Nuggets of the Future

Blinded by the light
Revved up like a deuce
Another runner in the night

-Manfred Mann

When making a point of view heard, one wants to stand out from the crowd with an original perspective or conclusion that is justified by the facts. At the same time, one does not want to be labeled as always on one particular side of the issue for several reasons, the most important of which is that it will be incorrect much of the time. In short, never be blinded by the light.

Over the past two years or so, my view of the economy has been consistently negative. Relative to others who opine on such things, my outlook has tended to be more cautious or the word I prefer is "realistic."

With the goal of remaining realistic, I'd like to take some time to review some of the positives we are seeing today and perhaps we'll continue to see tomorrow. These so-called "green shoots" are more appropriately described as core reversals in economic activity. Hopefully, they are indicators that will strengthen as time moves us to the point where we can feel more positive about the future, rather than simply feeling less negative.

First, of course, employment loss is slowing. Though we lost 247,000 jobs last month, the positive news is that this is the first month of job loss since the Lehman event that was significantly lower than the highest month in the last recession. Continued lower job loss figures will help stall the deterioration of confidence across the board, but we still have the effects of these job losses to deal with in coming quarters.

Second, activity indicators across the board seem to be bottoming, though at a very low level. From construction to manufacturing to services, it seems the slowdown is losing steam. Some of this is certainly attributable to capacity and inventory management; however, any jump in consumer demand will be quickly magnified throughout these measures, perhaps building confidence along the way.

Third, the Fed and, in particular, Ben Bernanke retain credibility in the marketplace. Certainly, there are indicators to the contrary, but the person on the street continues to have some confidence in the Fed as an entity independent of the political process, faithfully guiding the economy toward prosperity. Whether the Fed can actually do this remains to be seen, but without the confidence of the American public, failure would be a foregone conclusion.

Fourth, and somewhat related to the above, market indicators still do not predict high inflation in the foreseeable future. Treasury securities whose returns are tied to CPI are still predicting only slight increases in inflation. For example, Treasury Inflation-Protected Securities (TIPS) are trading on the assumption of only a 2 percent headline CPI rate over the next 10 years. Given uncertainty around oil prices over the near and long term, a 2 percent prediction of price movements by the bond markets is highly encouraging.

Fifth, and most important on my list, it seems there is some actual conversation about what to do with Fannie and Freddie in Washington. For my longtime readers, the mentioning of these twins probably elicits the feeling of ice picks in the eyes as this is a drum I've continued to beat from day one of this crisis. Any vision of resolution here is a step toward a functioning mortgage market - crucial for any consumer-led recovery.

Even with these and other positive events occurring, I retain a less positive view of the economy than the general perception of the public. The reason for my view is that our economy is driven by the consumer and the consumer is not consuming today, as a result of uncertainty regarding home prices. Unstable home prices will be the norm until the mortgage market begins to function once again. The mortgage market cannot function without a resolution to the Fannie/Freddie mess.

It seems we've reached the bottom of the riverbed that is our journey and are searching for the economic recovery that is other side. While growth prospects remain flat in the near term, once we get consumers and investors actively engaged again, the economy could grow rather quickly.

However, I believe the resolution to the Fannie/Freddie situation will be a long, drawn-out process, and therefore, we will be stuck in the bottom of this riverbed for longer than the average Joe suspects.

Key Developments

Wholesale inventories fell much more than expected in June, dropping 1.7 percent and continuing their downward trend since peaking last August. Though much of this sector is driven by auto inventory, it is interesting this is the one indicator that seems to retain strong downward momentum as most other indicators have leveled somewhat.

The Fed's FOMC met last week and unsurprisingly left interest rates unchanged. In addition, it repeated its stance that "exceptionally low levels of the federal funds rate" will be warranted for an extended period. The Fed also made clear its intentions to wind down the Treasury purchase program by the end of October.

Activity in the retail sector continues to move sideways as overall retail sales declined 0.1 percent in July versus expectations of a 0.8 percent increase. Difficulty accounting for the Cash-for-Clunkers program is surely part of the reason for the disparity, but with few signs of a rising consumer don't look for sales to lead the way toward recovery any time soon.