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& G e n e ra l Re a l i ty

Re b u t t a l

- Shane Obata-Marusic

This month’s Media Matrix comes in the form of a rebuttal to a mainstream article on the economy. Shane had a hard time swallowing what was being sold (can you even stand the smell?) and put together a thoughtful and insightful reply. The Globe & Mail would not print his rebuttal, however we will!. Enjoy!

Shane Obata-Marusic The original article from the Globe & Mail can be found here. Charts from the original article can be found here. Sections of the original article, charts, and Kevin Carmicheal's comments are presented first, with Shanes rebuttal following.
Kevin Carmicheal, Intro: But away from Wall Street, the story of the real economy has changed little in recent weeks. If anything, it is getting better. After several false dawns, companies are finding their footing and getting ready for future growth. A host of indicators – from home prices to jobless claims to government deficits – point to an economy that is healthier than it has been since the financial crisis. It’s getting harder, in fact, to argue that this recovery lacks staying power. The green shoots that Federal Reserve Board chairman Ben Bernanke first mentioned in 2009 finally are transforming into something more substantial. President Barack Obama’s ill-fated “Recovery Summer” tour of 201 0 came three years too soon.

A Star-Spangled Recovery: Why the U. S. Economy is Showing Signs of Life

Rebuttal to: Kevin Carmicheal's

The great American non-recovery

The US economy has not improved in a meaningful way since the financial crisis. The central banks of the world, led by the Federal Reserve, continue to pursue reckless and unprecedented policies that fail to address the underlying structural problems of their respective economies. We have not yet achieved the level of growth that we expected to achieve when these policies were first implemented. In spite of this reality, the central banks have been using the same strategy since 2008. Even though there are some bright spots in the American economy, all improvements must be viewed relative to the amount of debt that has accumulated. Since 2008, the US government has added close to 7 trillion dollars in debt; national debt now amounts to approximately 1 7 trillion dollars. What has all of that debt helped the US to achieve? The weakest recovery in recent history.
(cont pg.71)

Shane Obata-Marusic

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Rebuttal (cont.)

Remember the Standard & Poor’s downgrade? The debt ceiling? The “fiscal cliff”? In a shift, the U.S. is entering a phase of budget calm instead of hurtling from crisis to crisis. The Congressional Budget Office last month slashed its deficit estimate for the fiscal year ending in September to $642-billion (U.S.), or about 4 per cent of gross domestic product, which would be the smallest shortfall since 2008. The across-the-board cuts in the “sequester” are part of the story, but the bigger factor is increased revenue. An aging population still threatens to reflate the deficit through higher demands on Medicare, the health program for seniors. But that’s several years away. For now, a shrinking deficit promises to bolster confidence and lower the temperature in Washington. S&P this week changed its outlook on the U.S. to “stable” from “negative,” saying politicians have some “breathing room” to sort out longer-term budget issues. Regardless of whether or not the US is able to reduce its stated budget deficit is beside the point. One must consider the projected increases in entitlement spending – i.e. liabilities that have been acknowledged but not accounted for – to truly understand just how bad the fiscal scenario actually is. Social spending and total government receipts represent 1 3.82% and 20.43% of GDP, respectively. If these two percentages were equal, then “it would mean that it [would take] all the money collected by the Federal Government to only cover social spending.
(cont pg.72)

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Rebuttal (cont.)

Every recovery needs a housing boom, and the U.S. finally has one. Prices for existing homes are rising, and supply is relatively tight, good news for contractors – and sellers. The cities that came to exemplify the housing bust now are leading the turnaround. Prices in Phoenix rose 22.5 per cent in March from a year earlier, according to the most recent reading of the S&P/CaseShiller big-city price index. That was faster than technology hotbed San Francisco, where prices increased 22.2 per cent. Prices in Las Vegas climbed 20.6 per cent. Building permits, an indicator of future construction, increased 1 4.3 per cent in April, to an annualized rate of 1 .02 million, the highest since June, 2008. Building activity is on the rebound because there is a lot of ground to be made up. From the beginning of 2000 to the end of 2006, single-family housing starts never were lower than an annualized 841 ,000 and more often topped one million. In April, the figure was 454,000. There is some concern that the recent jump in mortgage rates could snuff out demand. But that seems unlikely. Mortgage applications increased 5 per cent in the week ended June 7, even as 30-year mortgage rates crept to their highest in more than a year.

It’s undeniable that the US housing market has gotten better since the financial crisis of 2008. That said, most of the improvements can be attributed to speculative buying – i.e. buying property in order to sell it or rent it out in the future – and withheld supply. Because the average American now has less purchasing power than he/she did in 2008, new one-family home sales are only around half of what they were in 2000.

(cont pg.73)

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Rebuttal (cont.)

The U.S. should be growing at annual rates of about 3 per cent. Instead, the economy will do well to grow at a pace of 2 per cent in the second quarter. That’s because of “fiscal drag,” which mostly is represented by the blunt, across-the-board cuts that Washington failed to finesse earlier this year. But austerity is running its course at the state and local government level. Government revenues are bouncing back, partly because of the housing rebound, which brings in property and development taxes and benefits lower levels of government more than Washington. Nominal state spending is projected to rise 4.1 per cent in the fiscal year that ends June, 201 4, according to the National Association of State Budget Officers. In May, state and local governments hired more workers than they fired for the first time since June, 2009. Government spending does not define an economy; savings and business investment do. Although the US government continues to increase spending, businesses are not making capital expenditures. On a year over year basis, revenue growth for most businesses is either negative or stagnant. This is due to the fact that average consumer is not doing well; real median household income has fallen to $51 ,01 7 – a level not seen since 1 996. Businesses are doing whatever they can to improve profitability because they can’t increase their sales. In the short run, cost cutting strategies might prove to be effective. That said, businesses that do not invest in capital will not be able to grow over the long term. The downtrend in capital formation does not bode well for the economy.
(cont pg.74)

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Rebuttal (cont.)

The weakest element of the U.S. economy right now is manufacturing, as weak global demand stifles exports. That’s a headwind, but not a body blow. The U.S. still is a consumption-based economy, as domestic spending accounts for more than 70 per cent of gross domestic product. And guess what? U.S. consumers are raring to spend. Housing and automobile sales are surging. There is every reason to think this is a trend. The U.S. dollar is getting stronger, making imports cheaper. Gasoline prices are falling, saving consumers money. The manufacturing industry has stalled, but services – representing the bigger part of the economy – continue to grow. Consumer confidence readings are at their highest levels since before the financial crisis.

Wage growth is stagnant and purchasing power of the dollar is in decline. Regardless of what the consumer sentiment index says, in terms of real wealth, the average American is worse off now than he or she was in 2008. As a result, Americans “are losing confidence that they’ll have enough money in retirement”.
(cont pg.75)

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Rebuttal (cont.)

The Labour Department’s nonfarm payrolls report – the one that gives the unemployment report – galvanizes the market’s attention. That’s a little odd, considering that the estimate has a wide margin of error and is backward looking. Todd Groome, a consultant and former International Monetary Fund Economist, prefers to watch the four-week moving average of weekly initial jobless claims, which dropped to 345,250 in the first week of June. Mr. Groome says a four-week average of about 350,000 correlates with non-farm payroll growth of 200,000 – the level needed to start significantly lowering the unemployment rate from its current level of 7.6 per cent.

The unemployment rate (# of unemployed/labor force) is no longer an accurate indicator of the health of the labour markets. This is due to the fact that 1 0 million people have left the labour force in the past 4 years. Even though the unemployment rate has been in decline since 2009, the employment rate has not increased accordingly. In addition to that fact, many of the jobs that have been added in the past 4 years are low-wage jobs. When it comes to the strength of the labour markets, quality is more important than quantity. Despite the fact that initial jobless claims are down 308,000 since ’09, the labour markets in the US are worse off than most people think that they are.
(cont pg.76)

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Rebuttal (cont.)

Global trade is in stasis because Europe is in recession and Chinese growth slowed to hot from white hot. Trade will rebound eventually, and when it does, the U.S. is poised to dominate. The productivity of the U.S. tradable goods sector is dramatically stronger than other developed countries, according to research by Michael Dolega, an economist at TorontoDominion Bank. The country’s oil and gas boom is lowering costs for manufacturers and transportation companies, and the still-elevated unemployment rate is keeping downward pressure on wages. As a result, more and more factories are being built or expanded. Manufacturing jobs won’t ever reach the levels of decades past, but they will increase from current levels.

Despite the recent bounce, the ISM manufacturing (Institute for Supply Management) new orders/inventory balance has been in decline for most of the last 11 years. Furthermore, growth in hires for durable goods manufacturing trending downwards since 201 0. Unless the US government lowers corporate taxes, it’s likely that multinational companies will continue to invest in manufacturing facilities in other countries.

(cont pg.77)

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Rebuttal (cont.)

World-beating American companies such as Apple Inc., Nike Inc., Goldman Sachs Group Inc. and Deere & Co. dominate the headlines. But smaller companies are just as important to the U.S. economy, if not more so. Companies with 500 and fewer employees have created 80 per cent of the jobs this year, according to Automatic Data Processing Inc. Smaller businesses have had it tough during the recovery. They have found it harder to obtain credit and are not as wellequipped to deal with the changes demanded by President Barack Obama’s health care policy. But there are signs these firms are about to turn a corner. The National Center for the Middle Market, a Columbus, Ohio-based research group that studies companies that earn between $1 0-million and $1 -billion annually, polls 1 ,000 executives of such companies quarterly: Almost threequarters of those executives said they are confident in their local economies in the first quarter, compared with 70 per cent a year earlier. The National Federation of Independent Business’s activity index is showing signs of life. Regardless of the recent gains in small business optimism, index values are still at recessionary levels. In addition, although the % of NFIB respondents planning to increase employment has increased since 201 2, actual changes in employment have stayed flat. Lastly, the % of NFIB firms expecting the economy to improve has been declining since 2009. If multinational corporations aren’t able to grow their revenues then how are small businesses supposed to?
(cont pg.78)

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Rebuttal (cont.)

In conclusion, if you’re counting on the US economy to lead the global recovery then you’re waiting on a miracle. At some point in time the US will be forced to deleverage; i.e. it’s becoming increasingly probable that the US will default on their debts. If and when that happens, the poor decisions that continue to be made by our central banks will be plain for all to see. In the meanwhile 1 ) The rich will get richer

2) The poor will become increasingly dependent on the government for support

(cont pg.79)

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Rebuttal (cont.)

And 3) the middle class will fade

In order for the US to improve its prospects for the future, it must first learn from mistakes made in the past.

- END -

Shane Obata-Marusic

A graduate from the University of Western Ontario, I am actively pursuing a career in the markets with a focus on macroeconomics. Having completed the Canadian Securities Course and the CFA level 1 , I am seeking any opportunities. Previously I have researched and written reports as an Equity Research Intern for Euro Pacific Canada (Toronto).

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