Listen to Joe Morgan's take on the latest economic data releases as it relates to today's ever-changing economy. Joe is the Chief Investment Officer of SVB Asset Management.
 
The views expressed in this broadcast are solely those of the speaker and do not necessarily reflect the views of SVB Asset Management, Silicon Valley Bank, or any of its affiliates.
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Geithner's Galls Gadflies
I want it all
I want it all
I want it all
And I want it now
-Queen
It's only a month before spring but we can already feel the fog beginning to lift. Of course, today's fog is the heaviest and thickest fog seen in a while, but it feels good to see a potential positive, in any case.
I'm speaking, of course, with regard to Treasury Secretary Timothy Geithner's speech last week. The quote above applies to many who waited breathlessly during the five-day buildup to this speech, expecting some sort of magical plan to appear. The reality is that no silver bullet plan exists and pretending it does would only bring further disappointment and loss of confidence in the future.
Certainly, society is not so focused on immediate satisfaction that an initial speech from an incoming official could be his death knell?
On the contrary, I saw many positives in last Tuesday's address. Here are a few:
| 1. | Most importantly, there were no specifics. |
| Yes. You read that correctly. Because no one has all the answers today, to come out and state that you do only sets yourself up for assured destruction. Instead, Geithner has set a course toward recovery, while increasing his credibility with those who understand the depths of today's economic woes. He seems to be taking the tack of a CEO who is navigating in uncharted waters with limited vision in every direction. In fact, that is the situation today not only for business owners, but for government officials too. To repeat, no one has all the answers. The government must react and adjust, but keep an eye toward a single course at the same time. Perhaps Geithner is the man who can lead us in this manner. |
| 2. | There were no four- or five-letter designations mentioned. |
| Over the last fifteen months we have had no less than 16 government bailout programs announced with acronyms from CPFF to TALF. The market has alphabet-fatigue. Instead, he has one name for the government's efforts: "Financial Stability Plan."
Sure, this is simply a marketing fix, but who doesn't realize boosting market confidence is a marketing game? After Lehman, a multitude of new programs were created pointing at every corner of the markets. Instead of realizing we had economy-wide issues to deal with and creating an economy-wide approach, the government attempted to use a scalpel on our individual problems. Geithner, it seems, is starting from scratch with a view from thirty-thousand feet. In the short run, I expect the market to lose confidence (as it did last week) as this is yet another shift in strategy. But if he sticks to his guns, inviting every market challenge under the same tent, eventually investors and consumers will realize he has created a flexible tool to address all of the challenges we face today and tomorrow. |
| 3. | He has created a simple three step approach. |
| Understanding where every market challenge fits is quite important for the institutional investor. We want simple fixes for simple problems. Instead, what we have today is a mishmash of approaches that are somehow supposed to come together and provide support across the markets. Investors are not buying it.
The three step plan simplifies the government's toolbox so that investors can more easily grasp their commitment toward resolution. The three steps, which necessarily have not been fully fleshed out, are: 1) create a "Financial Stability Trust" to oversee the government's investment in financial institutions, 2) create a "Public-Private Investment Fund" to make it less risky and/or more profitable for private investors to transact in the marketplace as opposed to asking the government to take on this task directly, and 3) create a "comprehensive housing program" aimed directly at the housing sector and the many potential problems to come from future bankruptcies and foreclosures. |
Hopefully, Geithner will move down this path consistently, certainly correcting course as necessary, but no longer abruptly changing directions. This will help instill confidence in both the business and consumer sectors of the economy.
Key Developments
The trade deficit in December narrowed slightly to $39.9 billion, much lower than its peak of $67 billion in the fall of 2005. Many who have wished for an improving trade deficit certainly did not envision an overall slowing of global trade as their preferred cause. Instead, the hope for greater productivity and more appropriate pricing of overseas goods was their goal. Today's lower deficit is simply a reflection of lower consumer and business spending around the globe.
In a surprise move upward, retail sails actually increased one percent in January after falling each of the previous six months including a three percent decline in December. In the context of sizable declines through the fall of 2008, January's jump, while encouraging, is not yet indicative of any sort of recovery on the consumer side.
The House and the Senate passed the latest economic stimulus plan which totals $787 billion to be spent over the coming years. While a headline politically, most market participants realize a one-time injection totaling approximately seven percent of one year's GDP will not provide a turn in the economy. Only an attitude reversal of dejected consumers and investors will get the economy back on track and this is why the actions of Treasury Secretary Timothy Geithner are placed genuinely in the front seat.
— Joe Morgan, Chief Investment Officer, SVB Asset Management
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Mixed Signals
In the business world, the rearview mirror is always clearer than the windshield.
-Warren Buffett
Reading our papers and looking at our markets, it is hard to be anything but gloomy. We now have irrefutable evidence that the new administration does not have a magic wand. If anything, they seem to be afflicted with the same communication challenges as the previous administration. While we wait for the stimulus package to pass and the financial rescue package to take shape, the financial sector remains in turmoil, jobs are being lost at a record pace and housing remains in the doldrums.
However, the picture is not quite as bleak everywhere. Clearly, most nations have been impacted by the U.S. led slowdown and the resultant demand destruction. Economies like Taiwan, which are heavily export dependent, have slowed dramatically, while most of Eastern Europe is struggling as well. However, there are glimmers of hope in China, possibly India and even Brazil. In China, for example, even though imports and exports have been impacted by the global slowdown, retail sales, industrial production and the PMI indices are showing resilience. That is not to say that a rebound is on the horizon; however, maybe the pace of decline is slowing, and if that turns out to be the case, the economy could bottom sooner than most expect, which would be an unexpected but welcome boon for the global economy.
The main downside drivers of this recession were housing and the banking industry. They in turn generated a series of byproducts, notably de-leveraging, risk aversion, unemployment and falling demand by both businesses and consumers. As the recession worsened, its impact spread to most regions of the world.
In Asia, banks have been impacted minimally by the housing correction and losses on structured assets. In many of those countries, consumer savings rates are high while debt is low. Therefore, the problems that they face are for the most part external in nature and the best defense is a cushion in the form of domestic demand. On a relative basis, that favors countries like China and India and hurts Taiwan and the Philippines, though arguably all of them have an advantage over us. Brazil enjoys many of the same benefits; despite the price declines in commodities and energy which hurt the economy, there are reasons to be more upbeat about Brazil than many other parts of the world.
The message here is that the drivers for recovery in each country or economic region will include domestic demand and external perceptions about the future of the region. Countries enjoying balance of payment, budget and trade surpluses will do better, as will those with high savings rates and better growth prospects. The ones that will struggle are those that will take time to work themselves out of the morass of deficits and sagging domestic demand. Everyone knows by now that decoupling is generally a myth, but while absolute economic growth might remain subdued until the U.S. economy bottoms, relative growth rates could differ widely.
When markets recover, recovery tends to be led by equities and other risky assets. Equity markets focus on forward-looking indicators and often start rallying two or three quarters ahead of an economy coming out of recession. With an increasingly global economy and plenty of cash on the sidelines, investors have many choices. I believe those investors willing to invest in overseas markets will begin to see signs well ahead of the U.S., though they may be sporadic and unreliable at first. When that happens, expect those markets and currencies to lead the global recovery, while our markets and the dollar lag.
Looking Ahead
Not much has changed in the two weeks since I last wrote this column. Most major currencies have been in a range, except for the JPY, which is slightly weaker. Asian and Latin American emerging market currencies have shown some stability as their equity markets have performed somewhat better, while Eastern Europe continues to be in turmoil. This relative stability and improved performance of risky assets reflects a degree of optimism about the resilience of the "BRIC" economies (ex-Russia) and others. While they have undoubtedly been impacted by the global recession, their underlying fundamentals remain sound and there are reasons to believe they will start growing sooner and at a faster rate than most developed economies.
For now, hedging most payables and receivables is the conservative approach in this time of uncertainty. As I said above, I believe we will see more differentiation in economic and currency performance as the year unfolds. The U.S. and the USD will lag, followed closely by the Europe and the EUR. The JPY has benefited from risk aversion and capital flows, largely an unwinding of carry trades. However, the economy is in terrible shape and the bounceback likely to be slow or nonexistent, which argues for JPY underperformance over time.
As time goes by, it would be wise to pay increasing attention to currency payables, with a focus on emerging markets. When the global economy finally recovers, we could possibly see a multi-year trend of emerging market outperformance of the developed world — that is, for the most part, where growth, savings and capital surplus resides.
— Dave Bhagat, Senior FX Advisor, Silicon Valley Bank's Global Financial Services
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February 18, 2009
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It was quite an amazing scene. Arrayed before the people's representatives high on their dais were eight CEOs of the largest most powerful financial institutions in the world. Although characterized as a "hearing", both sides understood that this session was not to gather information or discuss solutions for the financial crisis. Rather, it was an opportunity for these eight powerful men to be humbled and humiliated in public. The key goal of our public servants was to demonstrate their power and outrage, but most importantly to distract the public and the press from their own increasingly well-documented culpability. If they had a meaningful understanding of the issues they were attempting to discuss, it was certainly not obvious to those of us listening to the repetitious diatribes. Ultimately they looked petty and foolish — like inarticulate schoolyard bullies.
The stated goal was to find out what happened to the TARP money. With $350 billion deployed the congresspeople wanted to know why their constituents and especially their main campaign contributors were not able to get a loan on acceptable terms. That is a fair question. As the interrogators railed on and on about the banks providing more credit on easier terms with lower rates they seemed to have missed the main lesson of the past year's chaos. Credit is not a public good to be distributed like food stamps to the poor or clean needles to the addicts.
Chairman Frank also wondered why these men needed bonuses. "What are you going to do go home early on Wednesdays or take longer lunches if you don't get a bonus?" After beginning with the clear statement that, "I have always been in disagreement with the financial services industry," Maxine Waters then continued with such a confusing stream of consciousness that at one point, Ken Lewis, CEO of Bank of America, gave voice to the words we all were thinking. Exasperated he said, "I don't know what you are talking about." Neither did anyone else in attendance.
Others were concerned that consumer credit card terms and rates had been changed. They didn't seem to realize that the net charge-off rate on credit card defaults is approaching an all-time high of 10 percent according to one report cited in Time Magazine last November. It is not hard for the average citizen to draw a straight line between congressionally inspired loose lending practices and the tax payer dollars needed to recapitalize the system once losses on those loans are recognized. For those that make the laws this key understanding is missing.
They also seem to miss the fact that the credit system in the U.S. is also dependent on investors. These are the folks that buy the securitized consumer loans from credit cards, car loans and student loans. This market has declined by some $56 billion since October, representing $466 less credit availability for every household in the country. So who are these stingy investors and why can't Chairman Frank drag them in for a tongue-lashing? The investors are owners of money market mutual fund shares. In short, they are you and me.
As Chairman Frank continues to attack the terms of the commercial contracts at the heart of these funds, investors are getting more and more nervous. With political risk increasing, investors struggling to regain their confidence are reluctant to step back into the market. Clearly, the greater operational control of the banking and credit system by Congress, the less confidence we should have in the proper functioning of our financial system. After all, their handiwork is clearly on display in the failure of those trillion dollar twins Freddie Mac and Fannie Mae.
We have been schooled recently that "only government can solve this problem", which leaves us watching the government closely day to day for any hint of progress. As we wrote some weeks ago, the market is hoping for an "upside surprise" from those that feel they should be in total command of the economy. At this point we would settle for some deep thinking and fewer speeches. Organizing a truly impartial (note we didn't write "non-partisan") 9/11-type commission to assess the causes of the current crisis would be a start. Today, with each outburst from the White House or Congress, the market takes another header and consumer confidence sinks ever lower.
History, after all, is written by the victors. So Chairman Frank and his cohorts will likely never be called to account for their actions. When businesses fail there are consequences. Investors lose fortunes and jobs vanish. When public policy fails, there are only hearings organized to blame others. The accounting is left to that minority that finds their way to the polls every couple years. With districts so carefully gerrymandered as to eliminate any competition, those that brought us to this juncture are likely to remain in command for some time. The continuing posturing and finger-pointing in congressional committees will only delay the return of trust in the system and optimism about the future.
The Apprentice
As a prelude to the bankruptcy filing this week, Donald Trump resigned from the board of Trump Entertainment. This would mark the third bankruptcy for the group since its founding. Trump Entertainment has interests in gambling, so if you happen to be a bond holder you ought to know that the house always wins eventually. We know many of you might be concerned for The Donald's future but he is very well-connected and rumors are that he has already been offered several positions by some of those he fired from his well-known TV reality show.
— Jim Anderson, President, SVB Analytics
Investment Strategy Outlook is published each week to highlight issues we hope you find relevant and topical. The views expressed in this newsletter are solely those of its authors and do not reflect the views of SVB Analytics, Silicon Valley Bank, or any of its affiliates.
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