Friday, July 9, 2010

Implications of Slow Economic Growth

The Economic Cycle Research Institute reports today that WLI Growth Falls Further. This joins a host of other reports, ranging from Discover's U. S. Spending Monitor being down again in June to various disappointing surveys of small business that the economy is sluggish. The Reuters ECRI press release is terse today:

A measure of future U.S. economic growth fell to the lowest since July 2009, indicating that the economy will continue to slow, a research group said on Friday.

The Economic Cycle Research Institute, a New York-based independent forecasting group, said its Weekly Leading Index fell to 121.5 for the week ended July 2, down from 122.3 in the prior week. That was the lowest level since July 24, 2009 when it stood at 120.3. The index's annualized growth rate fell to -8.3 percent after a -7.6 percent growth rate a week earlier.


This level of economic activity is nothing horrible in and of itself, but matters are out of balance related to debt and opaque derivatives. Governmental debt has increased more than consumer or business debt has diminished; and what passes for "austerity" in such places as the U. K. is any but austere, simply less improvident. It now appears that a significant slowdown in the recent economic growth rate is baked in the cake. So far as my research on the ECRI site allows, an 8.3% negative growth rate (as defined privately by ECRI) in the WLI has always been associated with recession. Yet ECRI's other indicators don't allow it to call an upcoming recession, so I'm certainly not qualified to opine on that topic.

As a borrower in its own currency and wishing to maintain the fiction of never having defaulted (despite having more or less overtly having defaulted first under FDR and again under Nixon), it makes sense for the Feds to devalue against as many countries from which it imports as possible. The "traditional" response of domestic inflation, or at least anti-deflation, will allow loans that are now underwater to look good.

In the WW II and Korean War periods, short rates were kept ultra-low even when inflation raged. This may be happening now, depending on what one thinks prices are doing. Since precious metals are no longer cheap, how does an American handle capital?

Granted that markets are efficient, we can consider that just perhaps the markets are giving too much credence to the idea that U. S. finances are 'AAA'. In that case, perhaps small countries with records of truly no defaults may offer foreign currency gains plus a current yield. This could include Norway and New Zealand. Larger "smaller" countries could include Australia and Canada, but the former is at risk from a major economic slowdown in China and the latter may be seeing a housing mini-bubble begin to burst.

Another approach involves multi-national financially strong companies. AAPL, MCD, etc. High quality U. S. companies screen very well in Jeremy Grantham's 7-year asset price projection, a series which has often been prescient. Given that a BP-type disaster can befall almost any company, and unless one is very diversified, one disaster can sink such a strategy, this strategy is not for the faint of heart.

Meanwhile, regular readers know that I have had kind words to say about Treasuries on and off for quite some time. Now I think they are for gamblers and that cash is prospectively about as good as Treasuries and therefore better given complete liquidity. Yes, the 10-year yield could go to new lows. But it could blow out to very high levels faster than almost anyone thinks. So, new money likely will be better off elsewhere, in my humble opinion.

These are unprecedented times with the lowest short-term interest rates in history in some major countries. As with very high and very low temperatures where strange physico-chemical rules may apply, the same may well come to pass in the economy and the financial markets. Flexibility may be more important than any specific prediction, given how abnormal the "New Normal" is.

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