The Bull/Bear Weekly Recap - September 3

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Submitted by RCS Investments

Bullish

+ Jobs report comes in much better than expected
with the private sector generating 65,000 jobs, while prior months were
revised higher.  This is the nail in the “we are about to enter a
double-dip” coffin.  We are only experiencing a soft patch.  The economy
will pick up steam in the 2H of 2010 and 2011.

+ Chicago PMI showed continued expansion
and came in higher than expected.  New orders came in expansion
territory and doesn’t point to contraction in this region in the months
ahead, while jobs continue to be created.  This result led to a strong
Manufacturing ISM reading which surprised everyone.  Finally, the American Association of Railroad’s weekly report shows the highest carload reading of the year.
 These indicators show that the prospect of soft landing and steady
growth are not only possible, but likely.  Double dip fears are way
overblown.  These factors will buoy consumer confidence and loosen
wallets in the months ahead.

+ China PMI comes in better than expected and points to a soft landing in China, followed by steady growth.  Meanwhile, Eurozone GDP rises the most in a year.  The global economic recovery has legs, it’s just taking a breather.  This can be seen from shipping indexes, which have been rising at a healthy clip.  (Link Courtesy of Calafia Beach Pundit)

+ Sentiment continues to side more with the Bulls as analysts are growing exceedingly pessimistic.
 Many are expecting a double dip, therefore there’s a growing chance
that things aren’t as bad as most believe.  (Link Courtesy of The Big Picture)

+  PCE metric shows that consumption increased more than expected, while August chain store sales rise more than analysts expected.  Why?  The job market is indeed recovering as per the Gallup Job Creation Poll.
 It has been steadily increasing over the past three months.  Need more
proof?  The ISM Manufacturing employment sub-index hit its highest
level since 1983, while jobless claims have been steadily coming back down.

+ Housing prices as per the Case-Schiller index rose more than expected (third positive reading in a row)
and points to continued stabilization in housing prices.  This will
help consumer confidence and help bank balance sheets.  Meanwhile,
pending home sales for July rose 5.2% and shows that the fall in demand
from the tax credit has stabilized.

Bearish

- ECRI Leading Indicator Growth Rate shows continued weakness
and is once again below the historically important -10% level, which if
broken, has always presaged a recession in subsequent months.  Contrary
to bullish news regarding the jobs report, this indicator is leading,
not coincident. (Link Courtesy of Zero Hedge)

- The manufacturing sector, which has been responsible for most of
the recovery in the economy, is about to falter.  Factory orders rose less than expected
coming in at +0.1% for July, while inventories are rising at an
accelerating clip, a sign that demand is not as strong as supply,
factories will eventually need to reduce production.  Meanwhile, ISM Service Index came in below expectations with most sub-indicies showing weakness.
 Employment for this sector, which comprises the bulk of the US
economy, showed contraction for the first time since January.  New
Orders also showed its weakest reading this year.

- Unit Labor costs were revised up much higher, while productivity
has been coming back down.  Most of the rise in earnings has been due to
extensive cost cutting (look at the unemployment rate!) — ie margin
expansion.  With margins near all time highs, productivity declining and
Labor Costs rising, end demand will have to carry earnings growth from
here. Survey on end-demand says….

-  …PCE metric shows that income growth continues to struggle.
 Slow income growth will anchor consumption growth as there is debt to
be repaid and savings to accumulate.  Worse, what’s the unemployment
rate at?  High supply of workers vs. low demand for labor points to wage growth crawling or worst case scenario,   contracting.
 This could be seen in the Conference Board index of Consumer
Confidence as less people expect a wage increase than people who expect a
wage cut.  (See link in Bearish point below)

- Consumer spending is slowly decreasing as the Gallup Poll points to a very tepid August (smack in the middle of back-to-school).  The 4 week average for August is down 5%+ from the prior month, which was also down 3%.  Why is this occuring? Look at the Gallup, ABC, and Conference Board
(average recession reading = 72 for some perspective) polls.  They show
confidence is still in the dumps. There is clearly a trend of
reduced/cautious spending.  This is further evidenced in the Goldman and
Redbook metrics, which have shown a falling YoY growth rate over the
past month as well.

- More signs of a consumer slowdown as the growth rate in auto sales in the US has all but vanished.
 New sales rates are lower now than they were in 1990/1991.  If there
is no significant growth in end demand soon, the flashy manufacturing
numbers are not sustainable, plain and simple. (Link Courtesy of CalculatedRisk Blog)

Observations/Thoughts

 
Here’s a great example
of everyone trying to export their way out of their respective economic
difficulties.  Unfortunately, this means that everyone is attempting to
weaken their currencies (beggar thy neighbor policies).  That’s why
you’ve seen Gold outperforming all asset classes this year.  How far
down does the rabbit hole go?  Rumors are now surfacing towards the Fed
initiating QE2 but instead of buying mortgage or treasury bonds, it
would begin buying stocks, real estate, etc in an attempt to cut out the
middle men that are the banks.  I’m not buying this for a couple of
very important reasons.  The Fed would effectively and blatantly be
screwing all savers, the prudent, and the retirees seeking income by
plowing their wealth into bond funds for the better part of a year now
(note, this cohort is the strongest political bloc in the country).
 Second, pursing this policy would also signal to the rest of the world
that full blown monetization is ongoing and the dollar would take a
drastic turn lower.  Inflation would surely become more potent in
commodities, while companies, having no pricing power would have their
margins squeezed even more.  A dangerous stagflationary situation would
develop, however, given that we may indeed be in a modern day depression
I’ve come up with a new name.  We would be inviting a “Hyper-depression” if such policy were pursued.

Are problems in China worse than assumed?  Inflation troubles continue to surface,
despite the government’s statistical office announcing rather muted CPI
readings. One thing is certain, high growth rates in wages are
certainly not helping matters for them.  Additionally, we can begin
speculating that officials may be a little more forceful in deflating a stubborn real estate market.  However, they need to be careful in their policies as this is delicate process.

More articles are popping up regarding the Fed’s impotence in battling the recession.  This is something that I was thinking about at the beginning of the year.
 While the Fed had helped the banks out with a large interest rate
spread, demand for loans has been negligible.  Lack of credit creation
and expansion is severely disrupting investment and recovery.  There’s
really little the Fed can do in a balance sheet recession.  In general,
the consumer is paying back all the debt he/she amassed over the past 2
decades.  Unfortunately, there’s not a quick fix to this problem in my
view.  Lowering taxes will certainly help in the healing process, but
current consumption would probably increase only marginally as consumers
would sock away the extra cash for their retirement as their most
important asset, their home, is not what it used to be, especially if
the tax cuts were only for a year.  Maybe a massive jobs program similar
to the New Deal that put people back to work to rebuild our
infrastructure (the Recovery Act didn’t really help).  The problem is
that if there is deadlock, can we really count on our politicians to
agree and spend on another BIG stimulus package?

The Democrats are starting to lose control of the election
and possibly their majority in congress.  Filibusters will become
commonplace and important legislation may not get to a contracting
economy on time.

Barton Biggs is at it again.  “This is not a time where you want
to be underinvested.  The odds of a significant slowdown are one in
five, pretty remote”.  This guys been flip flopping more than a pancake,
and short-term, he’s been wrong at every turn last time I checked.
Meanwhile, the most pessimistic on the street right now as far as GDP
growth is concerned is Goldman Sachs with a forecast of +1.5% for the
rest of the year and a 66% of sustainability in this recovery.  Clearly
there hasn’t been capitulation, so we continue on our “slope of hope”
IMHO.

David Rosenberg pointed out this article
on the Economist regarding the current US job market’s woes.  After
reading it, I decided to check out the jobs section in my Q1 outlook and found that my thoughts were quite similar.  I also wrote this in
late 2009, where I mention technological innovation as a cause for
recent jobless recoveries.  It appears that I am on the right track.

What letter does this look like to you?