the latest Beige Book came out yesterday afternoon
I usually don’t pay much attention to the Fed’s Beige Book. I read news summaries of its conclusions, but not the report itself. But I found myself reading the entire thing–52 pages–last night.
I think we’re at a crucial juncture for the world economy–and therefore for world stock markets. As investors, we’ve got to decide whether the lurch downward we’ve seen in markets over the summer is a one-time event or not.
My central thesis is that we’re seeing a reaction to the fact that pent-up demand accumulated between 2007 and 2009 has finally been met in the past two years and the global economy is settling down to its true underlying run rate. Admittedly, by historic standards, it’s a pathetic run rate in the developed world, but we just have to accept reality and move forward.
The other possibility is that we’re seeing the early stages of a widespread economic downturn–and of an accompanying bear market that will last a year or so. If so, we have in store for us at least one, and possibly two, more downward lurches in stock prices of the type we’ve just seen.
The bottom-line issue is whether we need to get more defensive, and by how much.
what the Beige Book is
The Beige Book is a periodic report by the Fed’s twelve geographic regions about business conditions in their home territories. Admittedly, it’s anecdotal evidence. But it’s collected by professional economists from long-standing contacts in their local communities. The contacts are doubtless flattered to be consulted and are far more frank and complete than they would be if your or I, or a financial journalist, called. The local Fed knows the important questions to ask, and over time will presumably have gotten a good handle on the strengths and weaknesses of the people it talks to. So it’s valuable and reliable information.
The report itself has a certain homespun quality to it. There is a general format–summary, followed by sector information–but there’s wide latitude for local judgment on what information is delivered. Everyone uses the same typeface, but font size, spacing and margins differ noticeably. The whole report looks like a bunch of term papers from different students clumped together.
what the current report says
1. The US economy continues to expand, although at a slower pace than earlier in the year. The Richmond district is the only one that sees activity weakening.
2. In most regions, employers want to hire experienced engineers, industrial machine operators, IT specialists, truck drivers or other skilled workers–but can’t find them. Some firms have switched from hiring full-time new employees to using temps because they’re concerned about the slowdown in growth rate they’re seeing.
3. Consumer spending is up modestly. Demand for both new and used autos is surprisingly strong, with buyers looking for less expensive and more fuel-efficient models. Otherwise, consumers are postponing spending on big-ticket, housing-related items, like major appliances or furniture. Back to school spending is strong. Jewelry and women’s clothing are selling well.
4. Tourism has been strong throughout the country. Hotels are mostly able to raise prices without losing customers.
5. Manufacturing is still in the plus column, but slowing down. This is due mostly to decreased demand from government and financial institutions. Slowdown in Europe may also be a factor.
6. Housing and construction remain in the doldrums. Home remodeling is up.
7. Bank lending remains flat. Housing-related demand is from refinancing, not new purchases.
8. Throughout the supply chain, inventories are generally at desired levels.
9. In addition to concrete factors, such as declining demand from banks or from European customers, the regions all cite factors like “uncertainty about the economy”, “declining consumer confidence,” and “stock market volatility” as reasons their contacts are giving for becoming more cautious than they had been earlier in the year. Maybe that’s literally what the hundreds of interviewees are saying.
It strikes me as odd, though, that no one mentions the dysfunctional debt ceiling incident or the sovereign debt downgrade that ensued, or the strong linkage between legislative/administration failure in Washington and immediate declines in consumer confidence.
Maybe the Fed doesn’t want to get sidetracked into a political discussion, maybe “uncertainty” and “volatility” are code words that insiders understand, ormaybe it just doesn’t pay to criticize the boss.
The portrait I see being painted in the current Beige Book is of an economy moving sideways or up modestly–not down. But expectations among businesses have shifted from thinking the type of robust expansion we saw in 2010 to preparing for much more modest growth.
That’s fine with me, if this is as bad as it gets. Two consequences:
–I can still have a portfolio that’s based on the idea of finding areas of growth in an overall lackluster economic environment. I won’t be undermined by widespread economic weakness, so I don’t need to become seriously defensive. But
—it’s no longer a no-brainer that the benign outcome of at-least-flat will occur.
So I’ve got to monitor the situation more carefully–and think out more completely how I’d alter my holdings were the economy to begin to shrink.