Heat Wave

Is it hot enough for you? With two consecutive days in the triple digits here in the Northeast it is too hot for me (I am a fall and winter person). That heat boiled over into the capital markets today. The Dow Jones Industrial Average rose 274 points to close above the 10,000 mark. Stronger retail sales data, opinions from around the street that corporate profits will be impressive and news that details of the stress tests for European banks turned investor sentiments bullish. This is all well and good, but what does it all mean for the economic recovery.


Today's news and market reaction are positives indeed, but it does not mean that the recovery is going to be rapid or robust. Strong corporate profits may not result in a strong employment recovery. A good portion of the recovery in corporate profits is due to productivity gains (companies doing more with less). Although more hiring is likely to occur, it is likely to be below to what we have become accustomed.

Tell me, which companies will need to hire significant numbers of U.S. workers? Don't have an answer? Neither do I. During the last two recoveries job growth was driven by two industries, tech and housing. Since another Internet bubble is not likely to occur and the housing market cannot expand like it had during the mid part of the last decade cross them off or your lists.

Until the Fed overstimulated the economy by keeping rates too low too long and the GSEs helped engineer loans for those who could not afford them, the economic recovery following the previous recession was called a jobless recovery. If not for the housing bubble, job growth would likely have remained lackluster. There is nothing apparent on the horizon that is going to push the unemployment rate back down to 5.00% (or to 6.00% or 7.00% for that matter).

The other hope for job growth, small business, faces headwinds from spotty consumer demand, a lack of credit and what appears to be an unfriendly administration in Washington. Unless there are philosophical changes in Washington or an area of the economy takes off to the point that business activity consumes all areas of productivity improvement (technology and overseas production), employment is likely to remain strained and the economic recovery modest. Let's not forget the likelihood of more government and municipal worker job losses.

The Fed is just about ammunition. Bearing out this opinion were comments from Fed officials. Today, Kansas City Fed president Thomas Hoenig advocated a move of the Fed Funds target rate to 1.00%. Dallas Fed president Richard Fisher said that the Fed has done all it can do to foster an economic recovery. To me this sounds like Fed jawboning to get us accustomed to the fact that the modest recovery is what it is.

Look for earnings to be strong for the seconds quarter. Look for the markets to react positively (long-dated treasuries may sell off, but they should still be well bid for at next week's auctions), but also look for reality to slap us all in the face with elevated jobless claims data and another soft employment report on August 6th.


Last week I said that I would discuss Freddie and Fannie. I just wanted to note a comment I heard on CNBC that the GSEs are spending approximately $40,000,000 per day maintaining properties they have acquired since the housing bubble burst. The GSEs' balance sheets look worse now than they did before the bubble as they are being used to support a weak housing market and continue to do the bidding of influential politicians. According to the Chicago Tribune FRE and FNM owned a record $6.9 billion of foreclosed homes as of March 31, 2010. That compares with 8.56 billion owned by all U.S. commercial banks and S&Ls combined.

Freddie and Fannie bonds and MBS should be ok because the government has no choice but to keep them solvent to prevent a total collapse of the housing market, but it certainly appears that there will be little, if any, hope of recovery for common and preferred shareholders.

Do not reach for yield. Keep duration short (but maturities out to 10-years). Do not reach for yield buy taking on more risk than you would normally tolerate. Stay cool.