Friday's disappointing Non-Farm Payrolls report surprised many on Wall Street. It was not only the pie-in-the-sky optimists who were stunned, but also more realistic prognosticators such as yours truly. I thought the report would indicate flat job growth due to seasonal hiring. While an upward revision due to seasonal hiring may be in the cards, it does not appear that the holidays were merry for many aspiring workers. It just may be that the revised positive November data is all she wrote for temporary holiday employment. That remains to be seen. The Non-Farm Payrolls report is arguably the most difficult to predict.
The economy is truly showing signs of healing. So why aren't jobs coming back more robustly? First: The U.S. economy has lost more than 7 million jobs since the great recession began. Secondly: Technology and global competition for jobs (cheaper overseas labor) has led to greater productivity. Sub par job recovery has been the theme of every recovery since the early 90s. In fact, the two periods of robust job growth occurred during two bubbles, the tech bubble of the late 1990s and the late, great housing bubble. Stock market gurus and equity investors are fond of using the "Always Strategy."
The "Always Strategy" is based on the idea that certain phenomena always occur. Nothing occurs just because. There have to be circumstances which create outcomes. In the past we have "always" had V-shaped, strong recoveries because monetary and economic policies stimulated demand. However, during the past few cycles, an extraordinary amount of stimulus was needed to create a strong expansion.
What is different this time around? Each succeeding recovery since the 1990s required longer periods of copious stimulus to drive economic recoveries. The intent of the Fed and the presiding administrations was to stimulate the economy to create sufficient economic growth to create a sufficient number of jobs to spark a self-sustaining expansion. The problem was (and remains) that due to improvements in technology and a global labor market, economic activity must be greater than before to have low levels of unemployment. Recall that it was the so-called "jobless recovery" which induced the Fed to keep the Fed Funds rate very low (at 1.00%) for an extended period of time (a year) and to remove accommodation gradually (25 basis points at a time).
So how is the Fed and the Obama administration going to set the economy on the road to rapid expansion? They are not. This is not necessarily a bad thing. To have a fundamentally strong economy, fundamentals must be in order. When consumers repay a significant portion of their debt, they will be able to spend. The spending will come from both disposable income and renewed access to credit. However, economic growth cannot be sustained at levels seen during the last two expansions.
Why won't banks lend and what can be done to make them lend? Those who ask that question have little understanding of the modern economy. You may recall back in 2008 there was much mention of the "shadow banking system." The shadow banking system consists of non-bank lending. I.E. lending by non bank entities and / or via securitization. The amount of credit being extended during the latest two decades could not have been done using the traditional banking model.
In the old days, banks would take in deposits and make loans versus those deposits. If banks had to rely on deposits banks would be lending less than they are currently. At least now they can securitize mortgages via the GSEs. Conservative investors who were responsible for the purchasing much of the asset-baked supply will only purchase the most secure structures backed by the highest quality assets. Speculators willing to buy lower-quality ABS want rates of return too high to make lending economically feasible. Clearing out the tremendous overhang of consumer debt is required before we see sustainable economic conditions. Even then, demand will not be strong enough to generate the kind of growth to which we have become accustomed. Growth will have to come from elsewhere. But where?
At this time there is no alternative source of growth. There had been high hopes that China would lead the world to recovery. That is unlikely as Chinese growth is dependent almost exclusively on exporting to the U.S. It's pegging the renminbi to the dollar is causing inflationary pressures. China is now trying to discourage internal demand. No folks, unless something unexpected occurs, we are probably looking at modest growth with significant Fed accommodation to persist for years. The good news is that the U.S. remains the most dynamic economy on the planet and there is the possibility that someone develops a product, service or financial innovation which drives the economy to new heights. Look domestically for economic growth.
If the U.S. is the great driver of the global economy, why is the dollar weakening? The weaker dollar is the result of low rates, large deficits, fear of anti-business policies and legislation and a case of "the grass is greener in your neighbors yard." In the 1990s we had the bond vigilantes who took long-term bond yields higher is response to President Clinton's spending plans. In late 2008 and early 2009 we had the bank vigilantes who beat down banks stocks and even help ignite bank runs until the government assisted banks and proved their health with the (dubious) stress test. Now we have the dollar vigilantes. Currency market participants will bash the greenback until the U.S. government defends it.
This leaves the government between a rock and a hard place. Defend the dollar by removing stimulus too soon and there could be a double-dip recession. Leave the accommodation in place too long and prices imported commodities, such as oil, may rise creating head winds hindering the economy. Factor in proposed anti-business, anti-investors and anti-bank legislation and it is becomes obvious that an economic recovery as we have come to expect is not that likely. However, a recovery similar to what our parents or grandparents experienced is entirely possible. Such a recovery is probably better for the country and the markets in the long run.
Investors can be successful in such an environment, if they manage expectations. We are in a mature market cycle. There is nothing on the horizon which will result in a strong bull market. There is also nothing on the horizon which will call long-term rates to blow out. Investors should behave like the investors they are and not the traders which they are not. One way to increase returns is to keep investment expenses (fees and charges low). I am not suggesting that every investors open up accounts at discount brokerages and begin trading their own money (most investors are ill-equipped for such a task). What I am suggesting is for investors to not pay unnecessary fees. Pay 2.00% or 3.00% to have a money manager "manage" a portfolio of bonds for the purpose of generating income is not a wise choice. A qualified financial adviser at a full service firm can assemble a portfolio of bonds which will generate income for no annual fee. Bonds are instead purchased on a net basis. Equity investors may wish to use a manager, but it is often the case that a mutual fund is just as good. Income oriented investors should avoid using bond funds as fund managers often must liquidate positions due to client distributions. This can cause unreliable income streams and, in the case of municipal bonds, taxable events.
2010 will be a year of learning. U.S. consumers and investors will learn that fundamentals and responsibility matters.
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