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At Arm's Length: 08.31.05

But one item caught my eye and for the sake of fixed income investors, might be telling. Greenspan seemed to be concerned that investors are willing to accept lower rates of return for longer terms.

The full article.

Today's Commentary: 08.30.05
Theory of Need

We can safely call August the month of investor angst. In most instances when such ennui takes hold over markets and the overall sentiment begins to wane, there is little to do but wait for the tide to shift. For any sort of enthusiasm to return, investors must be able to meet all of their primary needs before attempting to grow any sort of wealth. And right now, that is becoming increasingly difficult.

Abraham Maslow had a theory for this change in sentiment. Maslow developed a school of thought based on human needs by offering a structured look at how we care for not only for ourselves and our loved ones but also how we view our place in the world around us. Maslow's 'Theory of Need' was based on a philosophy of the future that asks the question: what is the ideal life?

Once the physiological needs of a person's life were taken care of, the basic need for food and water, etc., the next level the late psychologist outlined was that of shelter. It has been greatly discussed that this segment of our needs has been overemphasized - and overbought and sold - of late which should have been a warning for all of those within shouting distance of the mortgage office that this market is all about bubbles. In its own turn though, the housing market may have created its own cooling. A recent New York Times front page article outlined the trend back to renting as a possible ominous sign that the housing market may be finally taking a breather.

This high cost need for shelter has been a two way street. For some who already owned a home, it was a sudden and welcomed wealth effect. For those who had yet to buy into the "frothy" market that produced such high values, a house was the golden ring of future retirement security. These people simply had to try and get on the ride.

It is possible that this cooling off of the housing market may be just temporary but it may also be a natural way of taking care of some of those past due debts of over enthusiasm. Either way, many of the people being forced out of the market and into rentals are the very buyers whose chance of ownership would have been risky at best. Forced to rely on the most creative financing, first time buyers with questionable resources are being pushed out of the marketplace and probably for the good of us all.

While on the surface, this seems cruel and unjust and in a way it is, it also pays to remember how these bubbles work. Once markets heat up and prices rise, new buyers who enter into the market will be unable to finance themselves through normal channels. Instead they will face greater challenges in terms of financing which will lead to higher default rates on loans. Eliminating some of the riskier folks will help shore up the current level of pricing while giving builders a chance to adjust their supply.

Next on Maslow's list was the world around you. If you were asked how you felt last month you might have found yourself falling in lockstep with the majority of those folks who were surveyed recently by the University of Michigan. Making a significant drop from the previous three months, the Consumer Sentiment Report, a survey that takes a longer look at the economy, came as a surprise to those who were betting on the three month trend to continue.

A similar report issued by the Conference Board on Consumer Confidence takes a much more tighter time frame in which they ask similar sentiment related questions about the economy. Keep in mind, the differences in the two reports are subtle but both have been gaining strength in their importance as a guage of market reaction. When the reported number fell below estimates, it started a retreat in equities and that was taken as an ominous sign of trouble on the horizon.

While it is never a good idea to focus on the month-to-month changes in any report, looking for trends over a several month period has become more difficult and just as unnerving. The report suggested that those surveyed are beginning to feel the pressures from rising prices at the pump and may even be worried about their winter heating costs as well.

Most economist agree that in sophisticated economies such as the United States, these drops in consumption and consumer enthusiasm and their subsequent measurements are mere bumps in the road. If Maslow is right, the focused pursuit of one segment of his diagram, shaped much the same way as the FDA's dietary pyramid, would put pressure on our goals often keeping us from reaching them successfully.

Perhaps some of our economic sophistication is wearing thin. Our dependence on spending, specifically importing goods to satisfy our needs, was generated by our feeling of wealth in our homes aided and abetted by cheap money. Ignoring shelter as a basic need caught the attention of the Fed chairman Alan Greenspan.

In a recent speech given at the Central Bank's annual jamboree in Wyoming, he worried aloud about the imbalances he has begun to notice. It seems that, according the man who may once again be late to the situation, consumers have driven prices up in large part because their homes have appreciated in value. (The reference to Greenspan's timing was an observation that margin accounts at brokerage houses might be the reason the stock market of the late '90's overheated with irrational exurberence.)

Of late, homeowners have begun to perceive ownership as more closely related to self esteem than necessity and it is this thinking that has pushed prices higher. In doing so, Greenspan has formally targeted this portion of the economy as all the economic reason he needs to keep right on raising rates.

It is on the back of our so-called "asset inflation" that we have helped drive the global economy. Now he wants to reign it in. Question is not if he should but whether he can at this late stage of the game.

His tardy acknowledgement of this problem - of his own creation - is evident in the types of jobs created over the last several years of the recovery. Not only are far too many of these unable to keep pace with our relatively tame inflation rate, but the quality of the employment found by those workers is not what it should be in a normal recovery.

The jobs report for August is expected to come close to the 200,000 mark. What is hoped for beyond just the number itself is a broad spectrum increase in the quality of jobs. As I mentioned last week, business has not fully participated in much of the growth we have experienced over the last three years. Their lean and mean approach to increasing profits through squeezed productivity has forced many workers once employed by our manufacturing industries to take whatever job was available often at a discount to previous pay levels.

The lion's share of the recent new jobs have fallen squarely on the shoulders of construction and services. Both types of employment are dependent on inexpensive fuel to drive their continued growth and both have shown signs of recent weakening. Even if we hit the estimated job number for the month, it will only show an increase in real jobs of 50,000. Economist have long known - and mostly ignored - the need for at least 150,000 new jobs per month just to accommodate the new workers entering into the workplace. With those figures in mind, the much touted growth of jobs over the last three years has not even met the necessary amount of jobs needed to employ the new job seekers.

If he were alive to witness this trend, Maslow would probably suggest that this significant change in sentiment was primarily driven by the need for fuel and shelter. He would probably explain that when forced to focus on any one specific need ahead of another, it would create neglict. It would appear as a major shift away from chasing the future to struggling with the providing basic needs and shelter in the here and now. This would come at a cost as less salient needs such as caring for loved ones and self esteem would be shelved.

Maslow's Theory of Need would suggest that what we would be left with would be personal deficits. Once these deficits are repaid he suggested, we would be able to once again persue other needs in our quest for that ideal life.

There are other deficits to contend with apart from personal ones. Although theconsumer will bear the brunt of the fallout, any attempt of our at moving forward will be furthered hampered by the humbling effects of this country's twin deficits. Because of them, we will have greater difficulty getting our needs fulfilled and this will have the domino effect of, pardon the pun, bringing down the house.

So much for our angst. As R&B artist William Bell once penned and recorded:

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