The Four Letter Word that's Choking our Economy

By Robert Zimmerman - August 8, 2012 | Tickers: F, GM, SPXU | 0 Comments

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Last Friday the Dow jumped over 200 points on favorable job creation news.  While the 163,000 or so created jobs certainly was better than the previous four months, I wondered why the euphoria since we need to create more than 200,000 jobs a month to truly pull out of the recession.  So, the job creation data was nice, but not worthy of a 200 point jump.  I believe the jump will be short lived since so-called negative macro trends have not changed.  

Perhaps the one important macro trend (or for us common folks, situation) that has not changed centers on a financial four letter word: debt.  Simply stated, there's too much in the public and private sectors to sustain an economic recovery.  Think about it.  The US government cannot pay its bills; it must borrow over $1 trillion a year.  The US government won't be able to pay its bills in the foreseeable future and will need to borrow even more.  There is growing concern that the US government will be unable to pay the interest on the debt it owes, particularly in the future when the Fed has to raise interest rates.  

The situation at the state and local level can be even worse.  Public workers pension plans are threatening to bankrupt many states and local governments.  California cities have declared bankruptcy in part to reign in pension costs.  My home state of Pennsylvania is facing a pension funding shortfall estimated at $29 billion. And the state's total FY budget is $27.65 billion.  The city of Pittsburgh has three pension funds that collectively are only 30% funded.  Philadelphia isn't much better and Scranton made news recently by paying its police and fire fighters minimum wage to help balance the books (the Scranton police and firemen should be glad they have a job; Camden NJ laid off half of their police and fire fighters). If you have invested in PA tax- free ETFs you might want to watch this situation very carefully.

Lastly, personal debt levels among Americans rival those seen just before the Great Depression.  According to the New York Federal Reserve, total debt held by Americans in 2011 was $11.5 trillion.  Credit cards, student loans, mortgages all have everyday Americans under heavy debt burdens.  Given the unemployment situation and lack of real wage growth, I don't see personal debt levels dropping anytime soon.  This debt will also keep Americans from being the voracious consumers they were in the first years of the 21st century. This is already becoming evident as the average age of the typical American car continues to grow older. Despite the upgrade cycle, high levels of consumer debt does not bode well for auto makers such as Ford (NYSE: F) or GM (NYSE: GM)

How are we going to get out from all this?  For the government, I suspect a combination of tax increases, spending cuts and, at the state and local level, bankruptcy.  For individuals, constrained spending and, at times, bankruptcy.  None of these are good for economic growth.  These can not be good for the stock market either.  So while last Friday's stock market gains are nice to see, in the long run I believe government and personal debt will keep the economy from growing and will eventually pull the market down.  My investing response:  I'm short the S&P 500 through ProShares Ultra Short S&P500 (NYSEMKT: SPXU) and am contemplating further hedging.  

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