Agora Financial’s Rude Awakening

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Laguna Beach, California

• Stocks deliver their best quarter in over a decade: so what now?
• Females vs. males in the battle of the unemployment checks,
• What manufacturing to services bodes for the U.S. economy and more…

Eric Fry, reporting from Laguna Beach, California…

Woohoo!…U.S. stocks racked up their biggest quarterly advance since 1998! The Standard & Poor’s 500 Index soared more than 15% between March 31 and June 30 – lifting its year-to-date performance marginally into the black, and breaking a streak of six consecutive quarterly declines for the S&P 500, the longest since 1970.

This champagne-cork-popping performance obscures a few trends that should be worrisome to the celebrants. First, the S&P 500 has gained no ground whatsoever since May 8, the first trading day after the Federal Reserve triumphantly announced the results of its banking sector “stress tests.” Second, the BKX Index of financial stocks has DROPPED more than 16% since May 8. (As we have noted in prior editions of the Rude Awakening, the finance sector has been leading the overall stock market – both to the upside and downside – for the better part of four years. So the sluggish recent performance of the BKX Index is probably not a “nothing.”) Lastly, most gauges of investor sentiment – like the VIX Index of option volatilities – are flashing readings of extreme investor optimism. Typically, as contrary indicators, such readings presage a market selloff.

But even if we were oblivious to all of these “inside baseball” stock market indicators, we would find plenty of reasons to worry about the near-term prospects of the US stock market.

Yesterday’s headlines, alone, offered ample evidence that something is rotten in the state of the U.S. economy:

For starters, the Office of the Comptroller of the Currency announced a troubling jump in “prime mortgage” delinquencies during the first quarter. Secondly, the S&P/Case-Shiller Index of home prices continued to slide, both year-over-year and month-over-month. (But the rate of decline is slowing which, we are told, means that the housing market is “bottoming.” Maybe yes, maybe no. We been hearing these pronouncements almost every month since the housing market peaked in 2006). Lastly, the Conference Board disclosed that consumer’s are feeling blue once again. Consumer sentiment dropped sharply from the prior month.

It’s true that much of the economic data flying across the newswires are less bad than before. But they are not good in any absolute sense of the word. Economic distress is still ascendant from coast to coast, with very few exceptions. The only other ascendant trend is self-delusion.

In yesterday’s edition of the Rude Awakening, we examined the adulation and success the “big men” in America are currently enjoying…and we postulated that the very existence of this adulation indicates that the crisis is far from over. But maybe this analysis of ours is too wacky and unscientific for most Rude readers. So let’s take a hard look at the hard lives America’s little men (and women) are enduring.

A “little man,” loosely defined, is any worker in the United States who does not appear among the “Friends” on former Treasury Secretary Hank Paulson’s Facebook page. A secondary definition of “little man” would be any individual without Ben Bernanke’s cell phone number in his “Fave 5,” and/or any individual without a direct line of credit from the Federal Reserve.

“Everywhere one looks these days,” we observed in yesterday’s Rude Awakening, “the big men are looking pretty darn smart. Meanwhile, the little men are suffering like never before.”

In what Sarah Baxter of “The Sunday Times” of London calls a “Mancession,” American males are suffering a disproportionate share of financial distress. “The economic crisis is sweeping away men’s jobs at a faster rate than those of women in America,” Baxter relates, “heralding the onset of a so-called ‘mancession.’” The Wall Street Journal’s, Mark Penn, dubs the growing ranks of unemployed males, “GLBs” (Guys Left Behind), and suggests their sufferings bode ill for the future of the American economy.

Picking up on the observations of Baxter and Penn, the Financial Times remarks:

“Men have lost almost 80% of the 5.1 million jobs that have disappeared in the US since the recession started. This is a dramatic reversal of the trend over the past few years, when the rates of male and female unemployment barely differed.”

This curious statistic may contain valuable a macroeconomic insight. Specifically, men are losing jobs because America’s metal-bending industries are atrophying.

“Men have been disproportionately hurt,” the Financial Times explains, “because they dominate those industries that have been crushed: nine in every 10 construction workers are male, as are seven in every 10 manufacturing workers. These two sectors alone have lost almost 2.5 million jobs. Women, in contrast, tend to hold more cyclically stable jobs and make up 75% of the most insulated sectors of all: education and health care.”

“The widening gap between male and female joblessness means many US families are solely reliant on the income the woman brings in,” the Financial Times concludes. This widening gap also means that America’s economy is becoming dangerously reliant on service and finance industries, rather than manufacturing industries.

To be sure, a paycheck is a paycheck, no matter whether a “Ms.” or a “Mr.” is cashing it…and a pink slip is a pink slip, no matter which gender is receiving it. But that’s not the whole picture. If the service-sector “Ms.” is cashing her paycheck, while the manufacturing-sector “Mr.” is receiving his pink slip, trouble is not far behind.

This is not a male-female thing; it is a national prosperity thing. Large economies cannot live on service industries alone. And large economies do not “recover” while their manufacturing industries are contracting. So, no, the U.S. economy is NOT recovering, no matter how many folks wish it were so.

Even if we look at the recent economic data through gender-neutral spectacles, we see a picture of national distress, not national recovery. We see soaring long-term unemployment, coupled with a subsistence-level consumer spending.

America’s “headline” unemployment rate is 9.4%, which is pretty darn bad. But America’s actual unemployment rate is more like 16%, which is a horrific. The chart below tracks the combined percentages of American workers who are: 1) unemployed; 2) partially employed, but seeking full-time employment or; 3) so discouraged that they have stopped looking for work, even though they are unemployed.

The chart speaks for itself…If this is a “green shoot,” it must be a weed.

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Buy Stocks!…at Dow 4,000
By Bill Bonner

“Less bad” is not good.

“Things seem a lot better now than they did back in October,” said a friend the other day. “I think we really hit bottom towards the end of last year.”

Our friend’s view is probably the dominant one. Things are looking up. Not that the news is good…but it just seems “less bad” than it was…or even less bad than was expected.

Foreclosure filings are at a record high. But “Most Homeowners Think Bottom Reached,” said a news item on the internet. “Bank Crisis in US Could Last to 2013,” adds a headline from Reuters. Yet, most people think the banks are on the mend. They think the financial sector will come back…maybe slowly, but more or less steadily and satisfactorily.

The average bear market bounce in the stock market lasts only two months. By that measure the current rebound should be over already. Stocks have recovered 30% to 40% – all over the world. But this rebound doesn’t seem to be ending. Why?

Well, it might last longer than most because the feds are fighting this downturn far more than they usually do. So, it wouldn’t be totally surprising if the rebound were robust. But if it’s what we think it is – a bear market bounce, not a genuine new bull market – the government’s support is pernicious. It helps disguise what it really going on…and draws even more investors into the trap. And the longer it goes on, the more investors will come to believe that this bull market is for real. As it continues, they’ll commit more and more of their money to it…

How far could it go? Who knows? But it wouldn’t be extraordinary if it took the Dow back to 10,000. And it would not be unusual at all if people stopped talking about the ‘green shoots’ and began noticing entire fields of clover.

So, let’s take a minute to try to remember why we think this is only a bear market trap…

The problem is debt. It built up over a quarter of a century to levels that even President Obama says are “unsustainable.” People have too much debt – student debt, credit card debt, private equity debt, mortgage debt, and every other kind of debt you can imagine. As long as the economy is expanding…and the credit markets are offering more debt…the problem is not critical. One debt is paid by taking on another, greater, debt. Houses are refinanced, for example, at higher prices…but lower interest rates.

Then, the cycle turns. Instead of continuing to expand, credit begins to contract. When people go to refinance, they discover that their collateral is worth less than it was before, real interest rates are higher, and the lenders don’t want to lend any money anyway.

Bummer…

And then, all that debt that they built up over the last quarter century is a problem. It has to be paid down to the point where it isn’t a problem. And that means the obvious thing – people have to cut back on their spending. As long as the amount of debt is contracting…as long as interest rates are rising…as long as asset prices are falling…and as long as people have more debt than they feel comfortable carrying – sales, profits, and stock prices are going to be depressed. No reason for a new bull market.

This process should last a long time. Why? Because it takes a lot longer to pay off debt than it does to run it up. People have to earn the money to pay down their debts. And it’s harder to earn money in a declining economy than it is when the economy is booming. People have to make changes…they have a lot to figure out…and a lot to reorganize. It could take two years…4 years…10 years or more.

But wait a minute. What about all this government bailout money? What about the most expensive financial commitment every made? Bigger than the pyramids, more expensive than Alexandria and Babylon put together, more colossal than the Colossus itself…

About $15 trillion has been earmarked for the big bailout/stimulus program. Surely, it will short-circuit the correction and get the economy going faster…won’t it?

Nope. Not likely.

You can’t correct financial mistakes by subsidizing them. You can’t erase bad investments by putting more money in them. You can’t turn bad businesses into good businesses by giving them money. And you can’t cure the problem of too much debt by borrowing more money.

Instead of forcing people to correct the mistakes of the bubble era, the government is doing all it can to keep bad investments from getting worse, keep brain dead firms alive and keep zombie banks in business. The more money the feds put to the task, the less quickly the economy corrects errors and adjusts to the new realities.

Still, all that money has to go somewhere, doesn’t it? Won’t a lot of it go into stock prices?

The answer is ‘maybe.’

But this money that might go into stocks, where does it come from? Ah, dear reader, there’s the glitch…there’s the fly in the ointment…there’s the rub.

Every dollar that goes to prop up Wall Street, for example, must come from somewhere else. A headline we saw recently reported that the “Rich Get Richer on Wall Street.” Of course they do. Instead of going broke and getting fired – as they should have – the government steps in with more money. Not only do the banks stay in business, they’re able to pay their managers even bigger bonuses.

The government borrows from the private economy – money that might have been lent to a developer…or to a bakery…or to an oil explorer – and fritters it away elsewhere. Now, it’s true that in a credit contraction, borrowing seems to go down. But it does so for a good reason. The economy is not working properly. People don’t know what projects will work and what ones won’t. Besides, asset prices – which tend to support lending – are falling. Who wants to take a chance on lending money when the collateral might be disappearing? So, new lending tends to freeze up…until the period of shock, adjustment and restructuring is over.

The feds’ theory is that they are merely putting idle resources to work…and getting the economy going again. What they are really doing is taking resources out of safe idleness, and wasting them on active projects that don’t pay off. That is not the basis for a genuine new bull market. It is the basis for a big disappointment.

Joel’s Note: Our annual Agora Financial Investment Symposium in Vancouver, British Columbia is rapidly approaching…and this year marks the 10th anniversary of The Daily Reckoning. So, this July, the Symposium will be focused around a “Decade of Reckoning”…four days that will help you to gain greater insight on how to turn investment ideas into the profit opportunities of the next decade.

So, will we be seeing you there? This event is already 70% sold out, so you’ll want to be nimble. Click below for all the info:The Agora Financial Investment Symposium: July 21-24

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[Rude Endnote: As mentioned above, the markets just enjoyed their best quarter in over a decade. And that despite finishing in negative territory for the past month. The Dow fell quickly at the open yesterday and was down 150 points before recovering slightly to end the session down 80 points. The S&P 500 tracked a similar trajectory, closing down 0.85%.

Asian markets were down by similar margins at the end of trading today. Hong Kong’s Hang Seng finished lower by 0.85% while Japan’s Nikkei 225 managed a 0.2% decline. China’s CSI 300, meanwhile, finished the session over 2% higher.

The Aussie All Ordinaries index was about the worst of the bunch, down almost 2% by the close. The poor performance came in light of a drop in building approvals over the past month and rising fear of unemployment worsening.

In Europe most measures are higher in early trading today. Major indexes in England, France and Germany were all higher by 1.4% last we checked.

In commodities, gold recovered a few bucks after dipping below $925 for a brief period yesterday. An ounce now fetches around $931. Crude goes for a smidge under $71 per barrel.

That’s it from us for the day. If you would like to drop us a line, feel free to leave something for us at the address below.

Until next time…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com