The state of the U.S. economy and stock market

An old Wall Street proverb says that the stock market “climbs a wall of worry” to march into bullish territory. The “wall of worry” phrase is cited in print from at least the 1950s, and that is exactly what has been occurring this year. That being said, the following is just a quick recap of some global market and economic events. 

The Good

Consumers increased their average annual spending by 3.3% in 2011, the fastest rate since 2006, according to the Labor Department's most recent annual snapshot of how Americans spend. The average level of spending in 2011 was the highest since 2008 for consumers. 

One factor in last year's spending jump was simply the rising cost of everyday goods. Consumer prices rose 3.2% last year. The Labor Department reported that consumers actually saw their average incomes, before taxes, rise in 2011, and that likely gave them more cash to spend. The report is further evidence that Americans' finances are slowly recovering after the 2008 financial crisis. Last month, the Federal Reserve said the value of Americans' real-estate holdings rose in the second quarter of the year. That also helps the balance sheets of Americans and could spur the economy by encouraging consumers to spend. 

Also, reflecting consumers' brighter outlook, the Conference Board, a private research firm, last month said consumer confidence increased last month to its highest level since February, another signal that spending could pick up. 

The Bad 

Transportation stocks have been losing steam even as the market has chugged higher. History suggests that such divergences could bode trouble. It is a worrisome development for followers of the Dow Theory, which believes that the transportation average constitutes an early-warning system for where the stock market is headed. Given that the transportation average is made up of 20 stocks that ship the stuff that other companies make and sell, there is some justification to the idea that its troubles could portend wider problems for the economy. 

The nation's gross domestic product grew at a rate of 1.3% between April and June, signaling even more sluggish growth than economists expected. Separately, orders for durable goods—long-lasting manufactured products such as cars and televisions—tumbled 13% in August from July, the biggest monthly drop in more than three years. Much of the decrease came in orders for commercial aircraft, which often show big monthly fluctuations, but the report nonetheless provided new evidence that the once-robust factory sector is losing steam. 

The Ugly 

Bill Gross is the CEO of the Pimco, the fund company that runs the largest bond fund in the world. In his recent investor newsletter he stated the following regarding the state the U.S. economy and our reliance on ultra-low interest rates and aversion to address our debt problem. "The U.S., in fact, is a serial offender, an addict whose habit extends beyond weed or cocaine and who frequently pleasures itself with budgetary crystal meth. Uncle Sam's habit, say these respected agencies, will be a hard (and dangerous) one to break." 

He went on to note that the Congressional Budget Office, Bank of International Settlements and International Monetary Fund have concluded that the U.S. balance sheet "is in flames and that its fire department is apparently asleep at the station house." 

"Unless we begin to close this gap, then the inevitable result will be that our debt/GDP ratio will continue to rise, the Fed would print money to pay for the deficiency, inflation would follow and the dollar would inevitably decline," Gross wrote. He concluded that, if that should happen, the results both for investors and the U.S. economy would be catastrophic. 

China's challenges and threats

Many in the economic and investment world look to China to carry the torch of future economic growth, especially in lieu of the problems in Europe and the uncertainty and slow down in the U.S. economy. Even though China's economy has grown like a weed over the last decade and a half, it has its own challenges ahead.

There have been recent uprising and riots at Chinese manufacturing facilities brought on by disgruntled workers. China's manufacturing and export oriented economy is being threatened by the economic problems or challenges in Europe, the U.S. and its other export (customer) nations.

In response to these concerns, last month, China unveiled a series of measures to help its export sector by approving infrastructure projects worth more than $150 billion, they cut interest rates twice and eased bank reserve requirement ratios three times since last November. All have been done to nudge their slowing economy.

In addition, Chinese banks are letting borrowers extend their repayment periods for loans coming due (i.e., they are letting the borrowers rollover balances due to new, longer maturities). Borrowers may get relief in the near term, but this puts off the day of reckoning for those problem loans that should be addressed now.

Validating China's economic slowdown concerns was another announcement by FedEx Corp. last month noting that the global economy is stalling, and it's going to get worse next year. FedEx specifically mentioned China in cutting its forecast for the fiscal year ending in May, citing slow trade and high fuel prices that are hurting the economy.

 
 

FedEx's forecasts are closely watched for signals of future economic health, since its results provide insight into the global economy because of the number of products it ships and the number of countries in which it does business.

One bright note from all of this is the new iPhone 5. Demand is expected to be so robust that some economist and analysts believe it could provide a $12.8 billion boost to the U.S. economy, which equates to a 0.33% increase to the GDP over the next year. China would be a primary beneficiary of this as well, since it is a manufacturer of many of the iPhone components.

On the political front, China and Japan are in a territorial dispute over a group of islands in the Pacific. Instead of a direct military confrontation, China is considering economic retaliation is if Japan does not acquiesce. China could dump its $230 million of Japanese government bonds. In addition, China may take additional measures under the World Trade Organization and go so far as to reduce the export rare-earth materials to Japan, which are necessary for many products produced there.

China has had a recent change in leaders over the past year, and the new leaders are trying to appear strong to the world and are doing so by being less patient and more aggressive in their dealings with other nations. Unfortunately, Japan and the U.S. are just two countries who've become dependent on China to buy their government debt. China can now use this debt as leverage to get what it wants during international negotiations. History shows that when it comes to negotiations, usually the party who owes money ends up on the short end of the stick. This is why large trade imbalances with other nations, especially those whose economic interests don't always align with yours, can be very dangerous, particularly during tough economic times.

China may be its own worse problem. It has over one billion people who have moved from an agrarian culture to a manufacturing and more professional society. Workers are enjoying higher wages, and with the Internet and other media formats, they can see all the luxuries enjoyed by others around the globe. As a result, they want a taste of the good life and are less satisfied with the status quo or an overbearing government.

The government must walk a fine line of keeping control over a large and expanding population that has become increasingly dependent on manufacturing and exports to fund their lifestyles. Due to China's explosive economic growth, its citizens are becoming more demanding and less patient and have little tolerance for going back to their old lifestyle.  As a result, Chinese leaders are feeling increasing pressure to maintain adequate economic growth to satisfy the citizens or face civil unrest from layoffs, rising unemployment and the other associated financial ills. Thus, if Chinese leaders appear as bullies, it may be because they are extremely scared of losing their control.

Quotes 

"Leaders can ill afford anything other than passion in protecting their character."

                                    Mark Eppler 

"You cannot maintain your integrity 90% and be a leader. It's got to be 100%."

                                    Leonard Roberts 

"Calm seas create amateur sailors."

                                    Author unknown

 

Tony Moeller, CPA 

The information listed in this commentary is a compilation of various publicly available sources and is for informational purposes only.  It is not a recommendation or solicitation of any particular investment or strategy.  A risk of loss is involved with investments in the stock and bond markets.

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