Ravengate
Partners - Stock market, economic and political commentary by Patricia Chadwick

It seems that some days all news is good news to the stock market and the next day all news is bad news. And other times it seems as though the stock market extrapolates one single economic indicator as though it alone matters.

No doubt the May 6 “Flash Crash” has spooked many investors, most particularly individual investors who were just getting their sea legs after watching their life savings decimated in 2008 and early 2009.

It is evident that the economy is improving. But the momentum is too slow. What the market wants to see is substantive job growth – not public sector jobs but private sector jobs. Over the next several quarters, as the Federal Government’s stimulus program winds down, we will experience a decline in jobs that were funded by that program. I, for one, would be happy to see Congress forfeit all the pork it packed into the back end of the stimulus package (which is not stimulus at all) and spend that money now finishing what was some way overdue spending on roads and bridges across this country. That would be money well spent.

What we need now is new private sector jobs. Since the onset of the recession and so far through the first phase of the recovery, the corporate sector of the U. S. economy has done a masterful job of reducing costs, enhancing productivity, maintaining a pristine balance sheet and fortifying cash flow. But as a country and as an economy, we cannot be prosperous with an unemployment rate of anything close to 9% – 10%.

The US economy differs from economies in Europe in many ways, but most particularly in the fact that the primary driving force in our economy is capitalism, whereas in Europe, the role of Government is far more pervasive on economics and growth. As an example, for decades now the Government has provided the vast majority of the job growth in France.

Despite the increasing encroachment into the private sector of the U.S. economy by Government, through regulation, taxation or outright confiscation of authority, there is still a vast opportunity for private entrepreneurship, job creation and wealth in this country. It is a well known economic fact that in the U.S. job creation is derived from new, small companies. That will and aspiration has not died or even gone dormant. What it needs is some fuel.

Unfortunately, SBA (the Federal Government’s Small Business Administration) has sharply curtailed its spending. So too have private sector banks, as they try to get their overleveraged balance sheets back in shape.

But the corporate sector does indeed have cash and cash to lend. And so do credit unions. And it is encouraging to see that those non-traditional lending sources are opening up their spigots and providing funding for growth.

In the next few months, we will witness the shedding of Government jobs – seasonal census workers are already being dismissed and many state and municipal employees are likely to lose their jobs as state and local governments work to close their budget deficits. Those jobs should indeed be shed.

The U.S. economy is in far better shape than it was just two years ago – consumers have pared down their bloated balance sheets, have added to their savings and have started living within their means. That is good. On the production side on the economy, corporations have cut costs and have reaped the rewards in giant sized productivity gains as demand has slowly improved.

As growth continues, and I admit that the growth will be gradual, that stupendous improvement in productivity needs to be converted into new jobs. Only in that way will the growth feed on itself and be self sustaining. When the first inkling of solid new job creation is evident, I believe the stock market will break out on the upside.

Patricia W. Chadwick
President
Ravengate Partners LLC

July 19, 2010

There has been lots of haranguing and hand wringing about the level of U.S. debt, fiscal irresponsibility, the rampant printing of money and the ultimate inflationary impact from the profligacy of the current fiscal and monetary policies in this country.

But I think that view is missing some important points. Yes, the U.S. debt level is high and if spending continues unchecked, it will become a problem. But deficits and rising debt in the midst of a recession are inevitable. We have been there before – in fact many times since World War II. But we have reversed course when the economy improved and we can do the same this time as well.

Cutting off unemployment benefits will do absolutely no good and lots of harm. People who have been just holding on financially will fall off, and there is no economic benefit from that.

Raising taxes will only serve to impede economic growth. There must be concrete signs of real economic recovery before trying to solve the deficit. When the recovery has truly taken hold, then tax receipts will rise and tax rates can also be raised.

But the real problem that faces the public sector – Federal, State and local – is its lack of accountability, its lack of competitiveness and its bloated cost structure. That is where the knife needs to be used.

The private sector is lean. In fact, the corporate balance sheets of U.S. companies are in the best shape they have been for decades. Corporations are flush with cash; they don’t need to borrow and they can and are investing. Productivity continues apace, proving a point Jack Welch used to make over and over, “Productivity is infinite.”

Even the consumer is getting into better shape. Savings rates are up; spending is more in line with earnings and balance sheets are improving.

But the public sector – which is aggregating more power and scope, as the U.S. Government gets its tentacles into health care, banking, housing and energy – is a mess, to put it bluntly. Public sector wages and benefits exceed those in the private sector on a per capita basis!!! Featherbedding is the name of the game in the public sector and that, together with benefits that seem mindboggling to employees in industry, is what is wreaking havoc with deficits at every level from the White House to Main Street.

Once upon a time, public sector jobs paid less than private sector jobs – compensation for relative job security and guaranteed retirement benefits. Today, those same jobs command a premium in pay, but have foregone none of the benefits. The collective bargaining system in the public sector is broken. Elected officials at all levels of Government are beholden to the votes of union members, so there is little incentive for them to negotiate the kinds of cuts that are necessary to reduce costs and deficits.

It’s time for private industry to assume the management of entire chunks of the public sector. How about starting with the U.S. postal system at the Federal level and the Department of Motor Vehicles at the state level?

Patricia W. Chadwick

President, Ravengate Partners LLC

June 29, 2010

Last week’s employment numbers were worrying; this week the indication seems that maybe jobs are increasing.  Next week will tell us more and the week after that some more.

Suddenly the market seems to be extra jittery about these numbers, and triple digit moves in the Dow Jones are a nearly daily occurrence.  Why the sudden panic?

After a monumental depletion of inventory in our economy, with “nothing left on the shelves” so to speak, the U.S. economy has benefitted from a significant inventory rebuilding.  It has added meaningfully to GDP over the last two quarters.

Now comes the moment of truth – will the consumer maintain the pace of acceleration in spending or are we entering a period of economic slowdown, incurring fears of a possible W shape to the economy (down, up and then down again before really getting back on track).

Retail investors, who have been guarded in their return to the markets over the last 18 months, appear spooked by the recent volatility as indicated by the significant redemptions in mutual funds.   And they have reason to be, despite some really good news.

Here’s the good news:

Corporate balance sheets for American companies are in great shape. Continued productivity gains are enhancing companies’ cash flow and profits.

Earnings growth will be excellent this year and most likely again next year.

To the extent that the stock prices reflect profits and the trend in earnings, the market’s correction we have been experiencing over the last month provides a good opportunity for long term investors.

So what is the problem?

The problem lies in the vast middle of our economy – those small to medium sized companies that are not publicly traded, companies which cannot get the access to capital as large companies can.  Without their participation in the recovery, unemployment will stay unacceptably high, because those are the companies that make most of the new hires.

In addition, State and local governments are being forced to make cut-backs because, unlike the private sector, their balance sheets are in bad shape and their cash flow is negative.

And to top it off, the economic stimulus program is going to be winding down just as Federal taxes take a giant step up.

I don’t believe these negative forces will result in another recession, but I am sure they will dampen demand at the margin.  And the markets do not like uncertainty.

But relative to where the economy and the financial system stood only 18 months ago, this is heaven.  From my standpoint, that means that panic selling is an opportunity to buy stocks.  I think we may have quite a few of those opportunities over the next few quarters.

In Today’s Wall Street Journal (Saturday, June 5, 2010) there is a must-read op-ed by Bari Weiss entitled Storming the School Barricades.   Using Dragnet’s Joe Friday comment, it is “just the facts, ma’am”.  Here is the link

For the last six months or so, the economic news in the US has been pretty good. Productivity has soared and most of the economic reports have been going in the right direction, producing a recovery that is not stellar but better than what we had. Given that fact that the real estate market remains in crisis mode, with the supply/demand characteristics indicating a long and painful restructuring, the rest of the economy has put in a pretty good showing.

But lurking in the background have been a number of issues that eventually would come to the fore. Primary among them were (1) the end of the one time home-buyer tax credit, (2) the wind-down of the Government stimulus program, (3) significant Federal tax increases, and (4) increased belt tightening by state and local governments.

Now the fiscal crisis in Europe threatens to add a new dimension to thwart the economic recovery in this country. The dollar’s strength – or better said, the Euro’s weakness – has been so precipitous that it could jeopardize the ability of the U.S. to improve its own trade deficit. Euro-sclerosis has long impeded job creation, as the non-profit Government sector of the economy has been the primary source of job growth for much of the area. It is almost inevitable that the Governments of most of the European Union countries will be forced to lay off workers, to cut back on far too generous benefits and to engage in years of belt tightening. That will not be good for economic growth.

It is too early to tell how much of an impact Europe’s woes will have on our economy here in the U.S., but for sure the impact will not be positive.

This week will bring a number of early indications of the trend in the recovery on the home-front – jobs, home sales, productivity and construction. They will start to tell the story, but it will unfold slowly.

The recovery looks as though it may be turning into some sort of W.

Listening to Warren Buffett as he discussed Goldman Sachs on Squawk Box yesterday morning, I was struck by both his eminent business sense as well as his common sense. His assessment of the securities firm and its CEO, Lloyd Blankfein, was reasoned, and was based on his many years of dealing with the company as well as his own immensely sound and proven business acumen.

Mr. Buffett understands risk and how markets work. He knows that in the world of buying and selling complex financial instruments, responsibility is a two way street. Caveat emptor. The buyers of the instruments at issue were not naïve individuals, unfamiliar with the vicissitudes of the market; rather, they were sophisticated investors, looking for a risky investment with a kick. Mr. Buffett admitted to making mistakes of his own, to failing to see the bubble in the residential real estate market. It was reassuring to hear him make that admission.

What a far cry his interview was from the experience last week of listening to the many U.S. Senators (on both sides of the aisle) grilling Goldman Sachs employees. It was plainly evident that none of the Senators comprehended the financial instruments at stake. Rather they were grasping at headlines – grandstanding, haranguing and trying to intimidate – force feeding isolated words and phrases to make theatre and to obfuscate their own enormous culpability in the real estate bubble and its subsequent bursting. Unlike Mr. Buffet who readily confessed that he isn’t right all the time, not a single Senator admitted to pressuring the banks to relax mortgage lending standards. Nor did any of them mention Fannie Mae and Freddie Mac, for which they have oversight and which have been so preposterously mismanaged.

The Federal Government is powerful, more powerful than any corporation in this country. If it wants, it can destroy a company, because it has infinite staying power and no profit motive. That is precisely what it did to Drexel Burnham, to Arthur Andersen, to Lehman Brothers. It can create an environment that makes it expedient for customers to abandon a company and for employees to jump ship. And in that way it can bring down any company if it so chooses.

Rather than admit their own involvement in the global financial crisis, Congress and the White House appear bent on finding scapegoats. Wall Street is an easy target, and the most profitable of the Wall Street firms is the easiest and most expedient target. And Congress, given its miserably poor standing in the polls, is hoping that by vilifying the private sector they will find redemption. That will not work.

Financial reform is needed. The citizens of this country would be well served by thoughtful and reasoned legislation that would mitigate the risk associated with rampant leveraging. If Congress really wants redemption, let it admit its own errors and work together with the private sector in the best interests of the people it is supposed to serve.

November cannot come too soon.

There is a large part of the U.S. economy that is not on investors’ radar screens. I am not referring to the underground economy or the barter trade economy or the money that is paid to illegal immigrants.

The invisible economy is much bigger than that. It is the vast part of our GDP that is not measured by stock prices on stock exchanges. I am talking about the “Ma and Pa” entities, the family run businesses, the real estate companies, the printing presses, the restaurants – companies not publicly held because they are either too small or because they prefer to remain privately held. They are the primary engine of job growth in this country. Many, many of them are profitable and well managed. Some of them are quite large. But most of them are small, and therein lies the problem.

As the banks continue to deleverage and shrink their over-bloated balance sheets, they must of necessity lend less. They are happy to lend to the Federal Government, which may have a dreadful balance sheet but is considered a good risk. They are even happier to lend to large, publicly traded and already well-financed corporate giants whose earnings have been improving. Fortunately, there are more and more of those companies these days which is good news. The banks are also increasingly lending to homebuyers, now that the risks have been mitigated due to lower home prices and increased down payments.

But left out in the cold are so many small companies with good business plans and positive working capital and profits. It is those companies that have been ignored or denied capital, as the banks have restructured their balance sheets. Without bank financing, many of them cannot carry on business, much less grow.

There is no lobby for this large and silent sector of the economy, no spokesperson to plead their case to the Government or to the banks for them. If they are left without access to capital, they will eventually fail and that will be a serious problem for employment growth and for sustained economic expansion.

The current burgeoning recovery in the economy is evident in the earnings of many our biggest companies in a wide array of industries, and their stock prices are reflecting the improved earnings and the stellar productivity gains achieved. But in order for the U.S. economy to recover fully, the great unwatched and unseen segment must also participate. Today much of that part of our economy is still in recession and without the banks serving them as banks should, they will remain there.

It’s all about the delta in the economy. That is, those little bits of change that add up and have the potential to make a meaningful impact – for better or for worse.

We are seeing positive delta all over the place in the U.S. economy. On the job front, the employment numbers are getting better. On the manufacturing front, inventories are being rebuilt. On the spending front, the consumer is getting a bit more venturesome.

If you go to Craig’s List, you will see that the job postings are steadily on the increase. Try to find a carpenter (as I am doing right now) to fix the garden fence destroyed by the storm two weeks ago, and he is busy. But only two months ago, he called wondering if there was any work he might do to bring home a little extra income. That’s positive delta.

And perhaps best of all, the state of the corporate balance sheet in the U.S. is healthy, really healthy. That, together with the astounding productivity gains they have been achieving, may encourage companies to increase capital investments. That would certainly provide more positive delta.

But we all know that delta can work both ways, and we need to keep our eye on what negative delta might also be out there to offset the brightening economic picture.

Here’s what comes to mind. Will China continue to be the engine of growth in this recovery? If so, then the delta force will gather strength. If not, if in fact China’s growth is peaking, we could be in for a nasty pullback.

Will there be negative delta as the Federal Government stimulus program comes to an end later this year? It is hard to believe it won’t have some impact, but if the private sector has developed enough of its own momentum, maybe the two will wash each other out. That would be good news, because private sector demand is more sustainable and more profitable than Government stimulated demand.

What will be the impact of the cessation of the $8000 tax credit for new home buyers at the end of this month? Most likely, it will be negative delta on home sales and home prices.

What will happen when unemployment benefits start to run out? Will the delta impact be negative? Or when the census workers are no longer needed? Or what if oil prices sky rocket? For sure that will be force negative on the consumer’s pocketbook. Or if interest rates head up too soon and too fast? A few small negative bits of delta can also add up.

It’s all food for thought. But for sure right now, there are more positive bits of delta than there have been for the last two years.

In his Op-Ed piece in Tuesday’s (March 2) New York Times, Congressman Harold Ford, Jr. opined that the reason he was unwilling to run for U.S. Senate in New York was that “a brutal and highly negative Democratic primary…….[would end up] where the winner emerges weakened and the Republican strengthened.”

I think the Congressman is wrong. Harold Ford, Jr. is a leader among the truly centrist and independent political figures today, and I think he would be surprised at the bipartisan support he would receive from voters in New York.

I say this not as a resident of the State of New York (which I am not) but as a registered Republican in the state of Connecticut. Were the Congressman running in my state, I would find him an attractive candidate most worthy of my serious consideration.

As he wrote in his article, Congressman Ford is an independent Democrat. He is also a pragmatist, a thoughtful leader, a man who listens before he speaks. And when he speaks, he makes eminent common sense – something that seems virtually impossible to find today in politics.

Harold Ford, Jr. is different from so many of today’s politicians. He is not a demagogue. His ability to rise above vitriolic rhetoric makes him a better man. Our Congress is chock full of blowhards on both sides of the aisle. The election in November will (hopefully) get rid of a host of them.

We need more legislators who are pragmatists and centrists to take the helm and provide true leadership. We need legislators who can find solutions and not hide behind obstructionist rhetoric. The fringe elements of both parties today have wrested control from the silent majority. The squeaky wheels are getting all the grease, while the axle is falling apart.

Congressman Ford criticizes his own party for “having spent too much time supporting a national partisan political agenda.” The same criticism must be made of the Republican Party as well. The hidden political payoffs embedded in thousands of pages of legislative bills defy any sense of honor or standard of ethics in the legislative process in Washington D.C. Americans are being hoodwinked by their elected representatives and they have had enough of it. Members of Congress have come to realize that the day of reckoning is at hand. That is why so many of them are dropping out of the race this year.

Fortunately, there are still some honorable politicians (or is that the ultimate oxymoron). Congressman Harold Ford, Jr. has consistently been a voice of reason both in Congress and since he left the House. It is tragic that the elective process is so distasteful and destructive that it drives a good candidate from even entering the race.