June Economic Update
June 15, 2010
In May, we witnessed how much anxiety investors still have. When a supposed technical glitch sent the market sharply lower, fearful investors immediately sold stocks sending the DJIA down 1,000 points in about 15 minutes. Although the same index closed about an hour later down less than 400 points, the large intraday swings showed the intent of many investors to try to avoid participating in another market freefall like 2008. The selloff in May has been the largest since the bull market began a year ago. Stocks may be forming a short-term bottom but we will need a few more trading days to be sure.
That fear remained as the events in Europe continued to unfold over the rest of the month. The sovereign debt problems of Greece, Portugal and Spain worry analysts that European economies will slow significantly as austerity measures are implemented and these countries cut their spending. As a result, the Euro has weakened significantly against the dollar. A stronger dollar makes US exports more expensive. When combined with European countries buying less of our goods, our future GDP growth may be curtailed as a result.
For now, the US remains in economic recovery mode. The housing tax credit was still available in April, and home sales continued to be stronger than expected at 14.8% for new single family homes and 7.6% for existing homes. Retail sales increased 0.4% in April beating estimates for the fifth month in a row. In April, the economy also added net jobs of 290,000 which was the most in four years. However, later this year, we may start to encounter headwinds created by Europe’s expected slowdown, a stronger dollar, and our own high debt level.
GDP growth for first quarter was revised down slightly from 3.2% to 3.0% which is still a respectable level in normal times, but it is not enough to create jobs for the 15.3 million unemployed people. Around 3% GDP growth is needed to hold unemployment constant, but 5% is needed for a full year to bring unemployment down one percentage point. Currently, unemployment is 9.9% so we need much stronger GDP growth for at least 5 years to bring unemployment back to 5%. Unfortunately, the National Association for Business Economics predicts 2010 GDP growth near 3%.
Company earnings have been encouraging and expectations for continued strong growth are built into stock prices. However, the recent GDP revision showed that consumers and businesses alike spent less than what was initially estimated. Then, consumer spending in April was flat. With unemployment expected to remain high, incomes virtually flat, credit tight, and uncertainty in the business environment, we are concerned that a catalyst to propel corporate earnings growth higher is missing. Furthermore, US company earnings could also be pressured by lower exports to European countries as well as to other countries who may
import the less expensive European goods rather than American goods.
Oil prices have been falling due to lower expected demand from Europe and China. With the President calling for a moratorium on drilling permits for six months and suspending planned exploration drilling, the reduced supply may push oil prices higher. Falling energy prices made the largest contribution to a decrease in headline inflation as measured by the CPI in April. However, underlying trends show a longer-term threat of inflation. The longer the Fed continues to keep interest rates artificially low, the more serious the inflation problem will become according to many economists.
Contrary to the goals outlined by Fed Chairman Bernanke, the size of the Fed’s balance sheet expanded further as the Fed continued to buy Mortgage Backed Securities. The US total debt has now reached $13 trillion and is 86% of projected GDP for 2010. Our annual deficit is projected to add $1 trillion in 2010 alone. Healthcare reform costs continue to be revised higher and are expected to add more than $1 trillion over the next 10 years. Former hedge fund manager Keith McCullough compares America’s current situation to Lehman in 2008 as it is borrowing short to fund long term liabilities. We can see the effect that high sovereign debt is having in Europe, and we are heading down a similar path. Our debt as a percentage of GDP is already higher than that of troubled Spain. Analysts have warned that higher taxes alone will not be enough to solve the debt problem of our country. Reduced government spending is needed and higher inflation may be unavoidable. With significant portions of the Federal budget dedicated to entitlement programs such as Social Security, Medicare, and Healthcare, cutting spending may be more difficult to do without reducing benefits.
17330 Wright Street, Suite 205
Omaha, Nebraska 68130
Lori L. Liffring, CFA
Michael L. Bridgman, ChFC
Gaylan C. Abood, CFA
Justin S. Anderson, MBA AAMS
Karen K. Benefiel, CPA AAMS
(c) Cambridge Asset Advisors