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Turning the Corner?
New York: June 22, 2009
By John Stephenson

In March of this year, financials and commodities were pronounced dead by stock market naysayers and doom merchants. But since the lows of early March, both commodities and financials have rallied sharply—a nifty feat considering we are in the worst recession since 1945. With governments bailing out banks left, right and center, savvy investors have reasoned that the big Wall Street banks are just too big to fail and have bid their shares higher. Commodities have moved higher as China , once again, is importing plenty of copper and iron ore.

But in spite of this seemingly good news, investors are left with a nagging question; how can the stock market rally when consumers have become savers and incomes are falling? In the short term, anything is possible, but longer term the record is clear—a rising stock market generally reflects an improving economy not a deteriorating one.

While China 's economic prospects may be looking up, America 's economic prospects are still a little uncertain. Joblessness is on the rise and saving has become fashionable. Detroit is on life support and credit is still not flowing to small and medium-sized businesses.

Since the global financial crisis first broke, Western governments have pumped trillions of dollars into their economies to shore up their big banks and restore consumer confidence. So far, the results have been impressive. But all of this spending comes at a cost—Western governments are massively indebted.

Not since the Second World War, have governments globally borrowed so much so quickly in a desperate bid to restore confidence and economic growth. According to the International Monetary Fund (IMF), the gross public debt of the richest ten countries in the world will reach 106% of gross domestic product (GDP), up from 78% in 2007. In just three years, government indebtedness globally has expanded by more than $9 trillion and the situation will likely continue to deteriorate with the IMF predicting that the ratio of public indebtedness to economic output will reach 114% by 2014.

Making matters worse for the West is the fact that all of this government borrowing is occurring at precisely the same time as their respective populations are greying. By 2050, it is estimated that one-third of the West's population will be sixty years or older. According to research by the Economist , the demographic bill to support health-care and pension costs of an aging population is likely to be more than ten times bigger than the bill racked up for mopping up the financial mess.

But with crude oil prices hitting over $70 per barrel, the stock market appears to be betting that the worst of the crisis has past. While Asia may be turning the corner, it is still too early to declare that America has begun the recovery phase. My reasoning is simple; while trillions have been spent on recapitalizing large Wall Street banks, only a small trickle of government money has made its way down to the small and regional banks that are needed to put America back to work.

So far, the big Wall Street banks have survived by pocketing government cash, paying down their debts and putting their financial health back in order. And while that is a good and necessary thing, the real economy hasn't benefitted a wit from all that government cash floating around. In spite of the fact that the U.S. money supply has increased dramatically over the last year, most of that money isn't being spent, invested or lent. And until that happens, America won't recover.

One sure gauge of what is happening in the real economy is the KRE Index, a regional banking index. Regional banks are the institutions that have the relationships with small and medium sized businesses that are so important in job creation. America 's small regional banks for the most part avoided the foolhardy investments in real estate and derivatives that almost tanked Wall Street. Yet in spite of their steady stewardship, regional banks haven't received government money by the truckload like their Wall Street brethren.

Figure 1: Regional Banking – Not What it Used to Be!

Source: BigCharts.com

Your signal that America 's economic health has been restored is when you start to see smaller regional banks outperforming the S&P500 stock index. Only then will it be evident that they are back lending to small and medium sized businesses that in turn will begin hiring for the economic good times that will lie ahead.

In the meantime, savvy investors should position their portfolios to benefit from the engines of global growth. Large capitalization financials will not be the place to be. Sure, the Wall Street banks have survived, but only because of a bailout from Washington . The place to be is in the great commodity stocks that have survived the meltdown and are now poised to head higher as the rest of the world begins to pick itself off the mat.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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