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August 2012 Market and Economic Conditions
By Adam B. Landau Permit Capital Advisors, LLC

Since Quantitative Easing was first implemented in early-2009, consumer confidence statistics have moved in near lockstep with the gold-adjusted, or real S&P 500 index, rather than the nominal index. The result is a breakdown in the “Wealth Effect” theory that Chairman Bernanke and his fellow central bankers have been counting on as a byproduct of QE and other unconventional monetary machinations. This tendency towards myopic behavior on the part of the Federal Reserve has been well telegraphed. Fed papers on the effectiveness of QE have focused almost exclusively on the short-term impact it has had on interest rates and risk premium in the financial markets, with very little analysis or reference to the resulting effect on the real economy.

Perhaps for good reason. It would appear clear after three-plus years and various iterations that QE and other unconventional monetary machinations lack any material transmission mechanism from monetary interventions to the real economy. Perhaps the US consumer knows what the Fed does not – that economic activity has very weak elasticity with respect to financial market fluctuations. Historically a 1% change in the value of the stock market is associated with a change of just 0.03-0.05% in GDP. It’s scary to think that the Fed may be artificially (and temporarily) propping up risk assets while simultaneously driving the financial system further from equilibrium.

The most eye-catching evidence of the inability to lift the economy out of its malaise was the early-July report that the ISM manufacturing index had slumped from 53.5 in May to just 49.7 in June. The regional surveys that came out later in the month were sobering as well. The Richmond Fed reported a deepening pullback in manufacturing with shipments and new orders declining further into negative territory, while backlogs, capacity utilization and delivery times continued to contract. The Philly Fed was particularly worrisome on the employment front, as various components showed labor market conditions deteriorated. The gauge of the number of employees dropped to its lowest level since September 2009, and the average work week contacted again. Indeed, recession signals are flashing red, as all three of the ECRI Weekly Leading Index, OECD US Lead Indicators, and OECD Total World Lead Indicators are below a standardized -0.5, traditionally a harbinger of recession.

Compounding monetary policy ineffectiveness and an already weak economy is a looming potential fiscal policy disaster. Fear of the fi scal cliff and uncertainty over taxation has caused spending, investment, and hiring plans to be put on ice. The tax hikes and spending cuts which would potentially take effect in January of 2013 would total in excess of $600 billion, or 4% of GDP. Tax hikes alone would amount to 3% of GDP, and the last time we saw hikes that large was in 1968, with a recession soon to follow in 1969. The biggest hit would be to disposable income, which is already suffering in many households. The fiscal cliff would raise taxes and reduce transfer payments such as extended unemployment benefi ts against a backdrop in which June was the third month in a row in which retail sales less food and autos declined on a monthly basis.

There is one important sector of the economy which appears to be turning – real estate. There, the Fed and its interventionist policies could be credited with providing support. Low mortgage rates have kept the market afloat while fundamentals repair, and QE, most specifi cally Fed MBS purchases which may be on the horizon again, has seemingly played a signifi cant role. In a current macro environment that is replete with confusing cross currents, real estate is once again showing its resiliency to investors. Real estate can offer secure and attractive income at a time when that is difficult to come by. It can also offer greater upside for those investors with an appetite for such opportunities. A strategy involving the acquisition of land or a well-located-but-flawed asset which is then either developed, improved, or otherwise turned over at the tenant level to create a Class A asset is compelling, and within reach.


About Adam Landau

Adam Landau is Chief Executive Officer and Chief Investment Officer of Permit Capital Advisors, LLC.

He has 15 years of experience evaluating investment managers, developing asset allocation strategies, and coordinating the process by which the two disciplines are merged.

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