Making New Highs

by Paul van Eeden

As I expected, the token revaluation of the renminbi has had no material impact on any markets thus far. Nevertheless, China and the renminbi remain key to the future of the U.S. economy. In the meantime, the U.S. economy is chugging along nicely with many stock indices making new highs this week on the back of better-than-expected corporate earnings.

Strong corporate earnings are making the case that the economy is on solid footing, according to the Wall Street Journal. For some time now I have been making the case that the economy is not on solid footing based on the automotive sector. Americans love cars and they are not afraid to go into debt to buy newer and more expensive cars. So when the auto industry suffers it tells me that consumers are tapped out.

This week General Motors announced that its North American automotive division lost $1.2 billion during the second quarter. The company recently shook up the industry when it started selling its cars to consumers for the same price it offers its employees, forcing other car manufactures to do the same. Both Ford and Daimler-Chrysler entered the price war by offering their cars at employee prices as well.

While Ford Motor Company made a profit in the second quarter, it was 19% less than last year because of a $907 million loss at its (you guessed it) North American operations. Both Ford and GM are suffering because higher gasoline prices have reduced demand for their high-margin sport utility gas-guzzlers. As a result, Ford is considering deeper cuts to its workforce: a third of its white collar workers could lose their jobs. That would mean an additional 10,000 unemployed.

Meanwhile General Motors said it would end its “employee discounts for everyone” promotion and cash rebates, and instead just reduce sticker prices permanently. I don’t recall how many times in the past eighteen months I have said that prices for durable goods and luxury items will go down (as the economy falters) while the prices of essential consumables such as energy and food could increase. It is busy happening.

Were we not still riding on the tail end of one of the largest economic expansions in history it might almost be tempting to buy the downtrodden automotive stocks. Had we been in the trough of a business cycle I would certainly have looked at it seriously. But we are at the top of a mega-cycle that was created during the nineties, and that has not yet been corrected.

During the nineties there was a lot of talk about the wealth effect and its impact on stock speculation. While the rhetoric has died down, the wealth effect has not diminished. Both the real estate market and the stock market are still rife with speculation. The major stock market indices (excluding NASDAQ) are almost at their all time highs again and I have commented in the past on real estate speculation.

Every business cycle expansion is followed by a contraction during which assets change ownership and excessive speculation is eliminated. We have not gone through that yet and, until we do, a lot of risk remains in the stock, bond, commodity and real estate markets.