About Me

Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!

Sunday, December 28, 2008

Economy & Liquidity

During periods of recession, it is right as rain for consumers, banks
and businesses to rebuild cash and cash equivalent liquidity. Since a
serious downturn can add more uncertainty to the outlook, the
rebuilding of liquidity can intensify during such times.

Real personal wages have rapidly turned positive in this quarter
as inflation has subsided quickly and dramatically. Normally, when
the real wage improves, spending quickly follows, and the desire to
build liquidity slowly wanes. So far, that has not happened, as
spending has remained weak and liquidity balances are rising. This
is partly attributable to the shock of a rapid decline in the economy
since late summer, but it may also reflect a desire by householders to
add to savings to offset sinking 401k and home values. If the latter is
so, then we might expect the period of liquidity enhancement to be
stronger and last longer than in prior recession periods, despite low
available rates on savings. The test of liquidity preference is
underway now, since the real wage has recovered quickly, with the
normal expectation of higher spending to follow now in the spotlight.
I would also say if consumers as a group plan to alter budgets to
accomodate more cash on hand to offset losses in asset values, that
stimulative monetary and fiscal programs may not be very
effective for a while until liquidity cushions are fattened further. I
would also point out since 2005, 2 million boomers cross the age 60
threshold annually, when liquidity preference naturally increases.

Banks are not liquid, and the natural process of improvement is to
allow loans to run off and liquid investments to rise. This process
has actually been slow to get underway. Banks are also taking
massive loan writedowns each quarter. This restains capital growth
and it is likely that the bulk of the rest of the TARP program will have
to be released to banks and other credit intermediaries to rebuild
capital. A big test for both consumers and the banks will come this
spring when more nearly affordable homes are prospected by
folks looking to buy (Improved affordabiltiy reflects both lower
prices and mortgage rates).

Business sector liquidity was well repaired after the 2001-02
downturn. However, my profits indicators have fallen dramatically,
and non-financials may want to further shore up liquidity if cash
flows sink as now expected.

As a recession winds down, the capital markets can rally nicely even
as sectors rebuild liquidity, as investors see such a process as normal
and healthy. The hitch comes in if consumers, banks and business
are seen as too zealous in propping liquidity, for that would mean
that recovery may be further afield then expected.

I take the dramatic weakness in the capital markets over the past 15
months as a sign that fundamental changes may be in store and that
one should treat the tried and true assumptions with more reserve.

A first stop for me vis a vis the economy is to watch consumer
spending now that the real wage has recovered sharply.

1 comment:

Doug Gryder said...

Money---Supply, Velocity, and Loss of

We all know that the money supply has been increasing, and many have been surprised at the decline in prices that has accompanied the recent "growth" of the money supply. We all know that inflation is a monetary phenomenon, Right? Yes that is right, but lets take a closer look at what is happening with the money supply and the velocity of money. If inflation is a monetary phenomenon and money supply is increasing, why aren't we already seeing inflation? During the time that the money supply has been growing the velocity of money has been declining---at an alarming rate. Why has the velocity declined. Financial innovations---such as those nasty Collateralized Debt Obligations (CDO's) increased the velocity of money. These innovations were "productively" increasing the velocity of money when they were created and when all was well with their value. As the credit crisis evolved--we had to unwind all of the "productivity" that was gained through the use of these "darling turned ugly duckling instruments". This unwind took its toll on the velocity of money and the real damage will be the unseen damage that is yet to come. What unseen damage? The damage that will be done as the velocity of money declines as these instruments are "cleaned up". The decline in velocity caused by the unwind of these instruments has contributed to the false sense of "deflation" that has gotten so much attention from many "talking heads" lately. We know, through both common sense and historical numbers that the velocity of money declines during recessions---sometimes sharply. During a NORMAL economic cycle, the decrease in velocity would be normal as central banks would increase the money supply, get the economy going again and then the velocity would again rise.

Read the rest of the article at www.stockshotz.blogspot.com