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Today's Commentary: 01.01.06
Let's Assume Let's assume that the economy really is doing as well as we have been told - a recent resolution delivered via this column in last week precludes me from mentioning the name of the giver of such good news, but nonetheless, the pronouncement was given. Mind you, it was on the heels of a rather disappointing jobs report (108,000 new jobs created in December, well short of estimates and much to the dismay of forecasters).

The revision of November's numbers were so much the caveat as November was all Katrina related under the surface and it turns out, they were not much in the way of what might be called productive economic contributors, at least in terms of real employment growth.

The employment for the year, touted throughout the land as the result of tax cuts and a generally well-directed economic policy, is still well short of were it should be in terms of quality jobs with adequate pay. That was blaringly evident in the lack of wage growth which has remained just behind inflation throughout the year. (According to the Jobs report, wages rose at a rate of 0.3% for the month bringing the yearly total to 3.1%. Latest Consumer Price Index numbers for 2005 have not been released. The period between November 2004 and November 2005 show inflation at 3.5%.)

The majority of the jobs created in December were in the service sector with the lion's share of which coming from the bar and restaurant industry. Add healthcare and you have 26% of all jobs created coming in industries that do not pay well enough to be considered economically strong. In fact, many of these jobs could be quantified as not much more than bill paying jobs.

Let's assume that the market's enthusiasm this past week was more than just hopeful, thinking that, because of the hint given by the relase of the minutes for the last meeting would indicate that the Fed has ceased its quest to slow the economy. One must be reminded that the new Fed chief was not in attendance for those reported minutes and there is little likelihood he will want to make his reputation on his first outing.

"Follow the pattern young Ben and you will find the answer in the market's reaction", Mr. G may have said to his successor, "but pay no mind. The strength of this economic growth is once again my doing." And perhaps Mr. Bernanke's undoing. Leaving the newly crowned Fed Chief to deal with Greenspan's legacy demands that he at first seem hawkish on inflation not once but possibly even twice. Reluctantly or at least on the surface, Bernanke will acquiesce and begin a steady decline in interest rates to keep the economy moving along. Not only is the GDP at risk of falling below 3% in the second half of the year, but the slowing enthusiasm of the consumer will prompt him to take a reverse tack on interest rates.

This lack of "enthusiasm" will be in part to the shrinking demand to refinance. There is no doubt that the last several years have been financed on the backs of, not the consumer, but the consumer's homesteads. Gradually rising interest rates have not put pressure on the mortgage industry. The two loans are unrelated. But with mortgages increasingly tied to adjustable rates, the borrower hasbecome skittish about the future. A show of confidence by Bernanke could change that and as a result, the way 2006 goes.

About those homesteads: The so-called housing bubble is not a whole country bubble. If you are beginning to think that your home might be worth less than your mortgage when the bubble bursts - if and when it does, there is good chance that you live on the sprawling outskirts of the city and not within its boundary. The housing prices within many city limits will remain higher than the homes that were built out of town as a result of growing demand.

Those homes, it turns out have been met with an added problem. With energy costs up 18.2% last year, those longer commutes have seriously crimped an already tight household budget. Fuel prices look as if they may have reached a stabilized level and have created the new benchmark. By September we may be looking back in wonder and longing at $60 a barrel.

In the city, homes will continue to be worth more than many consider affordable. Unfortunately, where the economy is concerned, the consumer may well be regulated away from borrowing more. Bankers have begun to realize that the risk they are assuming may not be as resale-able on the secondary market (although this is only a distant possibility, the risk assumed in many mortgage backed securities may rise as the chance of loan defaults increase over the course of the year) and have begun to put the squeeze on quantity in favor of quality.

You can see this in the willingness of the banks to adopt a new policy to force consumers with credit card balances to pay more than just the interest. MBNA, Citibank and Bank of America have all agreed to raise their minimum payments from 2-2.5% to 4% in the hopes ofhelping the consumer trapped in credit card debt. For a $5,000 credit card balance whose owner found affordable at $100 a month, banks will now be charging twice that amount. (Worthy of note: These same banks have set aside almost $130 million to handle consumers who default on their agreements. Not exactly a vote of confidence!)

By that reasoning, Bernanke will find reason to begin to slice those interest rates again. Consumer's will rejoice. Bankers, no longer faced with playing bad cop, will be able to lend money more easily to qualified buyers. In the end, everyone wins (including the guy who thinks that tax cuts are the reason the economy is doing so darned well and insists that they are).

Another heavily favored assumption puts spending on the shoulders of another kind of consumer.

It was heavily rumored in prognostication after prognostication that business would have to begin its spending spree and soon. The sudden loosening of the purse strings sounds so unbusiness-like in light of last year's attitude at corporate operations. 2005 saw many businesses across America enjoying the feeling of fattened coffers from tighter productivity and overseas operations, repatriated tax dollars, and the smoke and mirrors accounting that comes with share buybacks, that getting them to begin spending in the face of uncertainity seems unlikely..

Question is: If companies begin to spend some of that cash, who will benefit? Even though Ben Graham called them secondary players and unworthy of his investment world, small and mid cap companies stand to be the biggest beneficiaries of any corporate spending.

It should be noted that the year past proved the prediction of a large cap growth resurgence on the money. Mutuals fund specializing in this particular sector advanced 3.47% last year in part because many of these companies participated in the $400 billion plus stock buyback inflating their returns while decreasing their liquidity.

Compared to the lackluster performance of funds indexed to the S&P 500 (2.08%), this seems downright awesome for a year that had the Dow Industrials down for the year. It was a stock picker's market.

The Small Caps did the best they could in 2005 (up 1.73% on average in the final quarter of the year - the Kopp Emerging Growth fund topped the sector with a return of 8.23% with the Russell 2000 index of small caps finished up 7.71%) as they felt the pressure of higher interest rates and stingy corporate purchasing.

Mid Caps beat the S&P index handily and look to continue their run in '06. (Midcaps have had a great run with the top funds in the category finishing a five year run at 31.52%) Unfortunately, any gains to be had in the coming year may be found in a mutual fund. Just too many variables to consider when picking individual stocks to find the right company aligned with the right corporate spending.

Let's assume that more companies find the IBM answer to pensions acceptable to shareholders. If they do, two things will happen. First, companies will begin to stash even more cash than before. Financing the known actuarial estimate of retirees and future retirees while providing more participants for a market yearning for fresh money is like money i the bank. IBM's pension is worth $79 billion. By shifting all future contirbutions to the markets, the company will be able to estimate all future costs much more easily. (the first auction of 30-year Treasuries will be held in February of this year and will help many struggling pensions finance promises made while jettisoning all future contributions on to the banks of their employees.)

The second is not so reassuring. The majority of people who have access to a 401(k) plan do not participate and an alarming amount do so with the default investment offered at sign-up - a money market fund.

Charlie Gasparino of the newly refurbished Squawk Box on CNBC and their On-Air Editor apologized for disagreeing with the capitalist format the station encourages, found the move by IBM disturbing. His belief that the average American does not know how to direct their money to provide themselves with a comfortable retirement is borne out in the numbers.

Small business participation in 401(k) plans is a dismal 16%. Among the S&P 500 companies, participation is just over 70%. In between, investors languish in a no man's land of investor ignorance. Is it a reason to coddle these folks within the under-finance world of defined benefit plan? Possibly but any until these sidelined investor can find a good reason to trust professional many mangers and the markets.

BlueMoney Report

The Blue Money Report
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