WEEKLY ECONOMIC ANALYSIS: May 29th, 2009

Provided by TEAM Financial Services

"A dollar saved is a quarter earned."
- John Ciardi 

Items for Discussion

There were rumblings this week in Washington about the potential for implementing a consumptions/sales tax at the Federal level, comparable to the VAT tax you may have encountered for those who have traveled to Europe. Philosophically, I personally believe that consumption taxes are the fairest and most economically efficient way to raise government revenues, as taxing labor, savings and investment is tantamount to biting off one’s nose to spite one’s face. However, the very fact that such a discussion is occurring, and apparently in a serious way, speaks to the epic nature of the budget crisis the US faces. The recent plunge in the US dollar and sharp increase in long term US Treasury rates only highlights this issue.

After a brief flirtation with political ideology during my college years, I quickly shifted to a far more pragmatic view of political policy. As investors, we’ve found that it pays to maintain an analytical bent to things and try not to allow personal bias to sway our analysis. For example, many on the right of the political spectrum are reactionary about high tax rates and believe it would reap economic calamity. Many on the left believe that the golden goose has an endless ability to pay ever higher taxes to pay for social programs. We believe reality is far more complicated.

The 1950’s was perhaps the best economic decade of our nation’s history. This occurred as marginal tax rates were at extremely punitive levels – as high as 90%. One need only watch a documentary on the great boxer Joe Louis to get a sense of how punitive the tax rates were. Yet, our nation was able to enjoy a period of immense prosperity and growth. How could this be? In our opinion, it was largely because the government was relatively wise in allocating the resources it was confiscating via punitive taxes. Our nation’s infrastructure was enhanced exponentially with the construction of the interstate highway system. Such investment in productive infrastructure increases societal productivity and can result in a huge return on the money spent. The GI bill offered to “the Greatest Generation” after WWII and Korea produced a generation of well educated engineers and scientists that provided the expertise that allowed the infrastructure to be built well and technological innovation. It helped our country put men on the moon and was the seed planted that allowed the computer to blossom. . 

Unfortunately, we see little signs of a similar wisdom being displayed presently by either political party in Washington. The current deficits are not being incurred to invest in productive infrastructure, even as our infrastructure crumbles – sometimes literally. Our electrical grid is terribly outdated and ill equipped to handle the future demands of an increasingly digital society. Water and sewer pipes are corroding. Airports are a wreck. Bridges are in dire need of repair. Yet, a frighteningly small amount of “stimulus” passed in Washington is dedicated to these issues, which would not only create employment in the near term, but also provide long term productivity benefits to our economy. 

Instead, we have widespread political paybacks. We have bankers being bailed out by taxpayers, with no real “heads rolling”. Want a $100 million job that is secure even if you drive your company to the edge of insolvency and the entire banking system to the brink of disaster? Just become a large bank executive! We have 200 years of contract law being undermined by an administration that is strong arming (I could use a far more terse term) investors to hand over large industrial companies to unions.

The massive amount of debt our country is assuming COULD provide a way out of the long term economic crisis we face, but only if the resources are used in a productive fashion. We see just the opposite occurring. So while a cyclical economic recovery is likely to emerge over the next six months, TEAM has actually grown more concerned about the long term economic outlook in the US. 

Market/Economic Climate 

As we’ve expressed in recent weeks, our major concern for 2009 has been that the US funding crisis could emerge during the year, and described that a dramatically weaker US dollar combined with a spike higher in US long term interest rates would be an indication that the crisis may have arrived. We believe a crisis is likely to be something that unfolds in many phases, and we may very well be towards the end of the first phase. 

Our models indicate that a temporary exhaustion may have been reached for long term interest rates, though the US dollar still has another few percent of downside until it reaches our initial target for its decline – around 76.50 on the US dollar index versus Friday’s level around 79+. 

Interestingly, stock investors have not been overly concerned with the dislocations in the dollar and interest rates - yet. The hottest stock market sectors in recent days have been those related to higher commodity prices, as commodity prices have marched significantly higher as the US dollar plunges. The past eight months have been remarkable for precious metals stocks, as they have rallied, as a group, over 150% from their mid October 2008 nadir. Of course, the stocks still remain well below their March 2008 peaks, which is indicative of how horrific the 70% decline from March of 2008 to October 2008 had been.

Our intermediate term indicators for the stock market remain tenuous, but the stock market's resiliency continues to impress. We fear there may be a trap door approaching, so maintaining some defensive measures remains a focus. Should long term rates drop significantly and the US dollar stabilize for a period, our significantly appreciated positions in commodities and related stocks could be vulnerable to a sharp correction. 

Humor for the Weekend  

Weekly Economic Analysis newsletters are provided by TEAM Financial, and are written by TEAM's Chief Investment Officer, James L. Dailey. Visit TEAM's website if you want to receive weekly economic updates right in your inbox - Click here.