Standard and Poor’s changed the outlook for the US credit rating to negative last week but stocks managed to shrug off the obvious and end the week in positive fashion. S&P doesn’t quite have the credibility it once had after blessing the mortgage dreck of Wall Street with AAA ratings during the housing boom, but the warning is important nonetheless. With the ever pliant Ben Bernanke in charge of the US dollar printing press, the US will not default on its obligations but devaluation is surely a risk that must be considered by rating agencies and bondholders alike.
S&P’s warning was based on their fear that political stalemate will prevent approval of a credible plan to reduce the fiscal deficit before the next election. It may be true that the current political environment is not conducive to getting a deal done, but I don’t believe the market will wait until 2013 to force an end to our national profligacy. The Fed’s policy of quantitative easing has had no discernible positive effect on the real economy but it is having an effect on the dollar. The dollar index has fallen roughly 10% since Ben Bernanke’s Jackson Hole speech in late August but the decline against other measures is more alarming. The dollar is down 21.5% against gold, 49% against oil and a stunning 145% against silver. These real measures of the value of the dollar indicate that the loss of confidence in the US fiscal position has already occurred. As in the case of sub-prime, S&P is late to the party and merely confirming what the market has already revealed.
Some point to stocks as evidence that the US economy is improving but when adjusted for the decline in the dollar, the 26% rise in stocks since late August is much less impressive and more indicative of a stagnating economy. From the perspective of a non-dollar denominated investor, investing in the US right now is not attractive. The US economy is growing at 2% and the dollar is falling; emerging markets are growing at 6% and their currencies are rising. Even Europe with all its debt problems, at least has the attraction of a rising Euro. Currency risk is real for anyone considering an investment in the US. We are losing the international beauty contest for investment capital.
And make no mistake, it is investment the US needs. The anemic US recovery isn’t due to a lack of consumption. Personal income and personal consumption expenditures have surpassed their pre-recession peaks. Investment by contrast is still only 78% of the previous peak in 2006. A lot of that previous peak involved building unneeded housing and we want to replace it with more productive activities, but it must be replaced. Monetary policy is now a headwind to that goal and while the end of QE II may be supportive of the dollar in the short term, a change in our other economic policies is required for sustained improvement.
Absent those changes, I see little reason to expect a significant improvement in the US economy. It is certainly possible that we can avoid another recession in the near term, but we are very vulnerable to a shock of any kind. Indeed the recent rise in the price of energy and other commodities may have already delivered enough shock therapy. The economic calendar was light last week but what data we did get continues to point to a peak in economic growth.
As I said above, consumer spending is not the source of our troubles and the Goldman and Redbook reports both showed decent gains in same store sales. Some of Redbook’s 5.1% gain was due to the timing of Easter but the roughly 3% gains over last year are real if not robust. I have doubts about the durability of those gains though without an improvement in the employment situation.
The housing market reports showed some minor – very minor – improvement. Housing starts and permits both rose but are still stuck at the mid 500k level. Builders remain depressed though and there is still ample inventory of existing homes. The resumption of foreclosure activity also doesn’t bode well for construction in the near term. Existing home sales were reported higher by 3.7% but there is 8.4 months of supply at this depressed rate of sales. Prices were up from last month but down almost 6% over the last year.
Both the LEI and the Philly Fed Survey pointed to sustained growth but no acceleration. The Philly Fed Survey fell to 18.5 from 43.4 but remains above the zero point that indicates expansion. New orders, shipments and hiring all showed a slowing growth rate. The LEI fell to 0.4 from a revised 1.0 last month. Jobless claims fell slightly last week to 403k but remain elevated. All these reports point to a peak in the growth rate of the US economy.
Stock markets shrugged off the Monday S&P downgrade and focused on earnings for the rest of the week which turned out to be pretty good. The S&P 500 gained 1 1/3% on the week and foreign markets were also generally higher. If the US economy can continue to grow and emerging market economies can slow inflation without hurting growth and the dollar strengthens after the end of QE II and commodity prices fall back some and China’s bubble doesn’t implode and Europe avoids defaults in the periphery and the Miami Heat wins the NBA championship, then the rally might continue. The only one of those I feel even vaguely confident about is the Heat.
The gains in the commodity complex continued. Gold was up 1.2%, oil 2% and silver a whopping 8.4%. Silver in particular is starting to exhibit the familiar glow of a speculative fever. The rise in commodity prices is an ominous signal about the future of the US economy. Investment is being driven into the ground – literally – by the Fed and Treasury weak dollar policies. About the only companies announcing significant increases in capital spending are in the business of extracting wealth from the ground by digging or drilling. Companies that are increasing investment and hiring are doing it mostly in other countries with better growth prospects. We can change that with better policies but right now, like S&P, I don’t see much hope of it happening soon.
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