Stimulus is 2009’s buzzword: market, consumer, real estate, corporate, and foreign stimulus. Looks like we need it! The S&P500 just lost 8.4% during the worst January in its history and the US lost half-a-million jobs. For benchmarking, 2008 set a record for the most jobs lost in a year since World War II. Large and small firms remain vulnerable to the sharp drop in domestic demand, intensifying deflationary pressures, and earnings disappointment. Stimulus will help in the near-term, but long lasting effects against the negative economic tide are doubtful.
The collapse in discretionary consumer spending has a long way to run; it will continue to inflict damage on retailers, manufacturers and service providers through the end of the year. Financial markets are fragile, with confidence sagging anew and stocks breaking down again. To make matters worse, the expansion of the Fed’s balance sheet has temporarily stalled. Consequently, stocks have struggled, the dollar has strenghtened, bonds have sold off and gold prices are up. Additionally, beware of commercial real-estate. Bankers remain reluctant to extend commercial real estate credit because of the industry’s deflationary outlook and as a result of repeated FDIC warnings against increasing commercial real estate exposure. Meanwhile, demand for such purchases and loans is depressed. The difficult financing environment will exacerbate debt-deflation risks in the commercial real estate market.
Across the Pacific, the Japanese economy has fallen off a cliff. The economy contracted to a whopping -12.7% annualized pace, industrial production plunged -21%, and inventories surged to new highs. The Japanese economy is extremely reliant on exports and the weakest sectors of the global economy (autos, consumer electronics and machinery). Unfortunately, Yen strength – in response to unwinding carry trades – led to an implosion in Japanese exports, an erosion of the current account surplus, and a further undermining of Japanese businesses competitiveness. The economy is in severe contraction, with deepening price deflation and a sharp fallout in consumer spending. The housing market, which has already been in a sustained slump since 1990, is plunging anew. The Japanese authorities are under enormous pressure to quantitatively ease monetary policy. Thus, the Bank of Japan’s balance sheet should soon explode upwards and the Yen should weaken. Finally, political turmoil will provide an additional headwind.
On the other hand, there is tentative evidence that Chinese growth may soon stabilize. Chinese macro data will remain weak over the next couple months, however, there are marginal signs of improvement. The most recent purchasing managers’ surveys have edged higher in both export orders and industrial production. In addition, share prices of Chinese real estate developers and steel makers have outperformed strongly, suggesting the government’s growth-rescue policy is having a positive impact. Similarly, real estate companies are reporting a significant increase in transactions, auto sales appear to be stabilizing after sharp declines in previous months, and Chinese iron ore imports resumed their upward trajectory. As a result, asset classes sensitive to China’s growth cycle are enjoying an impressive near-term rally.
Michael Ashley Schulman, CFA
Hollencrest Capital Management