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Tuesday, August 30, 2011

Notes from the USA (Aug 2011) – a guest post

Going through last month’s introduction to KKP’s guest post gave me a sense of deja vu. More fear-mongering from the TV channels – this time about hurricane Irene. Flashlights, batteries, drills were flying off the shelves at Sears. Home Depot had set up a ‘command center’ with a large number of computer terminals and phones (reminded me of the NASA command center!) to ensure customer requests from the entire east coast could be attended to, and supplies provided immediately through a fleet of trucks on standby.

Doomsday stories about the economy got relegated to the back pages after the damp squib from Bernanke. But KKP thinks that the economic situation is of genuine concern, with a possible relapse into a recession. At best, it might turn into stagflation – where inflation remains low, but low interest rates do not attract enough spending.

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Why is US Economic Data CRITICAL to our Financial Health?

I’m sharing a lot of information from multiple angles here…..Pay close attention since the picture is saying a 1000 words below.

A lot of readers of Subhankar’s blog might not realize it but the big-dog still is the $15Trillion engine in the US that continues to spend beyond their means every year. This is ‘huge’, and ‘unparalleled’ to any other economy. Until there are other economies that ‘spend’ as much as a percentage of GDP, AND, import it from other nations, it is going to be really hard to avoid the cold, sneeze and flu linkages (‘when US gets a cold, rest of the world gets a flu’ syndrome).

Just look at the statistics of how many people earned more than $200K per year in income! Four million tax returns showed income more than $200K per year. 26% of the big-tax-paying-people of the full US population earned $2Trillion in sum-total. This is a wealthy nation currently, and hence very spoiled with the spending patterns, debt levels, and problems arising are also of significant proportion/magnitude. Expenses are relatively low for the basic needs; in my area, milk is still $2.25 per gallon, gasoline is $3.50 per gallon, 2 piece sofa is $599, 42” LCD TV costs $399, mid-size car costs $16,000, good pant/shirt combo is $25, vegetables are $0.39-$1.50 per pound, and finally, cost of school is approx. $300 per year (housing taxes pay for school).

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In researching the cause and effects, and the current state of the economy, I came across a unique chart that sums up the PFI (Philly Fed Index) and UoM (University of Michigan) Index. This chart is very interesting and thought provoking on what is coming down in the near future - especially if you map it to the previous recessions/slow-downs.

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The Bureau of Economic Analysis's (BEA) second estimate of second quarter 2011 U.S. Gross Domestic Product (GDP) was reported to be 0.98%, continuing their recent trend of revising previously reported economic growth rates down. As a quick reminder, the classic definition of the GDP can be summarized with the following equation:

GDP = Private Consumption + Gross Private Investment + Government Spending + (Exports − Imports)

So, we are entering the phase of a recessionary time and we need to brace ourselves. I have been talking about this slow down since I just do NOT see:

  • Job market improving
  • Salaries improving
  • Corporate spending improving
  • Attitude of corporate buyers still very conservative
  • Housing market pretty much in doldrums / recession
  • Investors talking about ‘what to buy’
  • Investment choices in the market improving
  • Commodities still grabbing market share of available funds
  • IPO market improving
  • Consumers opening their purses to spend ‘openly’

Housing is still terrible. Existing-home sales were bad recently. The inventory of homes-for-sale grew, even as mortgage rates are at all-time lows. A 30-year mortgage is at 4.15%. It is possible we could see a 30-year mortgage with a “3” handle if we slip into recession. That is going to really help since it will reduce the mortgage payments for a lot of people. It is too common to hold mortgages on houses even if you are 60 years old!

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If you follow the curve above, you will clearly see the Activity index going down into the deep end, and therefore, we will see the effect of this in a lower to negative GDP very soon in 2011.

The above chart is a good predictor of the recessions, along with the Laxman Achutan ECRI report that I have posted previously. Even the ECRI noted that it was because two of the financial components added to the positive numbers there seemed to be a temporary positive effect. One was the sharp rise in M2 money supply. But a lot of that is because people are going to cash (I am present in this list as a micro-drop), which is not all that positive from a macro viewpoint. The other is the steepness of the yield curve, which is being manipulated at the short end. But, the key is yield curve is inverted, and inverted yield curves are a perfect venue to predicting a recession. Without these temporary positive contributions, the index would be down and, down three of the last four months, and in a pattern that led to a recession in late 2007.

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US is all about driving around for everything since it is so large and geographically dispersed without the appropriate rail/bus system (outside of the top 100 cities). It is not unusual to drive 50 to 75 miles per day to get to job and back, with the average of 12,000 to 16,000 miles per year per person (not family). Therefore, above curve down in the chart shows the true effects of the loss of jobs, which reduces the number of cars on the road and shows the reduction in activity, consumption and therefore, justifiably a lower GDP on the cards in 2011-12.

For investors around the world, this is a sign of worry that needs to be treated seriously. I have been talking about it and reflecting in my portfolio holdings (mostly in non-US currencies, fixed income investments, and a handful of small dividend paying instruments in the US). For the Indian portfolio, it is pretty much 30%-40% in cash holding, with the rest of them being part of a long term (hold) portfolio.

What do you think about your own financial health situation in 2011 and 2012?

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

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