Posts Tagged ‘consumer’

Where are we in the business cycle?

Friday, February 9th, 2007

Yesterday, in our article, The real story behind the phenomena of booms and busts, we asked this question. Today, we will look at the indications of where we may possibly be in the business cycle in Australia (which is applicable to the US as well).First we look at the November 2006 Statement of Monetary Policy from Reserve Bank of Australia (RBA):

What does seem clear, however, from several sources of information, is that the economy is operating with very limited spare capacity.

Clearly, as in the metaphor we gave in What cause booms and busts? Introduction to the Austrian Business Cycle Theory, the bus is running low on fuel i.e. the economy is reaching its limit of productive capacity. This is also the same situation that the United States is facing right now. Further down the statement:

Demand in some sectors has been especially strong over a number of years, reflecting the growth of the domestic and international economies. If firms cannot bring new factories or mines immediately on line when capacity constraints become binding, they may decide to hire more labour to work their existing production processes more intensively. This would lead to strong employment growth, but also a fall in the growth rate of average labour productivity because only relatively modest additional output can be produced by hiring more labour without additional capital.

To cope with the strong demand, businesses are forced to increase output. Unfortunately, the effectiveness of the existing capital stocks in the economy is reaching its limit and the only way to increase production further is to employ more labour and pressure the existing employed workers to produce more. As the statement says, without complementary capital, these extra labours are constrained in its effectiveness in increasing output.

Recently, we read in this news report, Consumer confidence ‘lowest since 2003’, ?dragging sentiment down in the half was a sharp 14 point fall in the quality of life rating to 25.5 points… But (they are) finding it more difficult to achieve due to the demand for longer working hours and more intense competition in the job market.? Anecdotally, many of us are feeling the increasing strain of work. Though Australia may be experiencing the lowest unemployment rate, it comes with a cost at our quality of life. Worse still, according to our personal experience, we can feel that price inflation is more pronounced lately.

With the economy struggling to increase output and the money supply still growing, we can expect price inflation to still remain a threat. But price inflation has been quite benign during the past few years. Why is it so? As in the United States, price inflation has been ?controlled? by importing of goods from China. As we said in The Bubble Economy, the rise of the Chinese economy?s productive capacity has a disinflationary effect on prices worldwide. But such low inflation can only be achieved at the cost of incurring a ballooning trade deficit?our imports exceeding our exports. But make no mistake about it: we cannot always rely on the Chinese to save us from price inflation by blowing out our current account deficit even further. So, the greatest danger to Australia?s economy right now is price inflation. As we said in The real story behind the phenomena of booms and busts, if interest rates persistently remain out of sync from the natural rate of interest for too long, we can run into the danger of hyperinflation.

How can we restore the economy back to equilibrium and ensure that it remains in a firm footing for the future?

The first thing that has to happen is to increase our national savings. As we said in The myth of financial asset ?investments? as savings, we need to restore and rebuild our stock of capital goods to ensure our future prosperity. Already, the quality of our education, health, telecommunication and transport infrastructures are in decline and they are in need of repair and upgrade. This means that the only way we are going to achieve that is to reduce our current consumptions and cut down our debt. When that happens, the economy will slow down and many businesses and investments will fail as a result. Since most of the Australian (and the US as well) is made up of consumer spending, in which much of it is funded by debt, we can see that this remedy will be painful. If the consumers do not slow down and get their act together, we can expect the RBA to impose a restraint by raising interest rates.

Thus, we believe that Australia (and the US as well) is at the top of the business cycle. For investors, we have to bear in mind that we are now probably at the cyclical top. If we assume that the current trend of companies? profit growth will extend indefinitely into the future, we will be in for a nasty surprise.

Divergent sentiment

Friday, October 13th, 2006

Today, we looked at and saw something quite amusing. One set of headlines cheered in jubilation: ?Earnings driving the Dow? and ?Michael Farr says investors ‘are thinking positive’.? Another headline wallowed in worry: ?Manufacturers see gloom ahead.?

Is the US economy slowing down and threatening to roll over into recession? Remember, it was not long ago that the fall in manufacturing index prompted the stock market sentiment to turn negative. Now, the market merely shrugged off this report. The housing boom had already collapsed and threatened to cut down US consumer spending, which made up 70% of the US economy.

On the other hand, is the US economy going to power ahead as what the stock market is feeling it would right now? Perhaps the rebound in consumer confidence and the fall in oil prices will help the economy get into a perfect ?soft-landing??

Now, let?s get back to the basics. Make no mistake: the US economy is indeed slowing. The question is, whether this slowdown will result in a ?soft-landing? or recession (or worse still, a depression). Currently, the US economy is at an inflection point. The stock market seems to believe that after this inflection point, the US economy will not get too bad, maybe even mounting ahead. The bond market, on the other hand, believes the opposite. Who is right?

We believe that neither is right. As what we heard from Marc Faber?s (a famous contrarian investor) recent presentation, you can make the Dow Jones climb as high as you want as long as you print enough money. When excess money is being printed, company earnings will definitely grow in nominal terms, which will propel stock prices even higher. But that doesn?t mean that the economy?s production has increased. In other words, real GDP growth will not necessarily grow as much as the growth in money supply. Put it simply, the Dow Jones will rise merely due to inflation.

So, the stock market is wrong, not because the stock prices rise due to economic growth. They rise due to monetary inflation (printing of money). To illustrate this point further, over the past several years, the Dow Jones might be higher in nominal terms, but in real (inflation-adjusted) term, it had fallen.

The bond market is wrong, not because interest rates will be cut due to a recession. On the contrary, this coming recession will be accompanied by excess monetary inflation, which means nominal interest rates have to rise.

But be note that – the above-mentioned scenario will take time to work out. It will not happen overnight. Therefore, time is on your side as you fortify your financial well-being from the coming storm. In the meantime, expect more volatility.

Huge rally fueled by positive US consumer sentiment for September 2006

Wednesday, September 27th, 2006

This morning, we heard news of a strong rally in the US stock market overnight, triggered by much better than expected US consumer sentiment report for the month of September. Apparently, this improvement is due to the falling of oil prices, which will certainly translate to cheaper petrol at the bowsers. As of right now, the Aussie market, along with the rest of the Asian markets, is following suit- the All Ordinaries index is shooting up by almost 2 percent. Meanwhile, on the negative side, US home builder, Lennar, lowered its fourth-quarter outlook, due to the faster than anticipated pullback of the US housing market.

We look in amazement at the market?s rapid turnaround in mood. It wasn?t long ago that the market was fretting over worries of a recession in the US economy. It can?t seem to make up its mind in deciding whether to believe that the US economy is heading for recession or not.

As for us, cautious as we often are, we feel that today?s rally in the Aussie market may be short-lived. It looks to us that the market is over-reacting, given that in the context of so many bad news (including the ?good? news), this good news (the consumer sentiment report) is just only good for the month of September only. We prefer to base our tentative conclusions more on the trend (which is trending down for the US economy) than on individual isolated outcome (which is up for the consumer sentiment in September). Particularly vulnerable, are the stocks in which their businesses are related to the US housing market- US median home sales price fell for the first time in 11 years.