Private Account Wealth Management Services
Newsletter Issued 05-26-10:
By: John T. Moir

Position overview . . .

Our previous newsletter, dated March 31st, stated that the DOW continues within its period of elevated consolidation, at least for the near-term, and projected a trading range for the month between 10,400 and 11,100. We further stated that this type of gradual ascent is commonplace within bear markets or counter trend rallies, as various markets adjust to a point of neutrality or equilibrium, prior to resuming the primary bear market trend lower. The actual result produced a slightly narrower trading range than anticipated, between 10,326 and 10,955.

The US dollar was projected to remain within a broad trading range, between euro fx equivalent of $1.34 and $1.38. The actual result was a wider trading range than projected, between euro fx equivalent of $1.3237 and $1.3753.

The US treasuries were anticipated to remain under price-pressure, at least for the near-term, with the US 10-year Note having a base-yield for the month of 3.60% or higher. The actual result saw the US treasuries decline further in price, causing yields to inversely rise, producing a US 10-year Note yield range for the month between 3.59% and 3.93%.

Looking forward . . .

China has apparently decided to let its currency start rising again. There are two objectives. Domestically, a stronger renminbi will help counter inflationary pressure and dampen the excessive growth that is fueling it. Internationally, appreciation will start curbing China’s huge current-account surplus — and thus counter the pressures that are building in the US and elsewhere to retaliate against China by installing new barriers against its exports. The overriding issue is whether China will move quickly enough and substantially enough to achieve these goals.

China is exporting large doses of unemployment to the rest of the world, in a world where sub par growth and high rates of joblessness are likely to remain for some time. The US global current account deficit would reduce from $300 billion to $150 billion, if Chine eliminated its currency misalignment and thus cut its global surplus to 3%, reducing to 4% of its gross domestic product from over 5%. Every $1 billion of exports supports about 6,000 to 8,000 jobs — mainly high-paying manufacturing workers — in the US. Hence, such a trade correction would generate an additional 600,000 to 1.2 million jobs. Correcting the Asian currency alignment is the most important component of the US President Barack Obama’s new National Export Initiative. Its budget cost is zero, which also makes it by far the most cost-effective possible step to reduce the unemployment rate and help speed economic recovery.

Such exchange-rate realignment is not without precedent. In 2005, Beijing announced a new “market-oriented” exchange-rate policy and let its currency appreciate 20% to 25%. By mid-2008, however, China repegged to the US dollar, and the renminbi has ridden it down, taking back about half the previous rise. Hence, other countries must continue efforts to persuade China to revalue adequately and prepare retaliatory actions, if it does not actually let their currency trade at its appropriate value. The Chinese are much more likely to respond positively to a multilateral coalition, especially if that coalition includes a number of emerging-market and developing economies whose causes the Chinese frequently claim to be champion.

The US could intensify its initiative with unilateral actions. The Obama administration could decide that the renminbi’s under valuation constitutes an export subsidy that would be considered in decisions to apply countervailing duties against imports from China.

Product or sector-specific steps, such as last year’s tire tariff, are undesirable because they distort and disguise the across-the-board nature of the Chinese currency misalignment. A US led global effort offers that best chance to convince China to let its currency rise sufficiently and help both itself and other countries achieve sustained economic recovery.

April payrolls swelled by 290,000 and the household count came in at 550,000, with both March and February numbers were revised tangibly upward. The unemployment rate edged up to 9.9%, from 9.7%, mostly because the labor force expanded by 805,000, presumably in some part by workers who had been previously daunted by the difficulty of landing a job, but felt more optimistic of doing so last month.

The gains were pretty well spread over the length and breadth of the economy. Manufacturing added 44,000 slots, mining 7,000, construction 14,000 (from nonresidential building), professional and business services had 80,000 hires, hotels and food services added 45,000 and health care 20,000. Temps — a muted positive — were still in demand. This broad dispersal of hiring does smack of a better economy.

However, there are some dubious enhancements of the totals. Uncle Same, for example, accounted for something like 66,000 of the additions via census workers. Obviously, that bright-eyed bunch, helpfully padding the monthly employment totals, are likely to be mostly just a memory come the second half of this year.

Furthermore, no fewer than 188,000 were added to payrolls in April courtesy of the magical birth/death computer model that the Bureau of Labor Statistics (BLS) uses, to net out the number of firms too new to be included in the survey and presumably those no longer among the living. We hesitant to credit the actual birth/death reckoning because of the strange additions during many of the darkest months of the recession.

The April report, in any case, was not at all perfect. Our preferred barometer for the job market, U6, which measures both underemployment as well as unemployment, rose to 17.1% from 16.9%, just a few notches below the all-time high. Moreover, the average hourly earnings increased a paltry penny, while the tally of people out of work for 27 weeks or more extended its rise, reaching a stunning 6.7 million souls, nearly 46% of the unemployed.

There is an interesting list of things that most people do not want to discuss over dinner, that still speak eloquently to the state of the economy. Here is a sampling:

One in every ten Americans missed a mortgage payment in the first quarter of this year — a new record. One in ten Americans’ credit-card usage is being written off — also a new record.

One in six Americans are either unemployed or underemployed. Over four in ten of those jobless Americans have been out of work for at least six months and there are five unemployed workers competing for every job opening.

One in four Americans with a mortgage have negative equity in their homes. Only one in 50 Americans plan to buy a home in the next six months.

Also, only one in eight Americans feel the current government policy is actually helping the economy.

Long-term conclusions and current month expectations . . .

Currently, the US has pulled basically all of its policy levers, short of applying full throttle on the currency printing press, and , at best, we are in a statistical recovery — where the anemic numbers out of Washington show a slight recovery, but not one for the common investor. It is in this context, where the government can seemingly run a huge deficit, but households and states can not, that the market appears overpriced and over-hyped. We are looking at a true balance-sheet recession, which will take years to work through and which will make it difficult to drive the market-implied double digit earnings growth year after year as the government has only delayed the inevitable in the attempt to buy more time.

The international assistance to Greece has come too late and proven to small to prevent restructuring or default, and that such an event could set off a round of global financial turbulence similar to what followed the Lehman Brothers bankruptcy in 2008. Such a dislocation could easily jeopardize the economic recovery that has been underway for the past few quarters. At the same time, the ability of policy makers to respond aggressively to economic dislocation is much smaller now than it was in 2008.

The debt crisis may also affect the ability of US-based multinational companies to continue beating earnings estimates. Several have suggested that the euro’s decline will prove a headwind to earning’s either by making their products less competitive, and these headwinds may require analysts to lower Standard & Poor’s (S&P) 500 earnings estimates. The euro fx’s decline could continue this month, with a wide trading range between $1.21 to $1.32, due to the enhance level of uncertainty within several European countries and possibly the entire region.

The debt-induced spending spree that has captivated US consumers over the last decade has shifted to the public sector. Budget shortfalls and low interest rates have conspired to create a significant public-debt problem. In today’s environment, fair value for the fed-funds rate is a conservatively 4%, found by adding 2% long-term real Gross Domestic Product (GDP) and 2% inflation.

In addition, Europeans are not ready for the reforms they need, and politicians have not clearly explained the severity of the situation to their citizens. Europeans must realize that unless Europe moves forward with the necessary and deeply unpopular reforms still required, the newly available money will do little to save them. Leaders must use the time they just bought to build the political coalitions needed to implement the necessary changes, rather than postponing reforms again.

What will that look like exactly? The medicine for these sick countries is well known. Spain, Portugal, and Italy must cut their budget deficits, freeze or reduce government wages, and reform labor markets in a quest to boost productivity and claw back some of their lost competitiveness.

Meanwhile, Germany and other healthier economies must take more aggressive measures to boost domestic demand in order to keep Europe from spiraling into deflation.

European leaders, under this scenario, must come clean soon on cases in which debts simply can not be repaid — which is obviously the case in Greece — and insist that, instead of the European and Greek taxpayers carrying the entire burden, the private creditors also take a hit.

The way to gauge the economic measures decided by the European leaders on May 9th is not by watching the movements of the stock market. The real mark of success will be the determination and speed with which Europe’s individual economies pursue tough reforms at home. And, tragically, that is why street demonstrations in Lisbon, Madrid, or Rome would be a better indicator of the seriousness with which governments are pursuing the reforms.

The DOIW appears to enter a period of broad consolidation from an overbought situation, which could produce a larger trading range during the course of the month, between 9,800 and 11,200. The mentioned areas of concern could be some of the catalyst for the wider trading range. This could likely cause near-term price-support for the US treasuries, inversely producing lower yields, with a projected base-yield for the US 10-year Note of 3.60% or lower. .

FOOTNOTE: The April 2010 newsletter was not released and the May 2010 newsletter postponed, to the financial benefit of investors utilizing our Private Account Wealth Management Services.


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John T. Moir
Worldwide Investment Manager
Wavetech Enterprises, LLC
Phone: (775) 841-9400

Acknowledgements: Federal Data, C. Fred Bergsten with Foreign Policy, John Garofalo with GID Securities, Bureau of Labor Statistics (BLS), Gene Lancaaric with ING Investments Weekly, Uri Dadush and Moises Naim with Foreign Policy Magazine, David Rosenberg, Economist, Jack Ablin with Harris Private Bank.

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