Thursday, November 07, 2013 - The Road Not Taken

The Road Not Taken

by Sinclair Noe

DOW – 152 = 15,593
SPX – 23 = 1747
NAS – 74 = 3857
10 YR YLD - .03 = 2.61%
OIL - .51 = 94.29
GOLD - 10.00 = 1308.60
SILV - .14 = 21.77

Big story on Wall Street today was the Twitter IPO. I will now tell you everything you need to know about it in 140 characters or less.

TWTR IPO 2day. Priced @ $26. Pop 2 $50. Close @ 44.90 up 72%. Market cap = $24 bil, earnings = < zero. Smooth not Facebook. #bubblicious

Economic growth accelerated in the third quarter. Gross domestic product grew at a 2.8 percent annual rate, the quickest pace in a year, after expanding at a 2.5 percent clip in the second quarter. Inventories, however, accounted for a 0.8 percentage point of the advance made in the third quarter, as businesses restocked shelves, but the slowest expansion in consumer spending in two years suggested an underlying loss of momentum. Consumer spending expanded at a 1.5 percent rate, the slowest pace since the second quarter of 2011. It grew at a 1.8 percent rate in the April-June period. So, unless there is a surge in 4^th quarter demand, we might see future production reduced to clear out inventories.

The economy grew at a 1.8 percent rate in the first half of 2013, expect growth of around 1.5% for the fourth quarter. The private sector decelerated over the summer, providing less of a cushion for the government shutdown in October. Steady growth in spending by state and local authorities pushed government spending up for the first time in a year, but federal spending continued to drop.

If we are to see a surge in demand, it would likely come from improvement in the labor markets. In a separate report today, initial claims for state unemployment benefits fell 9,000 to a seasonally adjusted 336,000 last week. Tomorrow we'll get the monthly jobs report for October, which will be more than a bit bizarre due to the government shutdown.

Although the unemployment rate has declined significantly from a peak of 10 percent in October 2009, it remains at an uncomfortably high 7.2 percent. About 21.5 million people are either unemployed, working only part-time despite wanting full-time work, or want a job but have given up the search.

Meanwhile, the Commerce Department reports home ownership is holding near 18 year lows. For the 3^rd quarter, the seasonally adjusted homeownership rate, the share of households owning a home, held at 65.1 percent, the lowest since the fourth quarter of 1995.

Separately, Fannie Mae and Freddie Mac, the government sponsored entities that provide financial backstops to the housing industry will send the Treasury $39 billion in December, meaning they have almost paid back the government bailout of 2008. The companies, which own or guarantee about two-thirds of all US home loans, were seized by the government at the height of the financial crisis as mortgage losses threatened their solvency. They are now seeing profits surge as housing rebounds.

Freddie Mac will pay about $30 billion and Fannie Mae will make an almost $9 billion payment. By early next year, taxpayers likely will have turned a profit. The two firms' bailout agreements, however, do not provide a way for them to buy back the $189 billion worth of senior preferred shares the government received in return for its aid. Under the bailout terms, they will continue to make dividend payments as long as they are profitable.

The European Central Bank cut interest rates today. The ECB cut its main refinancing rate by 25 basis points to 0.25 percent. It held the rate it pays on bank deposits at zero and cut its emergency borrowing rate to 0.75 percent from 1.00 percent. That is the lowest rates on record for the EU. ECB President Mario Draghi says they still have room to act if needed. The ECB said it would prime banks with as much liquidity as required until mid-2015, indicating a new round of cheap money stimulus within the next few months. Shares in major European markets, from the German DAX to France’s CAC40 all jumped on the news, gradually giving up their gains into the close. The euro took a tumble, falling as low as 1.33 against the dollar before recovering.

By contrast, many economists expect the Federal Reserve to begin withdrawing stimulus next year; and the stronger than expected GDP report today reinforced that expectation. Of course, right now it's just expectations and the last time the Fed floated the trial balloon on cutting back Quantitative Easing, the markets threw a taper tantrum. So, we'll wait and see. There is much buzz over the possibility the Federal Reserve will lower the unemployment rate threshold at an upcoming FOMC meeting. To a certain extent, the issue of thresholds has taken on a new urgency as a result of the tapering debate.  The Fed's excellent adventure with tapering this summer indicated that they do not fully understand the transmission mechanisms of large scale asset purchases. Despite some improvement in the economy, and in spite of fiscal headwinds, and forgetting about today's GDP report momentarily; the economy has been giving little room for the FOMC to maneuver. They do not want to withdraw accommodation at this point, only to limit additional accommodation. 

The Senate Banking Committee says it will hold a hearing on November 14 on the nomination of Federal Reserve Vice Chair Janet Yellen to take the helm of the central bank when Ben Bernanke steps down at the end of January.

Back to Europe for a moment. There has been talk of improvement in the Eurozone economies, but clearly the ECB action today indicates that there hasn't been enough growth; and gross domestic product growth alone is not enough to provide sustainable prosperity, especially if it doesn't result in significant job growth.

Technically the Spanish recession is over; third quarter GDP grew at a rate of 0.1%. But a glance at their job figures shows the country has a long way to go before it can genuinely say it has escaped the diminishing effects of austerity — in the form of tight fiscal policies, public spending cuts and labor and entitlement reforms — imposed indirectly by Germany through the European Union.

In Europe, only in Germany and Austria is youth unemployment under 10 percent. In Spain, where economic growth is occurring only in the export sector, there is little suggestion the economy has been genuinely fixed by this protracted austerity regime. Spain and Greece each have more than 25% unemployment, and 13 other Eurozone countries have unemployment higher than 10%. Spanish unemployment is at 26%, and half of those age 25 and under are unemployed. More than half those age 25 and under in Greece and Croatia are also unemployed. Those kind of numbers can lead to a lost generation, or worse.

In Britain, where the Conservative government imposed austerity measures ostensibly to ward off a sovereign debt crisis and a run on the pound, the quarterly growth rate is up to 0.8%. Britain may have averted a triple dip recession, but only because they loosened up the austerity policy and the Bank of England has kept rates artificially low while the government has subsidized the housing industry with mortgage subsidies. According to the International Monetary Fund, Britain’s economy will grow 1.4 percent this year and 1.9 the next; though it is still 2.5 percent smaller than it was in early 2008.

So, after five years of austerity, there are still 11 Eurozone countries with negative growth. Only four Eurozone countries have growth above 2%: Latvia, Lithuania, Malta, and Luxembourg. Apparently there is some advantage to being small. And the Euro powerhouse, Germany is only growing at 0.5%, which is hardly cause for celebration. The European Commission says the euro zone as a whole will decline by 0.4 percent this year, year on year, though they predict 1.1 percent next year. Output in the euro zone, however, is still about 3% lower than in 2008.

But even if the modest European recovery is sustained, it remains fickle, capable of being blown off course by temporary setbacks such as an American federal government shutdown. And the US Treasury points out that even the slender European recovery has taken place on the back of America’s by comparison expansive economic policies (so to speak).

Germany’s postwar economic model has always been export-led. In the last five years Berlin has defended the very existence of the euro because it allows German exports to be priced comparatively cheaply, far cheaper than if they had continued to use the deutsche mark — which reflected the true strength of the German economy.

Added to this, in the last five years Germany has browbeaten its European partners into adopting austerity rather than allowing them to borrow and grow their way out of the Great Recession. Only Britain, outside the euro, has largely evaded Germany’s beggar-thy-neighbor policies.

It is impossible to predict the outcome of a road not taken. So it is unknown whether, if the Europeans had not reneged on the deal struck after the 2008 crash at the Washington G20 summit to ensure “the action of one country does not come at the expense of others or the stability of the system as a whole,” we would now be in a more prosperous world with millions more in work.

It does, however, seem likely.