Can This Production Lead Recovery Continue or Are We Putting The Cart Before The Horse

While attempting to handicap the recovery, aside from government spending, the real wildcard is the consumer. To take on the consumer we must examine the employment front. The resiliency of the recovery will be firmly on the shoulders of consumers. But, as corporate America deleveraged across the board, laid off consumers found themselves walking up to the buffet only to find no plates, knives or forks. Consumers, due to massive head count reduction, were forced into a deleveraging of their own. Incomes lost, credit lines eliminated and government benefits exhausted, they simply had no other choice. This leads us to the coming conundrum we will be facing over the next few quarters. We have most likely experienced the worst of on the jobs front and should not expect to see readings of -500,000 to -700,000 in non-farm payrolls. Why? Taking a look at where were the excesses and mistakes made brings into focus the following:

1. An auto industry at peak output, pumping out 17 million vehicles annually financed with zero interest rate to people with questionable credit.

2. Housing. Remember “Home ownership is the American dream and should be made available for every American”. I know we started out some many years ago with a much more modest, “a chicken in every pot”. Clearly we went overboard here. Another perpetrator, which at peak was building 1+ million new homes, far outstripping natural demand. All the while extending credit to borrowers unworthy of such generous proportion.

3. Wall Street. Greedy Villains! Shysters! Thieves! I’m quite sure there are enough of each skulking about Wall and Broad. But, there are plenty of honest, hard working decent people that make up the thundering herd as well. These people that comprise the rank and file, that don’t have golden parachutes and million dollar bonuses. Receptionists, secretaries, mailroom workers, messengers earning a decent living generating $25,000.00- $60,000.00 annually. Bonuses, if they trickle down to this level, on a given year are closer to the $1,000.00-$5,000.00 range, rather than the $500,000.00-$100 million, which grab headlines. We can see how the average skews reality when it comes to Wall Street compensation. We hear the average bonus for Wall Street was $112,000.00 in 2008, but the bulk of those payouts were gifted to the few. Case in point is the Citibank energy trader now getting his 15 minutes of fame for securing a $100 million bonus. Outrageous, considering the losses at the parent firm. This trading unit was part the fabled Solomon Brothers Investment bank that Citibank absorbed back in 1998 as part of the Travelers acquisition. The same Solomon Brothers that got caught submitting false customer bids in an attempt to rig the Treasury auctions in their favor, resulting in a $290 million fine and ultimate failure of Solomon and forced exit of its’ disgraced CEO John Guthfreund. Now with the SEC under marching orders from the white house, fully engaged and the CFTC having awakened from their eight year slumber, the music, for hedge funds and speculators, has finally silenced and a lot of chairs are missing. Change is coming, and coming rapidly. Some hedge funds are responding and adapting by returning client money and closing shop. Aggressive traders, sensing the change coming, are closing out positions evidenced by the drop in open interest figures.

These three, were the primary culprits that lead to the many excesses of the previous expansion and bubbles. They gorged themselves on cheap credit and overproduction. Which brings to mind the Kevin Costner movie, A Field of Dreams. The catch phrase, “if you build it, they will come”. Boy did they build it. Homes, cars trucks, more and more complex financial products. Then a not so funny thing happened, one day they stopped coming. What followed was the elimination of millions of jobs as these sectors of the economy right sized. Massively cutting production, head count and capital outlays, while attempting to conserve cash.

This brings us to where we are today. We are seeing incremental evidence of stabilization in these three areas. Ford and GM are ramping up production and calling back workers. The major home builders are seeing a pick up in new orders and extending work weeks. Wall Street firms are selectively hiring again. Good news sure, but in each group millions of jobs have disappeared and will never return. Never! That’s important to consider. This is, in my opinion why it is vitally important the stimulus money targeting Green and Renewable energy must succeed. This is nascent industry in its infancy that requires our support. We’re looking at a bit of a priming the pump to create new jobs where none previously existed, for some of those previously displaced workers. I think former Chairman Greenspan’s recent comments regarding this current stage of recovery hits it squarely. To summarize, we are experiencing and will continue to experience a production lead economic revival over the next few quarters. Past that, anticipating a resumption of increasing consumption becomes a much more difficult task. This leads us to the Horse and Cart dilemma.

Putting the horse before the cart. Corporate America took nearly fatal blows during this last 18 months, leaving large visible scars. They will not add to new hires until they are confident demand has sufficiently been restored and is largely sustainable.

Putting the cart before the horse. Consumers, lacking job security and in some cases jobs period, cannot and will not consume.

Who’s right and who will blink first? Maybe they both got a little something in their eyes. Early signs are suggestive the bounce back in growth will be sharper and more powerful than most had been anticipating. Consumption inched up two months in a row while the rate of job losses slowed significantly. No coincidence, the average work week extended along with gains made in average hourly earnings as severely depleted inventories begin the replacement cycle. Economists and analysts are ratcheting up estimates for 3rd and 4th quarter GDP along with earnings estimates and targets for the major indexes. GDP estimates are being raised from -1% - -2% up to +2% - +4.6%. S&P 500 projections have jumped from 600-900 range up to 1050-1400. Very aggressive on the latter, with analysts looking for anywhere from 15%-40% returns from current levels. These projections assume a lot of things continuing to go right. These assumptions seem to paint quite a rosy picture, and at present the pieces of this puzzle appear to be coming together quite nicely. However, should this picture begin to breakup, we’ll be quick to respond.