Who’s Buying?

June 27, 2009

Sputtering again, the S&P500 dipped 0.25% for the week, the first consecutive weekly loss since March.  Volume fell for the second week in a row.  Yet the VIX dropped as well, suggesting  that complacency is starting to set in.  Almost two months after April, and the S&P has gone almost nowhere.

The economic data did not fail to disappoint.  Both existing and new home sales were lower than expected.  Durable goods orders rose, but most of that came from aircraft orders; durable goods shipped, however, dropped again.  Initial claims jumped, unexpectedly, to 627,000 and continuing claims also rose to 6.74 million.  Personal income looked good on the surface–rising 1.4% in May–but much of that gain came from unsustainable government stimulus payments.  Most notably, personal spending did not match the gain in income, rising only 0.3%.  That meant that the personal savings rate spiked to 6.9%–the highest savings rate in 15 years. 

Technically, the S&P is in a slight downtrend, on a daily basis.  It is still overbought, especially on a weekly basis.  On the monthly charts, the bear market is holding, even after the run up from mid-March.

If American consumers are saving more than they have in years, where will fundamental demand from goods come from?  And since almost 70% of U.S. economic activity depends on consumers, exports or business investment are the two non-government options left.

Many economic experts have suggested that China, for example, must step up and start consuming more of the world’s production.  After all, at only 35% of GDP, Chinese consumption is far behind that of the levels here in the U.S.

The Economist, this week, examined this potential solution and the conclusions were not promising.

Because China lacks the broad social safety nets (for health-care, retirement, and poverty) that support the people of most OECD countries, Chinese people save much more of their personal incomes.  Lately, the Chinese government has taken steps to beef up social security programs; it has also provided incentives and access to credit–both with the intention of boosting consumption.  But The Economist concludes that unless China allows its currency to appreciate (as it would if it were freely traded against all other currencies), the Chinese production will not shift resources to its domestic market; instead it will continue focusing on the bubble era policy of producing for Western consumers.

And that’s a problem.  If we in the U.S. aren’t buying anymore, and if the Chinese don’t step up their buying, then who’s going to do the buying?  Who will fill the monstrous hole in global GDP caused by the implosion of the asset and credit bubble in the western world?

Christina Romer Wants It Both Ways

June 20, 2009

Two weeks ago, the S&P500 was stalling.  Last week, it started to fade.  Closing down 2.6%, the S&P seems to be running out of reasons to go higher.  Despite the massive liquidity poured into the economy, equity investors are starting to look for some evidence that the green shoots are real.  And they’re having a hard time finding it.

Less bad will not be good enough to justify current prices, much less higher ones from here.  Stock investors will need to see first derivative data showing sales and profit growth.  But it doesn’t seem to be happening.  FedEx reported losses that were worse than expected, and GE flat out reported in Bloomberg that it does not see orders picking up for another 12 to 18 months. 

Economic data were mostly negative.  NY Empire Manufacturing shocked at analysts by coming in at -9.4 when -4.6 was expected.  CPI and PPI, although relatively stable month-to-month, each fell the most since 1950, suggesting that inflation is currently not a problem.  Initial claims pushed up to 608,000 and continuing claims, although not another record, hovered at 6.7 million.  The Philly Fed came in better than expected.

Christina Romer, the chair of Barack Obama’s Council of Economic Advisers (and expert on the Great Depression), has been a major proponent of the green shoots theory.  Together with Larry Summers, Austan Goolsbee, Tim Geithner, and even Ben Bernanke, she has doggedly asserted that the economy is on the mend in the second quarter of 2009.

After speaking to Congress, the press and anyone else who’d listen that glimmers of hope are emerging, the equity markets have responded with a strong bounce and the credit markets have eased, allowing many corporations to roll over their debts.  And, partly in anticipation of an incipient recovery, U.S. Treasury’s have fallen in price–thereby commanding higher yields, as one would expect in a recovering economy.

So it’s interesting that in the current issue of The Economist, Ms. Romer writes a feature piece that essentially says–but on the other hand….

In this piece, she argues that because the recovery has not really taken root, we must not rush to remove fiscal stimulus.  Naturally, if the recovery is taking hold, then we should prepare to remove stimulus, so as not to create too much demand and not to stress our sovereign debt levels through over borrowing. 

But she can’t have it both ways.  How can an economy be recovering and not recovering–at the same time?  Economically, this doesn’t make sense.  And most of the data suggests that the economy is not yet recovering; it’s only falling at a slower rate.

Politically, this make sense.  Ms. Romer wants the public to believe things are getting better so that they resume investing (think stocks and houses) and spending (think plasma TV’s and vacations).  But she doesn’t want the public to act on this another way–by removing the stimulus that is needed for recovery to truly take effect, sometime in the distant future.

To most folks, this is called lying.  To politicians, this is called doing one’s job.

Clearly, Ms. Romer has a talent for politics.

Green Shoots?

June 14, 2009

Stalling.  That’s the best way to describe the government-engineered rally that began in March.  For all the trillions pumped into the capital markets, nothing can keep going up forever when the fundamentals don’t back up the prices.  The S&P500 managed to eke out a 0.65% gain for the week as many of the trashy stocks that led the rally started showing signs of breaking down.

The fundamentals were, as usual, not strong.  The trade balance came in worse than expected, primarily due to the rising cost of imported oil.  The Treasury budget was negative $190 billion in May–equal to 42% of the deficit for the entire prior fiscal year.  The Fed’s Beige book report was weak.  Initial claims stayed above 600,000, and continuing claims were 6.82 million, maintaining 19 straight weeks of record highs.  Michigan Sentiment, although slightly up from April’s reading, came in below expectations.

Technicals continue to show a very overbought market on a daily basis.  The upward momentum is clearly weakening and the declining volumes suggest that the conviction behind the rally is also melting away.

Nouriel Roubini, the NYU economist who warned of an impending economic crisis back in 2006, highlighted several key reasons why the hopes for true economic recovery are just that–hopes.

 Here are the key points:

1. Employment is still falling precipitously.

2. Private sector deleveraging has only just begun.  Trillions of dollars of debt must go away.

3. U.S. consumers are still spending too much, and not saving enough.

4. Our financial system is still broken.

5. Weak corporate sales and profits will cause firms shrink hiring and capital expenditures.

6. Ballooning government debt will push up real interest rates.

7. Fed money creation could lead to goods price inflation and asset and credit bubbles.

8. Some emerging market economies may collapse.

9. Current account surplus countries (eg. China) will probably not grow their domestic consumption fast enough to offset the drop in consumption from current account deficit countries (eg. U.S.). 

According to Roubini, all this may lead to global stagnation, and possibly eventual inflation. 

Sounds like a recipe for the 1970’s–complete with its single digit stock market P/E’s.

Bell-bottoms anyone?

Between a Rock and a Hard Place

June 6, 2009

The S&P500 moved up again this week, recording a 2.3% gain.  Interestingly, the volatility index (VIX) closed higher as well, up 2.4% for the week.  What’s interesting is that the VIX is usually inversely correlated with the S&P500 movement.

What’s also interesting is that the S&P500 is now valued at 34 times 2009 as-reported earnings (not operating earnings) estimated top-down (not bottom up) by Standard & Poor’s.   Even on an operating earnings basis, the P/E ratio (using top-down 2009 estimates) is now 22.  Cheap? Hardly.  Fairly valued?  Possibly–but only if the market is correct in anticipating a massive rebound in earnings (as-reported and operating) for 2010 and beyond.

The economic data last week was not showing many first derivative improvements.  Yes, the economy seems like it’s shrinking more slowly (as compared to January 2009), but getting less bad clearly does not mean it’s growing. 

Personal spending rose slightly (0.1%), but the savings rate spiked to 5.7%–great for the long-term, but in the near-term, any increase in savings means lower consumption, which lowers GDP.  Auto sales for May were dismal–again.  ISM services fell in May; they were expected to rise.  Initial claims stayed elevated at 621,000; and continuing claims remained near 7 million.  The average workweek fell to a record low of 33.1 hours; this is important because before businesses rehire folks, they ask their existing employees to work longer hours.  Instead, these hours are still falling.  Non-farm payrolls fell in May by 345,000; but when the 220,000 jobs magically created by the Bureau of Labor Statistics’ birth/death model are factored in, the actual job loss was over half a million.  The unemployment rate jumped to 9.4%, far higher than consensus estimates and the highest rate since 1983.  Also, consumer credit fell by $16 billion in April and a revised (and record) $17 billion in March.  Consumer credit is dropping at a 7.4% annual rate–again important because the consumer makes up almost 70% of GDP.

Last week, the Fed chairman Ben Bernanke, warned Congress that the U.S. government must get its fiscal house in order.  He pointed the finger at Congress and the Treasury and stated that the U.S. budget cannot run multi-trillion dollar deficits indefinitely.  The global capital markets will not tolerate excessive deficit spending and borrowing.

Meanwhile, German Chancellor Angela Merkel pointed the finger at the Fed and scolded Bernanke for going too far in expanding  the Fed’s balance sheet, especially with its program of monetizing Treasury and agency debt.  She contended that overly loose monetary policy will lay the groundwork for another financial crisis.

Ominously, over the last several weeks, the prices of U.S. Treasury and agency debt (as well as the dollar as measured against a basket of currencies) have been collapsing. In the fall of 2008, the 10 year note yielded only 2 percent.  As recently as March 2009, it yielded 2.5%. Last week, its yield soared to almost 4%.

What’s the problem?  The Fed has stated publicly that it wants to drive down government and agency (primarily housing related) debt yields to lower the cost of financing massive  public and household debt loads.  To do so, it has effectively printed money to buy this debt–initially driving the price up and yield down.  But it hasn’t worked.  Yields have jumped, sending the 30 year mortgage rate (for example) up from 4.5% to 5.5%. 

If the Fed does not step up its purchases of this debt, demand may fall further causing yields to go even higher.  BUT, if the Fed does continue and increase its buying of this debt, then the credit markets may reasonably worry that the Fed, by printing too many dollars, would debase the dollar that would repay all the debt held by other investors; this will give these investors a reason to sell (or at least buy less of) this debt, also causing yields to go up.

In a nutshell, the Fed is losing control of U.S. interest rates.  Not only could the resultant higher rates create headwinds for the economic recovery, but the failure of the global credit markets to keep lending to the U.S. at low rates, could lead to a currency (dollar) crisis and shove the economy over the edge of a cliff, for good.

The Fed is truly between a rock and a hard place.