Tuesday, December 22, 2009

A Profusion of Thoughts

December 22, 2009


The spread between Three-month LIBOR and Three-month Treasuries, which at the height of the credit crisis in the fall of 2008 was over 400 basis points, is now a negative 17 basis points. Its historical level has been about 50 basis points. Since much corporate borrowing is based on LIBOR, the collapse in the rate may indicate a lack of demand, but is a positive for those seeking funding.

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The lead article in the Money & Investing section of yesterday’s Wall Street Journal presented a bar chart showing compounded returns by decade going back to 1830. The decade of the 2000s was the worst ten year period in the past 180 years (slightly worse than the 1930s), but there had never been two contiguous decades comparable to the 1980s and 1990s.

Despite an S&P 500 that is up 24% for the year and has rallied 67% from its March low; we are merely back to where we were at the end of 2004, when the market was recovering from the 2000-2003 bear market. The Index is where it was in April 1998, giving proof to the obvious fact that equities were not the asset of choice during the last decade, but the past is not necessarily prelude.
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Housing has been at the center of both the credit crisis and the economic down turn. The median sales price, at $175,000, is 22% below its level of a few years ago. Last week the Wall Street Journal had an article suggesting the number of homes under construction was below the levels in 1960. While it is true that the Country, in 1960, was continuing its migration from cities to the suburbs, the population in the ensuing 50 years has increased 77%. It begs one’s imagination to expect the present low rates of construction to persist.

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The final revision to third quarter GDP was out this morning and it suggests growth of 2.2%, still positive, but below expectations. Preliminary fourth quarter GDP numbers will be reported in the last week of January and expectations have been rising. Today, consensus puts the estimate at 4%. Debate continues to rage as to the type of recovery – a V, W or square root – but the economy is in better shape than it was a year ago. Last December, a year after the recession began, the National Bureau of Economic Research officially placed the U.S. economy in recession. One can expect a similar delay in officially acknowledging recovery.
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Sovereign debt is where risk exists today, at least in the view of the rating agencies, with their recent, well-publicized downgrade of Greece. That they were negligent in reducing ratings on all forms of securitized debt a few years ago should not cause one to ignore their decisions today, but if one views them with a degree of skepticism it is understandable. I also note a headline on Bloomberg today: “New Jersey Leads Municipal Bond Downgrades as State Aid Shrinks.” The headline is indicative of the enormous debt transfer now underway, from consumers and corporations to government. And states, unlike the federal government, fortunately do not have the ability to print money, though they can tax in a confiscatory fashion. Whatever happens, it is difficult to believe that short rates will remain close to zero.

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Earnings estimates for next year are modest. I wonder if analysts are perhaps overly cautious. Many large companies, facing Armageddon a year ago, cut staff and expenses dramatically. The instinct to survive superseded any plans to grow and expand, so now a small increase in revenues could produce pretty strong earnings. The market has experienced cycles like this before. The problem with extrapolation is that it tends to accentuate the trends we have been experiencing.

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