April 3, 2009
THE EMPERORS AREN'T FIDDLING, BUT ROME'S STILL BURNING
The cheering over the positive news from the global summit of the so-called G20 nations is well deserved, but no one should think that all's well.
It's one thing to pledge more stimulus money and promise tighter financial regulations. That’s all well and good, and the stimulus efforts are especially timely at this point. But let's be clear: a new round of global stimulus will, at best, slow, perhaps stop the bleeding at some point, but probably not until later this year, at the earliest. As for economic growth, it's far too early to think of such things.
In fact, a fair amount of the good news dispensed by the conference of the world's biggest economies is related to what didn't happen. If the talkfest had ended with recrimination and a muddled outcome, as some thought was likely, the global economy would suffer that much more. Think of Nero playing his fiddle with Rome in flames.
Fortunately, the outcome was one of a modestly productive and coordinated effort, or at least the promise of such. Fiddling, one might say, was kept to a minimum. The key news boils down to a commitment to continue printing money to stem the tide of economic contraction and its dreaded byproduct of deflation.
The extra stimulus will help, and as today's employment update reminds the world's biggest economy still needs assistance of some magnitude. Unemployment rose to 8.5% last month, up from 8.1%, the U.S. Department of Labor reports. Driving the jobless rate higher is the ongoing trend of job destruction. As our chart below shows, nonfarm payrolls continue to recede at a painfully steep pace. Last month's evaporation of 663,000 nonfarm jobs isn't the biggest on record, but it's big enough to snuff out any thought that recessionary winds will soon end.
A month ago we discussed some of the tools for estimating when GDP would stop contracting. One observation is that initial jobless claims have historically offered an early sign of things to come. When this leading indicator appeared to be topping out, there was hope that the worst had passed. Alas, we reasoned a month ago that the economic trouble would roll on, as suggested by initial jobless claims, and we're sticking with that forecast.
Our broad reading of the leading measures of economy tells us so, as we discuss in the April issue of The Beta Investment Report, which will be published shortly. First among equals in those measures is the trend in initial jobless claims. Indeed, two years ago the metric was flashing a warning. In 2009, we expect it will remain a valuable window into gazing into the future, along with other economic trends.
Meanwhile, as you can see from the second chart below, initial jobless claims continue to rise. Until its ascent slows and flattens, there's little reason to think that the general economic turmoil is set improve. The labor market is ultimately the foundation on which much of the nation's prosperity depends, and so as long as the job market is hurting, we're inclined to stay cautious.
In contrast to initial jobless claims, the unemployment rate is a lagging indicator and so waiting for this metric to show improvement insures that the capital and commodity markets will have already anticipated the rebound. That's one reason why watching initial jobless claims is so productive, since it offers some clues about where unemployment is headed and when the recession will end, which in turn helps us develop some context for thinking about asset allocation.
On the positive side, the monetary stimulus is now digging deeper into the economy and it's starting to have some effect. For example, investors are growing weary of earning nothing on T-bills. In fact, that's just what the Federal Reserve wants to hear. By dropping rates to zero, the central bank is trying to induce investors to look more favorably on risky assets. For several months, investors were inclined to sit tight and ignore the Fed's message. But lately there's been some movement toward reconsidering risk, as the recent gains in the stock market suggest.
But embracing risk full out is still premature. We're watching for signs to tell us that it's time to be more aggressive, but so far those signs aren't there. Indeed, as we detail in the upcoming issue of The Beta Investment Report, our proprietary measure of leading economic indicators has started showing signs of renewed weakness after bursting higher in recent months. Some of this is a reflection of the fact that the monetary stimulus is about as aggressive as it can be.
The good news, thin though it's been so far, has been primarily related to thinking that the deflationary risk is ebbing. Maybe. But even that's mere speculation, based on a few pieces of data of late. It's still not clear if the good news on deflation is something concrete, or just statistical noise.
Yes, we're inclined to nibble on the margins at risk, as we have been for some time. That's largely a reaction to valuations, which remain relatively compelling compared to what Mr. Market offered a year or two ago. Waiting for absolute clarity insures you'll earn little over the yield on cash. But we still need more confidence that the worst has passed on the economic front before making bolder bets on risk. Unfortunately, we can't make that call yet. We could be wrong, of course, but that's the nature of swimming in risky waters. The possibility of earning a risk premium is offset by the chance of earning less than the risk-free rate, even when it's zero.
Posted by jp at April 3, 2009 10:01 AM