SUBDUED DEMAND AND CONSUMER PESSIMISM DOMINATE THE ECONOMIC LANDSCAPE
Mechanics Bank investment chief predicts “long hard road to recovery”
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RICHMOND, CA, October 26, 2010 -- The National Bureau of Economic Research (NBER), the keepers of the official US recession time clock, have declared the Great Recession over as of June 2009, but to small businesses and millions of unemployed it doesn't feel that way. Subdued aggregate demand is choking small businesses and optimism has dropped to levels consistent with recession. That's according to the latest Duke/CFO Magazine Global Business Outlook Survey, long considered a leading indicator. That means that a long hard road to recovery still lies ahead, says Brian Pretti, SVP and chief of investments at Richmond-based Mechanics Bank.
“Housing starts are near all-time lows,” says Pretti, explaining his own lack of optimism. “Auto demand is still 33 percent below the highs seen a number of years ago. And consumer credit has declined every single month over the past two years with only one exception, a pattern we've never seen before.”
The bank’s allowance for loan losses totaled $35.7 million at June 30th, 2010 ($13.9 million more than one year ago) and represented 2.00% of total loans. At June 30th non-performing loans totaled $47.1million, which was 2.64% of total loans, but the majority of those non-performing loans are secured to some degree by real estate or other forms of collateral.
Pretti points to a year-end slowdown in the economy, now that the bulk of government stimulus is spent. “Businesses and people are still deleveraging their balance sheets—as well they should,” he says. “At the end of the second quarter, US household debt was down almost $500 billion from levels four years ago. What's particularly interesting is that this deleveraging corresponds almost exactly to $500 billion in US bank loan defaults—suggesting that most of the deleveraging at the household level was accomplished by default, not actively paying down debt. It's no surprise, given that job and wage growth have been non-existent. Until we see job and wage acceleration, households simply will be unable to heal their balance sheets.”
Interest Rate Outlook: How Low Can It Go?
“I never thought I'd see a two-year US Treasury note with a .37 percent yield—or a TIP with a negative yield—but both are making history today,” says Pretti. “These historical lows reflect the unprecedented monetary stimulus measures of the Fed. From March 2009 through April 2010, they printed $1.5 trillion in new money to buy bonds, thereby increasing bond prices and lowering bond yields. They call it 'quantitative easing'—a polite term for printing money out of thin air. But even after driving mortgage rates to a record low it hasn't spurred housing or other domestic consumption in any meaningful way. Consumers recognize they need to pay down debt, not borrow more.”
Currency Devaluations: Nobody Wins the Race to the Bottom
Pretti also points to “a new world war” that has begun in the global currency markets as each country joins the “race to the bottom” in devaluing their currency.
For Equities, “Buy” May Be the Operative Word
September and October are traditionally weak calendar months for stocks. So, why did the S&P 500 rise 8.75 percent in September on a price-only basis—the greatest gain for this month since 1939? Does it mean the economy is about to get a whole lot better?
Safety in Blue Chips and Commodities?
Pretti recommends focusing on yield-oriented equities and undervalued blue chips. “In an environment pockmarked by deflationary tendencies, income is a scarce resource,” he says. “Additionally, the decade-long bear market in equities has caused the valuation of large, globally oriented blue chips to contract substantially. Ten years ago investors could not buy Intel fast enough when it was selling at 50 times earnings. Today, no one wants it at 10 times earnings with the price down close to 75 percent over the prior 10 years. I think many of the large brand-name global companies are currently at very reasonable valuations—not bargain-bin prices, but reasonable.”
About Mechanics Bank
For more than a century, Mechanics Bank has been committed to helping people build prosperous communities as a trusted financial partner, forging lasting relationships through teamwork, respect and integrity. The $2.9 billion independent bank, headquartered in Richmond, California, offers personal banking, business banking, trust, brokerage and wealth management services through 33 offices across Northern California.
Mr. David Louis