Tuesday, February 24, 2009

Pointers for the Prez

Much is being made of President Obama’s first Congressional address on the economy that is scheduled for the evening of February 24, 2009. The experts say he must strike a balance between reality (put your head between your knees and kiss…) and optimism (the American people working together can solve any problem).

In these hours before Obama takes the microphone I would like to offer a few pointers for the President on keeping the speech upbeat. He needs to get past the popular election campaign assumption that “Joe the Plummer” and “Joe Six Pack” are too dumb to understand finance. He also needs to stick to the facts. Americans are fed up with the baloney that had been fed to them by corporate executives, regulators and politicians. Conveniently for this web log, these same facts could cue investors on those really tough decisions on holding, buying and selling stocks.

Over the last few weeks investors have been shaken to the core at the continuing deterioration at the major commercial banks and the prospect of nationalization of those banks in a fashion that not even the communists in Russia would approve. The February 20th post "Where has all the Money Gone?" touches on the implications of system failure for equity valuation. This is reality, but not the entire set of facts.

Here comes the upbeat portion the program. The Federal Reserve has instituted special lending programs and the U.S. Treasury has injected capital into banks. Most importantly the money supply has been pumped up to record levels. The idea is to get banks to start lending again.

It appears these monetary policies may have started helping. Although defaults on corporate bonds have increased, issuance of new bonds also increased in January 2009. The spread on credit default swaps for banks has narrowed in recent weeks, suggesting investors perceive lower risk.

So how is business and industry doing? If you only read the paper or watch the evening news you might say the only thing going on is layoffs. The U.S. lost 2.6 million jobs in 2008. The U.S. Census Bureau reported declining manufacturing activity through December 2008, the last month for which their report has been issued. The Institute for Supply Management (ISM) issued data on January 2009 that suggests economic activity in the manufacturing sector failed to grow again in the first month of the year. However, ISM’s January New Orders Index increased to 33.2 in January 2009 from 23.1 in December. ISM’s Prices Index also indicates significant deflation in input prices paid by manufacturers, which should flow through to consumers in the coming months. So in two words, the economy is still contracting but at a slower pace.

The federal government through several departments and agencies has been trying to prop up the faltering housing market. Existing home sales and new listings increased in the last month. The total supply of homes for sales decreased to 9.3 months inventory in December 2008 from 11.2 months in November. Existing home sales increased 6.5% in December 2008, although that was driven by a greater number of distressed sales. Foreclosures dropped 10% in January 2009. Taken as a whole, the data suggests improved affordability as the result of lower home prices and mortgage rates. In other words the housing market is working through the excess supply of homes in a more orderly fashion with foreclosure less frequently the outcome.
The economy is not in the clear just yet. Our situation remains grim, but another two or three months of the same data points would be good reason to relax and take a breath. Hope would be a little less audacious than it seems today.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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