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Distortions and Side Effects

September 22, 2009 – 9:37 am

August’s leading economic indicator report was released this morning showing a gain of .6%. The expectation was for a rise of .7%. However, July’s report was revised upward and this is the 5th month in a row of positive numbers. The report attempts to gauge future economic activity. The trend is in the right direction but it clearly indicates a slow recovery.

Later in the week we will see housing data. Recently, home sales have increased but there have also been increases in foreclosures. The net result is a reduction in overall inventory, something that bodes well for a recovering economy.

The problem is that there are distortions in a number of statistics. The easiest to see is in housing. The government through Freddie Mac and Fannie Mae is buying 80% of all mortgages and the treasury bought 50% of all issued government bonds in the last quarter. The net result is an artificial unsustainable low interest rate for mortgages. Also, with the tax write-off for first time home buyers expiring and the attempts to postpone foreclosures by the banks using government mandates and guidelines, it is almost impossible to know the real story in the housing market. What we can conclude without considering the government interference is that affordability for housing is very low, and household formations, i.e., new families, is running at a little over 1 million per year. At the same time new construction of homes is about 600,000 per year. Eventually, these two facts will support the housing market.

More worrying is the distortion caused by all the government spending. You can argue that it is or is not necessary but you can’t argue the fact that as a result of this spending we can’t gauge the real strength or weakness of our economy. There will be unintended consequences, but just like strong medicine you first need to cure the problem and deal with side effects later. Let’s just hope those side effects won’t be fatal.

Good Trading
Steve Peasley

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