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To Our Valued Friends of Silver Oak,
This is an edited version of our Client Letter, sent recently with our Quarter 2 Portfolio
Performance Reports. This letter is intended to supplement that data and provide
continuing insight into our thinking about the markets and the economy.
Are the stock market and the economy no longer correlated?
In our June letter we provided a graph showing the roller coaster ride that was the stock
market in the first half of the year. Since then, the U.S. stock market has continued to
increase and has risen above the 9000 level on the Dow Jones Industrial Average. Many
in the national news have proclaimed the end of the recession is in sight. Therefore,
they argue, there is sufficient precedent to justify an interpretation that we are in the
beginning of the next bull market. These sources point to the slowing rate of decline in
our various economic indicators along with selective anecdotes such as home sales
rising as their justification.
We certainly agree the rate of decline has slowed. The massive government
intervention should get credit for avoiding a greater economic decline. Yet we are not
convinced that the next bull market has begun. On the surface, it certainly looks like
Pamplona and the running of the bulls with the bears scurrying out of the way!
However, numerous factors could portend another goring of the economy over the next
year.
While we hope that the charts on the next two pages will help illustrate our points and
simplify the statistical references, for those readers who prefer just the executive
Summary – please see the last page.
Waving the Red Flag
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3. CHART 1
P
Dow Jones Trend Line
C
Unemployment
Consumer Spending
Unemployment & Consumer Spending
Consumer spending remained steady coming out of the last recession. Unemployment
was at its worst a few months before the recession ended. Today, however, we clearly
are able to make a case for a different fact pattern in both of those factors.
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4. Chart 2
Chart 2 will help us get a better visual sense of what our job losses today look like
compared to the last two recessions. Not only have we not stabilized, but we continue
to lose a substantial number of jobs every month. From many resources we read, it is
thought likely that the jobless rate will increase into early 2010.
But as bad as that thought is, it does not tell the whole story. In order to cut their
losses, many employers have reduced their payrolls by forcing employees to work fewer
hours. When the underemployed are tabulated, the number of people looking for full‐
time work adds at least 7% to the current rate of unemployment. When things do start
to turn around, employers are more likely to give current employees more hours before
expanding the hours of part‐time workers, and before adding new workers.
This does not bode well for consumer spending, which has always been a critically
important element of a recovery after recessions. Historically, consumer spending has
added 3.5% to GDP growth in the first year of an economic renewal. At the end of the
last recession that number was only 1%. With today’s unemployment level perhaps
three times worse than during previous recessions, it is extremely unlikely that we will
see enough consumer spending to pull us out of recession. As one newsletter put it:
“The difference is that this 2007‐2009 cycle was double the asset deflation and triple the
job loss coupled with a credit collapse, which means that it is going to take even longer
for the consumer to come back this time around.“ This is of particular concern since
consumer spending typically makes up 70% of our GDP.
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