Investors must proceed with extreme caution as the government stimulus money may have created its own little bubble that could pop
The financial markets are no longer trading as though the end of the world is nigh, and for that we can all be thankful. Liquidity has been restored to key sectors of the credit system, and balance sheet repair is under way throughout Corporate America.
But the reason for the return of stability is obvious: The government, through the offices of the Treasury Department and the Federal Reserve, has massively increased its presence in the U.S. economy. Whatever thin reeds of growth have poked their heads through the ground are almost entirely due to government stimulus.
Few experts seem to be able to point to the sources of future growth once the government stops playing Johnny Appleseed. And while Corporate America may be rescued, the American consumer still seems imperiled, which is decidedly unhealthy for the economy.
Corporate earnings were better than expected through the first half of 2009. But the vast majority of companies beat earnings estimates by sharply cutting costs through job reductions and similar measures, which had a negative ripple effect throughout the economy. The American consumer, who for many years has been a prime engine of global economic growth, remains weakened. Most companies announced sharply lower sales in a reflection of slowing economic activity. Second quarter GDP was the third consecutive negative print, although it was a significant improvement over the previous two quarters' truly catastrophic numbers.
There is every expectation that the third quarter of 2009 will see positive GDP, which on a real basis would be even better than it looks because the economy is still suffering from a deflationary rather than an inflationary dynamic. But any third and fourth quarter growth would remain largely attributable to government stimulus as the private sector continues to hunker down trying to wait out what has become a severe recession rather than another Great Depression.
The stock market has recovered from its March low (666 on the S&P 500), when investors were actively contemplating the arrival of Armageddon. Credit spreads have narrowed significantly despite the fact that corporate default rates are running at record levels. The key to recovery in credit markets has been the reopening of the corporate finance window. Corporations have been able to access capital primarily from the bond markets, usually at far more expensive rates than they had grown accustomed to. Nonetheless, access to capital has again proven to be a key indicia of corporate financial health and overall market health. So long as companies can raise capital, stability should continue to reign.
As always, investors should proceed with caution and be aware that there are forces at work in the markets (such as high-speed trading) that remain a constant threat to their capital.
Auto Industry Replacement?
The long-overdue bankruptcies of General Motors and Chrysler are important steps in returning some portion of the American auto industry to health. There is a reasonable possibility that the cash-for-clunkers program coupled with greater consumer optimism will lift U.S. auto sales permanently back above the 10 million mark — which would be another sign that the crisis is ebbing.
But by the time the government is done restructuring the Big Three, these former American giants will be less than half of their former size. Job losses in auto manufacturing regions as well as in auto dealers around the country are nothing less than horrific, and the demise of an iconic American industry will blight the economic landscape for years to come.
Sadly, for the foreseeable future, there is no new industry to take the place of these manufacturing giants. Technology companies, perhaps the most likely candidates, are hit-and-miss propositions and tend to gather near Silicon Valley or other locales far from the old manufacturing regions where auto plants are closing. The social and economic impact of the demise of the American automobile industry has not been sufficiently appreciated by politicians or the media and will have a lasting effect on this country.
Wall Street has recovered remarkably quickly from its annus horribilis and is now spending most of its time figuring out how to get Washington to forget that 2008 ever happened. With little deal activity to distract the media, management's primary focus is on figuring out how to avoid government-imposed pay limitations or negative public perceptions about bad conduct it appears hell-bent on repeating. Firms are busy arguing that they need to offer fat contracts to so-called star traders (who were apparently missing-in-action in 2008 when their alleged talents were really needed) to be able to blow themselves up again. Wall Street is also actively lobbying against meaningful derivatives regulation in an attempt to protect the fat profits it believes it can recapture (until it loses them again) from credit default swaps and other weapons of mass financial destruction.
The good news is that the major Wall Street firms are much less leveraged today than they were heading into the 2008 financial crisis. But even that bright spot isn't likely to last unless the Obama Administration maintains a tough line on issues such as compensation structures, regulation and the like.
Overall, the picture is much brighter than it was at the beginning of the year. Whether it remains bright will depend on whether economic growth can find some roots outside the government in the months ahead.
Michael E. Lewitt is the president of Harch Capital Management, LLC in Boca Raton, Fla.