Burning Down The House

Those looking for signs of economic expansion in today's housing data were certainly disappointed. Housing starts fell to their lowest level since last October as demand for new homes waned following the expiration of government tax incentives. It is becoming apparent to policy makers and to all but the most ardent market bulls that it is nearly impossible to stimulate our way to economic expansion when the economy was already in a stimulated state when the bubble burst. There is a glut of housing on the market. The way to clear the surplus is to permit prices to reset to levels at which potential home buyers can afford a mortgage for which they can be approved. However, no politician wants to preside over such a repricing of most American's most valuable asset. Building permits were up, but that was due to a 20% jump in multi-family housing construction. Single family housing, the biggest segment of the market, fell by 3.4% to 421,000. This was the poorest total since April 2009.


Not everyone agrees with my opinion that economic performance and job growth will be modest in the near future. Noted economist Brian Wesbury (someone whom I respect a great deal) believes that easy Fed policy, thin inventories and strong corporate profits will lead the economy back to its former glory. I agree that these factors will lead the economy back to sustainable growth, but sustainable growth is a far cry from the overstimulated expansion during the housing bubble and the irrational expectations of the tech bubble.

Businesses are reluctant to hire. Why should they hire? Taxes are slated to rise (many small businesses are taxed at the owner's personal rate), the current administration is pushing a labor-union-friendly agenda and healthcare reform concerns weigh heavy on the minds of business owners and executives. It is safer and more cost-effective to keep staffing thin and using technology, outsourcing and temporary workers to meet the need for increased production. Face it. 4.00%+ growth and 5.00% and lower unemployment are probably unsustainable (with current dynamics unemployment below 8.00% may be difficult).

Remember all those calls to buy floaters to be positioned for WHEN rate rise? The bond market tells us that the cost of waiting at low current floating rates for rates to rise is a losing proposition. So is staying in cash. Credit products such as corporate bonds, GSE debt and a smattering of carefully chosen preferred securities are the way to go.

Goldman Sachs reported a second quarter profit which was down 82% due to a decline in trading revenue. Goldman was not alone in experiencing a decline in trading revenues, but as an investment bank Goldman has little in the way of banking revenue on which to rely. It is for this reason that Goldman and Morgan Stanley tend to trade at somewhat wider spreads to treasuries than similarly rated money center banks. GS paper is trading only slightly wider following today's earnings report. Analysts interviewed by Bloomberg News spoke positively regarding Goldman's ability to maintain its client base and have confidence in the firm's risk management capabilities.

What about Goldman's fraud charges? Goldman wrote a check and is moving on. Goldman 10-year bonds are yielding over 200 basis points above the 10-year treasury. Not a bad deal where I come from.