The Life of Ben

GDP was revised sharply lower, but not as much as the street had feared. I can't say that it is good news that GDP was revised lower from 2.4% to 1.6%, but it at least shows that the U.S. economy is not in free fall. Personal consumption was better than anticipated, but the primary driver were higher natural gas and electricity purchases during the early stages of the heat wave which began affecting the eastern half of the country in June. Long dated treasuries are selling off as weaker data had been baked into treasury levels. The price of the 10-year treasury note is down 17/32s to yield 2.54% and the price of the 30-year government bond is down 26/32s to yield 3.56%. Such a selloff is expected given today's data versus expectations. Yesterday's seven-year auction was very well bid for and priced at an all-time low yield for the seven-year auction. All eyes and ears will now turn to Fed Chairman Ben Bernanke when he speaks later today at the Fed conference in Jackson Hole Wyoming.


I have long been an advocate of paying close attention to not only what the Fed does, but also to what it says. However, I believe the market is expecting the Fed to be a miracle worker rather than a central bank. An increasing number of people have been calling on the Fed to find new ways to increase consumer demand and economic growth. The truth is that the Fed cannot create demand. It can only bring demand forward by enticing consumers to borrow at low rates and spend. As an increasing number of articles in the financial press have been stating the Fed is nearly out of ammunition. The Fed has very little ability to bring more demand forward.

Let me explain bringing demand forward. Be providing incentives to spend and borrow, many consumers make purchases that they would have normally made at a later date. At some point that artificial demand has to wane. However, for the past 25 years, every time that correction was set to take place (and the economic began to slow), the Fed would ease and bring more demand forward. Wall Street augmented the phenomenon by making it possible for more consumers to borrow and spend, but with rates as low as they can go (without becoming Japan) and investors now knowledgeable about what kinds of loans make up the securities necessary to facilitate such lending, demand cannot be brought forward further. Now consumers will have to pay off debts and deleverage to the point they can spend responsibly. Unfortunately that probably means growth rates far below to what we have become accustomed. It also means job creation will be poor for a number of years. It probably does not mean a double-dip recession unless consumers become more depressed and hold back spending. This morning's University of Michigan confidence reports indicates that consumers are becoming less optimistic. The danger of a self-fulfilling prophecy continues to loom. Thanks to Fed policy, Wall Street securitization and irrational exuberance by consumers (sorry Mr. Greenspan.) the country has become accustomed to growth rates usually seen in developing countries even though the U.S. economy is quite developed.

A paradigm shift is likely to occur where the U.S. consumer begins to live more within his or her means (don't worry, Americans will still borrow, just not as much). The result will be several years of sub-par growth and high unemployment until natural demand takes over as consumers need to replace durable goods which wear out and a growing population and gradually improving consumer finances eat thorough the housing surplus. Relying on housing to drive the economy in the manner it has during the past two decades is unreasonable and probably unfeasible. Patience is a virtue and will likely be rewarded.


The markets’ response to Mr. Bernanke’s speech at the Fed conference in Jackson Hole, Wyoming was reminiscent of Monty Python: The life of Brian. In the film, Brian desires to join the Peoples’ Front of Judea. He is asked by the group’s leader, Reg: “How much do you hate the Romans?” To which Brian’s response is: “A lot.” Reg tells Brian: “Alright you’re in.”


This is not much different than what happened in Jackson Hole. The markets have been asking Mr. Bernanke: “What are you going to do to stimulate the economy?” Last Friday Mr. Bernanke answered: “A lot.” The market said: “Alright, busy stocks and sell bonds.” In my opinion the stock markets rally and the bond market’s fall was a so-called dead cat bounce, or at least it should be. The Fed is mostly out of ammo. The guns have been fired. Now the economy must advance under its own power. The advance will be slow and there may be some set backs, but it will advance, unless of course, the leadership in Washington, insists on poor strategy.

Fear of the forthcoming policy and tax changes, along with an undeniable trend toward consumer deleveraging will slow the economic recovery. This is to be expected. As a country we spent like drunken sailors and we now have to become more responsible. The question is: Without bubble-like conditions can unemployment fall below 7.00%? I am not a trained economist, but I find it hard to imagine unemployment that low. Our best hope is for entrepreneurs looking to maintain or better their lifestyles to drive the economy forward and thus create jobs. Unfortunately, many of those in power are not pro-business, not even pro-small-business. They believe that to be pro-business is to be anti-worker. Shortsightedness will be the death of this nation.





Buy high-quality bank bonds 7-10 (15 years if a step up), callable agencies and (if one is an equity buyer) high-quality dividend-paying stocks. Many investors have been buying junk bonds even though they may be outside of their risk tolerances. Investors are better off taking duration risk to pick up yield rather than going down in credit quality. The problem is that the ability of lower-rated companies to issue debt may merely be putting off eventual defaults.