What we try to do is evaluate what point of view those who have some influence on the outcome might favor. If the big players want something to happen, they might just get their way. Try to think of who wins and who loses in each scenario and ask yourself who might be able to sway the odds.
Issue of the Week
For the next several weeks, barring some unexpected outcome, we will be prone to discuss the progress or lack thereof in the US deficit ceiling talks. The way this works is that the US can only issue debt that has been authorized by Congress and Congress decided many decades ago that without limiting the volume of debt available to be issued, they’d be likely to spend and spend until the US economy collapsed under the weight of Treasury debt. How prescient they were.
The debt ceiling now stands at $14.293 trillion. That sounds like a lot of money, and it is. Every budget, President Obama’s, Representative Ryan’s, the Senate Budget Committee’s and even the one proposed by the deficit reduction taskforce last year, all point to deficits of significant scale over the next several years. So, regardless of which budget answer you like, you’ll have to increase the debt ceiling to get there. We reached the $14.293 trillion in outstanding US Treasury debt back on May 15th. That was the first ‘deadline’ for raising the debt ceiling. Then Treasury Secretary Geithner explained that by playing some tricks with spending money in trust funds, utilizing budget authority for some programs that hadn’t spent their budget or by delaying some payments we could extend the government’s operations until August 2 before we really ran out of money and had to issue more debt. There may be a deadline after that once we get to the 2nd.
Since early May, one group or another has been bargaining to come up with a plan to raise the debt ceiling. The House of Representatives voted down a simple bill that would have raised the debt ceiling by about $2 trillion back in May. That bill would not have cut any spending or raised any revenue. It would have simply raised the debt ceiling, allowing more Treasury debt to be issued. We’ll call this Plan A.
Once that bill went down, negotiations began to come up with a plan that would cut spending, raise revenue or both that would include raising the debt ceiling. Those talks have gone essentially nowhere, although they have been instructive in how government in 21st century America works. Each party is blaming the other for not making any progress.
The big debate is all about what share of GDP the government ought to be. Republicans think that government doesn’t have to be as big as it already is. Democrats think that government ought to be bigger yet.
For the last couple of weeks, President Obama and leaders of both parties have been talking about a grand bargain to address some of the major stumbling blocks to reducing the annual deficit. This debate has essentially become an argument over whether the answer lies in higher government revenues to support the government we already have or smaller government that will fit in the revenues available. They have gotten nowhere. So, Plan B – addressing a whole long list of issues all at once, seems to be not working.
Both sides are going to the media with their side of the story in hopes of pressuring the other side to capitulate. This too isn’t working, but it does make for some good sound-bites that might be helpful in campaigning next year. And it surely confuses, angers and scares the electorate.
Before we close for this edition of ‘ceiling watch’, let us reiterate our position that even on August 2nd, or on August 6th, there will be no default on US Treasuries. First, we have revenues pouring into the government from tax withholding, user fees and other sources that will allow the government to pay interest on the debt. The debt ceiling does not prevent the Treasury from rolling-over maturing debt into new debt, so maturing debt will be paid. There will be no default. Most government services will continue. The odds are real good that grandma will still get her Social Security check. We’re confident that uniformed military personnel will get paid. There will be massive furloughs of government workers. There will be delayed payments to vendors like defense contractors. Payments to states for various programs will be delayed or forgiven. But, the debt will be paid. Just like a family in tough financial times, tough choices will have to be made. The light bill will get paid, the groceries will be bought, but the credit card may get postponed.
The US trade deficit rose to over $50 billion in May from $43.6 billion in April. The higher cost of imported fuel accounts for most of that rise. When you buy 10 million barrels each day, a rise from $80 a barrel to $110 a barrel makes a huge difference in your external deficit. To make matters worse, US exports actually fell for the first time in years, falling less than 1%. So, despite trashing the dollar, which is supposed to help our trade posture, our exports have now fallen and the trade deficit has risen to historic highs. If anyone is listening, please stop the trashing of the dollar. It doesn’t help.
The Federal budget deficit for June was $43 billion, much improved from June 2010, but still a big number. For the fiscal year to date (which began October 1, 2010) we are $970.5 billion in the hole. Before the year is over, it is expected to hit $1.65 trillion. Notably, June is one of the months when higher income taxpayers are supposed to submit their estimated payments for their 2011 income tax. This is also the last such month this fiscal year.
Retail Sales rose by 0.1% in a small surprise report. The expectation was for a small drop in retail sales last month. So, even the pale rise was a positive surprise. Gasoline sales fell due to price declines, while auto sales rose 0.8% to pace the gain. The retail sales figures are not adjusted for price changes, so any retail price inflation in June will overwhelm this paltry gain.
Producer prices fell by 0.4% in June according to the Bureau of Labor Statistics. Fuel prices fell by 2.8%. Food costs rose 0.6%. The core version of this index (excluding food and fuel) rose 0.3%. In the past year, producer prices have risen 7.0% while the core rate is 2.4% higher.
Consumer prices fell by 0.2% due largely to gasoline prices dropping substantially over the course of the month. Clothing prices, medical costs, cars prices and food prices all rose, but the 6.8% drop in gas outweighed all of that. However, the core index, which excludes food and fuel, rose by 0.3% on the month. For the last 12 months, consumer prices have risen 3.6% and the core version 1.6%.
Industrial production rose 0.2% in June on strength in utility output. The report was disappointing as most economists expected a bigger bounce back after the disruptions caused by Japan’s earthquake and tsunami.
Capacity utilization was unchanged at 76.7%, still below the 80% level that would auger a bigger threat from inflationary forces.
Consumer sentiment fell to 63.8 from 71.5 in the latest University of Michigan/Reuters survey. The drop was much bigger than expected. All segments of the survey, current conditions and expectations, saw significant drops. Don’t worry about this though. Consumer sentiment is a lagging indicator. This largely reflects the damage already seen in the economy, it doesn’t really predict anything. Even the buying plans survey in the consumer confidence poll doesn’t forecast buying plans very well. Why we even bother with this is beyond us.
Another wild week for stocks that took us nowhere. The earliest reporters have shown that there might be life in this quarter’s earnings after all. But, the macro picture is what people are focused on. When Chairman Bernanke spoke with the House of Representatives last Tuesday, the market liked what he said and skyrocketed. But, on further consideration, The Beard didn’t say anything new or declarative, so the market slipped after he was done. The following day, The Beard himself threw cold water on his followers when he spoke to the Senate and clarified that he hadn’t really said anything. So, we were off on another week of jumping myriad trends that went up and down all week long.
The net of all this frantic jumping was a decline in most US indexes. At least the large caps didn’t fall as much as the small caps and basically anything that went up one day would go down the next. Stocks fell from roundly 1.5% on the largest caps to nearer 3% on the smallest.
Foreign stocks did much the same thing even if they were jumping on entirely different trends for entirely different reasons. Most developed markets fell for the week, Europe falling further than Japan and resource countries falling less than manufacturing and service economies. Emerging markets fell somewhat less, with China actually eking-out a gain.
Bonds did better, though most developed bond markets are extraordinarily rich, with yields near historic highs nearly everywhere. Japanese rates have been absurdly low for a couple of decades with little to show the benefit of low rates. Germany has rates below 3% while Greece must pay 17% and Italy 6%. British rates, like ours, are below stated inflation rates. Bonds don’t seem to be a good deal anywhere, yet they still go up on a week when risks seemed closer than opportunities.
Real estate securities tended to fall like equities last week. That may have been due to the new focus on financial shares, with the major banks coming under renewed scrutiny for their mortgage underwriting from years gone by. European banks went under examination again with further stress-tests to show that most banks have adequate capital for a severe business cycle, but not enough to handle worst-case scenarios.
Commodities tended to have a pretty good bounce from short-term oversold levels. Energy lagged the agricultural sector and the metals.
Have a great week.
Karl Schroeder, RFC, CSA
Investment Advisor Representative
Schroeder Financial Services, Inc.