The New New Normal

The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates.

Do you feel like we do? 

        - Peter Frampton 
 

Markets around the world have experienced great turmoil over the last several weeks as they struggle to figure out what the world will look like going forward.  At least four major struggles erupted in near simultaneous fashion to confuse and distort the current economic situation around the world.

The primary issues facing investors today are, in no particular order:

• Renewed decline in consumer activity and revision of prior economic activity in the U.S.
• Continued struggles in Europe, including increased efforts to prop up struggling bond markets there
• U.S. budget shenanigans driving investors to consider an actual default by the U.S. government
• S&P's downgrade of the United States and associated entities

We cannot refer to these as a "perfect storm" because the market was able to focus on these issues one-by-one, but we are curious whether they portend a second version of the so-called "New Normal" economy. 

Consumers on the Sideline 

On August 2, the Bureau of Economic Analysis released its personal income and personal consumption data which showed a 0.2 percent decline in personal spending during the month of June.  This came shortly after aggressive revisions to various data left the estimate to first quarter's growth at a paltry 0.4 percent and a year-to-date average of less than 1 percent.

Economists had been forecasting growth would pick up in the second half of 2011, but with such an anemic appearance in the first half, they quickly adjusted estimates downward for the near future.  This has been a reliable pattern since 2008:  forecast slow, disappointing figures in the near term, but surely something will happen that allows growth to pick up in the future!

Descenso, Declino, Recul, Ruckgang! 

At the beginning of the month, traders ramped up their disdain for European debt and yields began to rise.  During the first week of the month, the European Central Bank (ECB) reinstituted a program to buy Greek, Irish and Portuguese debt.  The markets saw this as an inadequate and perplexing response to rising Spanish and Italian bond yields and, over the weekend of August 6th, the ECB changed course.  After Spanish 10-year bonds broke through 6 percent solidly the week before, the ECB began purchasing Italian and Spanish debt on August 8th, effectively enacting a ceiling on the yields of these securities.

As of this writing, Spanish and Italian bonds are yielding 5 percent, about 120 basis points below their high recent high.  By placing a ceiling on where their debt will trade, there is a risk the ECB will end up owning the problem, not only by mandate but also by owning all of the actual debt.

Because funds have to come from somewhere, this can be viewed as a taxpayer bailout of these countries paid for especially by the, ahem, "rich" countries.

Budget Showdown or Politics as Usual?  

The media truly enjoyed hyping the recent Congressional debate on the debt ceiling, attempting to work the word default into every article or comment possible.  Comparisons to Europe (who has countries with real problems paying their debt) luckily fell on deaf ears for the most part, but there was no escaping the fear overall.

Even after the resolution on August 2 to this issue, the idea we narrowly avoided a default was pushed time and again.

Of course, at no time were we near any actual default with Treasury having many other options to cut spending before defaulting on what the world thinks of as the one and only risk-free security.  For example, had they delayed social security payments for a week or two, it's likely enough representatives would have heard from their constituents to lead to some sort of agreement.

The agreement reached, of course, didn't solve anything except to exchange one consequence (automatic spending cuts) for another (reaching of the debt ceiling).  The debate leading up to the November 24 deadline should be interesting.

Grade AAA.  No, Grade AA+! 

S&P's downgrade of U.S. long-term debt shocked the market which had an entire weekend to contemplate before hitting the trading desks a week ago Monday.

Reaction in the market place was as we expected:  Stocks down huge as a result of the fact the stock market rarely is prepared for actions in the bond market and bond yields down huge as those same stock investors along with other risk-market participants flooded to the safe-haven of Treasuries.

Last week, S&P affirmed France's AAA stance, however French yields remained aloft.  S&P must feel pretty silly given so many investors around the world disagreed so heartily with their conclusion.

Feeling Like We Do 

So what does all of this mean?

My view since 2008 has been that there will be no consistent recovery until real, unassisted consumer demand returns.  This has not happened.

Furthermore, it is clear future government assistance, in the form of stimulus packages, cash for clunkers, or $8,000 credits for first time home buyers, is not on the way.  The markets are digesting this fact along with the Fed's statement they will likely hold rates where they are for the next two years.

The result is a lower, flatter yield curve providing cheaper credit and a lower stock market that must reflect an economy that will no longer benefit from the temporary demand created by temporary government programs.

Consumers and governments around the world must repair their balance sheets before resuming a significant growth rate.  Until then it is important to invest wisely, cautiously and with your stated objectives always in mind.