However, on a per dollar basis, cash for clunkers will be more effective in stimulating the economy than the 2008 tax rebate checks. While much of the tax rebates went toward paying down debt, the clunker cash is more likely to go back into the economy through personal consumption.

Consider those who are participating in cash for clunkers. If Jane Smith qualified for a $4,500 rebate and purchased a $15,000 Toyota Corolla, she has to make a $10,500 financial outlay. This is not a small amount of money. She is likely to take out an auto loan, which is only available to the credit-worthy. Furthermore, if she were in a tight financial situation, she would probably stick with her clunker, which is in driveable condition.

Jane is a confident consumer who won’t save that $4,500. She will spend it on a big screen TV, a family vacation, or a fancy dinner--all good for the economy right now.

This isn’t the only government program that rewards credit-worthy consumers who are likely to spend before saving. There’s also the $8,000 first-time homebuyer tax credit. The Wall Street Journal recently reported on a pending cash for appliance program. Again, this program will not provide a major long-run incremental sales boost to Whirlpool (WHR) and Electrolux (ELUXY). It just puts extra cash in the pockets of the customer, who can spend it on something else.

Obviously, I’m not happy that my tax dollars are going to people who don’t need it. But when it comes to economic stimulus, I prefer programs that reward the credit-worthy and encourage them to spend over programs that bailout the debt-laden.

Friday, August 14, 2009

It Ain't Over 'til It's Over

By Vahan Janjigian - A growing number of economists apparently believe the recession is over. According to the Wall Street Journal, 27 of 47 economists surveyed say the recession, which began in December 2007, has already ended. Another 11 economists say the recession will end by September.

Well, Thursday's retail sales figures threw some cold water on that idea. At the very least, if the recession has ended, the retail sales numbers suggest a double-dip is in the works.

The consensus expectation was for a 0.8% rise in retail sales in July. Turns out, however, that sales fell 0.1%. They fell 0.6% if you take out autos sales, which got an artificial boost from the "cash for clunkers" program. That program is merely bringing future sales forward. It is not going to create a long-lasting increase in auto sales.

Of course, some retailers are doing better than others. Wal-Mart (WMT), where it seems most of America now shops, is doing better than others. Yet even Wal-Mart is struggling with second-quarter U.S. sales falling 1.2%.

High-end retailers that are trying to hold the line on pricing are really getting hammered. For example, Abercrombie & Fitch (ANF) reported a 30% drop in same-store sales for the second quarter. Some of its competitors are doing better, but only because they are willing to discount their merchandise.

U.S. GDP is heavily dependent on consumer spending. Just as stock prices are often pressured by investor sentiment, consumer spending is strongly influenced by psychology. Some economists and government officials seem to think that consumers will believe the recession is over if we just tell them its over. Then they will start spending again and the recession really will be over. In other words, we will have a self-fulfilling prophecy. However, at this point, declaring the recession over is simply premature.

Friday, August 07, 2009

Employment Report Is Less Bad, But It's Not Rosy

By Vahan Janjigian - This morning's better-than-expected labor report was welcome news. Although non-farm payrolls continue to fall, job losses of 247,000 were better than expected. July marks the fourth month in a row that payrolls have fallen by less than 600,000. The employment picture is still ugly, but at least it's moving in the right direction.

Yet the strength of the recent rally in stocks already prices in a big improvement in the economy. While today's labor report is encouraging, it only provides further evidence that things are not getting better; they are simply getting worse at a slower rate.

According to the labor report, there are now 796,000 discouraged workers in the economy. These are people who have simply given up looking for work because they believe no work is available for them. That's more than twice as many as a year ago. This partly explains why the official unemployment rate fell from 9.5% in June to 9.4% in July. When people lose hope and stop looking for work, they are no longer counted as unemployed.

Wednesday, August 05, 2009

Do Blue Dogs Democrats Drink Beer?

The following commentary is from the August issue of the Forbes Growth Investor, which was released to subscribers on August 3.

By Vahan Janjigian - Is the recession over? With Q2 GDP falling just 1%, many economists are asking themselves this question. There is a general sense that the economy hit bottom during the second quarter and is already on the mend. While some corporations have been reporting better-than-expected results, the evidence for an economic recovery is not entirely convincing.

Corporations that beat their earnings estimates did so largely because of cost cuts, not because of higher revenues. In fact, in many cases the year-over-year revenue declines were simply frightening. While some CEOs claim to see signs of stabilization in their markets, almost no one is saying that things are getting better.

The decline in GDP was better than expected, but only because net exports and government spending contributed 1.38 and 1.12 percentage points, respectively, to growth. Ordinarily, a contribution to growth from net exports would be good news. However, exports did not rise in the second quarter. They fell. Net exports rose only because imports fell even more. This slowing of international trade is due to the weakening dollar as well as to consumers saving a greater share of their income. In fact, personal consumption expenditures, the largest component of GDP, fell 1.2% as the personal savings rate surged to 5.2%. As for government spending, there is no comfort in the fact that its role in the economy is growing. Even so-called Blue Dog Democrats are beginning to ask if this makes sense.

Measured in 2005 dollars, second quarter seasonally adjusted real GDP was $12.892 trillion, down almost 4% from its peak exactly a year ago. You have to go back almost four years to find a lower figure. If economic growth hits the top end of projections made by Federal Reserve economists, it will take well over a year to get back to where we were one year ago. Ironically, while those Fed economists have become slightly more bullish about growth, they have become considerably more bearish about employment. They now expect the unemployment rate to peak at 9.8-10.1% this year, an estimate that could easily prove conservative. Even by 2011, they don’t see it dipping below 8.4%.

Although rising unemployment puts a housing recovery at risk, the housing market may have already bottomed. Both existing and new home sales have climbed three months in a row and inventories have fallen. More importantly, prices are beginning to firm. The S&P/Case-Shiller Home Price indexes posted month-over-month gains for the first time since mid-2006. Because the most recent figures are for May, there is real hope that things are even better now than the data suggest.

The bulls got what they were looking for—evidence that the worst is over. They reacted by pushing stock prices to their highest levels since last October. I doubt the euphoria can last. Corporations can’t produce earnings by cutting costs forever. Eventually, they will need revenue growth. With consumers still cutting back on their purchases, the 46% rally in the S&P 500 from its March 9 low seems premature. Stocks are already pricing in a strong economic recovery. Evidence contradicting this thesis will likely cause a significant sell-off.

Monday, August 03, 2009

Cash for Clunkers Makes No Sense

By Vahan Janjigian - Although I hate taxes, I like the fact that taxes affect behavior. In general, if you want less of something, tax it. If you want more, provide a tax subsidy.

Americans used to smoke a whole lot of cigarettes. Today, they smoke less than they used to. No doubt, some gave it up for health reasons. Others, however, decided it costs too much. We have taxed the hell out of tobacco products and we got less smoking as a result. That's good news for health, but bad news for politicians who thought higher taxes would create more revenue.

On the other hand, many of our politicians decided long ago that home ownership was a good thing. They wanted to encourage people to buy more homes. So they decided to allow home buyers to deduct the interest payments on their mortgage payments. Those who don't own homes are subsidizing those who do. Things worked as planned and we got more ownership as a result--maybe more than was optimal.

Now our politicians want us to buy cars. So they came up with the "cash for clunkers" idea. Trade in your old car for a new one now and the government (read taxpayers) will pay a good part of the cost. So today's car sales figures should be no surprise. Stocks like Ford took a big jump.

Unfortunately, the sales jump will not last. All we are doing with this program is bringing future sales forward. The more cars we buy now, the fewer cars we will buy later. Auto stocks that surged today will likely give up at least some of their gains tomorrow.