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An Economic An Economic OverviewOverview

&&AnalysisAnalysis

2011 42011 4thth Qtr Economic Qtr Economic ReviewReview

Economic SummaryEconomic SummaryFed PolicyFed Policy

Bus InvestmentBus InvestmentOther Economic IndicatorsOther Economic Indicators

Employment AnalyticsEmployment Analytics““Falling Knife -1- Employment vs Falling Knife -1- Employment vs

Skils”Skils”““Falling Knife -2- The Great In-Falling Knife -2- The Great In-

equality of Wages”equality of Wages”Thought ExperimentThought Experiment

Market Forecast Market Forecast PicksPicks

Prepared by:Gary Crosbie

Economic Economic Summary:Summary:Overview:

•In general, economic conditions have shown sluggish growth through the year in a downward sloping trading range in just about every economic category. Job growth has shown some improvement but not at levels necessary to yield the kind of economic growth normally seen 31 months into a recovery. The most obvious example of this is reflected in GDP. The peak in GDP since the inception of this recession was 4% 4th Qtr 2009. The trend has been flat to down (see chart to right) since than dropping on average 2.3% to an avg of 1.7% for the year 2011.

•Normally , at the end of a recession, defined by the Fed as June of 2009 ..the following 5-8 Qtrs would normally reflect an average of 5-8% GDP growth . The good news is the current recovery sees the growth of GDP increasing in 2011, the bad news is the AVG GDP growth of 1.7% is problematic on its own merit but more troubling …decreasing from 2010 ….

GDP increased in 2011…but still down from 2009/2010..

Economic Economic Summary:Summary:

• The current anemic recovery is best understood when evaluated relative to previous recessions and is perfectly en-capsulated in the chart to the right which compares this recovery to every recessionary recovery post WW2. The main message in this graphic re-emphasizes not just the severity of the down turn but the persistence of the problem and while there is a recovery it is anemic in both duration and magnitude compared to other recoveries since WW2..

• The second chart is even more revealing comparing this recovery with the 19 post WW2 recoveries segmented into three categories Mildest, median and Harshest…reflecting this recovery significantly worse than the harshest.

• It is correct to observe some improvement as we have through Jan of this year. It is just as important to put that improvement into context with other recessions and to conclude the comparative differences are significant to the point that this could be appropriately summarized as a jobless and growth less recovery. The average recovery would reflect a $4000 higher per capita GDP and a 5-6% unemployment rate.

By Far the worst recovery of 19 post WW2 Recessions..

Compare the Median of all recoveries to the current…The slope of the median is Positive the current slope is negative..


• The ultimate consequence of the law of diminishing returns of a huge trillion dollar (including interest) fiscal stimulus program and targeted cash subsidy programs that provided some short term relief but left unresolved budgetary debt, capital flow, taxes and regulatory issues that yielded risk and uncertainty impeding capital investment and formation which is the key to improved business growth, Thus average GDP growth for 2011 came in under expectations of 3-3.5% to aprox 1.7% . For 2012 according to the CBO less than 2% GDP and unemployment at 8.9% %.

• The increased business risk defined above in concert with high productivity yielded significant improvements in the balance sheets of business. Cash balances approached 2-2.5 trillion dollars with The majority of corporate cash utilization currently allocated to M&A , stock buy backs and debt refinancing. This just continues to re-enforce balance sheets and M& A which results in corporate consolidations resulting in fewer jobs and puts more downward pressure on unemployment.

• Further as will be discussed later, in selective sectors currently but more significantly in the future there will significant skill gap problems. The majority of the layoffs are skilled labor who took early retirement. The problem is when expansion does occur and employers are back in the market place…the skills will not be available to meet the skill gap or those that are skilled will not be able to re-locate due to housing issues ..e.g. underwater mortgages.


• New capital formation and investment by business entities is occuring but the majority occurs in emerging markets(BRIC) where taxes and regulations are lower and more transparent and thus less of an impediment to capital formation, business growth and shareholder wealth.

• Further , in addition to lower taxes and less regulation double taxation impedes business from re-patriating there earnings back from foreign investment enterprises to the U.S for new investment in capital and labor.

• This is why 40-45% of earnings in large Cap multi-nationals come from international investments.

• Elimination of the double taxation on foreign earnings could result in approx 1-1.5 trillion dollars of new investment in US capital formation and labor growth(new jobs)

• So..with microscopic growth of less than 2% and a 8.3 % unemployment rate it is economic incompetence to continue the double taxation on Mult-nationals .

– You will not realize any new tax revenue because business will continue to keep 1-1.5 trillion dollars worth of potential capital formation and new jobs overseas rather than in the U.S

– the negative incentive encourages NEW capital formation and growth outside the US…

Economic Economic Summary:Summary:Overview:

• The bottom line is unlike previous recessions that have V shape recoveries at 6-8% this is likely to be a long slow slog of 2.- 2.5.%- growth thru 2012 and for some time. •Employment growth while seeing some minor improvement is sluggish at best with an average of 137K per month over the 2011 period. While Dec employment came in at 200K and Jan at 243k the employment rate needs to average 250-300k per month to impact the unemployment rate of 8.3 -8.5% to levels of 5.5- 6.5% normal for a recovery this “Long in the Tooth”. •The Dec number is artificially inflated due to the fact that more than 315000 individuals dropped out of the labor force totally. The Bureau of labor and statistics does not measure these people so the real Unemployment rate is really 16-20%.Gallop currently calculated the rate at 19.2%•. This is due to a low participation rate in the labor market. These are people who have run out of unemployment insurance or who just given up. The Bureau of Labor and Statistics DOESNOT count these individuals and they thus are lost in the smoke of the total unemployed.

63.5%..At this participation Rate the real unemployment rate is 16-20%


• Market Volume has been light for a prolonged period of time indicating that the retail investor has been sitting on the side line for a lot of the same reasons business is not spending. Uncertainty, risk aversion and fear has driven any significant in flows of investment away from equities to treasuries , commodities and the bond market. 2008 is still strong memory to the average retail trader. The result is the market is more volatile driven by the professional trader , & computer generated trading strategies

• In total the economy is at stall speed and significant improvement is not expected untill things change politically. Right now existing policies are not conducive to growth due to uncertainty on taxes, regulations , healthcare and Demand. Personal Consumption Expenditures (PCE) was -.1% in Dec which was a huge disappointment given holiday expectations.

• For the foreseeable future businesses are keeping inventories and employment tight due to uncertainty….The uncertainty of the Euopean fiscal crisis, Policy and regulation out of Washington to include healthcare, the bond market , demand and supply issues.


• So the question is Where are the “Animal Spirits ” that fuel the economic engine? Entrapanuear new starts, IPO’s and small business growth….The answer is….due to the above there is a large amount of risk aversion and the Risk OFF business strategy is in place.

• Further QE-2 has ended which means the money stimulus has ended but the Fed has substituted QE2 for Operation Twist to improve the Risk on trade for investors and the banking community . More about that under Fed.

• Corp earnings were up in the 4th Qtr but not as much as in 2010. Never the less the S&P valuations came in at around 12-13 times earnings (Versus an average of 15-17 times ) making equities in any analysis the investment of choice vs cash or fixed income.

• Thus markets are undervalued for 2012 and in addition with taxes due to rise significantly in 2013 will likely act as a positive stimulus for higher valuations at least through the first 6 months of the year. Further fear of higher taxes in 2013 will cause some investors to move Investment decisions forward to 2012.

Economic Summary:Economic Summary:Overview:• The bond market is projecting sluggish economic

growth. 4 th Qtr GDP was 2.8 % but the avg GDP growth for the year was 1.7%. The CBO is projecting growth for 2012 in the 2-2.5% range significantly below what is necessary to grow employment.

• The objective of Fed Monetary Stimulus …QE1, QE2 and Current “Operation Twist” was three fold;

1. Improve Large Cap Investment:Put downward pressure on the 10 year (see chart)through more and more liquitity which provide a more favorable environment for both equity & corp bond investment.

2. Improve Small Business Hurdle points for new growth investments; Lower yield curve rates provide lower cost of capital for new business investment:

3. Housing: Support a faltering housing market and thus keep mortgage interest rates low .

• Results: Equity markets have responded with high volitility ..up 5-6% first half ..down 7-8% second half..

• Small Business demand for new capital is still

lacking given all the uncertainty and while mortgage rates are low-(3.5-4%) housing starts and prices are still decreasing and threaten a housing double dip.

10 Year Bond Rate

Effect on the yield curve of QE1,QE2, Operation Twist

30 Year Bond RateEffect of Operation Twist has flattened the term structure of interest rates yield curve to historical levels between the 10 and 30 year bond to 100 basis points.


• Euro Contagion: Fear of Debt and deficit problems in Europe is enhanced by the tendency of the EU to continually wait till the zero hour before solutions are implemented. The problem is the EU is like the FED in that it can provide the liquity…which it has …some 500 billion euros(although the requirement is for close to 2 trillion Euros) to provide the liquitity in addition to cutting Interest rates(sound vaguely familiar).

• However it has no authority over members to manage sovereign fiscal issues(budgets, deficits) or dictate to banks to buy country sovereign debt to recapitalize the health of countries like Greece, Spain, Italy , etc. In other words to get the Toxic assets OFF the books.

• To accomplish this requires sacrifices by Germany and significant haircuts(40-60%) by investors. It will eventually happen..despite the pain because the fiscal viability of Europe is at stake. Bottom line….Despite the negatives above…

• The combination of all this does not yield a great deal of optimism on the small business new and growth front for 2012.

• Bottom line…… it is the “Fear Factor” rather than the actual economic impact to the US that will drive impacts to the markets and general economics.


Overview:• The equity markets were down -2.8%

over the 4th QTR 2010.

• 1st and 2nd Qtr were up nicely but matches history which basically reflects a sell in May and go away philosophy.

• Year to year results have been trending down with uncharacteristic volatility.

• This high volatility is driven by the end of QE-2 , the uncertainty around the impact of “Operation Twist” and the uncertainty around the Euro Fiscal crisis in Greece, Portugal, Spain and Italy.

DJ Total Stock Mrk

DJ Total Stock Market DJ Total Stock Market

I Year -2.8%Growth

• Additional risk has been added due to a greater than 100% Debt/GDP Ratio due to low growth and a debt that has increased by 5 trillion dollars over 3.5 years. As a bench mark Bush spent 5 trillion dollars over 8 years.

• Note this risk is reflected in the volitility chart to right.

– from Dec to June. CBOE goes down indicating more investors perceive less risk and thus are buying(Buying calls) into growth early in the year to June(see 1 in chart ).

– After June , the uncertainty discussed above finds investors perceiving more risk thus selling and shorting the market (buying PUTS)reflecting lower market thru NOV …Sentiment changed thru the end of the year but the market could not make it up and ended up as a year end loss of -2.8%

• However, the effect of QE-2 and Operation Twist resulting in 10 year note rates at around or below 2% still make equities the investment alternative of choice with a 2. -3% dividend floor and a 4-5% growth risk premium.

• Some additional Comments:

CBOE Volitility1-Volitility down…..less perceived risk positive influence on market thru June/July-

2-Volitility up…..more perceived risk NEGATIVE influence on market thru Nov. Positive from Nov to Dec yielding positive market results.

Market

Market


Fed PolicyFed Policy : : • Monetary policy..”The Back Drop”

– 1ST and 2nd Qtr 2011…In response to a faltering economy and an economic recovery that to date is going in the wrong direction the Fed has implemented a new phase of quantitative easing (QE2). This translates into 600 billion dollars of monetary infusion into the monetary base thru purchase of treasuries and Mortgage backed securities. The objective , as mentioned in the summary was to put downward pressure on the 10 year bond rate to :

• Help a “double dip:” prone housing market with lower mortgage rates, • put downward pressure on the dollar relative to other currencies to improve exports

and infuse some inflation. • Keep the cost of available capital low to Encourage borrowing and improve

incentives for more financial leverage and thus more velocity of money.• Keep the comparatives between the bond market and equities favorable to equities

and corp Bonds by lowering the risk premium in favor of incentives to overweight stocks and underweight fixed income.

– QE-2 ..other than providing additional liquity did not result in a significant infusion of risk cap into the economy. As stated last quarter this continued pump priming is sort of the last bullet in the chamber strategy due to the failure of questionable fiscal policy initiated from the current administration over the past two years.

Fed Policy :Fed Policy :

• Monetary policy- “ The Future Prospective”

• The real problem is still the velocity of money which comes from lending, borrowing and investment which despite a minor up tick in the first QTR of 50 billion dollars , is all but invisible. Banks have much stiffer regulatory and capital requirements not with standing the number of foreclosures, short sales and suspect commercial loans sitting on there balance sheets.

• Bottom line ..there is no incentive for banks to make loan. With a 1.9-3.% fed funds rate for 10-30 year bonds, what’s the incentive to loan when banks can “carry trade” the yield curve….borrow at zero and than turnover the money and buy 5,7, 10 years treasuries and earn 150 to 300 basis points with ZERO risk……Even bankers can make money doing that.

• However……Bottom line: QE1 and QE 2 have not provided the needed result so:

– As mentioned The Fed has implemented “Operation Twist” (QE-3) to flatten the yield curve to dis-incentivize the carry trade……BUT

– There is no particular incentive on the demand side(demand for loanable funds by business) because of regulations, taxes and product demand

– The supply side (loan availability ) by banks due to more restrictive capital requirements as a result of all the toxic assets on the balance sheet.

Fed Fed Policy :Policy :

Fed PolicyFed Policy : :• Monetary policy- “ The Future Prospective”(con)

– So when QE-2 expired and the economy continued to flounder The Fed brought on operation Twist.

– As mentioned previously , the objective to Operation Twist was to flatten the yield curve by selling 30 year notes and buying mortgage securities.

– The purpose here was to tighten the spread between the 2 year and lower maturity treasuries and the 30 year to minimize the carry trade which banks were using to fatten there balance sheets at zero risk rather than make loans. Further flatting the yield curve would put additional downward pressure on 30 year mortgage rates thus a help to the sinking housing market . Finally the flatten yield curve improves the risk premium to invest in capital ..both stock and new venture rather than fixed investments.

– However….perspective is important here… Outside of improvement in global demand through higher exports, this addresses primarily the SUPPLY side of the equation . This isn’t totally a supply issue …the fed has 2 trillion dollars on its balance sheet(m2).

Dollar IndexDollar Index• Monetary policy- The Impact

• So ..we will see if Operation Twist works. Right now all the Fed policy has done is encourage the incest of the carry trade and devalue the dollar There is no significant increase in the velocity of money which is the key to growth. Now , it does impact business investment prospectives to be discussed below.

• Finally, The extended low FED funds rate exacerbated by high level of monetary stimulus has had an impact of inflation. The core CPI rose 2.2 % in 2011 slightly higher than the FEDs hurdle rate of 2% with the total CPI including food and energy 3.2% for 2011 portending inflation. Leading indicators such as commodity prices are up and the dollar is down indicating inflation is on the horizon.

Fed Policy : Fed Policy :

Inflation3%

As Fed increases money supply Dollar is devalued AND

Inflation expectations increase .

Fed Policy :Fed Policy :

Business Investment.Business Investment.• Velocity of Money.

– The velocity of capital measures the degree to which increased financial leverage increases the flow of money from those who demand it (business) to those who supply it (banks as suppliers and intermediation vehicles, private equity).

– As discussed above (see 1 above) the problem is on both sides of demand and supply side of loanable funds.

– On the demand side businesses still face “political and financial uncertainty”. Despite the Nov elections there is still a “hangover” from Fin Reg and the healthcare bill that have a significant potential impact on an uncertain future revenue base. So despite the lower 10 year which is a proxy cost of capital for business new investment capital budgeting , you should see significant more capital investment in new projects that now show much better cash flow prove ins. But again…once you get past the cash flow models…you still have to deal with the uncertainty of the political and business environment. And right now the uncertainty sentiment is high.

Fed increases money supply but Demand for money thru loanable funds as measured thru Velocity of money is not there .

Business Business Investment:Investment:


– On The Supply Side.. For those who are optimistic about revenue growth and that number is growing, there balance sheets still don’t meet new bank criteria which restricts loans to only the best of customers. As stated above this is a result of the much higher capital requirements that are imposed on regional and community banks that had nothing to do with the financial crisis but have had a stifling effect on small business growth and thus employment.

– Additionally, as long as the toxic assets are still on bank balance sheets , restrictions on capital availability will be high.

– Bottom line…High money velocity flows ..translates in a geometric fashion to capital creation , investment, employment, GDP and thus growth.

The Demand for loanable Funds has decreased significantly .


• Quantitative Easing(QE2) and Future Stimulus(Operation Twist)

– We discussed Fed policy in 1 above. One advantage to additional quantitative easing is the impact on lowering the yield curve ..thus the cost of borrowing goes down. Lower borrowing costs means a lower cost of capital which means a lot of potential business growth projects that wouldn’t look profitable now have higher positive Net Present Value prove in’s due to the lower cost of capital. So what the Fed is attempting to due here is trying to improve the sentiment for more investment through low borrowing costs and indirectly lower cost of capital for prospective investment.

– Now that QE-2 has ended and the economic trends are down, the Fed is discussing the potential for future stimulus envolving more purchases of Mortgage backed bonds.


• More Quantitative Easing(”Opeartion Twist”)

– There is a financial paradox here: As discussed previously the Fed (thru QE2 ) wants to put downward pressure on the 10 year bond rate to keep mortgage rates down and provide incentives for investors to invest in equity alternatives rather than fixed income. That’s fine…putting the inflation issue aside for a moment….the problem is the lower 10 year does not provide a sufficient risk premium for banks to lend…that is to say, there is no disincentive to continue to “carry trade “ the yield curve..

– Further there has to be more Demand for Money by small business either through expansions, IPO’s or new start ups . As stated previously this growth has been dampened by higher cost of capital through govt regulations and higher taxes.

– Given small business contributes 45-50% of GDP and 65-75% of new employment this is obviously the critical success factor to future growth

– With low demand , low growth and currency devaluation, “the falling Knife” is inflation ….and worse stagflation..where inflation is higher than GDP growth.

– The problem is …the “falling knife” has 2 edges…The other edge is slow to non-existent and a possible double dip . With the unemployment rate at 8.3 % and GDP expected to be 1.8- 2 % for 2012 that becomes a potential issue.

– Since 1948 whenever there has been a rolling 12 month GDP growth rate below 2% another recession has followed within 1 -2 QTRS. The current 12 month moving average is 2.3%.

– That obviously is the worst possible alternative and why the FED is has implemented Operation Twist.

Business Business Investment.Investment.

Capital Investment: • After 2008 ,With no demand and

helped by historically low interest rates businesses rebuilt there balance sheets through turnover and refinancing there embedded debt to cut there carrying costs.

• This in conjunction with massive layoffs of human capital resulted in 1.7-2 trillion dollars of cash sitting on business balance sheets. That cash here to fore has not been invested due to low demand and as stated previously the sentiment of “Uncertainty” as it applies to taxes, fin regulation, Heath care , Cap and Tax

• Small business in addition to the same uncertainties of bad public policy (Taxes, healthcare etc) are further denied the availability of capital due to onerous financial regulation that limits capital availability .

• Large Businesses have increased capital investment in three areas..

.6%

Industrial Production turned up in Jan but long term trend is still flat to down.

Business Business Investment.Investment.

• Capital Investment (con) – Technology: Utilized investment to substitute

capital for labor (will be discussed in the unemployment section) to improve margins .

– Moves and Acquisitions (M&A)- To put the large amounts of cash to work , large businesses have been acquiring small and Mid cap companies that are undervalued or with troubled balance sheets to compliment there business objectives. The problem here is the acquisitions which generally are complimentary business functions usually result in consolidation…..resulting in less total employment.

– Manufacturing- The PMI(purchasing Managers Index) for Dec was 55.3% indicating expansion. By itself that is not a bad number . The problem it reflects a significant change in trend from 4th QTR 2010 of above 60%.See chart.

Other Economic Other Economic IndicatorsIndicators::

Retail Sales:

Retail sales were flat..0 % in Dec.from the previous month a big disappointment give all the discounts given by retailers to stimulate sales.

Up…6-6.2 % over Dec 2010

As reflected in the charts the current numbers are only marginally above 2008/9 levels in Retail spending averaging aprox 3.5-3.7%/yr

0 % Dec over Nov. 6.2 % annual

• Personal consumption expenditures for Dec decreased $2 billion in Dec or - .1% .

• The key is the downward trend from 4th QTR 2010.

• Consumer Confidence was 61.1.5 % up from the 4th quarter 2010 of 60.6 , overall reflecting a trading range of 55-61% with no significant consistent breakout.

• The key to these two series in 2012 is a return to more volitility that we saw in 2008/2009 until there is more certainty about political realities which will have significant impact on Fiscal and monetary policy.

• This combination of these two indicators suggest an average that is flat around 55% but more uncertain about the future.

Consumer Spending:

Other Economic Indicators:Other Economic Indicators:

-.1% in Dec

61.1% Jan

Other Economic Other Economic Indicators:Indicators:

• GDP: – We need a 3 -3.5% growth rate to just stay

even in unemployment(200-250k jobs a month) and 6-8%(250-350 k jobs per month) to make any significant gains at all…(Real gains not artificial gains due to low participation rates)

– The GDP growth has been down from 3.7% in the 1st qtr , 2.9 % in the 4th qtr 2010 to 1.9% 1st QTR 2011 to 2.8% 4th QTR 2011. Growth was progressive for 2011 but the trend growth (see chart) is still down.

– Thus, for all the reason’s stated above there is not sufficient growth , consumption and investment necessary to dramatically improve the growth and therefore the employment picture for a number of years.

2.8% 4th QTR, 1.7% 2011 avg


•Unemployment Rate:– Non farm payrolls increased

243K in Jan above expectations of 200-220K. This resulted in a decrease in the unemployment rate to 8.3%. This reflects a continued increase in monthly employment since May..reflecting a growth to rates achieved earlier in the year Jan thru April.

– The point is while the 243K is a solid number looking at the chart we have had only 7 months since the beginning of the recession in 2008 that have been 200K or larger. We need multiple consecutive months of 250K to 300K employment growth to make any significant inroads to improved employment in this recession.

– The key statistic here is 6.3 million or aprox 44% of the unemployed have been unemployed for greater than 27 weeks. Further the labor participation rate is at continued low levels of 63% .

8.3% In Jan

8.3% In Jan

Only 7 months since the inception of the recession were = to or > than


• Unemployment Rate (con)

– This is why it is necessary to have months of 250-300K employment because the real unemployment rate is close to 17-20% given that almost 2.5-3 million people have dropped out of the labor market completely.

– Note the correlation in the chart ..As the participation rate goes down the unemployment rate decreases…because people who drop out of the labor force are not counted by the Labor Department

– Note….If the economics improve , that rate of 8.3% is likely to increase as those workers who dropped out of the work force make there way back in and are counted by the Labor Dept when the economy improves.

– The unemployment issue has more fundamental complexities than in previous recessions and is not being addressed. I will discuss this in the technology analytics section.

Note the correlation

Other Economic Other Economic Indicators:Indicators: • Housing Market:

– Interest rates have gone down .25-50 basis points during 2011 with the full impact of QE2 and Operation Twist At less than 3.5-4% for some 30 year loans the cost of home ownership has never been lower. However now that the Fed has done about all it can due thru monetary policy mortgage rates have somewhat stabilized.

– Absent the fear trade due to Eurpopean contagion , Operation Twist will likely maintain a flattened yield curve over the term structure of interest rates. Further the Fed has stated that it intends to maintain low interest rates (thru ,25 fed funds rate) thru 2014., Most of the positive impact of lower rates has been realized . Most who could refinance already did at the end of 2009.

– However, due to increased regulations and capitalization requirements very few individuals except those with the very best credit and income history qualify.

– The problem continues to be further downward pressure on housing prices. Foreclosures continue to increase with 1/3 to 40% of all mortgages underwater. Even if home owners wanted to hold on they either don’t qualify for refinancing or can’t meet or want to meet the new financing requirements (who wants to put more money down on a home that is underwater) .of 20% down.

– The government has come up with another program that would require banks to refinance underwater loans for customers with current payment records through principal reduction. The details are not clear at this time except to say the banks and the investor will have to assume the cost

– Bottom line single family residential construction is still flat to down in the 400-500 k range…Multiple unit construction is in the 700-800k range.

Single and Multiple family construction Flat to marginal increase.


• Housing Market : (con)

– Existing home sales are slow but improving. Currently there is an 6-7 month inventory of stressed properties down from 9-11 month supply in the first half of 2011 with 11% unoccupied. Existing Home sales were 4.6 million units reflecting a 5% increase in December and 3.6% above the December 2010 rate. Avg median prices fell 5% in 2011 over 2010.

– Additionally…In 2011 thru 2013 a lot of 5 and 7 year ARM’s that were taken out in 2006 will come due for refinance. Again many of these home owners will not be able to meet the new financing requirements which mean more downward pressure on housing prices through defaults, foreclosure and short sales.

– This translates into another 10-15% decrease in housing prices as inventories of foreclosures continues to increase.

– Over 30% of all transactions are cash and 1 out of 5 first time buyers cannot afford the 20% down payment or meet the income or credit requirements.

Existing Home sales reached 4.6 million units in Dec 2012 with a 6-7 month supply .


• Housing Market: (con)

• It is hard to see how this economy can make much progress until the housing market turns around. Here in lies some of the justification for why most forecasts for growth in 2011 and in 2012 are predicting around 2.5 - 3.0%.

• That is on the light side of trend line growth(3-3.5%)…but to improve the employment picture the economy needs to grow at least 4-6% a year generating 250-350 k jobs a month in the initial stages of a recovery to make any serious in roads on employment , growth and investment in new capital formation.

Employment Analytics:Employment Analytics: • Structural Unemployment:

– The current status in unemployment represents a different taxonomy to the unemployment picture than what we have seen historically ln previous recessions. A lot of this can be attributed to the use of technology to maintain or improve margins in a decreasing revenue environment.

– In the 90’s , as an out growth of the technology boom there was a movement to improve productivity through the use of technology . It was generally referred to as Process Re-Engineering. The darling of MBA programs and management consultants alike.

– The objective was to save 20-35% through substitution of capital for labor through new hardware infrastructure and software applications…at least until management looked at the impact on the organization and power politics…than the objective quickly dropped to.. ..hope to get 5-10% with “Low Hanging Fruit”.

– Fast forward to 2008-2009…A recession resulting in massive reductions in the labor force…..All of a sudden all those dusty Power point preso’s generated on white boards in secluded corner conference rooms of Corp head quarters on process re-engineering were pulled from old file cabinets and re-invigorated.

Employment Employment Analytics:Analytics:


• Structural Unemployment:

– Result…Capital investment in technology increases to substitute for the labor component yielding high productivity and profitability.

– The increased technology utilization has resulted in big margins and profiabiity(1.5 – 2 trillion dollars) on Corp balance sheets tempering the demand for labor .

– Small business …existing and new starts could help bridge the gap but for all the reasons stated above, that is not forthcoming.

– This structural unemployment issue is complicated , important and not even readily identified and discussed as a problem much less solutions offered.

– This unemployment situation is a lot more complicated than just opening another manufacturing plant or stimulating shovel ready construction jobs.

– A significant component to solving the unemployment problem is going to have to involve the solution to this problem

Employment Analytics:Employment Analytics: • Structural Unemployment: “The Falling Knife”

1. Cause: As indicated in large businesses the substitution of capital for labor in 2007-2008 made maximium use of technology to increase productivity and efficiency through labor reductions.

2. Effect: Everyone talks about the construction trades as the driver be hind unemployment. But the big changes in major corporations where a lot of older(>50) very skilled individuals either retired early, forced retirement or were just let go. The strategy was that when it was time to re-hire you could move down the age scales and pay less for similar skill sets.The problem not anticpated by the business community was the individuals currently educated today do not have the skill sets or are not prepared with the academic skill sets to meet current job requirements.,

Employment Analytics:Employment Analytics:

3 –Long Term Unemployed: It has been long recognized that the longer one remains unemployed the rate of skill degradation increases at an increasing rate.

4- Skill Set GAPS; Set by the trend established in 2007/2008 with all the implementation of new technology ,any growth requires more of the same high Tech analytical skill sets. Those skill sets are lacking with current graduates reflecting a huge gap in engineering and similar analytical capabilities that provide the critical thinking skills that allow optimum adaptability to an environment that is ever changing . The tradition..

’I have a college degree..therefore I deserve a good job’ no longer applies.


• 5- “The Falling Knife- Part-1 “ : Employment vs. Skills

- Retired Skill Sets: So structural unemployment is where you have on one end of the age spectrum a lot of older technology savy people but who have skills but been out of the workforce to long(>27 weeks). The result of process re-engineering layoffs/early retirement packages referred to earlier.

- Educated Skills vs Demand; On the other end an “entitlement” oriented college graduate who doesn’t have the analytical skill sets or critical thinking skills to make a contribution to the business mission from day one. This is a technology generated global environment demanding skill sets that optimize the achievement of those business goals.

- Minimum Education and skills: 25-28% of the work force has a college or advanced degree. That leaves over 75% of the workforce competing for a diminishing demand for labor and that labor demanded requires specialized skill sets. Thus….This puts significant pressure on overall employment.


Unemployment for those who have college degrees or higher is less than 5%..

• 6- “The Falling Knife- Part-2” : The Great In-Equality of Wage Gains.

• A lot has been written concerning the stagnation of wages for the low & middle class over the past 30 years. The implication is that benefits have been inappropriately distributed to the “quote un quote” Rich while the middle class and poor have suffered disproportionately. A study by the Fed Reserve addresses this with an explanation that supports the comments made in the previous sections and illustrated by the following graphic.

• The blue arrow reflects the gap between those with Degrees and non-degrees . Note back in 1982 the differences are virtually insignificant.

• There is also some significance in the rate of hourly wage growth within the educated or degreed segments. This..as stipulated in the previous section is due to the growth in demand for specialized skills in an analytically Technology driven economy rather than to simply have “Just a Degree”

Margins in real hourly wages increase from insignificant to significant due to education


• So…this is not a case of the rich vs the “poor” as some would make it…but rather a case of those who made the choice to not just get educated but educated in the right skill sets.

• Further……..A final and probably the most significant point is class Identity…..that is…… belonging to any class is transient for most. A Fed Reserve study Shows that 40-50% of those in the lowest income class 5 years later have moved up the ladder to the middle class. Equivelently those in the middle class move to the upper class while some fall back to lower class. In other words the “Ladder of success” is fluid in BOTH directions… movjng constantly between..up and down… the wage and class ladder. So to talk about wage inequality as a static identifier of individuals in one class or another is to make a false point.

• Class mobility is characteristic of a Capitalistic opportunity based system and the acquisition of education and the appropriate skill sets discussed previously simply allow a higher entry point in the wage and class scale and maximize the potential for acceleration up the ladder of success.

Employment Analytics:Employment Analytics:

Employment AnalyticsEmployment Analytics• A “Thought Experiment” on how to stop the “Falling Knife” of structural

unemployment.

– To help incentivize job growth and Improve the education Gap ….allow business to depreciate Labor for some period of time as a test case.

• A “Thought Experiment:” Accelerated Labor Depreciation Method(ALDM)

• The concept would be to allow business to depreciate labor as in capital to include education costs.

• This would provide improved cash flow to small and large businesses alike BUT in particular allow business cases for entrapaneur ‘s to show positive hurdle points due to lower cost of capital..


Conclusion: You have a huge supply ..75-80% of the work force with limited skills trying to compete in an employment environment looking for very specialized skills …15-25% ….and willing to pay a premium for them. Conversely for the other 75% there is little demand putting significant downward pressure on non-technical wage rates…

If this is difficult to fathom…..Just think of two words….Professional Sports

7- Solution: This is a very complicated issue and requires a much different view of educational needs overlaid on business requirements. Clearly there are gaps that will not be provided in the short run. This will most likely mean more labor investment in countries where more emphasis is placed on critical thinking skills and discipline until there is a better match between graduate capabilities and business needs.


Employment Analytics:Employment Analytics: • So based on defined Labor groups

• Analytical Skills (Engineers, Math, Science, Computer science)- 2 years• Business analytical Skills-(Accounting, economics/econometrics)- 3 years• Liberal Arts-(history, Language etc)- 10 years• Technical Training- Mechanics, Manufacturing – 3 years

• Thus like capital costs Depreciate labor over a designated timeline.

• The timelines for depreciation above are “arbitrary talking points”

• The timelines are based on the value of the skill set based on demand and supply in the market place.

• The emphasis here should be “simplicty”….set by The Federal accounting Standards board(FASB)..(I know that’s an inherent contradiction…)


Market Forecast:Market Forecast:• Given the above and the S& P at 1277 at the

end of the 2011…(it was 1319 at end of QTR 1)…. The S&P markets are still 14-15%% below 2008 highs(1550) before the crash.

• GDP Growth in the 2-2.5 % range in the next six months is meager but with Positive Corp earnings price earnings multiples are still around 13. This is undervalued relative to a trend of 15-18 multiples.

• Fed Policy stipulated to:– Keep interest rates (fed funds = .25) low thru 2014

– A floor of 2.5-3.0% dividend with Mid and Large cap stocks ,

• Equities look favorable relative to fixed income alternatives. Thus expectations for the range of outcomes for the next 6 months of the year are:

– 1- Optimistic… S&P a trading range of aprox 6% -8% for the next 6 months…. ………………….….1350 to 1380 .

– 2- Most Likely… S&P in a trading range aprox …4- 6% …. for the next 6 months ……………………..1330 to 1350

– 3- Pessimistic….S&P moves flat to up aprox….2 to 4% … for the next 6 months ……………….........1310 to 1330.

Double Exponential Smoothing

Optimistic.

Pessimistic

Market Forecast:Market Forecast:

• After this next 3-6 months …unless growth in GDP and Jobs turn around significantly (250-300K per month), there is a implementable solution to the US and European fiscal crisis and a calmer middle east 2012 market growth will fall in the range of 2-3 %.

• Alternatively, a major change in November would result in a 4th Qtr 10-15 % market increase.

• Picks:– Large-Cap

• Yackman-YAFFX• Monetta Young Investors-MYIFX

– Mid-Cap• Brown Capital Mgt-BCMSX• Meridian Midcap growth- MERDX• Rydex S&P Midcap-RFG

– Small- Cap• Brown Capital Mgt-• Ridgefield Small Capo-SCETX

• Commodities/Technology (con)– Industrials –Power share-PRN

– Energy-PXI

– Pimco Global-DRGTX

– First Hand e-commerce-TEFQX

– Gold-GLD

• International– I Shares- Latin America-ILF

– Lazzard Emerging Markets

• Fixed Income:– Fidelity Strategic Income-FSICX

– Artio Global High Yield-BJHX

– Metro West High Yield-MWHX

Market Forecast:Market Forecast:

Download - 4th Qtr Year End 2011 Economic Review Feb 15 [Autosaved] [Autosaved]

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