November 7, 2006
OPTIMISM AND OMENS FROM A FORMER FED HEAD
Former Fed Chairman Alan Greenspan spoke yesterday to an audience of roughly 3,000 at a financial advisor conference in Washington, D.C. hosted by Schwab Institutional. Your editor, attending on a press pass, was audience member 2,986.
Alan talked far and wide on matters fiscal and economic, but his commentary about the housing market was particularly intriguing. To cut to the chase, the maestro thinks that much of the correction in real estate has passed. To quote the former central banker: "It looks like the worst is behind us." He expects a continuation of the current correction--or inventory adjustment, as Greenspan termed it. But a collapse doesn’t look imminent, nor does he think that the downdraft in housing will push the economy into a recession.
One reason for the optimism, he explained, is that single-family housing sales are running slightly ahead of new construction. Although sales are still vulnerable to falling, he said that it's the rate of change that matters most for divining the future, as opposed to focusing on the actual number of sales now vs. some point in the past.
The National Association of Realtors said as much last week in a press release that accompanied the monthly update of its Pending Home Sales Index. NAR said that home sales are expected to hold "fairly steady," based on it PHS Index, which tracks signed contracts for existing-home purchases. In September, PHS dropped 1.1%. Although that's a sharp reversal from August's 4.5% rise, the pace of decline has slowed considerably since July's 7.0% tumble.
Greenspan was also upbeat about the American economy overall. He admitted that there are warning flags to consider, including low household saving and a rise in manufacturing inventories. On the other hand, profit margins for corporate America are still high, he observed. History, he noted, suggested that the odds for a recession were quite low with high profit margins gracing the business world of late. Greenspan also reminded that consumer spending continues to roll on, prompting him to comment, "Things don't look bad."
But for all his optimism, his longer-term outlook offered a more sobering reflection. The disinflationary boon, which has arguably kept interest rates and inflation lower than they otherwise would be, isn't written in stone. "It's a one shot event, not a permanent change," he said of the surge in inexpensive imports from China and other developing nations.
As emerging markets have entered the global economy over the last decade or so, the low-wage-based creation of goods and increasingly services has unleashed a disinflationary wind. That's helped put a lid on inflation. But the future may be more challenging on that front. China's economy, for example, is growing rapidly, and that's starting to elevate wages there, albeit from a low based. Nonetheless, "It's going to be more difficult than when I was there," he said of running monetary policy at the Fed in the years ahead. Although he praised Bernanke and his team and said they were "very smart," there was no mistaking Greenspan's point that his successor faces a far more complicated economic environment.
As for Social Security and Medicare, both need attention, he asserted. Funding Social Security, however, is easily resolved, he said. There are 15 or so viable plans that would make the retirement fund solvent for the future. Choosing one and deciding to implement it should take about 15 minutes for a group of reasonable, non-partisan types (or politicians who temporary put politics aside).
Medicare, by contrast, is a far bigger predicament, Greenspan advised. The central issue is the rapidly rising demand for medical services, which he believes will exceed the nation's capacity to satisfy over time. "The government is promising more than it can deliver in medical services," he charged, a trend that threatens to promote an "unstable fiscal situation." The challenge will be exacerbated by the fact that the population of retirees is growing faster than the labor force. As a result, expecting a tax hike to solve the Medicare issue isn't practical in the long run. Alas, the political powers in Washington are largely "irresponsible" in facing up to the trouble and dealing with it, he said.
Fed chairman come and Fed chairman go, but some things in Washington never change.
Posted by jp at November 7, 2006 9:52 AM
I give AG begrudging admiration for his tenure as Fed chairman, but when it comes to predicting markets rather than controlling them, his track record is rather less inspired.
His ARM-vs-fixed speech was early 2004. He did not bottom-tick rates, but he was less than a year off.
"Irrational exuberance" was December '96, if memory serves, four years and over 100% in total return on the S&P early.
And while it's a long time back, he did famously encourage being bullish right before the '73-'74 market.
In short, when Greenspan says "raise rates," I might listen. If however he says, "buy," the smart money sells.
No wonder I feel comfortable short homebuilders.
Posted by: wcw at November 7, 2006 5:37 PM