Surveying the financial and economic landscape looks increasingly like an exercise in watching the perfect storm unfold. Today’s sour updates on durable goods orders, new home sales weekly jobless claims only strengthen the sentiment.
Durable goods first: they’re down. Big time. The government reports that seasonally adjusted new orders for durable goods slumped 4.5% in August, the biggest percentage drop since January. As the chart below reminds, the trend looks equally troubling in actual dollar value as well.
It doesn’t help that on a rolling 12-month basis, new orders for durable goods have fallen for six months running. Ditto for the fact that the back-to-back losses of nearly 5% in July and August for the 12-month change in new orders is the deepest loss for two consecutive months in six years. Let’s not mince words: the trend is definitely not our friend here.
It’s arguably even worse in this morning’s weekly update on new filings for jobless claims. As our second chart below painfully shows, the labor market continues to suffer. For the week through September 20, fresh claims for unemployment benefits jumped sharply to 493,000, the Labor Department reports. The last time initial claims were reaching so close to the 500,000 mark was September 2001.
The latest news on new home sales is also disappointing–again. The annual rate of sales of new one-family homes tumbled a hefty 11.5% last month from July, far more than economists were expecting. The 460,000 new houses sold in August is the lowest annualized pace in 17 years.
The message here is one we’ve been warning of for some time: the economic signals are weak, and they’re getting weaker. Initial jobless claims are particularly troubling because they’re a forward-looking metric. Joe Sixpack asks for unemployment benefits today, which invariably means he’ll be cutting back on spending tomorrow. And since 70% or so of U.S. GDP comes from consumer spending, it doesn’t take an I.Q. of 200 to figure out where we’re headed.
On top of all this is, of course, the implosion on Wall Street. Our duly elected representatives in Congress are working diligently on crafting legislative salvation as we write, a.k.a., putting together the mother of all bailout packages. We, for one, expect more government money is coming soon, and one could imagine some degree of relief will follow.
But let’s not forget the trend on this front: Washington, through its various institutions, steps in with liquidity in one form or another. The initial reaction in the markets is positive, but investors quickly get cold feet and return to selling. Maybe it’s different this time, but that’s not yet clear. Nor is it obvious that the economy is set to recover, or even tread water.
The final capitulation in the investment realm may still be ahead of us, at which point even greater bargains in asset classes will arise. For what it’s worth, we believe tthat to reach that point of maximum opportunity will require a broader, deeper and more comprehensive sentiment adjustment from even currently low levels. We’re more than halfway there, or so we guess. Save for a catastrophic collapse, next year will be loaded with bargains. But we’ve not quite arrived at the station.
But remember that calling bottoms and tops in markets or economic cycles is inherently risky. So, yes, we could be wrong, which is why holding 100% cash is probably a bad idea–ditto for fully loading up on risk, for that matter. In fact, absolute extremes are almost never a good idea, unless the valuation levels are so extreme as to warrant taking a jump. More generally, as Tobin long ago advised, one needs to separate the risk portfolio from the cash portfolio and think intelligently about blending the two halves.
When it comes to designing and managing a risk portfolio, our strategic beliefs remain unchanged. As for cash, well, that needs no explanation.
The great question, as always: what is the appropriate ratio for weighting risk to cash? The answer depends on the individual (or institution), of course, although as a general observation we’re not yet convinced that the cash weight should be minimal. But that’s just a guess—an enlightened one, we’d like to believe. Or, if you prefer, a strategic outlook. But let’s emphasize the word “guess” for now, since that’s ultimately at the bottom line of every forecast, be it economic or financial. In the interest of full disclosure, it’s refreshing to admit it every now and again.
Originally published on September 25, 2008 at The Capital Spectator and reproduced here with the author’s permission.