Stifled by an icy housing market, a record trade deficit, soaring national debt, over-stretched consumers, high energy costs and a prolonged war in Iraq, the U.S. economy is slowing down.
The key question remains: will it be a hard landing or a soft landing?
Former Federal Reserve Chairman Alan Greenspan recently showed he still has the power to move markets when he pronounced that there is a one-and-three chance that the U.S. economy will bottom out with a recession.
“There is no doubt there is a slowdown going on in the U.S.,” Greenspan said. “We are clearly having troubles in the capital investment area, as well as potentially in the consumption area and obviously housing being a significant drag.”
Michael Sadoff, an investment advisor and principal at Sadoff Investment LLC in Milwaukee, agrees with Greenspan that a recession could be looming. However, Sadoff says a soft landing, with slower growth, is more likely. Sadoff, whose company manages more than $400 million in assets, recently shared his economic outlook with SBT executive editor Steve Jagler. The following are excerpts from that interview.
SBT: At the start of this year, economists predicted a year of slower growth. What has happened at the half-way point, from your perspective?
Sadoff: “I would agree with the slower growth. That’s definitely been the case. And the main culprit of that is the Federal Reserve hiking interest rates over the past few years. That definitely has the potential to keep inflation from taking hold, to moderate growth, so there is growth, but it’s a slower rate of growth and usually will allow the economy to expand for a longer period of time.”
SBT: Greenspan spoke of a chance of a hard landing. What would make this economy have a hard landing into a recession?
Sadoff: “Probably a couple of things. One would be the housing market. The housing market has led the slowdown. Now that the housing market gains aren’t there and there’s some year-over-year losses on home prices … If the housing market starts to slow much more, that could really pull down the whole economy. And the next step from the housing market is consumer spending. People were basically using their houses as an ATM. Interest rates were low, so every year or so, their houses went up 10 percent or so in value, they refinanced their house and cashed out. You know, the average person was cashing out like $50,000, and they’d go and use that to finance cars, go shopping, do some remodeling on their house, and now that really doesn’t exist. Mortgage rates are not lower than they were before. The debt part of it is over, and the housing gains are pretty flat. So, there’s a double-whammy there.
“We were just talking to one of our clients. He owns a local auto dealership. He said, ‘You know, we’re slow. We were seeing a lot home equity checks come in to buy the cars. And that’s really dried up.’ So, I think you’re starting to see retail sales pull back a little bit.”
SBT: A lot of economists have under-estimated the spill-over impact of the icy housing market, haven’t they?
Sadoff: “Yeah, I think they’re aware of it, but they think the consumer is just going to find a way through it. Already, you can see like home equity withdrawals that were in the billions are coming down. The real lynchpin would be the unemployment rate. If you see unemployment start to pick up, that is where you could see the potential of a real hard landing.”
SBT: The housing market is starting to spill over into the banking sector. Some banks are reporting losses from mortgage foreclosures.
Sadoff: “The sub-prime lending … people who shouldn’t have gotten loans in the first place. The next would be small to regional banks that are really heavy on real estate. Banks have gotten heavier and heavier, and their real estate portfolios have gotten larger and larger. But a big regional or national bank won’t be hurt as much because they’re so diversified with all kinds of credit card fees and other sources of income.
“Another sort of spillover would be to the Best Buys of the world. J.C. Penny’s, Macy’s … You talk to any of the department stores, their home department (sales) are down, you know, for bedding and things like that.”
SBT: And the automotive sector.
Sadoff: “Yeah, you would see some spillover there. One of the things we’re watching is publicly traded homebuilding stocks.”
SBT: Yes, I saw that in your company’s most recent “Major Trends” bulletin, you warned, “The housing stocks are dangerously close to another breakdown.”
Sadoff: “We’re watching those closely. Those are forward-looking (indicators). That being said, we’re concerned about the risks of the hard landing. Greenspan’s probably right about a one-in-three chance of hard landing. Odds are likely that things will be OK, that the economy will grow at a slower rate. The other fear would be that the economy starts to heat up too much. Then the Fed is going to be forced to start raising rates, which then causes a whole other problem. Then is this the time they over-tighten and cause the economy to come crashing down? The best is the ‘Goldilocks economy,’ where it’s not too hot, causing the Fed to raise rates, and not too cold, causing a recession.”
SBT: That’s where you want to be?
Sadoff: “That’s where you want to be.”
SBT: Well, we’ve got a lot of negative factors, but the stock market’s doing well, interest rates are historically low and jobs continue to be created.
Sadoff: “Short-term, there’s probably excessive optimism. But long-term, there’s still a lot of cash on the sidelines. There’s still a lot of private equity money …”
SBT: That’s what I want to get to next. In your most recent bulletin, you refer to the “Bullish Picture.” You say, “In 2006, approximately $420 billion in leveraged buyouts occurred. More than 1,000 U.S. companies have announced stock buybacks during the past 12 months. The common stock supply shrunk by $604 billion in 2006. This year, shares traded on the U.S. stock exchanges have declined by an additional $175 billion.” What is driving all of these stock buybacks? These companies obviously feel that their stocks are undervalued on the market.
Sadoff: “Exactly. You know, they’ve got tons of cash. For the most part, it’s been a good thing. These companies are flush with cash, and they’re looking to return it to shareholders. Some of them are very aggressive buybacks. We own IBM shares. They just completed, in a very short period of time, a $15 billion buyback. Now, they didn’t have $15 billion in cash. What a lot of these companies are doing is, because interest rates are so low, they go borrow the money, buy the shares back, basically taking on more debt, which is a two-edged sword. Now, you’ve got extra debt load. So, it could come back to haunt a lot of these companies down the road.”
SBT: The U.S. dollar is weak, and that is a good thing for American manufacturers, because their goods can be sold for less overseas, making them more competitive. Is that likely to continue in the second half of the year?
Sadoff: “It’s likely to continue. I think the dollar will likely get weaker and help a lot of these multi-nationals that do business overseas.”
SBT: Finally, we’ve got the U.S. presidential election in 2008. Historically, the year before a presidential election is the strongest year of a cycle for the stock market. We’re seeing that play out again this year. Even locally, the BizTimes Stock Index (a local stock index at www.biztimes.com) hit an all-time high June 1.
Sadoff: “Yeah. The pre-election year – this year – has been by far the best year. Using the S&P 500, there hasn’t been a down pre-election year since the 1930s. The election year is still a good year. The theory behind it is the party of favor wants to do everything they can do to make the economy look good for the election year. So, they never want to do anything that’s going to hurt the economy. If anything, they’ll do stuff that’s going to help the economy.”
SBT: If you buy that theory, and it has historical precedence, then you believe that presidents can, in fact, have direct, substantial impact on the economy, and therefore should accept a good deal of credit or blame for the economy during their administrations. That’s if you buy that theory …
Sadoff: “With us, it tends to be that politicians, if they’re going to throw out negative stimulus to the economy, if they’re going to do it, they’re going to do it in the first year or second year of the presidency. You could make a case that presidents, in general, do have an effect. But if you try to break it down and say that the stock market does better under a Democrat or a Republican – you would think it would do better under Republican, but that’s not been the case. It did fantastic under Clinton. It didn’t do well in the first term under Bush. It’s coming back in the second term, but there’s not a lot of correlation there. But the election cycle has a strong correlation.”
Michael Sadoff
Title: Investment advisor
Company: Sadoff Investment Management LLC
Address: 250 W. Coventry Court, Suite 109, Milwaukee
Web site: www.sadoffinvestments.com
Managed assets: More than $400 million
Education: Bachelor of arts degree in economics from the University of Minnesota; master’s degree in business administration from George Washington University.
The Sadoff team: Includes his father, Ronald Sadoff (founder); and brother, Bryan Sadoff.
