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Newsletter July, 2010

July 9, 2010

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The economic green shoots of the last few quarters appear to be wilting as new fears of a double-dip recession emerged in the second quarter, with a number of economic measures signaling a slowdown in the momentum that has been building for the past six months. Equity markets quickly responded with sharp declines and plummeting bond yields.  Most major global bond indices now yield less than 3%, pointing more to recession than recovery. With the elections approaching in November, politicians collectively continue to focus on the short-term measures that can influence the outcome of the elections, but are not necessarily in the long-term best interest of our country. 

The S&P 500 finished down 11.43%1 for the quarter, more than erasing the gains of the prior two quarters. As yields fell on bonds, fixed income was one of the bright spots in the quarter, with the Barclays Capital U.S. Aggregate Bond Index increasing 3.49%2.

A Double-Dip Recession?

We have discussed throughout the last several quarters the complex set of dynamics that has existed in the U.S. and world economy in dealing with the economic downturn.  Many economists began predicting a V-shaped recovery in the United States as economic indicators improved throughout the second half of last year. In our last letter, we discussed GDP and its continued improvement in the first quarter of 2010 due to the impact of

the government stimulus programs trickling through the economy.  In addition, businesses, which had let inventories fall to very low levels, began an inventory rebuilding process that fostered resurgence in the manufacturing sector. As we entered the second quarter, the stimulus programs were beginning to wind down and business inventories had returned to near normal levels, eliminating the excess demand.  Additionally, April 30 marked the end of the tax credit programs that offered an $8,000 credit for first-time homebuyers and a $6,500 credit for homebuyers who had owned their existing home for five of the last eight years. A new headwind also emerged in Europe, with the Greek debt crisis causing fears it could cascade into a new global contagion.  Without the benefit of the stimulus programs and in the backdrop of new problems abroad, GDP growth has fallen from the first-quarter peak and could be headed back down to sub-par levels as we enter the second half of the year. 

As prospects for a V-shaped recovery have diminished, those who were predicting such a recovery are now wrestling with the prospect of slower economic growth, persistently high unemployment, and renewed weakening in the housing sector. We have maintained that we cannot have a sustainable recovery without improvement in employment, credit, and real estate. We will touch on them all, but would like to focus on employment.

Unemployment Rate Falls in June - Good News or Not?

There are a number of components in the employment data that are regularly reported and we realize this set of data can be very confusing and misleading (especially when data is mined or used to promote agendas). In the latest headline report, we managed to create 83,000 new private sector jobs, while the number of people that are underemployed or have simply given up dropped slightly.  The challenge remains that we need 150,000 new jobs each month just to absorb new entrants into the workforce.  Further, we have an additional 7.9 million unemployed as a result of the recession.  If we were to create 300,000 new jobs per month going forward, it would take almost 4-1/2 years to recover these lost jobs.  Earlier this year, momentum appeared to be building, yet, in the last two months, the U.S. economy has only created 122,000 jobs, contributing to the talk of a slow down or a double-dip recession. 

And What of the Chronically Unemployed?

When Congress returned from recess on July 12, some 2.14 million unemployed Americans had lost their unemployment benefit checks.  By the end of July, that number is projected to rise to 3 million.  Most of those who have exhausted their benefits (collecting as many as 99 weeks of unemployment) have consistently, if unsuccessfully, sought work. With the percentage of long-term unemployed at the highest levels dating back to

the beginning of the data in 1948, this is becoming a looming structural problem, one that creates a real dilemma for Congress and for society.

In a vacuum, policymakers would like to provide a safety net for those who need it until viable jobs are available.  However, the dilemma lies in the potential pitfalls of continuing to extend these unemployment benefits on an indefinite basis.  On a personal level, there is no question that the failure to extend benefits could create a large number of tragedies and that is not desirable or politically smart.  On a societal level, the impact is more complicated and unclear. The money to pay unemployment benefits is not created from thin air; it must be created through a transfer of payments from those who are working to those who are unemployed.  As a result, the employed person will have less incentive to produce and since the unemployed person isn’t as pressured to find work, they are less likely to work as hard to find employment. The amount of overall

productivity in the economy is reduced and the incentive for both to create more output has also been reduced.  In addition, under this scenario, the money went directly to benefits to simply sustain the unemployed worker and not to further educate or re-tool their job skills, and, in the process, adds to our dangerously high national debt. 

Where Are the New Jobs?

The debate over extended unemployment benefits would be moot if a meaningful number of new jobs were created.  As we mentioned, the economy requires at least 300,000 new jobs per month to make a significant dent in the overall unemployment picture.  So why aren’t we creating jobs at this pace?  It seems that the barriers to job growth stem from three areas: large corporations and banks are hoarding cash, small businesses are

still pessimistic, and the ramifications of the real estate crash remain persistent.

Corporations exist to make profits utilizing their available capital. By having more cash on their balance sheets than ever before, large corporations are making a clear statement that they do not perceive opportunities to deploy their cash.  In addition, large banks have a record $1 trillion dollars in excess reserves on deposit with the Federal Reserve. The size of these deposits, which earn just .25%, shows how little confidence banks have that potential new borrowers will repay their loans and is also evidence that they are bracing for continued deterioration in existing loans.

Small businesses traditionally lead the economy out of recession and are the driver of new job creation.  In June, the National Federation of Independent Business’ small business survey showed the outlook for expansion in its economic activity index fell to its lowest level in its near forty year history.  Remarkably, seventy percent of the decline in the index this past month was from deterioration in the outlook for business

conditions and expected real sales gains, with only ten percent of small businesses planning on new hiring.  Moreover, NFIB’s Chief Economist, William Dunkelberg, said in the press release that "the U.S. economy faces hurricane force headwinds and the government is at the center of the storm, making an economic recovery very difficult." 

One of the primary drivers of both large and small business hiring reluctance is a lack of visibility on tax policy and regulatory reform.  Given the backdrop of higher employer taxes, such as unemployment and the growing uncertainty of future health care mandates and costs, employers are unable to predict future costs with confidence and are limiting their hiring to absolute necessity.   

Real estate is a pivotal contributor to the economic engine of the U.S. and the real estate crash created a double whammy, eliminating jobs while significantly impairing overall household wealth, as virtually everyone has seen the value of their homes decline.   Construction unemployment has reached as high as 27.1% and construction employment has dropped to a 14-year low, both showing very few signs of improvement in the near term. The negative wealth effect of declining home values has touched virtually every segment of consumer spending.  In our quarterly letters as far back as 2005, we repeatedly discussed how concerned we were over the inevitable consequences of exploding consumer credit and people using their homes as ATM machines.  Not only did that spending create a false sense of prosperity, but it ultimately magnified the collapse that we are dealing with today.

The combination of unemployment and falling home equity has resulted in a credit contraction, the likes of which we have never seen.  We had some recent eye-popping consumer credit numbers, with the Fed reporting that consumer credit plunged $25 billion over the last two months!   Further, recent figures provided by FICO Inc. show that 25.5% of consumers — nearly 43.4 million people — now have a credit score of 599 or below, marking

them as poor risks for lenders.  It's unlikely they will be able to get credit cards, auto loans, or mortgages under the tighter lending standards banks now use.  It will be very difficult to spur job growth when credit and spending are contracting at this pace.

The Opportunity Ahead

Recent data indicates a pause in the momentum of economic activity, yet the building blocks of a recovery remain in place.  Businesses and individuals are rebuilding their balance sheets and liquidity exists to fund economic expansion once confidence is restored. One of the most significant challenges in this economic transition is the utter lack of faith in our leadership on both sides of the aisle.   Confidence will not be restored until credible plans are in place to address the undeniable structural problems with Social Security, Medicare, Medicaid, health care, and the exploding national debt of our country.  Both here and abroad, we have some painful decisions to make, but postponing them will do more harm than good.  As such, the uncertainty of future policymaking makes it difficult for all of us to plan for our future and it provides a headwind to economic recovery.  We remain hopeful that both parties will come together after the mid-term election and develop credible bipartisan solutions that ignite a new level of confidence and rejuvenate the economic expansion.

Now more than ever, it is critical to be prepared for the future through careful planning and personal fiscal discipline.   We can’t control what goes on in Washington or around the globe, but we can control many of the other factors that will affect our financial security.   It is certain that the solutions that will emerge to address the structural problems we face in this country will involve disproportionate financial burden for

those who have accumulated wealth.  We remain vigilant in our effort to provide you with personal strategic planning advice and portfolio solutions that will provide you the greatest chance for success.       

Client Survey

We want to express our appreciation to everyone who responded to our Client Satisfaction Survey in the second quarter.  We truly value your feedback, so if you did not receive it or you lost the e-mail link to the survey, please contact Marcy and we will be glad to send it to you. Several clients checked the “Contact Me” box on the survey, but did not enter the “Optional” personal information on the last page, so we cannot identify who you are to contact you.  If you would like to discuss any issues from the survey, please do not hesitate to contact us.
 
The survey is providing us with very useful feedback in our ongoing efforts to meet and exceed your expectations.  We were extremely heartened by the very positive feedback on our organization’s knowledge, integrity, and, most of all, your willingness to recommend us to a family member or friend, which is the truest measure of your confidence in our work.  One area of attention was the overwhelming request for e-mail or online

delivery of quarterly reports, which is already a part of our planned technology upgrades.  We will provide you with more detailed results in the next several months and will incorporate your feedback as we develop our operating plans for 2011. 

Thank you for your continued confidence in our services! 

Wealth Dimensions Group, Ltd.

1 www.standardandpoors.com
2 http://us.ishares.com/product_info/fund/performance/AGG.htm

Investment indices are represented by the S&P 500.  Performance of these indices is not indicative of any particular investment.  The indices are unmanaged and individuals cannot invest directly in any index. The Barclays U.S. Aggregate Bond Index is comprised of  variety of taxable bonds, and is used as a measure, or benchmark, of the US bond market.  No strategy including diversification can guarantee a profit in a down market.

Past performance does not guarantee future results.