Posted by Joseph Y. Calhoun, III

Last year, Cash for Clunkers was hailed as a success by President Obama:

In his radio address on Thursday, President Obama said the program, designed to stimulate auto sales and production and get gas guzzlers off the road, had “been successful beyond anybody’s imagination. And we’re now slightly victims of success because the thing happened so quick, there was so much more demand than anybody expected, that dealers were overwhelmed with applications.”

What the President discovered was that if you offer people a financial incentive to do something - especially something they were going to do anyway - you’ll get lots of takers. 700,000 cars were purchased during the program and I’m sure some of them would not have happened without the subsidy. How many? I have no idea but the cost of the incremental sales was surely more than the $4500 offered by the program per car. The bottom line is that the program may have had a minor - very minor - positive impact on the economy but it is hard to calculate.

To me the most egregious element of the program was its effect on the poor since it was bound to raise the price of perfectly serviceable used cars. Here’s what I said in a post entitled, Broken Clunkers:

One last thing to consider is the effect on the poor. While politicians like to pose as defenders of the poor, this is just another program that does the opposite. At least some fraction of those clunkers being destroyed were potential cheap transportation for the working poor. Now the market for low priced older cars will face a lack of supply and the prices of the remaining “clunkers” will rise. If the goal was to eliminate cheap transportation for the poor and force them onto public transportation, well, then the clunkers program is a rousing success. If the goal was to create economic growth, then not so much.

So how much of an effect did this program have on the price of used cars? The recently released July Consumer Price Index shows a 17% rise in the price of used cars and trucks in the last year. I don’t know the average cost of a used car but a 17% rise in price probably priced at least a few people out of the freedom provided by a car. It may have prevented them from getting to a new job or kept them on public transportation when they could be home with their families. So my question is this: Was President Obama and the other politicians who pushed this program just too ignorant to anticipate this very obvious result? Or did they just not care? Strangely, I hope its the former….

Update: Jeff Jacoby has a good article on the same subject at Boston.com

Posted by Joseph Y. Calhoun, III

Has sentiment reached an extreme? Is anyone surprised anymore when weak economic data is released? Were you surprised that existing home sales fell 27% last month? I wasn’t and apparently neither were the people buying up home builder stocks when that news was released last Tuesday. Were you surprised to read the Goldman and Redbook retail reports and discover that the year over year increase in sales is waning? If you read this missive every week you sure weren’t. Does it surprise you that retailers are using big markdowns to move merchandise during the back to school selling season? Yeah, me neither.

In more news that surprised absolutely no one new home sales also fell last month to a 276,000 annual rate. Inventory rose to 9.1 months but that is mostly a function of the very slow sales pace. As I’ve said many times this rate of sales cannot continue indefinitely. Of course, I’m assuming the nativists don’t manage to scare off all new immigration and that the drop in the birth rate reported last week is just temporary. In more normal times we see well over 1 million new households each year and those folks have to live somewhere. Eventually the pace of new construction will have to rise. Not yet apparently, but eventually.

Considering the pace of new and existing home sales it also wasn’t surprising to learn that durable goods orders, ex-transportation, were down in July. About the only thing I could find that was positive was that in the transportation sector motor vehicles were up 5.3%. A major disappointment was the non defense capital goods orders excluding aircraft (which as we’ve pointed out before is a good proxy for capital spending) which fell 8%. Recessions, and this one was no exception, are caused by a drop in investment. Recovery for the economy as whole requires more investment (hopefully in something besides houses this time around); the best I can say about this report is that it is very volatile and one month doesn’t make a trend.

Even amidst all the bad news every week, there are always hints of sunshine. Last week, mortgage applications offered a glimmer of hope. Purchase applications rose 0.6% but more importantly refinance applications continued their spike, up 5.7%. One of the reasons the Fed is now reinvesting the proceeds of their MBS portfolio in Treasuries is that the prepayment rate has been higher than expected. Low rates are having the desired effect.

Two other decent reports were jobless claims and corporate profits. Claims fell 31,000 to 473k in a reversal of the weird seasonal spike last week (see this blog post). That is still way too high and I won’t be even vaguely comfortable until new claims fall below 400k but at least we’re back under 500k. Corporate profits were up 37.7% year over year in the second quarter and are now approaching the all time high as a percentage of GDP that so many others said we’d never see again. I’d also say it is good news that financial industry profits actually fell fractionally quarter to quarter while non financial profits rose by a healthy 8% from the first quarter. I can’t think of much that is more important than a rebalancing of the economy away from the finance sector.

The corporate profits data was released as part of the GDP revision which lowered growth to 1.6% for the second quarter from the previously reported 2.4%. The revision lower was due to the worse than expected trade deficit but the good news is that real final sales were revised higher to 4.3%. That is a major improvement from the first quarter’s 1.3% rate. What that means is that contrary to the first quarter, second quarter growth was more about final sales and less about inventory rebuilding.

Sentiment about the economy is also reflected in the markets and various surveys. The American Association of Individual Investors poll shows bulls falling to 20.7% while bears number 49.5%. That’s about as negative as this survey ever gets and matches up pretty well with the March ‘09 bottom. We also know that US equity mutual funds have seen a steady outflow which continued last month to the tune of $12.37 billion according to Morningstar. The total for this year is a whopping $28.35 billion which already exceeds last year’s total. Meanwhile, these same investors continue to swamp bond funds of all kinds with new money. I don’t want to be too harsh but mutual fund investors do not have - to put it nicely - a very inspiring track record. In fact Trim Tabs, the mutual fund research company, has published research that shows ETF equity flows are a great contrary indicator. Short the market when ETF inflows are above normal and get long when the outflows are more than normal and you outperform the S&P by a hefty margin.

The point is that sentiment is just about as negative as it gets and for long term investors that has to mean there are some bargains around. Now as others have pointed out, valuations are not at secular bear market, single digit lows but with interest rates this low that isn’t exactly surprising. And again, as others have also pointed out, the quality of much of the S&P 500 earnings have to be questioned. The habit of using “operating earnings” that excludes all kinds of bad stuff that companies want you to believe are one time in nature is one that makes valuing stocks more difficult. But with sentiment this negative, investors need to at least be looking for long term buys. There are plenty of companies with no reason to cook the books that offer dividends - which can’t be faked - at rates higher than bond yields. And by the way, dividends can go up while most bond coupons are fixed. What are the alternatives? Joining the herd buying bonds?

On that note by the way, Bernanke’s speech Friday at Jackson Hole could be read as a bit of a warning to those bond buyers. Bernanke seemed, at least to me, to kind of draw a line in the sand saying that the Fed would “be vigilant and proactive in addressing significant further disinflation”. With core inflation approaching 1% that doesn’t provide much cushion for new bond buyers. If the Fed is determined to prevent core inflation from falling below 1% I would take them at their word. If you own Treasuries in a fund or individually, you might want to take a gander at what happened to Treasury rates the last time the Fed engaged the QE lever:

As you can see the 10 year Treasury yield rose pretty dramatically in early 2009 when the Fed announced the initial QE program. A similar move now would lop roughly 10% off a 10 year Treasury holder. A fund with longer maturities would take a bigger haircut. I also don’t think owning corporates would give you much cover either. In March 2009 spreads were a lot wider so corporates were able to rally even as Treasuries sold off. That probably won’t happen again.

Friday’s action might mark the nadir of negative sentiment for the US economy and stock market. Bernanke has now told us that he won’t let deflation happen - and I think that is a promise he has to and can keep - and that means a further expansion of the balance sheet if need be. What that means to me is that real assets are a buy. Bernanke just put a floor under commodity prices and probably emerging market stocks. Many of the emerging markets, along with Australia and Canada, are resource rich and high commodity prices are a boon. US stocks will probably rally too if Bernanke keeps his promise but you might get more bang for your depreciated buck in other, more foreign markets.

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Posted by Joseph Y. Calhoun, III

Nice post by Jack Hough at Smart Money on the savings rate:

Grab the resuscitation paddles. The American consumer has lost the will to shop. Haven’t you heard? Jolts of stimulus cash are needed to get sales registers ringing again and restore lost jobs.

Don’t believe it. Such logic was used to justify programs like the “cash for clunkers” incentive, which expired a year ago, and additional cash perks for home buyers, which ran out in April. Judging by data reported by the Bureau of Labor Statistics, the programs failed to produce a surge of home-building and car-making jobs.

The two charts below suggest why. The first shows our supposed crisis of frugality. Consumers do one of two things with their after-tax income. They spend or save. The first chart shows the portion they’ve saved since 2000. Notice how the trend has risen menacingly since 2007. Judging by this chart, today’s rate seems abnormal.

Hough then shows a short term and long term chart of savings:

I’ve pointed this out before but it bears repeating. The recession was not caused by a lack of consumer spending. The negative change in GDP was a result of the collapse in investment spending. And investment is a function - obviously - of savings. You can’t invest if you haven’t first saved. So the increase in the savings rate back to a more normal rate is required for a real recovery. The paradox of saving the Keynesians so lament  and want to prevent is the source of recovery.

One other point about Hough’s comment about consumers either saving or spending their after tax income. That is true but it should also be noted that all income is spent even if it is saved. One person’s saving is another person’s spending. If a saver buys a bond, he is lending money to a company which will spend the proceeds on something. If a saver puts his money in a savings account, the bank will lend it to someone who wants to spend it. Well, that last one is working so well right now but you get the point. Unless the saver puts his money in a coffee can and buries it in the back yard, it will be spent by someone.

Posted by Joseph Y. Calhoun, III

The Calafia Beach Pundit, Scott Grannis, is on a roll:

We’re not witnessing a bond bubble in the making, we’re living in a statist nightmare.

The future, however, is not written in stone, and there is little reason—in my view—to expect that the current state of affairs is going to go on forever. But you have to be an optimist to venture outside the safe haven of ultra-low Treasury yields that only the pessimists are content to receive. Today’s bond market will prove to be a bubble if and when the people take back control of government from the statists currently occupying the White House and running Congress. I believe they will, come November. If you don’t, then go out and buy some of those Treasury bonds; you’ll have plenty of company.

As I said yesterday about the current extremely bearish sentiment:

Being a contrarian, which means nothing more than being an investor, is not easy. It takes guts to buy when everyone else is selling and to sell when everyone else is buying. But it is absolutely necessary for long term investing success.

I have also pointed to the election as a potential game changer but I suspect the market will move well ahead of the election. Ever hear the old Wall Street adage about buying the rumor and selling the news? If the market rallies substantially before the election the actual event may be disappointing. Will a takeover of the Senate be baked in the pre-election market? If it is and it doesn’t happen that could engender a bit of buyer’s remorse. For that matter, even if the Republicans retake both houses of Congress, what will they be able to actually accomplish? Unless, Obama does a Clinton pivot to the political center - and maybe even if he does - the result is gridlock. That was a fine outcome in the 90s but may not be sufficient today.

On the other hand, I would also repeat something else I’ve said recently:

I have said many times and continue to believe that the politicians have only marginal impacts on the economy. When it comes to government effects, the Fed has a much greater impact than anything that comes out of Congress or the White House. And that is true for whichever party happens to be in power. But the greatest impact of all is the natural resilience of our semi-capitalist economy. It isn’t perfect by a long shot and it sure isn’t lassez faire, but it is about as good as you’ll find anywhere in the world.

We need good economic policy that affects real growth but more important is a stable monetary policy. Given that stable framework, the natural resilience of the economy will get us through. After all, the US economy has endured and prospered with higher tax rates and more oppressive regulatory regimes. So unless the election somehow awakens a new understanding of economics on the part of Ben Bernanke and his banker loving pals at the Fed, the election doesn’t change much.

I am not a bond market fan right now and I think the sentiment is sufficiently negative that stock buyers today are likely to be rewarded. A positive change in real economic policy would surely help but I don’t put a lot of faith in the ability of the Republican Party to deliver. In the short term however, anticipation of a change in control of Congress may be enough to rally the market.