January 26, 2010Memo to: Oaktree Clients
From: Howard Marks
Re: Tell Me I’m Wrong
My readers treat me well. They indulge my penchant for dissecting the past, and they send kind messages of encouragement. To repay their generosity, I’m going to venture into something I usually avoid: the future of the U.S. economy.
This memo won’t be about the future in general, just the elements I find worrisome. As I see it, every investor is either predominantly a worrier or predominantly a dreamer. I’ve come clean many times: I’m a worrier. By saying that, I absolve myself of having to describe the whole future. I’m going to cover the negatives, starting with the immediate and ending with the systemic (some of the latter repeats themes from “What Worries Me,” August 28, 2008). For the other side of the story, I’d suggest you consult the optimists who seem to be in charge of the markets these days.
The Near Term
One thing is indisputable: the rally in financial markets worldwide has outpaced the fundamentals. At the beginning of 2009, most onlookers expected a generally weak economy and were concerned that the behavior of consumers and banks would remain conservative. They were 100% right, and fundamentals are still tenuous. And yet, the rally has exceeded all expectations of which I’m aware.
Market participants have grasped at slender “green shoots”: things that are declining but at a slower rate, or that have stopped getting worse, or that have begun to improve, albeit anemically (e.g., “At some of the nation’s largest lenders, the number of consumer loans that are going bad is starting to level off.” The New York Times, January 21). Most of the good news falls into those categories; little or nothing has blown anyone’s socks off. We haven’t seen much economic news that’s overwhelmingly positive, despite the fact that (a) today’s comparisons are against very weak periods a year ago, (b) our exports have been made cheaper by a dollar that’s 10-20% lower, and (c) there’s been an enormous amount of government stimulus. The gains being reported are often in tenths of a percent, and the other day my drive-time radio commentator said, “Hirings are almost equal to firings.” That doesn’t tell me we’re in the midst of a strong recovery, or on track for one.
In particular, most companies’ sales remain quite weak. The economy is generating very little growth at the so-called “top line” on which Gross Domestic Product is based. Rather, the profit gains being reported have been aided in large part by cost cutting. But “cost cutting” and “productivity gains” are nice-sounding ways of saying companies are getting by with less labor. Thus the employer’s productivity gain can be the employee’s job loss. It doesn’t bode well for the general welfare, consumer spending or GDP growth if the level of business activity, as seen in revenues, isn’t rising; GDP doesn’t benefit from profit margin expansion.
Reliance on Government Stimulus
A year or so ago, the government came to the rescue of the economy with massive stimulus. With the Great Depression as a reference point, Bernanke et al. were determined to limit the contraction in liquidity, support financial institutions and encourage economic activity. Some say too much has been spent, the resulting deficits are worrisome, and the program’s a flop, since the economy’s still languishing and unemployment remains high.
But the fact that growth is sluggish doesn’t mean the stimulus has failed. The relevant question isn’t how the economy is doing, but how growth compares against what it would have been without the stimulus. “What if” questions like that are largely unanswerable, but I’m sure we’re much better off than we would have been without the government’s help.
Home sales are weak, but what would they be if the federal government wasn’t directly or indirectly backing 80-85% of all new mortgages and providing $8,000 tax credits to first-time home buyers? What would 2009 auto sales have been without the “cash for clunkers” program? GDP growth is insubstantial, but what would it be if government spending hadn’t risen by double digits?
Although not all the money has been well spent – “a blunt and messy solution” according to William Dudley, president of the New York Federal Reserve (The New York Times, January 21) – it seems clear the stimulus program has prevented a much more dire outcome. Regardless, the economy’s response is tepid, and I wonder whether the slow growth reflects negative underlying secular trends. This makes me tend toward an expectation that the recovery will be lackluster, and that it will take years before we get back to anything approaching the vibrancy of the period preceding the crisis.
I fall back on the analogy of a stalled car (the economy) being pulled by a tow truck (government stimulus). The tow truck will want to let the car down one of these days and go on its way. Will the car be able to move on its own? We can only wait and see. I think it’s more likely to sputter along than it is to move forward energetically. But at least we don’t have to worry any longer about the analogy of fifteen months ago: an airplane whose engine has flamed out. A powerless plane in mid-flight presents a far more troubling image than a stalled car. To continue reading, click here.
(c) Oaktree Capital
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