2nd Quarter GDP at 3.3% 8/30/2008

The long awaited 2^nd Quarter GDP (gross domestic product) figure was released early yesterday at 3.3% - revised up from 1.9% - a huge improvement over almost every estimate and a staggering blow to the ‘recessionists’ in the market. Though the investment markets were obviously paying attention, the DOW rose by nearly 200 points, the media at large focused virtually all their attention on the Democratic National Convention and McCain’s VP choice, now known to be Governor Palin of Alaska. The only truly important news of the day went nearly unnoticed and you can bet that though it wasn’t heralded at the Democrat’s convention in Denver, it will certainly be a hot topic at the Republican convention next week.

Noted economist, Larry Kudlow, who admits he is a ‘glass half full’ kind of guy, proclaimed the end of any credible recession talk some eight months ago on the strength of employment figures announced at that time. Many continued to doubt, and more recently others have begun to point fingers at Kudlow and those of us who have consistently defended the strength of the US economy. With 1^st Quarter GDP growth already reported at 1% and 2^nd Quarter figures in at 3.3%, Kudlow and others are vindicated. Now, this doesn’t mean that the economy hasn’t struggled and that there aren’t problems that still need to be dealt with. But the single strongest indicator of the health of the US economy is the growth, or retraction, of the gross domestic product. It tells us clearly whether we’re moving forward or backwards, and at what pace. With the pace at 3.3% during a calendar quarter that also met with staggering energy prices, constrained availability of credit, slumping jobs figures and various international concerns, it is a clear sign of the long-term strength and resiliency of US business. Also reflective of this is the recent strengthening of the US dollar and the some reduction in the trade deficit.

Housing, credit, energy, federal deficits, and politicians are still issues to be concerned about. While the politicians will work themselves out, or in as the case may be, with the help of the electorate, the remaining issues will take time and likely some level of discomfort to deal with.

In other recent economic reports, we see that personal incomes reflected a .7% decline in July over the same period a year ago, but July durable goods orders were up by 1.3%. The first of these tells us what has already happened, and the second gives us a look into the future some six to nine months out.

As noted in last week’s Signature Update, the market is an excellent indicator of the economy six to nine months into the future. By then, the housing markets will have had that much more time to work themselves out, and we should be approaching a point where excess housing inventories may still be higher than usual, but nothing like the excess inventory in 2007 and early 2008 that sent prices plummeting. The credit markets will have shaken out a few more weak financial institutions and are likely to begin to open up some. The demand for energy is likely to continue its domestic and international decrease and the US dollar is likely to have benefitted, each of these may have a positive effect on energy costs.

The recent climb in the DOW from July’s 10,850 low to today’s level of 11,600 simply supports the market’s confidence that these elements are headed in the right direction. The markets despise uncertainty, and when it becomes clear who the next US president will be, it is likely that the markets will reward investors with additional gains. The rhetoric of the president and his administration may color the level of those gains, of course, but at least we’ll know what we’re going to be dealing with, rather than left to wonder and muse about the possibilities – both good and bad. Jeff Thredgold, in his weekly internet based economic column, Tea Leaves, (http://www.thredgold.com/html/leaf080827.html) points out numerous positive points to remember in the US economy. Thredgold’s offering this week is titled ‘Happy Talk’ and is worth reviewing.

DEFICITS, THE DOLLAR, AND A BARREL OF OIL 8-25-2008

Rarely have we seen a time when there were so many obvious influences on the various financial markets than we’re experiencing right now. When one stops and considers the impact of real estate, construction, energy, hurricane season, international conflicts, elections, credit, inflation, trade deficits, taxes, domestic economic growth, employment… it’s enough to give you a headache. It has given you a headache. In truth, it’s not that there are any more areas of focus for the economy today than at any other time, but elements in the economy are so clearly publicized today, and there are so many more people talking about them, that it raises the collective awareness level. So… here are a few comments regarding some of the more impactful economic topics that we knew you just couldn’t live without:

The US Dollar has gained considerable strength over the last six weeks, though some pull back a few days ago. Gold, oil, international trade, etc. have benefited by the improved dollar, and our economy will see meaningful improvements as a result. But a strong dollar also means that it costs other countries more to purchase US goods and services – it also means that other countries will continue to search for capital investment opportunities in the US.

The US trade deficit has begun to decrease. This seems like better news than it is, by the way. The dollar value of goods we import has begun to decrease as the dollar has gained strength in recent months. Conversely, the dollar value of goods we export has increased, bringing the trade deficit to lower levels. The cost of oil is a major part of this; the price of oil is decreasing at the same time that we’re using less of it - this has had a positive impact on the trade deficit. That’s only part of the story, and it’s largely the good part. The bad news is that we’re also importing less because we’re consuming less. At the same time, other countries are beginning to feel the effect of their own economic slow down and they’re beginning to purchase fewer US goods and services. As the dollar strengthens and the US economy picks up pace in 2009, we’ll still have a substantial trade deficit, but we’ll be grateful for it.

Credit remains inexpensive, 30-year home mortgage rates hover at around 6.4%, but it is increasingly but hard to get. All the talk of financial difficulties for Fannie Mae and Freddie Mac have only made this situation more difficult. One of the biggest problems primary lenders have faced is that of maintaining capitalization requirements. As the collateral value of loan portfolios has softened, it has had a chilling effect on the ability to extend additional loans, so banks are having to be more particular about who they extend loans to in order to not risk making the problem worse.

Inflation appears to have peaked in July at uncomfortably high levels, though still low compared to many other important international economies - China, Brazil, and much of Europe support inflation in excess of 8% - and other periods of domestic economic uncertainty - think late 1970’s and early 1980’s. Bernanke’s comments from Jackson Hole last week support the data suggesting that July represented a peak in inflation and that increasing price levels have begun to ‘cool’. This was to be expected; personal incomes, adjusted for inflation, have decreased and while that’s bad news in the near term, it will help ward off a sustained inflation trend. As consumers make alternative choices with their purchasing dollars, price increases begin to subside – this is clearly evidenced in the recent pull back in energy costs. Inflation cannot be sustained without a substantial increase in personal income. As the dust settles and we see the real relationship between personal income, energy costs, and inflation during this difficult period, we’ll likely see that it was only a short-term, though intense, inflation period that reduced the strength of personal incomes.

In 2004 and 2006, the US electorate ceded control of the house and senate to the Democratic Party, largely due to the unpopularity of the Iraq conflict and out of control spending. In spite of promises to reign in that spending, our federal deficits have mushroomed to intolerable levels. Many blame this increase on US military expenditures, but it’s just not that easy. In his July 30, 2008 issue of Tea Leaves, Jeff Thredgold writes, ‘While the projected $482 billion deficit would be a record as measured in dollars, it would be something less when compared against the enormous American economy. A $482 billion deficit would be roughly 3.2% of annual U.S. economic output (GDP) likely to exceed $15 trillion next year. Such a deficit would slightly exceed the average deficit of the past 40 years. The current record is a deficit of $413 billion in fiscal year 2004, while deficits approached 6.0% of GDP at times during the 1980s and 1990s.’

Oil prices, though somewhat expanded earlier this week, are well below their early July highs – by some 20%. There is considerable disagreement over whether this is a sustainable pull back or simply a short term breather. We expect to see oil at $100 per barrel or less in the coming months. The retraction in demand is now evident across the globe, first in the US and now in consumption heavy China and India – people simply can’t sustain their former consumption trends with energy prices at all time highs. At the same time, there is evidence that the speculation has voluntarily decreased and allowed a calming trend to occur.

I strive to stay as far away from politics as possible. While I’m more conservative than liberal, like many, I eschew the republican or democrat labels. If there was a ‘throw the bums out’ party I might actually offer it financial support. State and Federal Taxes are a burden, plain and simple. Though we should each bear our respective burdens, it is counter productive to begin shifting burdens from one part of the population to another simply because they appear as though they can handle it. The unexpected slowdowns and stress that results can be catastrophic and this is exactly the fear many have relative to greater democratic control of the house, senate, and possibly the executive branch. That said, I thought Steve Forbes’ comments in the ‘Fact and Comment’ section of the September 1, 2008 Forbes Magazine was excellent. Under the title, ‘Truly Toxic Tax Boost’ he discussed what happens when politicians get creative with the tax structure. It was followed up by a reprinted Investors Daily article under the title, ‘A New (Raw) Deal’, and by another editorial written by Paul Johnson under the ‘Current Events’ moniker.



Finally, and perhaps on a lighter note, The Salt Lake Valley Parade of homes ended its run last weekend. For those that participated in the parade, there was little sign of a weak housing market. Many of the homes were, in a word, opulent! One realtor present at a particularly posh home in South Jordan approached me with the following question, ‘Do you want to drive the Mazzeratti or the Lamborghini?’ Both were being offered as part of the package for the right home buyer. Oh well…

REVISIONS AND REALITIES 8/19/2008

Last week I offered a more light-hearted discourse about middle-aged men and their Harley’s. I should admit here that I don’t have one; I’m more of a Corvette guy and enjoy driving my Mercedes, but I love that men and women my age have the financial where-with-all to drive the toys of their dreams. Today it’s time to get serious again.

The investment markets have long been understood to be markets of forecast rather than reflection. Today’s news has little bearing on today’s markets other than to influence the emotion and volatility of the DOW and S&P 500 for a few hours or days. The markets, analysts, traders, and forecasters recognize that what’s done is done, and it’s time to look forward 6-9 months into what’s likely to come. This is why, in the face of some recently reported, mixed economic data, the DOW is up from its mid-July low by almost 800 points.

At the same time that the DOW has staged a rally of over 7% in recent weeks, gold is down over 18%, oil is off over 22%, and the dollar has strengthened considerably – this is all great news. It’s also an indicator of our economy 6-9 months into the future, not our economy today, and there is a difference. Reported data tells us what our economy has done, the markets strive to forecast what it will do in the future. Much of the reason that the markets have been down so severely over the last 9 months is because of the slow down those markets were forecasting for our economy in the first half of 2008. The recent market rally would suggest that growth lies somewhere ahead of us in early to mid 2009.

Let’s look at some numbers released in the last few weeks while the markets have been showing strength and resiliency:

The CPI (consumer price index) rose .8% in July representing an uncomfortable, though unsustainable level of consumer inflation.

Retail sales were down .1% in July (inflation adjusted) suggesting consumers had less money to spend – the truth is that retail spending always dips in July and rebounds before school starts and as we slow down our outdoor recreation activities.

The US Department of Commerce reported 1.9% positive economic growth in 2^nd Quarter 2008, but revised 4^th Quarter 2007 to a decrease of .2% versus the earlier report of a .6% increase. Is it likely that 1^st and 2^nd Quarters 2008 will see similar revisions? Possibly so, but in economics, the past is always in the past.

The US Trade Deficit decreased to $56.8 billion in June, reflecting a stronger US dollar, but also suggesting a weaker US economy.

Non-farm productivity increased by 2.2% over the last year – not exactly robust, but better than the projected decrease.

The ISM (Institute of Supply Management) non-manufacturing index rose to 49.5 in July – anything over 50 suggests market expansion, under 50 suggests contraction. The import here is that the index rose to a level above the expected 48.8, the first such rise in months and in direct correlation to the June and July rise in durable goods orders.

Our economy has struggled, to be sure. Families have had to cut back or do without, and that’s not likely to change overnight. Real estate values, new home construction, and investment values will take many more months before we begin seeing any meaningful increases. But if the markets are accurate indicators of what the economy will look like 2-3 quarters out, and they always are, then right about the time we’re inaugurating a new president, we’ll also be enjoying renewed economic growth – regardless of who that new president may be or what party he represents.

FANNIE MAE AND FREDDIE MAC – REVISITED - AGAIN

Over the last few weeks we’ve seen and heard more about the bad news from Fannie Mae and Freddie Mac – in fact, the DOW’s precipitous decline a few weeks ago, and again today, have come largely on news of the losses these organizations had posted for 2^nd quarter 2008 and the possibility that getting the additional capital they’ll need to make an ongoing stream of mortgage loans may be more difficult than might otherwise be expected. But what’s the news here? Where’s the revealing story?

Hadn’t all the news, weeks earlier, regarding Fannie Mae and Freddie Mac already heralded terrible earnings for these two Government Sponsored Entities (GSE’s)? Of course it had, and the markets rebounded within days, but here’s the more concerning issue: As we hear from all but the most knowledgeable market watchers, business leaders, and economists regarding Fannie Mae and Freddie Mac, we continue to hear about how the US taxpayer has had to bail out both of these entities, when in truth there has been no bail out… none whatsoever. US Treasury Secretary, Henry Paulson, while vacationing at the 2008 Summer Olympics in Beijing, participated in a 45 minute interview with Tom Brokaw and once again set the record straight. He reminded Brokaw that the Federal Reserve and Treasury had indeed set up a credit facility that Fannie Mae and Freddie Mac could access in the event that they needed additional short-term capital, but asserted that neither organization had done so and affirmed that he didn’t expect that they would do so in the foreseeable future. He admitted that setting up this access to capital had much more to do with quieting concerns in the financial markets some weeks ago than it had to do with a real need by either GSE.

The misinformation concerning the activities and fates of these GSE’s and the market reactions to news of them is unfortunate. The media is partly to blame, of course, but so is the individual that repeats something he or she heard from someone who has little reason to actually know, but who might enjoy being perceived as knowledgeable.

Fortunately, volume in the major markets is light towards the end of summer as many active traders and market makers are vacationing, minimizing the impact of some of these less-than-rational market movements. As Wall Street gears up again, right about the time school starts, saner heads typically prevail and values are driven back to more rational levels. In the mean time, these dips translate into lower portfolio values, simply adding to the concern of individual investors.

The recent run on, and failure of, Indy Mac brought about a similar wave of concern that had little foundation, but certainly raised the blood pressure of many depositors in other, very healthy banks and credit unions. Such concerns were unwarranted by these federally insured institutions, but that didn’t keep their officers from having to work overtime to reassure depositors and avoid a possible run against their liquid assets. Now, weeks later, such concerns have taken a back seat to more important, or at least, more interesting news and events.

One of the most difficult things for individual investors to do is to keep focused on their all-important long-term goals and investment objectives, and to not be swayed by temporary or less meaningful trends. Such distractions bring about poor decision making and tend to help investors extend their losses rather than structure their portfolios to maximize future gains.

THE HARLEY DAVIDSON ECONOMIC INDICATOR 8/15/2008

I had an opportunity to travel through several of the northern-plains states last week and witnessed a phenomenon that may well be a barometer of our nation’s economic strength, which we’ll now refer to as the Harley Davidson Indicator. But first, some background.

In the late summer of 1973, I traveled with an uncle through some of these same states and saw hundreds, if not thousands, of bikers – my mother referred to them all as Hell’s Angels, though few of them likely were. They were mostly free-spirited young men and women traveling towards Sturgis, South Dakota for the nation’s largest motorcycle rally. They were mostly in their 20’s, fit, out for a good time, with little to share and even less to spend.

The quintessential big bike then, just as now, was a Harley. But as years passed, the Harley brand began to fade as most of these enthusiasts were buying homes, raising families and keeping their collective noses to the grindstone. By the late 1980’s, Harley Davidson teetered on the brink of collapse and desperately needed a shot in the arm. One visionary Wall Street investment firm saw that those same ‘twenty something’s’ that loved Harley’s in the 60’s and 70’s, but couldn’t afford them in the 80’s and early 90’s, would come back with a vengeance as their children grew up and their incomes continued to increase. That firm guided Harley Davidson through a major public offering that ultimately provided Harley with the capital needed to manufacture the extraordinary bikes we see today.

Harry Dent, one of the most optimistic and accurate economists in our country, even developed an entire economic theory behind this demographic of young men becoming mature adults and eventual retirees. He called it the ‘spending wave’ and wrote about it in his 1993 book titled ‘The Great Boom Ahead’ and again in his 1999 release of the ‘Roaring 2000’s’ – great reads, both of them. Dent’s theory is that those in our economy with the greatest spending and investing power drive the markets. He concluded in 1993 that 50+ year old men held this power and in the early 2000’s revised this to include professional women of the same age. His theory is built on the fact that this demographic is at the peak of their earnings and are most likely seeing a decline in necessary spending, resulting in an increase in discretionary income. Further, Dent concluded that they would become the highest spenders and most active investors and you could predict the rise in the investment markets by the rise in the number of these individuals in our economy. He was right.

So if Dent had been with me and my wife as we followed I-90 west through northern South Dakota, he would have seen the embodiment of his theory. Thousands of big bikes headed towards, or coming back from, motor cycling’s largest rally destination – Sturgis. Unlike my 1973 trip, the riders were Dent’s ‘fifty something’s’; and this time they had more to share and substantially more to spend. Some of the evidence of this could be seen in the splendor of these bikes, the gear and back-up vehicles that support them, the apparel worn by those riding them and the ‘bling’ on the hands, arms and necks of the ‘mamma’s’ riding on the back of about half the big bikes. To suggest that this was a spectacle would be a gross understatement. We decided to get off of the interstate about 150 miles east of Sturgis to steer clear of the swarms of bikes – naïve to say the least. The closer we got to Sturgis, the more bikes crowded the roads. Every little town we went through was jammed with bike and bikers and more importantly, the motels were full, the restaurants were jammed, every gas station and convenience store we happened across had lines to rival those of the mid 1970’s and you could almost hear the cash registers over the roar of the hog’s (the two and three wheeled kind)!

Being a curious guy, I stopped and talked to 10-20 of these bikers a day for three days. They were factory workers, physicians, accountants, school teachers, republicans, grandparents, sales people, lawyers, patriotic, engineers, democrats, married, divorced, and from virtually every walk of life. What they had in common was a love of the road, a drive to see to it that 50 really is the new 30, and lots and lots of cash! They were less concerned about the cost of gas than the cost of health care. They weren’t amused by the decline in real estate values or the volatility of the stock markets, but they expressed confidence that the markets would come back with even greater profits than before. They were having a great time and supposed that whoever becomes president next will likely offer as many problems as solutions. And, like Dent, they’re right.

I came away from this trip pleased for the opportunity to get away with my wife for a few days and appreciative that I’d crowded into the terrace at Mt. Rushmore with over a thousand bikers and others. I also came away confident in the resiliency of Americans and the American economy. The Harley Davidson as an economic indicator? Maybe not, but those that are riding them have money to spend and proud of it.