Column: Economic Musings
An economy characterized by constrained credit and a retrenching consumer continues to weigh on growth. Although GDP growth was positive into the third quarter, much of this could be attributed to the tax rebates of the spring. It is noteworthy that even with this stimulus adding 10.5% in annualized disposable income growth in the second quarter, real spending grew at less than 1%.
Meanwhile, no sign of a bottom in housing prices has emerged as weak incomes (ex government stimulus) and the limited availability of mortgages hold prices down. Not until these two factors reverse can we begin to clear out the inventory of unsold homes and see prices stabilize and climb.
The dollar continues to gain against the Euro and the Pound – currently selling in the 1.45 to 1 area against the Euro. The dollar is also gaining against the Japanese yen. Some emerging market currencies, notably China’s, are continuing to gain against the dollar. With worldwide materials demand coming off somewhat, material-oriented economies such as Brazil find for the first time in some while that the dollar is gaining against their local currencies. While it is clear that the U.S., Europe and Japanese economies are currently cooling off somewhat, it is not at all clear whether this will extend to China. China, now that the Olympics are over, is making great efforts to re-stimulate her economy and most particularly in the areas around the Olympic cities which had been shut down in the interest of clean air.
Crude oil is settling back after having for the first time in history passed $100 a barrel only in April, and vaulting to $147 in July. With slower-paced U.S., European and Japanese economies and perhaps some slower pace in the emerging world led by China and India as well, world demand has come down somewhat.
Crude oil and natural gas, unlike other materials, are in short supply relative to average worldwide demand at this point in time. There is additional land for planting grain crops, there are more trees to be cut for lumber, and there are substantial amounts of copper ore in the world. But oil is increasingly found only in places like deep water drilling offshore Brazil, Ghana, the Gulf of Mexico and the Canadian tar sands where average recovery cost is now in the $70 to $80 a barrel area. This means that should the price of crude world-wide fall to or below $80, many planned additions to the world oil supply to replace oil which is being pumped everyday will necessarily be suspended, thereby reducing world supply.
In addition, the OPEC nations have announced a cut back in production of 500,000 barrels a day. All the OPEC countries have had big spending programs and some countries like Dubai and Abu Dhabi have strung themselves out on enormous infrastructure building programs. Most of OPEC cannot afford to have oil go back to the $50 – $60 a barrel level and therefore strenuous efforts will be made in terms of reducing output if necessary.
For some weeks now, hedge fund operators and other speculators who came late to the purchase of energy stocks and commodities are now liquidating those hastily bought holdings. This has put short-term pressure on the price of energy stocks and commodities and that may continue for some weeks. We would think at some point in the next month or two such forced liquidations would be behind us and prices will return to values based on underlying economic fundamentals.
In any event, were oil to sell at $80 a barrel, the oil, natural gas and oil service companies would still be enormously profitable. Prices of these stocks are at or below where they were when oil was selling at $80 to $90 earlier this year. Accordingly, we believe adequate representation in the energy sector is a viable long-term position for long-term capital gains production.
U.S. Treasury yields continue to move lower as investors around the world once again look to dollar-denominated prime issues for safety, this in spite of some concern about monetary inflation.
The government’s move to stem a large portion of the credit melt down by taking control of Fannie Mae and Freddie Mac is welcomed. The two organizations have been placed in conservatorship backed up by government guarantee of their debt financing. The stockholders will in all likelihood not fair so well as most of the equity has evaporated.
We continue to employ a risk-averse strategy consisting of U. S. government agency bonds offering about 4% for a 5-year maturity, or U.S. corporate bonds yielding a bit more. The tax-exempt municipal market continues to offer value to investors paying the full tax rate. As of this moment the ratings remain solid.
Equity market declines have begun to broaden out beyond the housing, financial and consumer discretionary sectors as estimates of corporate earnings in general are cut. It is worth noting that year-to-September 18, 2008 Wall Street has outperformed most global equity indices (London FTSE -22%, Hang Seng -34%, Nikkei -24%) in terms of both local and common currencies. This suggests that the U.S. is probably further along in de-leveraging economic excesses and also reflects more reasonable valuations.
A well-grounded and thoughtful Catholic, Los Angeles-based founder and CEO of Chelsea Management Company, Mr. Fred Ruopp, Sr., is ranked by Kiplinger's as one of the... MORE »