... Billyboy has secured re-appointment to the Federal Reserve for another four-year term as chairman after a rather noisy lobbying campaign conducted via the press. There will now be an equally noisy nomination process in Congress. GREED & fear should make it clear that there is no support here for Bernanke’s re-appointment even if he is in no way as culpable for the grotesque excesses of the credit bubble as the unlamented Pinball. Still it is appropriate that as the high priest of mechanical monetarism he should be left to deal with the reality of an intensifying liquidity trap as his policies are rendered impotent.It is not only about the Ben, it is also about the so popular "moral hazard" trade lately ...
The news on Billyboy has also coincided with the premature celebration of the end of the financial crisis. The crisis is not at an end as the American economy is not going to recover in the real sense of the term. Meanwhile, Billyboy’s trick box of liquidity extensions, guarantees, and purchases of garbage securities have done very little to help the ordinary American wage earner and done a lot to allow Wall Street’s proprietary trading desks to make lots of money gaming the system.
When the full reality of this becomes clear to Joe Six Pack the reaction will be ferocious. This will be detrimental not only to the already battered reputation of the Fed but also to the already fast shrinking credibility of the Obama administration which under the influence of Tiny Tim the bailout king has been comprehensively captured by Wall Street. No wonder Obama’s activist supporters, increasingly frustrated by the president’s failure to make the case for socialised medicine, are starting to freak out.
Monday, August 31, 2009
However, I do like this chart. Where are the bears? They are usually coming when nobody expects them ...
Stocks – Europe outperforming China!
It is clear to everyone that investors enthusiastically embrace the continuous positive economic statistics published during August while ignoring Chinese events (e.g. yet another stock market sell-off this morning). As mentioned before this recent divergence between China and Western bourses is a warning due to the fact that the lead global recovery story or theory is based on exactly China. Europe is now clearly outperforming China and this is most likely due to rebalancing among asset allocators (from China/Asia to previously very underweighted Europe) rather than a changed perception of the long term relative macro growth prospects! Consequently, we believe that our recent caution about the new stock market highs in the West remains prudent while recognising that real market action still doesn’t confirm our short-term fear. These considerations cause us to still advocate buying some protection while remaining structurally bullish.
Bonds – Holding up well in spite of strong Western bourses
The month of August has seen a clear overweight of surprisingly “strong” economic statistics, Western bourses making new high ground and a stable US dollar. In spite of this encouraging recovery development even long bonds have held up well, and not even last Friday’s bearish technical “Key Day Reversal” signals could encourage some follow-through selling in bonds. These observations are perceived to illustrate that investors are generally becoming somewhat concerned about the valuation of cyclical assets – perhaps even influenced by the China events, and that some of the recent reallocation evident between equities in China/Asia and Europe/West goes into bonds, and that long bonds are perceived as less overpriced with leading central bankers talking dovish about implementation of exit-plans. Overall, we continue to expect prolonged trading ranges in yields and that the short-term direction will be guided by the two transient investment themes: 1) “supply fear and economic recovery” and 2) “high real yields and central bank responses to protect a fragile global macro economy”.
Commodities – Industrial metals remain strong
With Chinese stocks in trouble, the speculative short squeeze in copper futures over and classic recovery potential in metals almost fulfilled then we maintain that risks are increasing to a commodity exposure. Still, our recent caution about commodities lack any clear downward price momentum to confirm that such fears are become reality.
Currencies – Global and local Japanese events suggest caution
A soft revolution is taking place in Japan with the political change of power at this weekend’s election raising prospects of a major structural change and the Japanese tax exemption to internationally held funds have helped JPY recovering this month. Or are there more to the gains in JPY? We still believe that the severe correction in Chinese stocks is a warning as China has been the lead story in the global recovery… and USD has been stable during August with CAD, AUD and GBP registering some depreciation in spite that CAD and AUD remain very popular among speculative futures traders. Other questions can be raised why CEE currencies haven’t outperformed with global macro statistics overwhelming on the good side during August and Western bourses at new highs. Adding it up, we remain structurally bullish but short-term risks appear to be building to cyclical bets. Accordingly we are recommending buying protection e.g. via a put option in AUD/USD. Be aware, our short-term risk scenario still lacks confirmation.
Friday, August 21, 2009
Meanwhile, Mr. Macro talks about the double-dip tail risk, but worries about one final push for the risk on trade. Well, not giving up yet, but realizes the risk of better than expected? Just wondering about stockpiles of cash on the sidelines, and underinvestment in risky assets ...
The Big Ben says: "fears of financial collapse have receded substantially" and that "economic activity appears to be leveling".
Dark clouds cover Spain?
Thursday, August 20, 2009
Fear fizzles out, but optimism only skin-deepIndeed, "Where are the bears?"
August FMS a feast for contrarian, tactical bears. Headline data reveals strongest market sentiment in two years. Big turnaround from apocalyptic bearishness of March. But underlying data shows lack of conviction. Four out of five investors predict a “below trend” recovery and neither regional nor sector positions are
extreme. The optimism is skin-deep.
Only 8% of investors expect weaker economic growth
Consensus (75%) expects some sort of global recovery. Few expect a “double-dip”. This means “weaker-than-expected” data in coming months would be negative for equities. Next set of Chinese & US data now crucial for September direction. China growth expectations dipped again (to 49%) in the August FMS.
Cash balances plunge to 3.5%, lowest since July’07
Strong inflows now required to fund further equity and credit rallies or investors likely to raise cash. Highest equity allocation (34% from 7%) since Oct’07; bond allocation (-28% from -12%) lowest since April’07.
Optimism built with narrow regional leadership
EM equities (52%) by far the big OW. Asset allocators UW every other equity region, although the Eurozone UW was narrowed considerably (from -23% to -13%). Note, GEM investors sharply cut exposure to Chinese equities to neutral.
Optimism built with narrow sector leadership
Tech (28%) the most favored sector everywhere. Big monthly jump (-11% to 11%) in exposure to industrials. Defensives (telco, staples, pharma) cut back to neutral, while utilities (-15%) most detested global sector. The underweight in bank stocks narrowed (to -10%), but investors remain UW the credit plays.
Contrarian long & short trades
Contrarian longs: Japan, US, Asia utilities, US & UK banks, UK & Eurozone real estate, Asia telco, EM materials. Contrarian shorts: US, Eurozone, Japan, Asia tech, EM consumer discretionary, Asia and Japan banks, Russia.
Our view: there will be dips…buy them
Short-term pullbacks often coincide with a bullish FMS. That’s happening. But August optimism feels grudging and only skin-deep to us. We remain cyclical equity bulls and buyers of dips. August FMS resembles June 2003 FMS, when big reduction in cash balances (4.9% to 3.9%) and increase in equity allocation (3% to 22%) caused a nascent cyclical bull market to pause for breath. The bull market resumed a few months later.
Wednesday, August 19, 2009
China earlier this year was engaged in a massive explosion in money and credit that went way beyond the conceivable needs of the real economy. Excess money creation in China has few outlets. It took those that were available and so we saw a turnaround in house prices, a boom in the stock market (up by over 90% in 2009 by early August) and leakage into commodity markets. The Chinese government clearly thought that 6-month annualised rates of growth of credit and money were excessive and so signalled their disquiet. They began selling sterilisation bonds and further measures later on are to be expected.
Just the question of causality remains open?
China's "inflationary sins" are miles ahead of US, but who is worrying about the inflation risks in the US? Pimco? Buffett? Of course, bank trading rooms are much more forceful than Main Street.
Tuesday, August 18, 2009
As we said in last Tuesday’s verbal strategy comments before leaving for a road trip, “If past is prelude something BIG will happen in the equity markets during our sojourn.” Accordingly, the next day the equity markets rallied sharply, only to give back much of that on Friday’s shockingly bad consumer sentiment figures. And this morning Friday’s Fade continues as world markets worry about the durability of the economic recovery. As one particularly bright money manager notes:
“In studying the charts I noticed the MACD on the daily chart of the Dow has crossed to the downside for the first time since the rally off the July low. This is another sign the rally is running out of steam. The support, short-term, is the 9200 area and if broken then a more substantial decline could get underway. One of my indicators on the daily chart, however, hints that this decline will be shallow and we will see a final surge over the next few weeks to the 9700 – 10,100 area. The ability of the market to continue to rally with volume continuing to decline does not mean it cannot go higher short term, but tells me that the calls for a new Bull Market are certainly suspect. If I am correct, the current pullback will only last until options expiration starts this week then the final rally will begin. Watch the 9200 area for clues for the market direction over the next few weeks.”
In the July survey, domestic banks indicated that they continued to tighten standards and terms over the past three months on all major types of loans to businesses and households, although the net percentages of banks that tightened declined compared with the April survey. Demand for loans continued to weaken across all major categories except for prime residential mortgages. The fractions of domestic banks reporting additional weakening in demand in this survey were slightly lower than those in the April survey for C&I loans and home equity lines of credit, approximately the same for commercial real estate (CRE) and nontraditional residential mortgages, and slightly higher for consumer loans.There are more or less fair commentaries, in my view, by bank analysts, like these from Danske Bank and BNP Paribas. However, couple of them are forcing to raise the eyebrows.
In response to a special question, domestic banks pointed to decreased loan demand and deteriorating credit quality as the most important reasons for declines in C&I lending this year. In response to a second special question, most banks reported that they expected their lending standards across all loan categories would remain tighter than their average levels over the past decade until at least the second half of 2010; for below-investment-grade firms and nonprime households, the expected timing is later, with many banks reporting that standards for such borrowers will remain tighter than average for the foreseeable future.
Tobias Levkovich, the US Equity Strategist at Citigroup, has a clear bull's message (my emphasis):
The Federal Reserve Board survey generates more predictive recovery evidence. The senior loan officers’ survey continues to show that tightening trends are easing back, with the just released July polling data finding that a net 31.5% of large banks are tightening their lending criteria versus a net 83.6% last October. Moreover, the survey data has often led credit market conditions, arguing for some further narrowing of spreads which often move in tandem with equities. Historically, this survey has been a strong lead indicator for business activity with a nine-month lag, supporting renewed investment in human, physical and working capital well into 1Q09; and in kind this should support earnings trends.Errr ... "tightening trends are easing back"! Think twice of "trends" to be sure you get it right that "net 31.5% of large banks are tightening their lending criteria..."!
Whatever, but the economists at Societe Generale brought the "killer note", click to enlarge, my marks.
Do I get it wrong? Well, let's read once again. This sentence is the killer:
"The latest survey, covering the period from May to July, showed an across-the-board improvement in lending terms."
Monday, August 17, 2009
China's FDI inflows fell 20.3% y-o-y in Jan-July to USD48.3bn, after a 17.9% drop in the first six months of this year. In the month of July alone, FDI was down 35.7% y-o-y, marking the tenth straight month that FDI has fallen from year-earlier levels. Not only in China, but across Asia, FDI inflows have weakened, reflecting substantial overcapacity in the global economy.Let's go for some additional investments in capacity?
Chinese growth story by:
Stocks – China alters the odds
The Chinese growth and stock market revival has been at the forefront of peoples’ minds since the global recovery in financial assets began back in March. As a consequence of this lead the last two week’s sudden correction in Chinese stocks – contrary to western bourses – does suggest that the odds of the next global risk aversion period has returned to balance! This more balanced probability of the next major market move remains countered by: 1) Western bellwether bourses still haven’t experienced any significant technical pattern deterioration and 2) sentiment surveys at neutral readings and 3) macro statistics (see page 3) are still generally supportive. Consequently, the China event suggests that it is now prudent to be tactically bearish and structurally bullish i.e. buying protection appears wise while we wait for market confirmation or disconfirmation.
Bonds – Friendly reallocation ahead
The environment has been hostile to bonds since March when market perceptions turned constructive towards cyclical sensitive markets like stocks, commodities and emerging markets in general and not least augmented by the constant hefty supply of sovereign bonds. As we have been stating in recent weeks the latest yield rise towards the June highs should not blind us to the fact that real bonds yields are soaring with inflation so benign and central bankers having informed us that they will not commit the Japanese mistake of the -90ies, i.e. caution about when to implement their “exit plans”. In this light two interesting observations can be made: 1) strong bond buying has in recent days commenced close to the June yield highs for a second time and 2) the leading recovery story since March has centred on China and Chinese stocks has been falling for two weeks by now. Consequently, we can now observe initial signs that the global risk recovery begins hesitating, and this could easily lure investors to initiate a reallocation back towards bonds… confirmed if yields break below the July lows! Overall, we maintain that the yield direction within expected overall ranges will be guided by the two transient investment themes: 1) “supply fear and economic recovery” and 2) “real yields and central bank responses to protect a fragile global macro economy”.
Commodities – Is oil faltering near $75?
Lots of classic recovery potential in metals have already been attained and oil prices appear unable to maintain – let alone extend – the recent break above $75. While no real pattern deterioration has yet occurred odds for a further substantial commodity recovery now appears to be fast disappearing – not least judged in light of the global Chinese recovery story faltering (stocks falling fast). Commodity exposure is now witnessing increased risk!
Currencies – AUD appears in particular sensitive to risk aversion
Global short USD positions were reduced by 1/3 as of last Tuesday (re. CFTC) and it appears that cyclical sensitive AUD is in a very sensitive position should risk aversion return. And odds of a new risk aversion period appears right now to be rising as the lead story of the global recovery has centred on China and Chinese stocks have now been falling for two weeks. An extreme large speculative long gold position appears a further risk to AUD too. Consequently, it seems that the dominating “US dollar collapse theory” took a hit with the US job report and with the lead recovery story (China) evaporating building strategies with short AUD exposure appears to offer some attractive opportunities.
Shanghai Stock Exchange Composite Index
Baltic Dry Index
yeap, and these boys at trading desks may be of some relevance too!
August 14, 2009 (Reuters) - A U.S. future economic growth gauge rose in the latest week, as its yearly growth rate surged to a 26-year high, suggesting that recovery will commence at the briskest pace in decades, a research group said on Friday.Some charts and data available here. However, one may wish to have more behind the reasoning of consumer recovery, as it is told here.
The Economic Cycle Research Institute, a New York-based independent forecasting group, said its Weekly Leading Index rose to a 47-week high of 123.9 in the week to Aug. 7 from a downwardly revised 121.7 the prior week, which was originally reported at 121.8.
Meanwhile, the index's annualized growth rate leapt to a 26-year high of 13.4 percent from last week's five-year high of 10.4 percent, which ECRI originally reported at 10.5 percent. It was the index's highest yearly growth rate reading since the week to Aug. 26, 1983, when it stood at 13.9 percent.
"With WLI growth surging, the odds are rising that the early stage of this economic recovery will be stronger than any since the early 1980s," said Lakshman Achuthan, Managing Director at ECRI.
Achuthan recently told Reuters that the national recovery would be stronger than many expect, though signs of such strong growth will not be apparent until sometime next year.
"Next year, looking back you'll see that GDP, industrial production, sales, and even non-manufacturing jobs growth -- where 91 percent of Americans work -- began rising as recovery took hold," Achuthan said.
On the other side of the opinion spectrum we find credit strategy team at BNP Paribas. In their recent "Credit Driver" they are arguing the following:
If this severe deflation dynamic is allowed to continue, sooner rather than later, not just equities but AAA corporates and treasuries will also come under pressure due to rapidly shrinking revenues and tax receipts. Recapitalising the financial system is of the essence here. Investors betting on restocking of inventories to drive growth will be disappointed to know that the underlying dynamics simply do not support that argument.
Firstly, we note from Chart 2, that there has been no building up of inventories in Q2. Secondly, just because inventories have come down by a large dollar amount, it does not imply that restocking has to take place because sales have declined faster than inventories.So, you know that you don't know really ... Let's hope that the wealthy pull the rest out of slump!
Also, restocking will only take place when sales begin to stabilise, which is yet not apparent and can be seen in the significant fall in retail sales for July, despite the Cash for Clunkers programme. Importantly, the restocking will also be smaller than usual, as final demand from the consumer is likely to be very weak due to rising unemployment, falling wages, rising energy prices and lack of credit availability.
For those who are unconvinced about this argument, it is all there in the FOMC policy statement, where the Fed states that, “businesses are still cutting back on fixed investment and staffing but are making progress in bringing inventory stocks into better alignment with sales.” What we are really concerned about is how businesses will manage to restock without the availability of credit.
Friday, August 14, 2009
I am keeping in mind the reasons of global crisis ... and marginal propensity to consume.
Mass consumption is not maintained via borrowing, so the ability to consume is impaired ...
Let's pray for wealthy to pull the rest, and supply side economics will do the miracle?
Thursday, August 13, 2009
Aug. 13 (Bloomberg) -- Sales at U.S. retailers unexpectedly fell in July as a boost from the cash-for-clunkers automobile incentive program failed to overcome cuts in other spending.
The 0.1 percent decrease in sales, the first drop in three months, followed a revised 0.8 percent gain in June that was larger than previously estimated, Commerce Department figures showed today in Washington. Purchases excluding automobiles fell 0.6 percent, also more than anticipated.
Today’s report underscores the threat to spending from the continued deterioration in the job market; a separate government report today showed more Americans than forecast filed claims for unemployment insurance last week. Retailers such as Wal-Mart Stores Inc. and Macy’s Inc. are cutting costs and inventories to bolster profits as households cut back on non-essential items.
The table from Nomura is rather interesting (click to enlarge), with a full comment here.
The commentary by BNP Paribas available here.
Non-bank commentators like Ritholtz or Calculated Risk are somewhat dovish...
Initial weakness in equities used to buy on dip ... so far today.
Wednesday, August 12, 2009
US productivity is rapidly rising. The 6.4% annualized gain posted in Q2 was the highest since 2003. It was achieved on deep cuts in man hours (-7.6%) while output contracted more modestly (- 1.7%).
A lagged response of employment to GDP is a normal cyclical response as businesses use the first few quarters of the recovery cycle to shore up profits. In that, they appear to be succeeding. Not only is productivity up sharply, virtually all of the gains in Q2 accrued to businesses. Hourly wages were flat in nominal terms, and contracted by 1.1% in real terms. As a result, unit labour costs contracted by 5.8%.
Such a steep contraction in unit labour costs is not unprecedented, but it is rare. The last time it occurred was in 2001, or in the late stages of the previous recession. It was a time when ULC exhibited strong volatility, but the y/y trend at its trough experienced a sharp drop of 3.2%. In contrast, unit labour costs are now down 0.6% on y/y basis.
The charts below show profit proxies derived from the productivity report. Historically, the proxies have had a modest lead on profits. The overall picture looks quite strong, with non farm profits expanding at the fastest pace since 2004.
So what does it all mean for the economic outlook? To the extent that profits are up, layoffs should begin to slow, stabilizing employment. Increased profits should also strengthen corporate credits and improve the availability of financing. Ultimately, improved cash flow (internal financing) and access to external financing should encourage business investment which has fallen below the rates of depreciation. This last impact is not immediate, but some of the necessary conditions for an investment rebound are slowly falling into place.It is almost sure there will be some inventory rebuild. Assuming the steepness of the drop in economic activity in 4th quarter of last year, it is almost certain that achieving of positive year-on-year growth rates should be quite easy? Well, "cash for clunkers" will boost some pent-up demand in auto sector, but bring forward also some future demand. Infrastructure programs will boost some investment activity ...
Further on, I do not think that good corporate credits had ever a problem to raise some money. I thought it was banking system seizing up all the credit flow and driving the costs to the sky?
But, if the US household consumption remains weak and there is no real re-leveraging emerging?
Well, Asian consumer is there ...
Tuesday, August 11, 2009
The result of this is an asset price bubble – accompanied by price deflation. Liquidity is being created to allow countries to re-adjust their obligations, reform their economies, restructure debt and bring down fiscal deficits. It is also being created to bring down the cost of borrowing. All this takes time as the healing process begins. In the meantime, this liquidity is searching out returns. (Money never rests.)Now, let's move straight to intensive care unit:
What’s a central bank to do? This is especially problematic when (and if) inflation returns before liquidity measures are withdrawn. If inflation returns while the economy is still in the “intensive care unit”, then central banks would see fit to raise rates. The problem is that central banks may see a temporary phenomenon as somewhat permanent and raise interest rates only to cause a worse “relapse” in economic problems later.
So, the US consumer so far is very indifferent to liquidity supply ... Let's drive the food and energy prices to the sky, so we can experience another consumption shock?
While spreads have come down by half from the extreme levels around the collapse of Lehman Brothers, we want to create a context for just how high they currently remain:
1) Spreads are now higher than spreads during the two recessions of 1971 and 1975.
2) Spreads are now higher than the economic malaise and high inflation of the early 1980s.
3) Spreads are slightly higher than just after the attacks of 9/11.
Indeed, we can see that the system is still in a critical condition. To state otherwise is to deny what credit spreads are telling us. Withdrawing liquidity right now is simply too dangerous, even if the odious presence of asset inflation is amongst us.
Monday, August 10, 2009
US failed to decouple from global fundamentals? Indeed, "Baltic" sounds so gloomy these days ...
US Financials, though, has a problem with dark cloud cover?
Statistics Bureau says:
Nordea analyst Annika Lindblad responds to it:
In the 2nd quarter of 2009 compared to the same period of 2008 gross domestic product (GDP) value has decreased by 19.6%, according to flash estimate of the CSB*.
In the 2nd quarter of 2009 decline of economic development continued both in fields of manufacturing and of services. Major volume decreases were observed in retail trade – by 28%, in hotels and restaurants services – by 35%, in industry – by 19%. The drop of value of collected product taxes continues to maintain negative impact on GDP.
According to the flash estimate Latvian GDP extended its decline to 19.6% y/y, less than the -22% y/y expected. This was worse than the -18% y/y in Q1, and was the fifth straight decline in GDP. Considering the level of GDP, however, it rose compared to Q1. The Statistics Office noted that major declines were recorded in e.g. retail sales and on the industrial sector. A more detailed release will be given on September 8.Danske Bank closes on with a gloomy outlook anyway:
The prolonged recession in Latvia is expected to continue this year, but the pace of decline is awaited to abate towards the end of the year, with the whole year showing a decline of approximately 18% y/y. The economy has weakened on all fronts, with imports and exports falling, private consumption contracting and investment declining steeply. The recovery of the global economy is expected to support a pick-up in export demand, and the year 2010 is seen as showing a slower decline of 3% y/y.
Latvia has received the second tranche of EUR 1.2 bn from the EU and also the IMF has preliminarily promised to deliver their second tranche of EUR 200 mn, but receiving the funds and ensuring short-term liquidity has required steep budget cuts to be made. The savings have included wage cuts and labor force reductions on the public sector, further hurting private consumption.
When taking into account a positive base effect, a considerable deceleration of the downturn is expected for the second half of the year. However, we expect GDP this year to shrink up to 20%. The recovery will depend on the external demand outlook and export-oriented manufacturing performance. There are some signs of stabilisation in Latvian industrial output. In recent months the drop in industrial production has slowed down, but this does not mean a sustained recovery and is more likely to be a one-off factor effect.The country is still printing a positive year on year change in consumer prices. "Internal deflation" still to come, at least in public sector ...
We do not expect a significant rebound in growth in 2010, and forecast GDP to decline a further 5-6% y/y on average. On the other hand, in the case of a more visible economic stabilisation scenario we might see a weaker downturn. However, we should take into account fiscal tightening, which will continue next year as well. We expect an additional cut in budget expenditure by LVL500m with the option of an increase in VAT and some other taxes.
Friday, August 07, 2009
Raymond James’ Jeffrey Saut, another Dow Theory watcher, maintains that the key level for the Dow Jones Transports is not the June high. Rather, he says it was the high of 3717.26 which occured on Jan. 6, the same day the Dow hit 9015.10, which remained the yearly high until it broke that tape again on Monday. The fact that the DJTA and the DJIA peaked on the same day, and that those were the highs for the year, fixed the Jan. 6 numbers in Saut’s mind as the data points to watch.I watch my screens at NY cash closing:
“I’m trading this market like it’s a new bull market,” Saut said in a brief chat. “But for me to call it a new bull market according to Dow Theory you’re going to have to better the Jan. 6 highs of the transports and the Dow,” he said. That doesn’t look like it’s going to happen today. The DJTA was down about 1.7% at last glance, to about 3613.
Despite his belief in the bull market signal he says he saw July 23, Russell remains somewhat cautious about the recent run-up in shares. Mostly, because he says sentiment never really hit the bleak tone that signals a true bear-market bottom, in which “people are disgusted with the stock market.” He added that just a couple months after the March lows “everybody was optimistic.”
DJIA 9370.07 at closeConfirmed or false?
DJTransport 3749.58 at close
Well, adjust please for starting dates on the charts, but there seem to be striking parallels?
Did you notice the reversal in USD today? This rather smells like too strong growth according to Merrill Lynched...
And here is the first page of the note by Stephen Gallagher at Societe Generale, click to enlarge.
So, probably, not so dark at all? Still bad ... but a chance of less bad than expected?
WSJ Real Time Economics has an opinion, why did the unemployment rate drop?
Gigantic error of pessimism?
Economists at Societe Generale had a quite decent overview of the key issues yesterday (click on charts to enlarge, courtesy of Societe Generale):
Employment is becoming a central question in the economic outlook for 2010. Production rebound is underway and should cement positive growth in the second half of the year. However sustaining this rebound into 2010 will require a pickup in demand. Will a jobs recovery materialize in time to support a smooth handoff from inventory-led growth to consumption-led growth?
Understandably, there is growing concern among investors about another jobless recovery. The last two recoveries saw anemic employment and wage growth during the early years of expansion. This time, a repeat could be more damaging because credit creation is unlikely to be strong enough to offset any persistent weakness in income. Therefore the next “jobless recovery” may be no recovery at all.
The stakes are high, and there are not straightforward answers. Standard economic models, i.e. those reflecting normal lags between growth and employment, suggest that payrolls should stabilize by year end and begin to climb in early 2010. That is our baseline view.
However, these models failed in the early 1990s and early 2000s and we must consider the risk that they fail again. The difficulty in correctly forecasting jobless recoveries is that they require sustained productivity gains and productivity is notoriously difficult to predict.
Nonetheless, we can evaluate the risks in the context of explanations for previous jobless recoveries. There are legitimate arguments on both sides.
Why another jobless recovery?
One of the reasons for jobless recoveries in the previous two cycles was an unusually high share of permanent layoffs relative to temporary layoffs. Permanent layoffs tend to be more structural than cyclical. Reabsorbing those workers back into the workforce requires creation of new industries and/or businesses and this process tends to take more time than recalling workers back to the same jobs. In the latest downturn, several sectors – including construction and financial services – have undergone large permanent layoffs that are unlikely to be reversed when the recession is over. In addition, recent reports suggest that a large number of workers are involuntarily working part-time. Therefore, the initial demand for labour may be filled by extending the workweek of those part time workers rather than creating new jobs.
In our own analysis, we have also found that divergences between output and employment can be explained by relative pricing power of businesses. When margins are getting squeezed due to inability to pass-through higher material costs, businesses typically try to offset the pressure by reducing labour and squeezing more productivity out of their workers.
This occurred in late 2007 and early 2008 when energy prices squeezed profits. It also explains to some extent the jobless recovery of 1992 and 2002 when pricing power was weakened by a flood of cheap goods out of Asia and the rest of emerging world.
This has mixed implications for the next cycle. Pricing power of businesses is very weak, but declines in material costs relative to year-ago levels could be easing layoff pressures.
There are also several good arguments that can be made in support of a more normal jobs recovery than 1992 or 2002. First, there was no overinvestment or over-hiring in the preceding expansion, which means that there is less need for any payback effects in employment. In fact, job losses are already undershooting GDP (or output) which suggests growing pent-up demand for labour. The only scenario in which this pent-up demand fails to materialize is a surge in productivity.
To dig a bit further into this argument, we have compared employment and output trends by sector. We found that the undershoot in employment is particularly strong in the service sector, far more than in any previous recession. To put this in perspective, the service sector has lost 3.4 million jobs so far in this recession, or more than half of all jobs lost. In previous two downturns, the service sector accounted for only 20% of all job losses, or about 450K jobs on average in each recession.
This may be a good sign, because it is generally easier to drive productivity gains in the capital intensive manufacturing sector than in services. It is also more difficult to outsource or export service sector jobs, including those in retail, business services, healthcare and education. This suggests a more normal jobs recovery as the economy begins to expand.
So, you know now!
Here is an excerpt with key message:
... conventional wisdom is not always a guide to the present. In the May issue of American Economic Review, Stanford economists Peter Blair Henry and Conrad Miller argue that Barbados has been economically more successful than Jamaica because Barbados pegged its exchange rate to the US dollar in 1975 and stuck to it. In 1991, Barbados experienced a serious current account crisis, and “the IMF recommended devaluation,” but “the Barbadians resisted the recommendation,” according to their paper. “Instead of devaluing, the government began a set of negotiations with employers, unions, and workers that culminated with a tripartite protocol on wages and prices in 1993,” they write, in which “workers and unions assented to a one-time cut in real wages of about 9 percent….The fall in real wages helped restore external competitiveness and profitability….The economy recovered quickly.” Unlike Barbados, Jamaica devalued repeatedly and ignored structural reforms.
There are many other examples. Slovakia has outperformed Hungary in the last decade, and their main difference is that Slovakia had a pegged exchange rate for long periods, while Hungary has had a floating rate. In 1982 Denmark pegged its krone to the Deutschmark. This peg that still holds helped Denmark start radical liberalizing reforms a decade before Sweden, which persistently devalued.
The conventional wisdom that devaluation is inevitable in a severe current account crisis is simply not correct. Barbados, Slovakia, and Denmark have shown that a peg can enforce economic discipline and facilitate structural reforms.
The goal of any country in this kind of economic distress is to reduce costs, which is best done directly by cutting salaries, prices, and public expenditures. Devaluation is a second-best solution if the government lacks the political strength to undertake direct cuts, because devaluation boosts the foreign debt burden of the country in crisis.
But run and read the full article!
Thursday, August 06, 2009
We continually hear that the Lehman's debacle produced an excessive liquidation of inventory as companies over-reacted to events and that if production schedules are stepped up to prevent additional declines in stocks, this will make substantial additions to GDP growth (e.g. a 4½% addition if Q3 inventory change comes in at zero).
This is simply wrong. The inventory liquidation, although large in $bn terms, has NOT been excessive given the unprecedented 18% collapse in sales (see right-hand chart below). The rate of inventory decline, at 8% yoy, has barely exceeded that seen at the nadir of the last shallow recession in 2001/2 when sales fell only around 5% yoy. Manufacturing and wholesale inventory/sales ratios are still excessive (see left-hand chart below). This is exactly the explanation the American Trucking Association Chief Economist Bob Costello gave on the release of the 2½% decline in June's tonnage - link. That is why recent inventory data has been surprising on the downside and why H2 growth will be weaker than expected.
The excess inventory situation would not be such an issue if final demand revived. Yet as consumption continues to flat-line, recent data revisions in the latest GDP release show the true extent of shockingly bad consumer fundamentals (see charts below).
US nominal household incomes are now contracting at an unprecedented rate. The largest component of household income is wages and salaries which had been declining some 1% yoy. But after revisions the statisticians now admit to an unprecedented 4.8% decline! Total pre-tax household income is now recorded as falling 3.4% yoy in June.However, John Hempton is extrapolating his view on Brunswick to the whole economy ...
"But aren't tax cuts holding up household incomes?" I hear you say. Even factoring in massive tax cuts, disposable income is still down 1.3% yoy. Total hours worked in the private sector are down a horrendous 7% yoy. This headlong plunge into negative NOMINAL income and GDP numbers is exactly what happened in Japan and is the stuff of classic Fisher debt deflation ... As debt/income ratios are excessive and need to be de-leveraged, a declining denominator will be the key driver to the coming "Vortex of Debility".
Who is right?
One may assume and hope that asset inflation helps spending in the retail sector.
However, Citigroup in its daily "China Consumer & Retail Daily Bites" wrote yesterday, click to enlarge, courtesy of Citigroup.
Just to zoom in:
China Information News, a daily paper affiliated with the National Statistics Bureau, expressed concern over high residential property prices in China in 1H09. The three worries about high residential property prices, according to the paper, are 1) crowding out effect on urban private consumption, ...And now think about it once again. Higher asset prices are not always helping the retail sector:
1) as people are more focusing on speculation in the asset markets, and diverting attention from productive investment in the real economy (so probably creating, e.g., additional jobs)
2) created wealth is not necessarily flowing into retail sector, as it may be accumulating among individuals with already high wealth and low additional propensity to spend (a problem of inequality of income) ...
especially, if the liquidity glut and the reflationary trade is stuck in the trading rooms (of, mostly, banks)!
Wednesday, August 05, 2009
First 100 Days — Global equity markets have rallied 46% since their March lows in anticipation of an earnings recovery. But we remain in the Twilight Zone. As corporate earnings are still falling, valuations have re-rated sharply.
A Bull De-Rating — Global corporate earnings should start to turn around at the end of this year. We expect earnings to rise faster than prices, which would drive an equity de-rating. This is typical at this stage in the earnings recovery.
Valuations Reasonable — Global equities currently trade on 21x our trough earnings forecast, but should de-rate to 16x as the earnings recovery comes through in the next two years. Equity valuations against bonds look compelling.
Still Upside — Reasonable valuations and a solid earnings recovery suggest further upside for global equities. But the greatest gains have already been made. In such an
environment, stock selection will become increasingly important again.
Earnings Recovery — Sectors with low RoEs have outperformed high RoE sectors
during the early stages of earnings recoveries. This time round such a strategy would leave investors Overweight in Financials and Underweight defensives.
Where were these guys when Citi itself was sinking? I do not know ... but this feels late.
Bond Markets: Spread Compression Lingers
Equities - S$P500 Closes Above 1,000
• Asia led the way with the BKAS break higher
• S&P closes above 1,000 and Golden Cross Confirmed
• DJIA Golden Cross Just Confirmed and Testing 9422, Break Opens 10,000
• Bank stocks break out from bearish channel with imminent golden cross
• Stock volatility stays depressed, good for risk taking
• Stock volatility declines in Europe and Asia too
• Main Europe spread tightens dramatically
• US investment grade spread tightens further too
• Japanese investment grade spread testing trendline support
• JPM EMBI+ index back to pre-Lehman levels
• USD 10Y swap spread widening reflects mortgage hedging activity
• UST 10Y yield heading back towards 4%
Commodities: Charging Higher
• CRB index breaks trendline resistance with golden cross formed
• Gold joining the party too
• Copper flies off the handle, now targeting 6600
• Baltic Dry Index in bullish channel with golden cross intact
FX: USD Breaks Down
• Led by Asian currencies (ADXY) and remains so
• USD Index cracks 78.35 now looking 3% lower at 76.00
• Even the Fed's TWI threatens to fall off a cliff
Trend is your friend (until it is not)! Respect the market script! Markets appear to be driven by price momentum (especially looking at commodities right now ... industrial metals appear exhausting), the discount of the decline of latest US Non-Manufacturing ISM Index, that shows even sharper contraction in July, was rather short and mild so far today ... Wait, how much services contribute to GDP?
Financials save the party today! Buy on dips is still the rule!