Several conditions have emerged from the recent market turmoil: tighter credit, deflating real estate, monetary reflation, and a weak dollar. The strong themes emerging from these circumstances are: A) We are probably past the worst and won’t face recession; and B) We will see higher equity markets, stronger export growth and increased commodity prices.
Financial companies are past the worst: write-downs related to this summers’ credit crunch have not been as bad as initially feared. The industry will return to a healthy fee generating environment. On the flipside, credit conditions have tightened markedly for consumers and homebuyers. One of the more telling signs of the fear of an economic malaise is Wal-Mart’s preemptive move to garner early holiday sales before consumers felt poor or threatened by a weak economy by lowering toy prices two weeks earlier than last year. Although job growth will expand, consumer spending expectations remain weak. As a result, discretionary spending will continue to sag and undermine the ability of consumer finance companies to generate loan growth. The credit market has not yet returned to normal and flight-to-safety could easily be rekindled by renewed fears and trepidation if market turmoil returns.
Home sales fell to six year lows as the stock of unsold homes rose to a record 5.1 million and prices declined 4% from a year ago. To make matters worse, this figure does not include hundreds of thousands of ‘stealth’ houses where owners are sitting on the sidelines eagerly waiting to list their homes at the first pickup in volume. There were previous periods of real estate price deflation and recession in 1970, 1982 and the early 1990s. Today’s real estate price decline is unique in that it seems to be an isolated de-bubbling process that is not accompanied or preceded by any contraction in key macro indicators. Of course, declining U.S. real estate values could bring down U.S. consumer spending.
Monetary reflation will be the dominant positive force in global financial and equity markets, especially for emerging market stocks which were largely unaffected by the subprime problem. Historically, monetary reflation commits the Central Bank to deliberately fostering inflation in the economy. With enough money sloshing around, the theory goes, banks are sure to lend and companies and consumers, to spend. In addition, there still are plenty of excess global savings to help keep interest rates low. The pre-emptive nature of Fed policy reflation should help stock prices, but may hurt bonds.
The U.S. Dollar may weaken further against every currency except the yen. This is positive for exports and strong overseas growth and will thereby aid the domestic economy. The U.S. dollar’s weakness is also adding fuel to the rally in commodity prices that has mainly been driven by continued solid global growth, particularly in China. Gold usually thrives on easy monetary policy, falling real borrowing costs and/or a weakening U.S. dollar. With monetary reflation on the way and interest rates on the decline, gold prices will increase.
Michael Ashley Schulman, CFA
Hollencrest Capital Management