Farrell: A Lack of Confidence
Chief Investment Officer, Soleil Securities
"The mass of men lead lives of quiet desperation" said Henry David Thoreau. The Conference Board said on Tuesday that 45% of Americans are unhappy in their jobs. I don't know if that qualifies as "the mass of men", but it's a lot and probably not surprising given the economic circumstances the nation finds itself in. Mark Haines, CNBC host, added that two thirds of lawyers don't like their work. Mark was a lawyer (I guess still is) so he would have reason to know.
People don't seem to have the confidence you would hope. It might be too broad an interpretation of just one piece of data but the pending home sales number released Tuesday morning was a disappointment. Pending home sales (contract signed but not yet closed) were down -16% for November. That breaks a streak of nine straight months of advances. It's apparent the anticipated decline of the home buyers tax credit (which did get extended) capped potential buyer interest. If a better number had been reported we could have interpreted it as a sign of pent up buyer demand and that low prices and low mortgage rates overcame a government program's pending expiration. Now we are left to wonder about the strength of the consumer and the economy and will we pass the test when the government eases out of their support programs. But like I said, this is probably too broad an interpretation of one piece of data. Potential homebuyers could have just waited on the sidelines for what proved to be a very brief period while the tax credit extension was debated and/or "pulled forward" purchases to make sure they got the credit.
My partner, former Fed Governor Lyle Gramley, Soleil's chief economic advisor, came out with a piece Tuesday morning entitled "Signs of Life in the Economy." Lyle thinks Q4 2009 GDP will advance at a 4.5% annual rate with inventory investment a main reason for the strength. Inventory adjustments will continue to be a modest plus for the economy for the next few quarters. The impact of the stimulus program on federal consumption and investment will have run its course by about mid year and there will be constraints on state and local budgets. So private domestic final sales - like consumer spending, cap ex and housing - will determine the economy's growth. Lyle sees encouraging signs in this respect.
"Core retail sales were surprisingly strong from August through November, and Christmas sales appear to have beat last year's." Orders for non defense capital goods while still below year ago levels have risen at an annual rate of more than 15% since the trough of last April. Despite the above mentioned blip in pending home sales, existing housing sales, starts, and building permits have all risen substantially since hitting a bottom earlier this year. There is still a "shadow inventory" of homes, an unprecedented decline of more than $600 billion (annual rate) in credit in the third quarter, and a nervous consumer who is saving more.
But, says Lyle, the risks are shifting to the upside. "Recoveries have a way of developing a self-sustaining momentum." As job opportunities improve "the confidence of consumers strengthens and they begin to spend more freely...businesses. are encouraged to invest more in equipment and inventories. " Lyle thinks we "may now be at an inflection point" although it will still be several more months before conclusive evidence is in.
If economic growth is moderate as he thinks, the "unemployment rate will remain high enough to promote further moderation of wage rates, unit labor costs will rise little, inflation should remain subdued...the Fed will be able to keep the key Federal Funds rate at essentially zero throughout all of 2010." One key he points to is if the Fed wants to telegraph a shift is coming they will change the wording they have been using from keeping rates low for an "extended period" to something like they will keep rates low "for some time." Such a change "seems improbable at the first FOMC meeting this year (January 26-27), but it could come anytime thereafter" (my emphasis).
Staying with things Soleil, Greg Valliere, who has the dubious privilege of sitting next to me, has some ideas for the stories that will come out of Washington this year. One is that "Deficit Reduction is Illusory ." There will be a torrent of rhetoric lambasting the deficit. The President will promise to cut it, and leading Democrats will call for a Deficit Commission. Republicans will get their voice in the argument demanding spending cuts. One big problem, says Greg, "It's all just words." Conservatives are backing away from the idea of a credible Deficit Commission figuring it would be a stalking horse for tax increases and liberals want to spend more on stimulus programs.
Cap and Trade is Dead. It's bitterly cold, Copenhagen was a farce, and anything that involves new taxes is radioactive.
U.S.-China Relations May Deteriorate This is a troubling wild card. There is a pending arms sale to Taiwan, an upcoming meeting between President Obama and the Dalai Lama, and ominous trade disputes. The U.S. International Trade Commission recently ruled China's steel imports have harmed U.S. industry. China describe the ruling as "abusive protectionism." Greg reminds us we need China's help on Afghanistan, North Korea, and Iran. And they buy a lot of our debt. Watch out for this one. Greg has a bunch more so call/email for his full report and for Lyle's as well.
To prove not all stock ideas are buy ideas, Harry Fong, Soleil's insurance guru downgraded shares of ACE ( ACE; hold rated; recent price $49.27.) Ace announced guidance for 2010 of $6.25 to $6.75 a share "before any favorable or unfavorable loss reserve development". Harry has moved his estimate from $8.15 to $7.25 and lowered the rating to hold. The company is trading at a 10% discount to its current book value of $53.38 but he figures investors will take a wait and see attitude. His target is $55, or a 10% discount to 2010's estimated book value. Ace, despite having excess capital, does not have a share repurchase program like many of its competitors. The resulting potential of making an acquisition will also likely limit near term price appreciation.
Vincent Farrell, Jr. is chief investment officer at Soleil Securities Group and a regular contributor to CNBC.