Monday, August 29, 2011

Winner, Winner! Chicken Dinner!

Winner, winner; chicken dinner! That could be what many were saying before calling it a day on an up-day Friday, packing and heading out of town in order to avoid hurricane Irene. Yes, combined with the worse than expected news regarding initial claims, Q2 GDP and consumer confidence, Bernanke's assurance that it will basically do anything (if still necessary) by the end of Sept. pushed the S&P 500 up 1.51% for the day, and helped end the week up 4.74%. The market is basically looking at that assurance as an 'insurance' (with an invisible premium), especially if economic news worsen.

Regarding the speech out of Jackson Hole, we briefly reviewed what Bernanke discussed. Below are a few things that stood out.

"In the broader economy, manufacturing production in the United States has risen nearly 15 percent since its trough, driven substantially by growth in exports." Of course, this is expected especially when recovering from a "trough".

"Temporary factors, including the effects of the run-up in commodity prices on consumer and business budgets and the effect of the Japanese disaster on global supply chains and production, were part of the reason for the weak performance of the economy in the first half of 2011; accordingly, growth in the second half looks likely to improve as their influence recedes." If the run-up in commodity prices is considered as temporary, then we could say that the recovery can also be considered temporary. The somewhat of a slowdown that we have seen in the emerging markets, along with disappointments at home have driven commodities down. Add to that the artificially low interest rates and devaluation of the dollar (thanks to Mr. Bernanke), and the commodities will react twice as much to an appreciation in the equity and economic markets. So expect the commodities to jump again if the Fed comes to the rescue at the end of Sept.

"Historically, recessions have typically sowed the seeds of their own recoveries as reduced spending on investment, housing, and consumer durables generates pent-up demand. Improving income prospects and balance sheets also make households and businesses more creditworthy, and financial institutions become more willing to lend. Normally, these developments create a virtuous circle of rising incomes and profits, more supportive financial and credit conditions, and lower uncertainty, allowing the process of recovery to develop momentum." Such rate of growth and recovery cannot be maintained if the state of employment, balance sheets and the housing market remain weak. That is what has basically taken place. That initial injection of liquidity may have been necessary, but by keeping the rates so artificially low for such a long time, the Fed has taken away any incentive for people to save, and has 'forced' many to take unnecessary risks. By the way, Bernanke did say that we need incentives to save in order to have economic growth for the long-term.

"Households will continue to strengthen their balance sheets, a process that will be sped up considerably if the recovery accelerates but that will move forward in any case. Businesses will continue to invest in new capital, adopt new technologies, and build on the productivity gains of the past several years." We shall just ask - Mr. Bernanke, is it the chicken or the egg? Is it the cleanup of the balance sheet that makes the recovery faster or is it a faster recovery that helps clean up the balance sheets? By the way, basically putting a ceiling on interest rates will not help speed up the balance sheet clean-up process; making that “move forward in any case” a very slow move.

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