Bullish Supply Side Productivity Paint

One should get conviction in supply side economics. The economists at Societe Generale have the story today:

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 ...

Nomura: We Are Far Away From Any Kind Of Normalization

Strategists at Nomura in their Asian multi-startegy note wrote yesterday:

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.)

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.

Now, let's move straight to intensive care unit:

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.

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?

Transports Fail To Sustain The Bull's Ride

Dow Theorists failed in the Transports on the next day after breakout above January highs.

US failed to decouple from global fundamentals? Indeed, "Baltic" sounds so gloomy these days ...

US Financials, though, has a problem with dark cloud cover?

Latvian Roses And "Gigantic Error Of Pessimism"?

Latvian statistics blow the mind today. Million miles better than expected :)

Statistics Bureau says:

In the 2^nd 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 2^nd 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.

Nordea analyst Annika Lindblad responds to it:

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.

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.

Danske Bank closes on with a gloomy outlook anyway:

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.

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.

The country is still printing a positive year on year change in consumer prices. "Internal deflation" still to come, at least in public sector ...

US Consumer Reflation

Main-Street still missing the Wall Street's call? At least in June ...

Chart from EconomPicData.



Be ready for a breather in risk markets.

Dow Theory Bull?

Dow Theory practitioners were still arguing about the bull market validity this week. According to WSJ MarketBeat:

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’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.”

I watch my screens at NY cash closing:

DJIA 9370.07 at close
DJTransport 3749.58 at close

Confirmed or false?

Striking Parallels?

I had no intention to post anymore today. However, I went through the latest research, and the latest note by David Rosenberg, the chief economist and strategist at Gluskin Sheff, catches my eye with a chart:

Well, adjust please for starting dates on the charts, but there seem to be striking parallels?

Well, there are many factors in play, like productivity growth, and also debt leverage ...

Calculated Risk has a very rational approach to the analysis of employment in the US, including the commentary on the alike employment chart above. Mish had an "Austrian translation" of Rosenberg's take ...

WSJ Real Time Economics compiled a long list of opinions ...

However, I would like to stress the latest media appearance by ECRI. ECRI informed us already in March that US business cycle is turning around. They also predicted the end of US recession already in April. Now, here is a nice video appearance with a summary of key messages, here is the latest release on US WLI, and here is the WARNING about the US inflation ...

Did you notice the reversal in USD today? This rather smells like too strong growth according to Merrill Lynched...

Probably, reassess the approach? There seems to be no dark cloud covers in US financials ... at least, so far! Retail, Financials, Real estate still make a bit of spin? Or I cannot see that far in the future?

Data Show Better Than Expected Situation In US Job Market

Reaction by selected bank analysts at:

Nomura
BNP Paribas
Citigroup

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?

While Waiting For US Non-Farm Payrolls

There are a lot of concerns about the jobless recovery (again) in the US.

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.

Why not?

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!

Aslund: Latvia Defies The American Conventional Wisdom

Anders Aslund has a story at RGE Monitor:Latvia Defies the American Conventional Wisdom.

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!