08 Oct 2010 Gradual Improvement Not Good Enough

As the manufacturing side of the economy shows signs of fatigue, the much larger service sector appears to be waking up. Tuesday’s strong report sent the Dow Jones Industrials up almost 200 points or 1.8%. But the pickup is not nearly fast enough to generate sufficient job growth to cut into the 9.6% unemployment rate reported today.  

The Labor Department reported today that the US lost 95,000 jobs in September, more than economists’ estimates. The additional 64,000 jobs produced by the private sector were not enough to offset government cuts by state and local governments and the federal layoffs of temporary census workers. Economists expect unemployment to average 9% through all of 2011. The high estimate does not necessarily preclude economic growth. Rather, as new jobs are created, workers that previously left the workforce will re-join the unemployed workforce roles as they seek jobs.

A closer look at the weekly jobs data reveals some good news. The Challenger Job-Cut Report showed that layoff intentions declined modestly in September. But the best news was that hiring intentions for the retail sector soared to 114,000 in September, a huge jump from a year ago when retail hiring totaled only 2,000.

The government’s weekly jobless claims report showed incremental improvement. Those laid off workers receiving initial benefits fell 11,000 in the Oct. 2 week to a lower-than-expected 445,000. Those receiving continuing benefits fell for a fourth straight week, down 48,000 to 4.462 million. The four-week average of 4.511 million is slightly lower than a month ago according to Bloomberg.

The non-manufacturing sector which represents two thirds of the US economy and employs more than four of every five private-sector workers is showing renewed vigor. The ISM’s non-manufacturing composite rose more than 1-1/2 points to 53.2, which is in line with the year’s trend of 53.6. The WSJ noted that of the 18 industries tracked, 11 reported growth in September from August; including management firms, wholesalers and retailers.

Manufacturing, which has singularly sustained the economic recovery to date, is beginning to weaken. On Monday, the Commerce Department reported that their ISM survey of purchasing managers of manufacturing companies showed that growth cooled a significant 0.5% in September. On a positive note Bloomberg noted that non-defense capital goods orders excluding airplanes rose by 5.1%, which is a good indicator of business investment.

Political trends increasingly threaten manufacturing. Politicians are bending to voter pressure for protectionism. The movement looks to defeat congressional approval of pending free-trade pacts with South Korea and Colombia. The latest Wall Street Journal/NBC News poll shows that more than half of people surveyed, 53%, said free-trade agreements have hurt the US, up from 46% three years ago, and 32% in 1999.

Bill McInturff, a Republican pollster who helps conduct the Journal survey said “the important change is that very well-educated and upper-income people compared to five to 10 years ago have shifted their opinion and are now expressing significant concern about the notion of…free trade.” You history buffs may remember that it was the Smoot Hawley Tarriff Act of 1930 that prompted retaliatory tariffs by US trading partners which reduced American exports and imports by half, triggering the Great Depression.

Former Fed chairman Alan Greenspan spoke out this week on what he sees as the greatest current threat facing America – the US fiscal deficit. He called it “scary” and said the federal government must cut spending on entitlements. “We’re involved in a dangerous game,” Greenspan said yesterday at a foreign-exchange conference in New York. “We’re increasing the debt held by the public at a pace that is closing” the gap between our debt and “any measure of borrowing capacity,” Greenspan said. “That cushion is growing very narrow.”

Bloomberg reported that Greenspan went on the say that US companies may be holding back on investment because of the rising federal deficit, which causes uncertainty about future tax policies, Greenspan said in an opinion article for the Financial Times this week. Weak investment by businesses in capital equipment and fixed assets has helped to crimp the U.S. economic recovery, he said. “You need” austerity, he said. Greenspan reiterated that he supports allowing tax cuts enacted under President George W. Bush to lapse at the end of 2010.

Another notable spoke to America’s ailments this week. Warren Buffet at Fortune Magazine’s Most Powerful Women conference in Washington said Wall Street is like a church that benefits society, then falters by operating a gambling venture on the side. Wall Street “does a lot of good things and then it has this casino. It’s like a church that’s running raffles on the weekend.” He said “people have a propensity to gamble, and it gets made easier and easier for them. One of the problems we still have is we have unbalanced incentives for managers of huge financial institutions.”

Then the ‘Oracle of Omaha’ moved on to tax policy. The increasingly politically outspoken billionaire boasted “I have no tax shelters, I have no tax accountant, my tax shelter really was the Bush administration. They took care of me. They thought here’s this endangered species, kind of like the bald eagle out in Omaha, and if we don’t take care of this guy they’ll all quit working and we won’t have any arbitrageurs or hedge fund operators. So we’ve gotta give this guy a special kind of break. . . . If you’re not going to get it from guys like me, why should we get it from the people who served us lunch today?”

Lastly, the oracle gave some investment advice to the herd which follows his every whisper. He said his businesses are “coming back” after the recession. In his opinion investors buying bonds after yields fell this year “are making a mistake. . . it’s quite clear that stocks are cheaper than bonds. I can’t imagine anyone having bonds in their portfolio when they can own equities.” Surprisingly, no one asked Mr. Buffett; why does Berkshire Hathaway own $33 billion in bonds in its investment portfolio valued at $107 billion as of the June 30, 2010 quarterly report?

We believe that investors who are saving for important lifetime goals are ill-served by taking trading advice from billionaires, financial talking heads, and hedge-fund gurus. Mr. Buffet wisely pointed out that “people have a propensity to gamble, and it gets made easier and easier for them.” Yes it does Mr. Buffett. You advise all who are listening to buy nothing but stocks now because they are “cheaper than bonds.” Will you be there to tell them when stocks have become expensive relative to bonds? Shouldn’t you tell them too that the odds of losing money in an all-equity portfolio are 1 in every 4 years compared to 1 in every 8 years for a 70%/30% Treasury/Equity portfolio? What about the size of the worst annual losses in stocks – 45% which compares to only 15% in the more conservative portfolio? Oh and the difference in average return – 11.5% vs. 7.6% over the past 75 years and 9.25% vs. 8.67% over the past 30 years.

We realize that a 70% Treasury and 30% equity portfolio is not right for everyone. That is why we continually monitor our clients’ funded status, adjusting our recommendations when necessary. Portfolio allocation of stocks and bonds is but one of the many factors that comprise our advice: spending, savings, giving, goal timing, and career length are some of the other factors. And our advice is always tailored to our client’s unique goals and priorities. Point is, Mr. Buffett has no idea of the investing requirements of his audience. He provides an incredibly valuable service to the stakeholders of Berkshire Hathaway, but he would (or should) be the first to say that he does provide individual investment advice. Have a plan, monitor it, and stick to it.

Have a great weekend.