In a post on Thursday, we mentioned the steep decline in state and local government saving. The next day, revised GDP data from the Bureau of Economic Analysis (BEA) showed that state and local government finances (along with most other variables) were in worse shape than initially believed.
Here’s a graph as of Thursday’s post, before the latest revisions:
And the revised graph following Friday’s report:
Where it was previously believed that significant savings had occurred from 2009 through 2010, it now looks as though no net savings ever materialized at the state and local level. And while state and local finances were sharply deteriorating according to previous estimates, they are almost $50 billion worse than believed following yesterday’s revisions.
To repeat from Thursday’s post and a client note earlier in the week (bold added):
The [debt ceiling and deficit reduction] issue is a…straw man that distracts policymakers [and the electorate] from actual issues like unemployment. It’s important to understand that every dollar the government receives in taxes or in debt auctions was previously spent by the U.S. Treasury (or in unusual cases, created by the Federal Reserve to buy something other than outstanding Treasury debt). So the President and House Speaker’s recent comments that the U.S. could ‘run out of money to pay its bills’ is utter nonsense. The primary purpose of Treasury debt is to provide holders of U.S. dollars (including China!) with an equivalent asset that pays interest. That’s it. And the rest of us cannot save unless the entity that creates the money that we save is running deficits.
As we noted on Thursday, there’s not a large historic sample to work with, but it looks like the trajectory of state and local government savings has been a reliable indicator of recessions in the past. And with yesterday’s revisions, this variable becomes an even stronger vote in favor of a looming recession. Inventories showed a slight bump recently, but are now negative year-over-year. Business investment looks OK, but growth in software and equipment has definitely peaked and is declining sharply. Corporate profits are positive, but the rate of growth has peaked and is falling sharply, and there are signs that they will start to decline in the next six months or so. Certain demographic trends will also turn negative in 2012. Taking all of our indicators as a whole, we have an even higher level of confidence in our call for a recession taking hold by 2012, though the final shape of a debt-ceiling resolution (i.e., if the so-called “savings” are almost entirely backloaded) could temper our view.
Of course, equity markets are not currently discounting a recession, and it’s unclear when they might begin to. However, each time I see a long-term chart of the S&P 500, I wonder why more technical analysts aren’t calling for them to, given the 20-year fabled head-and-shoulders pattern that the S&P 500 is forming in rather dramatic fashion:
Assuming there is a resolution to the debt-ceiling impasse, stocks could gain some of their recently lost ground. But given the overall investing environment, they’re anything but a bargain at the moment.
In our Special Opps portfolios*, beyond our continuous search for promising but unloved orphan securities, we have been raising cash levels, tilting toward lower-volatility, higher-yielding stocks, and placing some negative bets in the form of long put options and bearish ETFs** (though one of the latter positions was closed out near the end of trading yesterday). In our strategic portfolios***, allocations remain relatively conservative.
We continue to believe that long-term Treasuries (20-years or more to maturity) still offer the best balance between risk and return. In equities, we favor lower-volatility stocks with stable underlying cash flows and attractive dividends, as well as Japan, which, as maddening as its political environment can be, is less likely to hurt an investor today than almost any other equity market on earth. It’s neither glamorous nor go-go, but that’s not what prudent investors should be after (unless you can buy it on the cheap, of course!).
Admittedly, these are highly contrarian calls, but in a macro environment as negative as the prevailing one, that only tends to reinforce our views. Economic policies are being set by the herd around the world, and there’s simply no way that markets will be left untouched.
IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (SCM) is a Pennsylvania-registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, nor is it a recommendation to engage in any investment strategy. This material does not take into account your personal investment objectives, financial situation and needs, or personal tolerance for risk. Thus, any investment strategies or securities discussed herein may not be suitable for you. You should be aware of the real risk of loss that accompanies any investment activity, and it is strongly recommended that you consider seeking advice from your own investment advisor(s) when considering any investment strategy or security. SCM does not guarantee any specific outcome from any strategy or security discussed herein. The opinions expressed are based on information believed to be reliable, but SCM does not warrant its completeness or accuracy, and you should not rely on it as such. *The Special Opps strategy is primarily focused on capital appreciation through the identification and exploitation of opportunities across a broad universe of equity, debt, and derivative securities, including OTC and foreign securities, and publicly traded partnerships that, in the view of the manager, are compellingly valued. There is a substantial risk of loss, including permanent loss of principal. **Options and inverse or leveraged ETFs involve significant risk, including total loss of principal. *** Our strategic or Comprehensive Portfolio is a carefully designed, long term allocation, invested primarily in fixed income securities and exchange traded funds (“ETFs”) that replicate various equity, fixed income, commodity, and financial market indices, in proportions that SCM believes will provide efficient diversification. The underlying allocations are tailored to each Client’s objectives and tolerance for risk, and may include allocations to cash or cash equivalents. As with any type of investing, there is a significant risk of loss, including permanent loss of principal.