Exports Stabilize Economy

The May-Investments Index of Leading Economic Indicators set a new 12-month high in March. While economic indicators remain severely depressed compared to previous year levels, most of the indicators are improving, particularly as compared to when the economy stood at a standstill in April of 2009. While slow growth in the money supply is holding back economic activity, a recovery in export markets and a receding bank crisis helped nudge the indicators higher.

Slower growth of the M2 money supply remains worrisome. A year ago, M2 was growing at a double-digit pace which indicated an upturn in economic activity in the coming months. Unfortunately, today the money supply is growing at only about 2 percent, which is usually associated with less activity ahead, and is even more of a concern given that today’s low interest rates suggest that the Federal Reserve has the spigot wide open, but only a drizzle of economic activity is coming out of the hose.  Money is practically being given away for free, yet the demand for it (by the economy) is almost nonexistent.

Export activity is getting stronger. Higher freight rates are a result of improving global export activity, so the global economy is still moving forward and our manufacturing sector is benefitting from that.  To the degree that economic activity continues to get stronger, the cash rich industrial sector seems to be a primary beneficiary.  We recently added to our investments in this area to take advantage of this activity.

Bank lending is still on the decline, but not at the same pace as a year ago. A year ago, companies were scrambling to find cash, just to survive. Today, though the banks are still hoarding cash, which doesn’t help, but at least the banks are not calling in as many loans as they were a year ago, which has made this recession worse than it needed to be. 

Bank regulators continue to force banks to call in loans on real estate, not understanding that forcing banks to cough up these assets only further bloats the number of distress sales, depresses prices, leads to below-replacement-cost appraisals, and generally cause things to get worse.  For loans already in the system, the bankers should be working with the borrowers, not forcing them to join the ranks of the unemployed.

Raise lending standards on new loans.  Yeah - I get that.  Janitors in California that earn $1,000 per month really shouldn't qualify for a $600,000 mortgage.  But when inexperienced out-of-town appraisers refuse to approve of real arms-length sale/purchase agreements, because the computer models can't find any recent transactions to use for comparisons, that's a Catch-22 that might just drive Milo Minderbinder nuts.  In order for a comparable sale to hit the record books, the lender has to approve a loan.  But the lender won't approve the loan - because there aren't any recent transactions, except for the one that the seller and the buyer would like the lender to approve, so the appraiser can't come up with a value unless it's well below previous sales, and the current proposed sale, and probably below cost as well. 

And for this, the bankers want to borrow money at 0.25%, the ability to sell their toxic assets to the government at 100 cents on the dollar, and to be out from under TARP so they can pay themselves million-dollar bonuses.  Don't you just know that Milo Minderbinder is running a bank somewhere on the left coast and studying up on how to package and sell Cap & Trade credits to the pension fund of someone you love?

The May-Investments indicator shows an economy which is operating at a much lower level of activity than at the prior peak, whereas the widely watched Conference Board Leading Economic Indicator index shows economic activity to be reaching new highs. The Conference Board indicators err by giving today's low interest rates too much credit.  Despite low rates, money is still tight.  As a result, the traditional LEI indicator is indicating that the economy is marching full steam ahead.  It is not.

We’ve stablilized with high unemployment and a lot of excess capacity.  But at least we’re moving up.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

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