Unemployment Up - Rate Cut?
The markets are set to sell-off this morning on the heels of a dismal employment report from the Labor Department. What is remarkable to us is that it is coming as a surprise to the financial media and the Street generally that we are heading into recessionary weather. We have taken it as a foregone conclusion for some time now that a recession is inevitable given the state of the economy and the U.S. consumer. Now, the labor market is the last card to fall with unemployment now rising to 5 percent. The Street’s expectations had been for the number to come in at 4.7 percent. Our expectations were 4.9 percent, so the number even surpassed our bearish mood.
Expectations are now 100 percent for a rate cut of 25 basis points from the Fed at the next meeting and about fifty-fifty that the Fed will cut 50 basis points. We see this as a huge mistake that will have much more negative repercussions on the dollar and the U.S. consumer. Unfortunately, the broader consensus on the Street has the Fed’s ear and the Fed is now in a well-established pattern of satisfying the Street’s expectations.
Our rationale for why more rate cuts are a bad thing for the economy and for the consumer is as follows: That we are heading into a recession is inevitable. But at this point, stagflation is still avoidable. However, if the Fed cripples the dollar, which will happen with more rate cuts, we will see a dramatic increase in price inflation. And this sets the stage for stagflation.
Contrary to what many out there think. Fed policy is not the silver bullet, but rather a band-aid (and a pretty poor one at that) for recessionary pressures. The key result from Fed rate cuts are that it makes borrowing at the institutional and bank level more plausible. But an economy driven by easy money and unrequited debt spending is exactly what got this economy into the current mess it is in, in the first place.
The key that we are focused on is the American consumer, which accounts for more than 70 percent of GDP. And it is the American consumer that is tapped out, with negative personal savings and record credit bills which she can no longer afford to pay. Now, the Fed’s expected rate cuts will just increase the burden as the American consumer is thrust into a scenario where her dollar is able to buy less (more than 35 percent since the current president took office) and exacerbated by the fact that energy prices are soaring.
And for those pundits and apologists out there that make a bad case that a weaker dollar is palatable in as much as it will spur further export growth, we would remind them that exports only represent 12 percent of GDP. So the price is not worth it, in our opinion. The fact is that the economy is in bad shape, and there will be no easy way to avoid it. A more responsible administration will have to fill the office and change policy. We will finally have to pay the bills, as a country, that have been racked up in the past 7 years.
The federal deficit ceiling has been raised six times by a complicit Congress that has passed on uncontrolled spending and borrowing. It now stands at $9.2 trillion, and growing by $1.2 billion per day. As a nation, we have to float $2 billion in debt each day to try and keep pace, where the first $500 million goes towards servicing the interest on the debt alone. By the way, your share and mine of the national debt is more than $34,000 and we will have to pay that bill at some point.
So this no-tax, low-tax administration has been smoke and mirrors. We are getting hit by some very real taxes indeed, of more than 35% on the dollar and more to come.
And what does this mean on Wall Street? Well, stocks will sell off, as we are witnessing in pre-market activity this morning. The only buoy for stocks will continue to be the expectations of more Fed rate cuts. This has been the only catalyst that the Street has had since August, and frankly, the only reason that we saw the third quarter of 2007 post the gains on Wall Street that it did.
But now, with acknowledgement that the employment market is deteriorating, 25 basis point cuts at a time will not be sufficient to stop the markets from retreating back to last Fall’s lows. The Street will be looking for a strong fix - 50 basis points at the next meeting and at least another 25 basis points at the next. It feels like a prize fighter that, while mortally wounded, needs another shot of adrenalin just to finish the fight, regardless of the longer-term damage he has done to his body to keep it up.
In the same case, we have, and continue to make the case that the Fed rate cuts will do longer-term damage to the American way of life as the dollar loses its place as the benchmark currency for the world. We are seeing it happen in front of our eyes. Foreign governments are shedding their treasury and dollar holdings, while our financial institutions are on fire sale to the highest foreign bidder. The longer-term implications of this, like our adrenalin-ridden prize fighter, are not happy ones.
In terms of our recommended investment strategy for 2008, we recommend caution. We have been staunch advocates of treating any rally over the past couple months as an opportunity to hedge against downside risk. We see the risk today as being greater than ever. After all, it seems today is the first day that the financial media is actually coming to grips with the state of the economy – more to come.
We think there will be some fantastic opportunities to invest in the next couple quarters, but we would avoid altogether discretionary stocks, financial stocks and housing stocks. These are sectors which have much more bad news to work out before things get better. And these sectors will take quite some time to get healthy again, so bottom-feeding strategies here are just going to tie up liquidity and underperform.
We remain more bullish than ever on the renewable energies sector. In particular, we like solar, geothermal, biofuels and energy efficient companies. These outperformed dramatically in 2007 and with oil prices at the $100 level, we think 2008 will bring more of the same as energy prices trend higher on a weakening dollar and the impulse to find alternatives to dependence on foreign oil remain both environmentally and politically charged.
Use broader market selling as an opportunity to average in and build positions in these stocks, and don’t get caught chasing them into rallies. There will be plenty of volatility ahead and plenty of opportunity to buy great companies on broader market weakness. Strategies that we continue to employ and recommend include selling puts to establish and build positions, protecting profitable positions with protective puts and writing out of the money covered calls into strength to enhance profits and lower cost averages. Talk to your broker about any of these strategies if you are not familiar.
We wrap this commentary up emphasizing that things will get worse before they get better. We are a long ways away from a credible fiscal policy to truly get our economy back on track. And there will be a lot of cleanup that needs to be done in the process which will cause more volatility and uncertainty in the markets. 2008, in our opinion, will be a challenging but potentially rewarding year ahead for investors that employ disciplined strategies, that don’t get caught up in the hype and that do their homework.
Expectations are now 100 percent for a rate cut of 25 basis points from the Fed at the next meeting and about fifty-fifty that the Fed will cut 50 basis points. We see this as a huge mistake that will have much more negative repercussions on the dollar and the U.S. consumer. Unfortunately, the broader consensus on the Street has the Fed’s ear and the Fed is now in a well-established pattern of satisfying the Street’s expectations.
Our rationale for why more rate cuts are a bad thing for the economy and for the consumer is as follows: That we are heading into a recession is inevitable. But at this point, stagflation is still avoidable. However, if the Fed cripples the dollar, which will happen with more rate cuts, we will see a dramatic increase in price inflation. And this sets the stage for stagflation.
Contrary to what many out there think. Fed policy is not the silver bullet, but rather a band-aid (and a pretty poor one at that) for recessionary pressures. The key result from Fed rate cuts are that it makes borrowing at the institutional and bank level more plausible. But an economy driven by easy money and unrequited debt spending is exactly what got this economy into the current mess it is in, in the first place.
The key that we are focused on is the American consumer, which accounts for more than 70 percent of GDP. And it is the American consumer that is tapped out, with negative personal savings and record credit bills which she can no longer afford to pay. Now, the Fed’s expected rate cuts will just increase the burden as the American consumer is thrust into a scenario where her dollar is able to buy less (more than 35 percent since the current president took office) and exacerbated by the fact that energy prices are soaring.
And for those pundits and apologists out there that make a bad case that a weaker dollar is palatable in as much as it will spur further export growth, we would remind them that exports only represent 12 percent of GDP. So the price is not worth it, in our opinion. The fact is that the economy is in bad shape, and there will be no easy way to avoid it. A more responsible administration will have to fill the office and change policy. We will finally have to pay the bills, as a country, that have been racked up in the past 7 years.
The federal deficit ceiling has been raised six times by a complicit Congress that has passed on uncontrolled spending and borrowing. It now stands at $9.2 trillion, and growing by $1.2 billion per day. As a nation, we have to float $2 billion in debt each day to try and keep pace, where the first $500 million goes towards servicing the interest on the debt alone. By the way, your share and mine of the national debt is more than $34,000 and we will have to pay that bill at some point.
So this no-tax, low-tax administration has been smoke and mirrors. We are getting hit by some very real taxes indeed, of more than 35% on the dollar and more to come.
And what does this mean on Wall Street? Well, stocks will sell off, as we are witnessing in pre-market activity this morning. The only buoy for stocks will continue to be the expectations of more Fed rate cuts. This has been the only catalyst that the Street has had since August, and frankly, the only reason that we saw the third quarter of 2007 post the gains on Wall Street that it did.
But now, with acknowledgement that the employment market is deteriorating, 25 basis point cuts at a time will not be sufficient to stop the markets from retreating back to last Fall’s lows. The Street will be looking for a strong fix - 50 basis points at the next meeting and at least another 25 basis points at the next. It feels like a prize fighter that, while mortally wounded, needs another shot of adrenalin just to finish the fight, regardless of the longer-term damage he has done to his body to keep it up.
In the same case, we have, and continue to make the case that the Fed rate cuts will do longer-term damage to the American way of life as the dollar loses its place as the benchmark currency for the world. We are seeing it happen in front of our eyes. Foreign governments are shedding their treasury and dollar holdings, while our financial institutions are on fire sale to the highest foreign bidder. The longer-term implications of this, like our adrenalin-ridden prize fighter, are not happy ones.
In terms of our recommended investment strategy for 2008, we recommend caution. We have been staunch advocates of treating any rally over the past couple months as an opportunity to hedge against downside risk. We see the risk today as being greater than ever. After all, it seems today is the first day that the financial media is actually coming to grips with the state of the economy – more to come.
We think there will be some fantastic opportunities to invest in the next couple quarters, but we would avoid altogether discretionary stocks, financial stocks and housing stocks. These are sectors which have much more bad news to work out before things get better. And these sectors will take quite some time to get healthy again, so bottom-feeding strategies here are just going to tie up liquidity and underperform.
We remain more bullish than ever on the renewable energies sector. In particular, we like solar, geothermal, biofuels and energy efficient companies. These outperformed dramatically in 2007 and with oil prices at the $100 level, we think 2008 will bring more of the same as energy prices trend higher on a weakening dollar and the impulse to find alternatives to dependence on foreign oil remain both environmentally and politically charged.
Use broader market selling as an opportunity to average in and build positions in these stocks, and don’t get caught chasing them into rallies. There will be plenty of volatility ahead and plenty of opportunity to buy great companies on broader market weakness. Strategies that we continue to employ and recommend include selling puts to establish and build positions, protecting profitable positions with protective puts and writing out of the money covered calls into strength to enhance profits and lower cost averages. Talk to your broker about any of these strategies if you are not familiar.
We wrap this commentary up emphasizing that things will get worse before they get better. We are a long ways away from a credible fiscal policy to truly get our economy back on track. And there will be a lot of cleanup that needs to be done in the process which will cause more volatility and uncertainty in the markets. 2008, in our opinion, will be a challenging but potentially rewarding year ahead for investors that employ disciplined strategies, that don’t get caught up in the hype and that do their homework.
Labels: Debt Ceiling, Deficit, Oil Prices, Rate Cut, Unemployment
posted by "Staff" at
7:18 AM
0 Comments:
Post a Comment
Links to this post:
Create a Link
<< Home