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October 2010 Quarterly Market Commentary 4800 I-55 North, Suite 21 Jackson, MS 39211 Post Office Box 14888 Jackson, MS 39236-4888 Phone: 601-368-3500 www.sbcorp.com 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.