Cash For Clunkers

The NBER said Monday that it's too soon to call the recession over, although many of its members think it is. Is it over? Is there a flaw in their analysis?

The U.S. economy’s recent growth has been underpinned
significantly by government policy, yet this short-term cyclical
support will likely fade in the second half of 2010. As a result,
investors should take advantage of the tighter credit spreads and focus
on de-risking their portfolios in order to prepare for the increasing
long-term secular headwinds stemming from the growing deterioration in
public sector balance sheets in many developed economies.

Mark Kiesel, PIMCO Managing Director

A lot of conflicting data came in last week. There is a lot of positive news, but does it all add up to a recovery or is the cyclical recovery headed for a stall? Nothing has changed the underlying conditions that would relieve the credit freeze. And without credit, the economy will stall.

In our recent post, Coming to America, we encouraged readers to study Nail Ferguson’s concerns voiced in the Financial Times – A Greek crisis is coming to America. It does not take a wild imagination to see that ballooning debt levels on government balance sheets pose a grave systemic risk to the global economy and capital markets. This is precisely why we are left with our tongue on the floor when we hear Nobel laureate Joseph E. Stiglitz describing the prospect of a US or UK default as absurd, “particularly in the US because all we do is print money to pay it back.”

This is the first report of a series of 3 reports on the state of the economy as we enter 2010. Part II will appear Wednesday, and Part III will be posted on Thursday. Econophile, as usual, has a different take.

One of the early year themes we have been discussing on our subscriber site has been our expectation for an increase in market volatility. Probably about three weeks back we wrote, “Unlike the consensus and big Street houses which have been predicting/expecting falling volatility in 2010 after an already accomplished death defying drop in volatility during 2009, we’re not so sure shorting volatility is such a wonderful investment idea right here. Although we could be dead wrong, we believe 2010 will present us with a great opportunity to buy volatility. We could be very close right now.” We’re not reprinting this to proverbially pat ourselves on the back as the year is still very young. Secondly, anyone spending time patting themselves on the back in this business are usually about 15 seconds away from having the proverbial rug pulled out from under them. Anything can happen, so judgment is reserved for now as we’ll just have to see what happens on the financial market front as we move forward. We think an increase in volatility is in store not only for the financial markets, but also in a much broader context we’d like to discuss in this missive. We want to quickly talk about another type of volatility – economic volatility. And we want to take a look at the long term in the hope that perhaps we can “see” the future more clearly. Here’s the question that may indeed morph into an investment theme for 2010 and beyond that we’d like to pose. Looking ahead, will the US economy be more or less volatile than we have experienced over what is close to the last thirty years? Yes or no? If indeed were are anywhere even close to the mark regarding our thoughts that economic volatility will increase, then that has direct and meaningful implications for equity and broader business valuations. Let’s start digging through some facts.

This whole Toyota recall thing has had us puzzled. The scale of the recall keeps getting bigger and bigger, the hit to Toyota stock greater with every single day. This is extremely uncharacteristic for a company that has taken PR fallout containment (not to mention quality) to an artform. Which, one would speculate, may implicate other forces in this dramatic collapse in everything that Toyota has stood for. The just released announcement from the US Government, in which the government is telling Toyota Owners to "stop driving the recalled vehicles" (can Congress quickly make this into a law please?) which is a defacto endorsement of buy American, and not just any American, but cars made by bankrupt and spun off automakers, in which the country has a major equity stake in via TARP and loan facilities, could be a big clue as to what the behind the scenes play here is. As everyone knows, Cash For Clunkers was a benefit exclusively to Japanese automakers, with Ford barely sneaking into a top 5 spot for cars sold. Well, now it's time for Uncle Sam to demand his pound of flesh; if that involves a "recall" and a huge hit to Toyota's sales and market cap, so be it.One thing for sure: with the various spending freezes , we won't be seeing another Cash For Clunkers for years to come, if ever... Or we may, if and only if, Toyota's reputation has been destroyed beyond measure.

An interesting observation emerges when one analyzes the various holders of non-revolving consumer credit. While the traditionally largest players in non-revolving consumer credit provisioning, commercial banks and finance companies, have been materially curtailing their lending of auto loans (the primary form of non-revolving credit and which also includes student loans, as well as boat and trailer loans) with their combined holdings declining by 5% year over year (from $989 billion to $940 billion), another actor has jumped in to take their place. It should not surprise anyone, that with a 68% increase in non-revolving credit holdings over the past 12 months, this entity is none other than the Federal Government.

Cash for Clunkers is long forgotten, and it is now time for another manufacturing stimulus: from 34.6 in September to 24.5 in October to a mere 2.55 most recently. Diffusion data suggested further contraction in margins, evaporation of optimism and an ongoing decline in inventories: the whole 5% of Q4 GDP is becoming a Liesmanian myth.

Christina Romer is one of Obama's chief economic advisors. But she has absolutely no clue what to do about this crisis. Her recent letter defending the Administration's policies is just the usual hack political stuff one would expect from them. She is typical of the problems in Washington. She means well, but she is fabricating the truth in order to justify their actions. Their approach to using government power is one we should all be afraid of. She spells it out quite clearly.

It appears that all the improvements in the housing market have not been due to market corrections, but are from government stimulus, and the numbers are fake. Such actions will only delay a recovery and housing prices will continue to fall.

Yesterday it was Philly Fed's Plossner, today it is Richmond Fed's Jeff Lacker who joins the chorus demanding an end to Bernanke's insane monetary policy of drowning the market with unprecedented liquidity which is not getting to consumers but merely propping Amazon stock at a bubblelicious 100x P/E. In a speech before the Charlotte Chamber of Commerce, Lacker stated: "The perception of inflation risk could be particularly pertinent to the current recovery, given the massive and unprecedented expansion in bank reserves that has occurred, and the widespread market commentary expressing uncertainty over whether the Federal Reserve is willing and able to promptly reverse that expansion... If we hope to keep inflation in check, we cannot be paralyzed by patches of lingering weakness, which could persist well into the recovery. In assessing when we will need to begin taking monetary stimulus out, I will be looking for the time at which economic growth is strong enough and well-enough established, even if it is not yet especially vigorous. Although it is hard to predict when that will occur, I can confidently predict that monetary policy will remain particularly challenging for some time to come." Then again, the stock market does not seem to share Mr. Lacker's concerns.

Don't say the market is unkind to Goldman. First the firm's employees are about to rake in all time record bonuses. Then, courtesy of of a rocking bear market rally, top-tick Goldman is about to get the hell out of dodge in another GS Capital Partners LBO, Adesa, basically a vehicle auction firm, which the firm bought in conjunction with Kelso in 2006. And who gets to pocket the underwriting fee? Why, Goldman. No way is the squid going to let any capital leave the firm. As for the company: prepare to own a 10x EV/EBITDA Craigslist knock off which will spew $100 million in free cash flow on a good year (and with consumers waiting for Cash for Clunkers 2 thru 100, don't expect a whole lot of car auction activity any time soon).

A reader submits the following disclosure released by Ocean Reef Club, a country club, which very much unlike America's 35 million food-stamp recipients, has roughly a $35 million net worth cutoff for members, who enjoy such amenities as 100 foot yachts, a private airport, and two golf courses. It is precisely in connection with golf that we see these very needy multi-millionaires follow in Wall Street's footsteps and proceed to redistribute wealth away from those who actually work for their money, to those who merely use the dollar as a temporary (or otherwise) replacement for one-ply Cottonelle.

The Federal Reserve's balance sheet hit a new all time record of $2.19 Trillion in assets, after an unprecedented spike of over $70 billion in MBS purchases pushed the number over the previous record from late April.