Mechanics Bank Investment Chief Predicts Major Changes to Economy
Globalization and Shrinking Government
RICHMOND, CA, May 7, 2010 -- Corporate profits may be up, but every Main Street in America is punctuated by empty windows displaying “For Lease” signs. Main Street has not yet been invited to the recovery party.
Brian Pretti calls it “a tale of two economies.” Delivering his latest economic forecast at a series of meetings around Northern California, the senior vice president and chief of investments at Mechanics Bank says, “Small businesses are struggling while the biggest corporations are doing relatively well. This may be a precursor of how globalization will effect change in the U.S. business landscape of tomorrow.”
Pretti says smaller businesses can’t leverage the cost disparities and sales opportunities in burgeoning markets outside the U.S. and they can’t compete with the lower labor costs abroad. In part they’re losing out to their larger corporate competitors—an economic reality that recovery may not change.
While Pretti agrees the federal government bail-out was a necessity, he decries the fact that the bucks stopped on Wall Street. “Help simply hasn’t trickled down to Main Street,” he points out. “Small businesses are being hit with increasing costs including health care, energy, shipping, raw materials. Small business surveys remain somber to this day. At the same time, the average consumer is taking a vacation from spending. So, ask yourself, if small businesses can’t fully participate in recovery, who is going to take over the role of job creation? Since the middle of the last century, small businesses have generated over one-half of all new jobs in the US. It’s imperative that some of the bail-out funds provide a lifeline to this important economic sector.”
A new economic “normal”
Pretti predicts permanent changes in the economy are at hand. “Every recession since 1970 has brought down the costs of fuel, food and raw materials in the U.S., but not this time,” he says. “China and other emerging nations now are taking up the slack from declining U.S. consumption as was not the case in the past. For the first time in history, there were more car sales in China than in the U.S. in 2009, and even with a recovery, that isn’t going to change. We are likely to see higher prices for commodities in the current recovery as the process of globalization rolls forward, recession or not.”
He sees this effect as part of a larger, fundamental change in the U.S. position in the global economy, one that began long before the current recession.
“Essentially, we haven’t seen U.S. job growth for ten years,” he says. “In the past, the scarce resource globally was a smart, highly educated workforce, which gave the U.S. large advantages within the global economy. But developing nations now have a growing pool of educated workers available and they’re eager to work for lower wages than comparable U.S. workers. That means certain jobs that disappeared in the current recession may never come back to what we once thought of as being normal—or may never pay as well again.”
And don’t count on government jobs to take up the slack. With $49 trillion of unfunded entitlements (Social Security and Medicare)—before the healthcare reform package is taken into account—and unparalleled levels of state and local governments deficits, Pretti sees a recipe for challenges ahead that will require time to reconcile or heal.
“Local governments are going to have increasingly tough time borrowing money given their already difficult fiscal conditions,” Pretti says. “Likewise they can’t simply tax their way out because of high unemployment and dropping property values. Increasingly it seems federal assistance will need to come into play. In the meantime, we’re going to see deep service cuts and outsourcing.”
Even if the states get a short term fix from the federal government, there are hard choices ahead at all levels: adjustments to services, wages and benefits in the public sector. “If we don’t have the fortitude to address these problems while the economy is recovering, the financial markets will ultimately force an adjustment. That would not be a good outcome,” Pretti says.
Pretti believes one way states and local governments can bring down deficits is to outsource more and more of their responsibilities, from running prisons to gardening and maintenance of public places. “Government simply can’t operate as cost-effectively as the private sector,” he says. “And they won’t have the money to continue paying more for these services.”
Despite the slow recovery and other negative signs Pretti thinks there is a window of opportunity for investors. “As wild as this may sound, we could potentially see a new stock market high based on the historic level of liquidity produced by the Fed that simply has nowhere else to express itself,” he says. Commercial and residential real estate are still burdened by over leverage and bond yields rest at generational lows, so equity really becomes the default choice for the moment. A Fed Funds rate at zero forces investors into riskier assets to obtain any nominal rate of return.”
He cautions against putting too much faith in a V-shaped economic recovery. While retail sales are up they are still well below the 2007 peak, and high gasoline prices are fueling some of the reported increase. Additionally, over half of retail sales are generated by the top 20% wealth demographic in the U.S. – the exact segment that most benefits from higher stock prices.
“Government transfer payments are currently higher than taxes collected,” Pretti says. “Because 8.5 million people have lost their jobs, taxes paid relative to income rests at the lowest level in post-War history. A full 45% of all citizens didn’t pay taxes in 2009. The pressure to raise taxes on the rest of the population is going to grow.”
Opportunities and advice for investors
So, what’s it all mean for investors?
“The world is not coming to an end,” Pretti says. “We’re in a bit of a speculative environment again. Interest rates remain low, encouraging people to seek opportunities outside of traditionally safe investments such as U.S. Treasuries. I believe there’s money to be made in equities…for now.”
According to Pretti, the economy has been saved, but the key question becomes, has it been fixed?
“It’s time to focus on where investment opportunities will be found in a post stimulus global economic environment. The emerging economies have all raised short term interest rates to both fight inflation and cool domestic speculation resulting from unprecedented stimulus. They are already moving into a post stimulus world. It’s a good bet they will drive global economic outcomes in the post stimulus world that lies in front of us. Think globally!”
He encourages investors and businesses to think in a global perspective as opposed to focusing only on the domestic economy. “Don’t let speculation take your eye off the ball,” he recommends. “There are real challenges ahead. And, accept globalization as the new norm, then figure out how your investments can benefit from this secular change.”
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About Mechanics Bank:
Mr. David Louis