Don’s Outlook 7/2/2009
We received new employment figures today. Unemployment failed to reach the expected 9.6 percent in June, but that was due to a continuing exodus of unemployed workers from the labor force. Job cuts were higher than expected and the U.S. markets opened with losses of nearly 2 percent.
Economic fears spilled over into commodity markets, with oil and gold losing ground. Today is shaping up as a repeat of the Tuesday losses that closed out an otherwise impressive second quarter of 2009, when the Dow Jones Industrial Average gained 11 percent.
A relatively quiet rally occurred in the high-yield debt market as well. Federated High-Income Bond Fund (FHIIX), for instance, has climbed 25.4 percent off its March 9 lows. The steep rally from the lows was the easy part. Going forward, the gains will be smaller and take longer to realize. Nevertheless, it is positive to see the credit spreads falling because without access to capital, business would find it nearly impossible to invest for future growth.
As opposed to improvements for business, the public debt sector is headed for turmoil. California issued IOUs today to contractors and taxpayers expecting a rebate. Some banks have said they will accept IOUs, but it is not mandatory. California is essentially printing its own money because it cannot pay its bills, but no one is required to accept them.
Of course, California is not broke and has the money to pay its bills. This is a political crisis because the state has two options: raise taxes or cut spending. Voters rejected a slate of revenue-increasing measures in May, leaving only the option of cutting spending, which Governor Schwarzenegger agrees is the only option. Legislators were working on a deal to close some of the deficit yesterday, but the “Governator” said he would veto any bill with tax hikes or that does not close the gap once and for all.
Investors must not get swept up in negativity surrounding government budget crises. Just as people often confuse the stock market with the economy, governments are not the economy either (though they can be more influential than financial markets). Despite the negative news that California and other states’ budget woes generate, the economy is driven by the private sector. Where the ax falls on the public sector, it is bullish for future growth, but where it falls on businesses and consumers, it is bearish.
