A strong rally, fueled by perceived progress in Europe towards more-reasonable economic oversight resulted in the first positive June in seven years. September is the only month that is historically worse. Still...the markets only managed to make back about half of what they lost in May and finished the 2nd quarter in the red. To date, the S&P 500 is still 7.3% below where it was at the beginning of 2000.
But, the market is not the economy and there are signs of continued weakness everywhere you look. U.S. consumer sentiment ticked lower and the Chicago Purchasing Managers' index was weak. Personal and disposable incomes rose in May, but consumer spending remained flat indicating that some folks are once again looking to reduce debt.
The June Institute for Supply Management services index fell to 52.1% from 53.7% in May indicating service activity slowed. We also had the European and Chinese central banks cut interest rates while the Bank of England held rates steady but increased asset repurchase programs. These are all forms of easing and all indicate the major central banks believe their economies still need help.
An awful June employment report showed the economy continued to struggle three years after the recession ended. 80,000 jobs were created and the unemployment rate remained at 8.2%. The average job growth for the second quarter is an anemic 75,000/month. That's 1/3 of what it was in the first quarter and less than 1/3 of what it needs to be to get us on track to realizing lower unemployment rates.
Job growth in May was revised up to 77,000 from 69,000, but April was revised lower to 68,000 from 77,000. The pesky U6 unemployment number which includes discouraged seekers and those forced to work part time who would rather be working full time edged higher to 14.9% from 14.8%. The labor force participation rate did not change.
According to industry surveys, corporations are opting to reduce debt with the cash they have on hand rather than increase their workforce in the face of still very uncertain times and potential policy and regulatory changes...not to mention the looming "fiscal cliff"...a rather disconcerting term popping up all over the media. As bad as it sounds, it describes a return to a recession and economic contraction in the U.S., not global economic Armageddon...yet.
If a silver lining can be found in any of this I'll offer the observation that all of these indicators are lagging. We won't see improvement in jobs, unemployment or GDP growth until after they've already started to improve. Look to the leading indicators like manufacturing activity, retail sales, corporate plans for hiring vs. layoffs and building permits for guidance.
The worst part is, and corporate management knows this is the major policy components that the experts agree will drive us over a fiscal cliff are already "baked in" unless something changes between now and the end of the year. The "cliff" is a predicted slowdown in the economy as early as 2013 if taxes rise and government spending falls. Both of those things are currently scheduled to occur. Since congress and the white house seem perfectly willing to dig their heels in and not compromise between now and the elections, this "mini-doomsday" scenario is increasing in likelihood.
Tax Increase #1: Taxes will increase if the Bush tax cuts expire as they are set to at the end of 2012. Republicans want them extended across all income levels. Democrats and the president want them extended only for lower and middle-income families, and the president has said he'll veto anything that extends the cuts for upper-income families.
Tax Increase #2: Also likely to expire are the president's payroll tax cuts, meaning employee's Social Security withholding will go back to 6.2% from 4.2%. Less money in peoples' pockets and more for Social Security, which desperately needs it, but until the government stops using the Social Security trust fund like a piggy bank, it will unfortunately result in more for them to spend with little or no accountability.
Tax Increase #3: The recently upheld Affordable Care Act is paid for in part by a tax on investment income which will take effect in 2013. Families with incomes over $250,000 ($200,000 for individuals) will pay an additional 3.8% tax on investment income, e.g., interest, dividends, capital gains, rents, royalties, etc. This additional tax will not apply to currently tax-free income like that from tax-exempt municipal bonds or to withdrawals from IRAs and other qualified retirement plans...for now.
Spending Cuts: Remember the debt ceiling fiasco of last August? Part of that agreement was $2.1 trillion in discretionary spending cuts over the next ten years, including cuts of $1 trillion in defense. Those cuts start in 2013 and are unlikely to be postponed, modified or scrapped because the president has threatened to veto any changes to that agreement.
Economists disagree on the amount the economy would be affected by these provisions, but average estimates are a slowdown of around 3.5% in GDP growth. Keep in mind the GDP is currently growing at less than 3.5%, so that equates to an instant recession.
Again, these taxes and spending cuts are automatic unless congress and the president can agree on a different course. Regardless of the outcome of the November elections, it is highly unlikely a lame-duck congress will be in any mood to compromise between Thanksgiving and New Year's.
I know all our readers do not share my economic or political views. I just ask, as always that you listen very closely to what the candidates are saying, what they're talking about spending and how they're going to pay for it as you make your decisions. As the elections loom ever-closer, candidates on both sides nitpick at each other, making mountains out of molehills and misstatements. Keep your eye on the ball...the important stuff and how they'll deal with it. All the nonsense is distraction because neither side really has a plan to deal with it.
Any candidate here or abroad that advocates more borrowing and increased government spending as a way out of this economic mess is promising to work directly against the most-productive members of society. You may call them whatever you want, but the single, definitive difference between the 1% and everyone else, governments and 99 percenters alike is responsible vs. irresponsible use of debt. In simplest terms, it was personal and public fiscal irresponsibility that caused this financial crisis. Borrow more, print more, spend more has to end someday. The alternative to getting the deficit spending and debt under control is not pretty.
The republicans will lose this tax-cut argument, and look bad doing it through sheer ineptitude and incompetence on the part of their leadership, and I expect more of the same between now and January. They don't have a plan. They're not serious about fixing the problem. They like to spend money every bit as much as the democrats.
A fairly blatant example of the problem as I've described it comes from the president's recent speech in Pittsburgh. He got lots of cheers and good press for saying "We had to put two wars on a credit card, taking a surplus and turned it into a deficit." Later in the same speech, to more cheers after he reports the Iraq war is over and Afghanistan is winding down he said, "Let's take half the money we're saving on the war and use it to pay down the deficit...and the other half and do some nation building here at home." He then talked about putting Americans back to work rebuilding bridges and schools and building broadband lines, wireless networks and high-speed rail.
This is great, feel-good stuff, full of applause lines but did you catch it? He doesn't have any of that money. It doesn't exist now because it was borrowed to begin with, and as long as we continue to have a deficit, he's talking about borrowing money to reduce borrowing. We're not paying down, or paying off anything!
As for the other half of his spending plan...I'll file that under more stimulus spending and more borrowing. The last round of that didn't work out so well, so let's do more. Redistribution is not growth. I can't say it any more simply than that. The stimulus program did not keep unemployment under 8% as promised, there were no "shovel ready" jobs, the math on "cash for clunkers" was abysmal, and when the president, or his advisors, or Nobel-prize winning economists who have never had a private-sector job say, "the private sector is doing fine, we need to concentrate on the public sector," they are essentially proposing more of the same.
So...what does this mean for your investment portfolios? Unfortunately, it probably means more of the same, volatile, net-sideways markets and low yields. Second-quarter earnings reports begin this week. Corporate balance sheets are getting stronger as they opt to reduce debt, but production and consumer sales will not recover until we see some meaningful job growth. A few individual companies and their stocks will do well and we'll keep looking for those with strong balance sheets and dividend growth. Looking for income in government bonds will continue to be tough as long as rates stay in the basement, but there are other sources. Please call us if you have questions.
