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HERON FINANCIAL
GROUP, LLC
FINANCIAL MARKETS
COMMENTARY
August 18th,
2010
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Earnings
reports for Q2, which were announced over the last month, were
outstanding! Net income grew 42%, revenues grew 11.8% and 75% of
firms beat expectations. Not surprisingly, stocks soared 7% in
July, taking the S&P 500 back to unchanged on the year. No
carry forward of price appreciation so far in August. With daily
price swings in the range of 1%, stocks are down 2.3% on the quarter and
down 2.4% on the year. Why can't investors focus on the generally
rosy outlook for corporate earnings for more than 24 hours?
Housing, state spending and jobs - bogeymen for rest of 2010
With each passing year, it seems that fewer and fewer investors are
actually researching individual companies. Instead, the focus
revolves around the "macro picture" of economic growth, money
supply, inflation or deflation, and the risk of a "double-dip"
recession. The prevailing narrative is that jobs growth will remain
flat to negative, housing will start falling as the current stimulus
ends, and plunging state spending, driven by plunging tax receipts, will
offset any remaining federal stimulus.
These concerns are not unreasonable. Excess housing investment over
the last ten years created a lot of well-paying blue-collar jobs in
construction, and additional well-paying white collar jobs in finance and
mortgage lending. People have taken comfort from the recent upturn
in prices but our forecast remains flat real estate prices at best for
the next 10 years.
Compared to the rally
in housing prices that lasted from 1997 through 2007, the rally that ended
in 1989 was modest. Even so housing did not rise to new levels
until 1999. At present, supply remains well above demand for the
foreseeable future. Even though mortgage rates are low, a return to basic
lending standards means that many people no longer qualify for a
mortgage. About 25% of homeowners have negative equity in their
homes (the balance on their mortgage is higher than the current value of
their house.) Plenty of those owners are willing to abandon their
properties, which end up on the foreclosure market. Other owners
are looking for the slightest rise to get clear. Finally, home
building hasn't stopped. Housing starts are down by 75% since 2006,
but ample permits are issued at the rate of 565K units/month.
Federal spending surged in 2009-10 (tax credits for first time
home-owners, direct grants to states for infrastructure  spending, the TARP rescue of the banking system.)
However, state spending, which is governed by balanced budget legislation,
is plummeting as tax revenues fade. Federal stimulus peters out
this fall, but the real impact of state cuts won't be felt until this
winter.
State spending grew about 60% over the last 10 years, so some
discretionary spending can be cut easily. Social programs, however,
face increased demand from stressed families. Another burden on
states: pension plans are dramatically underfunded after the market
selloff last year and because projected investment returns are sharply
lowered.
There's no easy solution for these problems; states have to muddle
through as best they can until tax revenues turn up.
The jobs situation remains bleak. There's no chance that
construction spending will return to pre-recession levels. States
should use this opportunity to launch infrastructure projects of their
own, but lack the funds and Federal support to do so. We estimate
that every high paying construction job generates 2-3 low-paying jobs -
everything from retail and fast-food jobs, to manufacture of construction
materials. Meanwhile, corporations, between increasing health care
costs and fear of the "double-dip" are pushing overtime to the
max without taking on new workers.
This chart shows that the rate of jobs growth coming out of this
recession is on par with the post- 2001 recession -  the so-called "jobless recovery."
Projections from the Bureau of Labor Statistics show total employment not
reaching a new peak until 2012, possibly 2013. To bring
unemployment down to 5%, jobs growth would have to average about
250K/month, which is well above the projected 125K/month.
The
Eurozone countries have adapted to permanent unemployment in 8-10% range,
and the US may well be headed in that direction.
Strategy
Net, a contraction in spending in both construction and at the state
level means poor jobs growth means reduced consumer spending means
continued high unemployment. There isn't a magical way to break out
of the vicious cycle; American simply must wait until the excesses of the
last decade are washed away. So does that mean we should abandon
all stocks and invest only in bonds (and gold, and canned goods?)
No! As we have said time and again, US corporations derive 60% of
revenues from overseas operations, which remain strong. In times of
stress, large publically traded corporations take market share from
smaller private corporations, and the current environment is no
different. Interest rates remain locked at 50 year lows.
Granted banks are reluctant to lend right now, but credit issues are easing
for most corporations.
Lastly and most important! The time to buy stocks is when the
economic forecast is grim. If you wait until the forecast looks
great, stock prices have already moved higher. Right now, the stock
market feels like a pressure cooker on the boil. Growth in
earnings, which continue to impress, is the heat source. However,
fears of a double-dip recession, which leave most investors bearish, have
kept a lid on stock prices since April. What happens to net short investors
if the risk of recession recedes? As we have seen, short-covering
rallies are usually explosive to the upside. We continue moving
cash into stocks as there are plenty of companies with great prospects
and reasonable valuations.
at.
As always,
please don't hesitate to call with questions and concerns.
Yours sincerely,
David
Edwards
President
The HERON FINANCIAL GROUP Financial Markets
Commentary is published following month end and when market
conditions require comment. The views expressed in this letter represent
HFG opinion and strategy as of the date published and can change at any
time upon receipt of new information. Data quoted in this letter are from
sources deemed reliable, but no guarantee of such data is implied.
HERON
FINANCIAL GROUP, LLC, is an SEC registered investment
advisor providing fully managed investment and wealth management services
to individuals, families, trusts, defined benefit plans and
corporations.
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HERON FINANCIAL
GROUP, LLC
www.HeronCapital.com
(800) 99-HERON
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