Economic & Market Update: February 9, 2009

“Even Cupid is Having Trouble Finding a Job”

The Fortigent Investment Research Team

Last Week’s Highlights:

Personal Spending:                  -1.0% – no surprise as consumers not willing to spend

Nonfarm Payrolls:                    -598k - not much to say here

Unemployment Rate:                7.6% – see above

Stocks:                                           869 – stocks rally in hopes of stimulus

Bonds:                                           3.0%

Oil:                                                 $40 – OPEC considering further cuts

Dollar/Euro:                               $1.29 – fairly range bound at this point

Economics This Week:

Date      Item                                       Est.                     Comment

2/11       Trade Balance:           -37.0bln    Keep a close eye on this one

2/12      Retail Sales:                     -0.3%     Slight improvement from the holidays

2/13      Consumer Sentiment:    61.5      Consumers not overly optimistic

Negativity is Abundant

The ever-confusing markets rallied during the week in anticipation that the abysmal economic numbers would force the government to quickly pass the stimulus package.  This is a somewhat odd response in our opinion given the relative unknown of what the final package will ultimately encompass and considering the high cost that will be flushed through the system. 

The unemployment numbers released Friday were slightly worse than expected, with 598k jobs lost and an unemployment rate of 7.6%.  Somewhat more surprising was the U-6 unemployment rate hitting 13.9%.   This number accounts for individuals who stopped looking for work or those who simply can’t find full-time jobs.  The U-6 data series is still in its infancy (it was launched in 1994) so it is difficult to compare the numbers on a historic basis, but the recent level is the highest since the series started.  This number warrants attention going forward because it appears that a lot of workers are simply giving up and deciding to wait this recession out. 

Factor in the 1% decline in personal spending and the self-perpetuating cycle of further job cuts leading to lower consumer spending and it feels like we will never get out of this mess.  Until consumers have confidence that their job isn’t the next one to go, we have yet to figure out how the economic picture will correct itself. 

So, Where Does That Leave Us?

As evidenced by the chart below, job losses were trending along the same path as previous recessions until recently.  The past 5 months witnessed a steep increase in the speed of job losses and suddenly it looks like we’re heading towards levels not seen since 1948.  We are concerned that unemployment may become worse yet as many businesses are entering survival mode.  Businesses are being forced to cut costs in the quickest way possible - layoffs. 

Source: Minneapolis Federal Reserve

Credit Markets Revisited

The inability/unwillingness of banks to lend is one of the biggest factors leading to our present situation.  As we all know, following the failure of Lehman Brothers in mid-September, credit markets effectively seized up, creating economic havoc around the globe.  There have been moderate signs of improvement and it looks like the credit wheel may once again be spinning in the right direction. 

Yields on the 3-month Treasury bill moved out of negative territory in mid-December and have slowly been ticking upwards.  This signals that the “flight-to-safety” trade is in the early stages of unwinding, barring any severe global collapse.  Previously risk-averse investors are no doubt recognizing the tremendous opportunities in the markets right now and moving money elsewhere.

Source: Wall Street Journal

In addition to Treasury yields, the TED spread (3 month LIBOR minus 3 month T-bills) has declined precipitously since peaking in early October.  The TED spread is a good indicator of interbank lending and indicates that counterparty risk is diminishing.

Source: fullermoney.com

The spread between LIBOR and Overnight Index Swaps (OIS) is another measure of risk and liquidity in the markets.  Higher spreads indicate that banks believe a higher likelihood of default is possible among other financial institutions.  Historically, the spread is around 10 bps, so while full confidence has not returned to the market, the currently implied levels of 20bps for 1-month swaps and 95 bps for 3-month swaps are clear indicators that the risk of bank default is diminishing.   The last time the 3-month rate closed below 100bps was the day before the collapse of Lehman Brothers. 

Source: Federal Reserve

Food for Thought

The scream you heard echoing out of the Northeast this week was likely bank execs discovering that compensation would be capped at $500k.  The best analogy we’ve heard so far is that every strategic partner in a business has certain stipulations they expect to be met.  In this case, the government has a right and an ability to implement said stipulations.  But, there is a bigger issue that banks will need to be cognizant of now that this dangerous precedent has been established.

The idea of “brain drain” is an idea that is as old as time.  Simply put, skilled employees will migrate wherever they feel most adequately compensated for their labor.  There are obviously numerous underlying assumptions in that statement but the overarching idea is straightforward.  By implementing a pay cap now, the Obama administration is potentially laying the groundwork for future legislation along the same vein. 

As much as some may hate admitting it, American financial institutions are an integral part of this country’s economic output.  Capital markets require individuals with bright minds - people that tend to respond best under a bonus structure. 

Anyone who blames the current economic failures strictly on Wall Street greed is acknowledging that they have a fundamental mis-understanding of how this mess evolved in the first place.   But, that’s a discussion for another day. 

Given how complex world financial markets have grown to be, do we really want to push the best and brightest out of the markets?  On the other hand, we hear the SEC is in need of highly sophisticated financial minds to reinvent their image. 

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