This was a rough week for economic optimists and stock market cheerleaders. The stock market took its biggest beating in months. Long-dated treasuries reached their lowest yields in months. Auto sales dropped sharply in September without the benefit of "Cash for Clunkers." Let's discuss.
GM reported a sales decline of 45% and Chrysler a drop of 42%. The government and it's UAW supporters have their work cut out. Both companies are losing markets share and are directionless in terms of product. GM, Chrysler and Ford need annual U.S. market auto sales of approximately 15mm to 16mm. The current sales pace is just over 9mm. With traditional lending standards back in use (one actually has to prove their ability to make payments) it is unlikely that auto sales will reach necessary levels, even when the economy rebounds. How critical is it for the Detroit Three to sell to subprime borrowers? Prior to its bankruptcy filing, GM's management asked the government to assist GMAC in lending to subprime borrowers. GM and Chrysler are done in their current forms and as long as they have to depend on UAW labor.
Speaking of recovery, nearly every economic indicator is pointing to another moderation as inventory replacement peters out. Lenders report that foreclosures continue to be problematic and credit card defaults and delinquencies continue to rise. Asset-backed experts continue to warn of significant, permanent impairments to loans, especially those issued from 2005 onward.
The financial media continues to report that, in spite of encouraging economic signs, companies are reluctant to hire (actually, they continue to shed jobs). Either these journalists are trying to help jawbone the economy and especially) the markets higher or the are clueless as to how the economy works. It is the consumer which drives business, not the other way around.
The financial markets are telling a divergent story. The equity markets are (or were) indicating that the economy was poised to make a sharp, V-shaped recovery. The reason given is so lame. "It has to recover sharply because of the government stimulus" is not a valid argument when one considers why the economy fell into the deepest recession since the great depression. There is no leveraging our way out of this. The stock market is wrong. However, it was wrong when it sunk to its cyclical low in March.
The equity market may be considered the market of hope and fear, but one could argue that the bond market is the market of reality. This is not to say it has never been wrong in its ability to predict the economic future, but it is less influenced by wild springs generate by speculative greed and fear. The treasury market in particular is an institutional market with much foreign central bank involvement. Until the U.S. economy exhibits structural and not credit-driven or inventory replacement growth will foreign central banks reduce their purchases of U.S. treasuries.
The fear that foreign central banks will abandon the dollars are unfounded, at least for now. Remember, foreign exporters to the U.S. are paid in dollars and not their home currencies. They have a vested interest in keeping their exchanges rates versus the U.S. dollar favorable. One way to do that is to buy U.S. treasuries. This as the added benefit of helping to keep U.S. consumer interest rates low making it even more affordable for U.S. consumes to spend. This is not to say that long-term rates will never rise. It is not a far fetched scenario to see the 10-year treasury note approaching 4.50% or 5.00% in 2011, but that could be the cyclical high. I think we see the 10-year hit 2.75% before we see it hit 3.75%.
Investors and consumers had better change their outlook. We will be back to the days when buying a television required looking at the family budget and buying a new car was the talk of the neighborhood. In may opinion, this is not a bad thing, unless you work for the UAW and the Detroit Three.
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