Download Battening Down the Hatches

October 2010
Quarterly Market Commentary
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Battening Down the Hatches
M.L. Ballew, III T. Doug Dale, Jr.
[email protected] [email protected]
spent time analyzing the events
Well it’s official. The National
around the 1930s. We believe an
Bureau of Economic Research
in-depth knowledge of the
(NBER) has declared the
economic and financial market
recession over effective June
circumstances surrounding the
2009. I find it interesting that
1930s (and Japan 1990 to date) is
NBER made the announcement
imperative if you plan to stay
the day of Obama’s televised town
ahead of current market trends.
hall meeting on Monday,
You do not need to sift through
September 20, 2010. One has to
the economic data to realize that
wonder if the two events are a
the largest economy in the world is
coincidence or perhaps an attempt
fundamentally
weak
and
on the administration’s part to
susceptible to a recessionary
persuade America to vote to keep
relapse.
Economists
and
the Democratic Party in control of
strategists, on balance, are under
Congress this November. Time
emphasizing where we are in the
will tell but it appears that
deleveraging cycle (See chart on
America is growing increasingly
impatient with the less than robust It has been over 80 years since the page two.) There continues to be
discussions of a stabilizing
economic recovery, increased world last experienced anything
housing sector that is unlikely
regulatory
environment, close to the scale of debt
given the amounts of excess
healthcare mandate on the private deleveraging and anti-economic
inventory and bad mortgage debt
sector, and prospects of higher growth policies that are present
today.
that
remains
present.
taxation in lieu of a more fiscally
Additionally, 30% of the U.S.
prudent government.
population has a FICO score
This quarter’s commentary,
under 620 (i.e. not credit worthy).
like all of our commentaries, will be devoted to
The fact that jobless claims have not gone back
helping you think through the issues that we
up over 500,000 is viewed as a positive when at
believe are relevant in the current investment
this point in the recovery claims should be well
environment. It has been over 80 years since the
under 400,000. Even more interesting is that
world last experienced anything close to the scale
of debt deleveraging and anti-economic growth
Obama’s economics team is quickly departing:
policies that are present today. Few business
First Christina Romer (Counsel of Economic
schools and investment management firms have
Advisors), then Peter Orszag (Office of
Security Ballew • Quarterly Market Commentary • October 2010
business owners conducted by the U.S. Chamber
Management and Budget) and now Larry
of Commerce, which found that 78% of the
Summers (National Economic Counsel). Some are
respondents believe that the economy will “remain
speculating that Tim Geithner (Treasury Secretary)
stagnant or get worse over the next
is next. Perhaps each of them
wants off the political stage You do not need to sift through year.”
However, we are told not to fear,
for what they fear lays ahead the economic data to realize
“Helicopter” Ben Bernanke’s Federal
for the economy and the that the largest economy in the
Reserve
is here. More “money” will be
administration.
world is fundamentally weak
printed to buy more U.S. treasuries and
The reality is that this is and susceptible to a
force long-term interest rates even
the weakest recovery on recessionary relapse.
lower in an attempt to encourage
record in terms of the growth
borrowing. How exactly does this work
rate in real final sales. As it
you might ask? Answer: The Federal Reserve
pertains to employment, housing, and personal
purchases treasury securities by crediting the
income, there has not really been any recovery at
account of the clearing bank used by the primary
all. Each measure of consumer and small business
dealer who owned the security. This process
sentiment is locked in recession terrain, but these
directly affects the monetary base but the monetary
items do not go into the Business Cycle Dating
Committee’s process at NBER. Recently, the
base by definition is not money. In order to be
Investor’s Business Daily cited a survey of small
money, these new deposits at the Federal Reserve
Page 2
Security Ballew • Quarterly Market Commentary • October 2010
a bear market, interest rates all along the curve
Bank would have to be available to make
should drop to levels approaching a 2% yield on
transactions. The actual creation of new money
the 30-year U.S. Treasury bond. Going to a 2%
depends on the banks making loans. If the banks
yield on the 30-year long bond delivers a 60%+
don’t make loans, then nothing happens with the
capital gain from current bond prices (assuming the
reserves that have been added to the banking
yield drop occurs within the next few years as we
system. In this circumstance, an increase in the
expect). The 1930s in the U.S. and Japan’s
monetary base has occurred with no increase in the
economy to date have delivered such outcomes.
money supply. When this happens, the money
Not a bad potential return for a deflation hedge that
multiplier falls and that means that the Fed’s
is secured by the government’s “printing press.”
attempt to engineer more inflation isn’t working.
This is precisely the scenario that we are seeing
Double Dip Recession?
today.
We’ve made our case for very slow U.S.
Unlike the recovery from the 2002-2003
economic growth in the quarters, indeed the years,
recession, we believe that consumers will resist the
ahead. The recent economic rebound due to the
temptation to leverage themselves into another
inventory cycle and government
asset bubble. The notion of fool me
stimulus is likely over. Just as we
once, shame on you, fool me twice, More savings and less spending
called for a big bounce from the
shame on me, applies here. While is the order of day.
March 2009 lows (see January and
most central bankers believe they
April 2009 issues of Market
can merely start up a printing press and initiate a
Outlook), we are recommending that prudent
new borrowing and lending cycle, the reality is that
investors under weight their equity exposure now
current monetary policymakers are subject to the
that equities have had their large (4,000+ Dow
private sector’s desire and ability to borrow and
point) bounce.
invest or spend. Our view remains that a secular
Remember, employment and consumer
mind set shift has taken place as baby boomers and
spending remain weak. Housing is too over
others will increasingly live within their means and
burdened with excess inventory and the resulting
pay cash more often than use credit, not unlike
price weakness to revive any time soon. State and
those who lived through the deflationary 1930s.
local government spending and employment are
More savings and less spending is the order of day.
retreating. Meaningful export gains are unlikely as
This will be good for the economy in the long run
economic growth abroad slows. Interestingly, the
but a challenge for the economy’s ability to grow as
consensus forecast is moving toward our position
expected by economic bulls in the short run.
as growth estimates have been reduced rapidly in
Lenders are aiding this new norm of frugality with
recent months. In both April and June, The Wall
stricter
(government
imposed)
lending
Street Journal’s poll of economists expected 3%
requirements. Credit worthy borrowers who were
economic growth in the second half of this year.
accustomed to being able to call up their banker for
Now that an anemic growth rate is being realized
a blank check on a moment’s notice are
as more likely, equity markets are only beginning
understandably frustrated. For those who aren’t
to price in this “new normal.” Most stocks are at or
already on board owning long-term treasuries as a
barely above their January 1st opening prices as I
deflation hedge, you had better hurry because the
write. How’s the performance of the long term U.S.
train is leaving the station.
Treasury market that we seem to love so much
The current environment should be a long
these days? Answer: Long duration (30 year) zerobattle between more frugal consumers and
coupon U.S. Treasuries are up 25% YTD. Not bad
government policy makers. Before we get a real
considering we believe substantially more upside
policy-induced inflationary credit cycle that turns
remains.
the secular bull market in U.S. Treasury bonds into
Will slow growth deteriorate into another
Page 3
Security Ballew • Quarterly Market Commentary • October 2010
recession, the so-called double dip scenario?
Before exploring that question, let’s define a
double dip. It means a second period of economic
decline within a relatively short period after an
earlier recession has officially been declared over.
In the U.S. this would be a rare event as there has
been only one such occurrence in the last 50 years
(1980-1982). However, Japan experienced the
following three recessions within a decade of one
another:
February 1991-December 1993 - Stock market
bubble bursting
June 1997- October 1998 - Real estate and
banking crisis
September 2000 – December 2001 - Global
economy lead recession
Sounds familiar doesn’t it? Granted, Japan’s
recession start and end dates were on average 2 1/2
years apart. However, we should note that their
period of three recessions in a decade was in the
middle of a booming global economy and their
stock market rallies often petered out six to 12
months ahead of the economy rolling over.
Double dip or no double dip, we believe that
global economies around the world are on a bumpy
road to a new normal, to use PIMCO’s term. This
is a world where one should expect to see lower
valuations (i.e. prices) in risk assets, deglobalization (i.e. protectionism), de-leveraging
and de-risking (i.e. less leverage and risk taking),
and more government intervention (i.e. money
printing to keep interest rates low and currencies
cheap) and regulation (i.e. more rules to make it
The Quarterly Market Commentary is a quarterly publication for
the benefit of the clients of Ballew/Russell, Inc. Pursuant to the
provisions of Rule 206(4)-1 of the Investment Advisors Act of 1940,
we advise all readers to recognize that they should not assume that
recommendations made in the future will be profitable or will equal
the performance of past recommendations. The contents of this
letter have been compiled from original and published sources
believed to be reliable but are not guaranteed as to accuracy or
completeness.
M. L. Ballew, III and T. Doug Dale, Jr. serve as portfolio managers
at Ballew/Russell, Inc., a registered investment advisor,
Ballew/Russell, Inc. is affiliated with Ballew Investments, Inc., a
fully-disclosed introducing broker/dealer and FINRA/SIPC
Member utilizing the clearing services of Pershing, LLC.
Ballew/Russell, Inc. and Ballew Investments, Inc. are both
subsidiaries of Security Ballew, Inc. Clients of Ballew/Russell, Inc.
may have positions in and may from time to time make purchases
and sales of securities mentioned herein.
Page 4
harder for honest people to make a living). At the
end of this long journey, we believe equities will
finally be priced where history screams, “Load
up!” And, if we do get presented with such an
opportunity, our only question for you is, will you
be prepared and ready? In the mean time, we will
continue to maintain a focus and priority of being
able to give you a return of your money vs. living
in the old normal world’s focus of the return on
your money.
As always, thanks for your continued interest in
our economic views. To our clients, we are
working harder than ever in an attempt to keep
getting it right. We count it a privilege to be a
steward of your wealth.
T. Doug Dale, Jr. MBA, CRPS
Our BOttOm line
• The reality is that this is the weakest recovery on
record in terms of the growth rate in real final
sales. As it pertains to employment, housing, and
personal income, there has not really been any
recovery at all.
• Unlike the 2002-2003 recession recovery, we
believe that consumers will resist the temptation
to leverage themselves into another asset bubble.
• The recent economic rebound due to the
inventory cycle and government stimulus is
likely over.
• Double dip or no double dip, we believe that
global economies around the world are on a
bumpy road to a new normal, to use PIMCO’s
term.
SB Advisors
M. L. Ballew, III, CPA, JD, LLM, Chairman of the Board
C. Brooks Mosley, CPA, President
Karl E. Byrd, CFP, Shareholder
T. Doug Dale, Jr, CRPS, MBA, Shareholder
James A. Hurt, CLU, ChFC, Shareholder
Alan McCormick, MBA, Client Advisor
Robert Scott Rives, Client Advisor
Security Ballew Wealth Management is a comprehensive
wealth management firm serving high net worth individuals,
foundations, corporations and institutional pension funds. Among
the firm's subsidiaries, IPS, serves as a TPA consultant to hundreds
of corporate sponsored qualified 401(k) retirement programs.