Cash sitting in extremely low-interest instruments is not productive. Investing in new projects, equipment, research, employees, and so forth is. Encouragingly, the Index of Leading Indicators rose 0.3% in September, indicating continued economic expansion, which should also help bolster corporate confidence.
Housing concerns grow
Unfortunately, confidence remains shaken by continued problems in the housing market. The recent moratorium on foreclosures due to questions surrounding processes shook hopes that the housing market may be on the road to recovery. While we believe we're bouncing along the bottom as opposed to heading toward a sustained new downturn, we can't discount that possibility. Inventories remain high, and with the foreclosure uncertainty, it's likely to take longer to whittle that number down.
Inventories Need to Decline
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Source: FactSet, and the U.S. Census Bureau, as of October 25, 2010.
Additionally, the overhang of a "shadow inventory" remains. There are those who want to sell their homes but haven't due to pricing uncertainty—many will quickly put their homes on the market when improvement is perceived.
More concerning are the hundreds of thousands of houses that are in some stage of foreclosure or are being held by banks waiting for the market to stabilize. These homes are not listed on official inventory data, but will surely come to market at some time in the future.
The prospect for a near-term recovery in the housing market has dimmed in our view, although continued near-record affordability helps, and the September reading of a 10% increase in existing home sales was well above expectations.
Does confidence return?
The Fed continues to fight the battle of boosting both corporate and consumer confidence. The most recent Beige Book survey showed economic growth remains sluggish and hiring remains limited; but it was a brighter report than the recent few.
Unfortunately, the Fed can't simply wave a magic wand and instill confidence so consumers will spend and companies will hire. We don't believe that throwing more money into the economy will do a great deal of good.
We caution that a continued weakening of the dollar could have detrimental consequences as commodity prices denominated in dollars increase—raising costs for businesses and consumers.
With a likely more-divided Congress following the elections, there's a growing likelihood that the Bush tax cuts will be extended—allowing companies some increased measure of cost certainty.
Growth concerns go global
The debt hangover in advanced economies is a long-term theme, and many nations will likely pursue low interest rates and monetary stimulus amid weak growth prospects. These low rates are causing currency dislocations and are increasing the specter of protectionism. Additionally, the rush of money to high-growth assets threatens to fuel potential future bubbles.
However, valuations of Chinese stocks remain attractive, and the Shanghai Composite is still underperforming year-to-date, indicating that worst-case scenarios were priced into the market. Stronger-than-expected growth in China could be a leading indicator of better sentiment regarding the global economy, although China's recent interest-rate hike could be a concern.
Debt hangover threatens growth in advanced economies
We've discussed the impact of elevated debt many times, particularly the outlook for Southern European countries such as Greece. However, many advanced economies are converging on the 90% debt-to-gross domestic product (GDP) level that tends to weigh on economic growth.
Debt in Advanced Economies Threatens Growth
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Source: The International Monetary Fund (IMF), as of October 2010.
Growth is reduced due to rising interest rates on debt, increasing debt servicing costs and crowding out private sector growth. While Greece's problems continue, it's sometimes forgotten that other large and more-fiscally prudent economies have similar problems.
