Economic Update: June, 2009
By Mark Oelschlager, CFA
Portfolio Manager
June 19, 2009
There has been a lot in the news. We will start with Iran, where President Mahmoud Ahmadinejad “won” reelection. In the aftermath of the reported results, which were heavily in favor of Ahmadinejad, Iranian citizens flooded the streets in protest. Today Supreme Leader Ayatollah Ali Khamenei blessed the results. Suspicion of a rigged election is high both in Iran and around the world, but there is likely little that can be done. However, that doesn’t diminish the significance of what we saw this week. It has been striking to see the protests in Iran, and we believe it is a positive sign for the future. Seventy percent of the population there is under the age of 30, and western culture, particularly with regard to the Internet, is ingrained in many of them. The people of Iran want change, and eventually this will matter, even if it didn’t in this election. Jim has said for years that Iran would crumble from the inside and possibly become a beacon of freedom in the Middle East. This week provided hope for such an event.
On the economic front, while rising gas prices and tough comparisons with last year’s stimulus check-aided spending are hurting a bit, there are still plenty of signs that a recovery is either upon us or close at hand. ISI Research points out that plunges in inventories, like the one we just had, are a reliable signal of the end of recession. We are already seeing a reversal in global industrial production. ISI also points out that initial unemployment claims are declining, leading indicators are picking up, and the recent bounce in interest rates is typical in the early stages of a recovery. All of this isn’t surprising given the massive monetary and fiscal stimulus that has been at the economy’s back.
Of course, this apparent strength in the economy doesn’t mean our problems are behind us. One recurring thought I have had is the bad news is that all this government intervention might actually work (in terms of stabilizing the economy), tempting our leaders to be all too willing to return to the well in the future. In a similar vein, there was talk this week that the Obama Administration wants to broaden the Fed’s responsibility and make it a regulator of risk. If this were to happen, it would only be a matter of time before it came back to haunt the US. The Fed has always been independent, which has allowed it to carry out, with limited political interference, its mission of price stability through adjustments to the money supply. As a regulator, its independence would be eroded and politicians would be more tempted to influence it to further their agendas.
Speaking of price stability, it is rare to have as many people as there are on each side of the inflation/deflation debate right now. Those who believe deflation is imminent cite the slack in the economy, global economic weakness and the effects of deleveraging. Those forecasting inflation point to the large amount of stimulus in recent quarters and the ballooning federal deficit/debt. The answer might be a matter of timing. Prices will likely stay depressed due to the aforementioned issues, but may, in fact, reaccelerate if the Fed, for whatever reason, does not withdraw the liquidity from the system soon enough.
Healthcare stocks got a boost over the past few days as the Congressional Budget Office reported that the Democrats’ proposed health plan would cost more than expected, thus reducing its chances of being enacted. While Obama and the Democrats are trying to take advantage of their spike in relative popularity, and many agree the healthcare system is flawed, cost is a major obstacle to the passage of an overhaul of the healthcare system, especially in this time of rising deficits. The cost issue may end up acting as a governor on the size of the plan that is ultimately implemented.
One of the reasons that cost is such an issue is that public sentiment toward spending is increasingly negative. In a recent poll, people were asked if the President and Congress should worry more about boosting the economy even though it may lead to larger deficits, or worry more about keeping the deficit down even though it may delay economic recovery. Thirty-five percent chose the former, versus fifty-eight percent for the latter. The healthcare issue aside, these are surprising results, and we are encouraged by them. It indicates people are aware of the deteriorating federal ledger and the potential problems it presents. It’s a short-run versus long-run issue, and the American people, at least in this poll, are more concerned about taking care of the long-run.
After a strong run this spring, the market has taken a breather, which was to be expected. As the economy continues to turn, we think corporate profits toward the end of this year and in 2010 might surprise investors on the upside. Capital spending was more restrained than usual during the up cycle, which has all sorts of positive ramifications for profitability. In addition, companies have cut expenses a great deal during the downturn, which should lead to strong operating leverage when revenues recover.
This manager commentary represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice.