Is $9 Trillion a Problem?

August 29, 2009

The S&P500 eked out a 0.27% gain last week, hinting that it’s running out of steam.  And after buying into every story based on “green shoots”, “less bad is good” and “V-shaped recovery” arguments under the sun, the equity markets are approaching judgment day.  Over the next two months, the economy must actually deliver on these expectations.  If it does, then the run up in prices will be justified; if it doesn’t deliver, then the prices ought to correct.

Economic data last week is suggesting that the consumer is still struggling.  Consumer sentiment fell slightly from July’s reading.  Personal income was flat, rather than growing 0.1% as expected.  Consumer spending rose only 0.2%, not the 0.3% expected.  Initial claims were higher than expected–570,000.  New home sales rose, but were driven by the temporary government tax credit and a continuing slide in new home prices.

Technically, the daily and weekly charts are still at nose-bleed levels (extremely overbought).  The monthly, long-term, charts are still in bear market territory.

The Obama administration last week made a startling announcement:  it now projects that the cumulative 10 year deficit will jump from $7 trillion to $9 trillion, and that federal debt (excluding agency debt and indirect obligations from Medicare, Medicaid and Social Security) will hit 77% of GDP in 2019, up from 41% of GDP in 2008.

Is this a big deal?

Paul Krugman, the Nobel winning economist blogging for the NY Times doesn’t think so.  He compares the U.S. debt (relative to GDP) after WWII, which hit 109%, and argues that since we hit high levels before (and were fine), we shouldn’t worry now.  We’ll be fine.  And besides, we don’t need to pay it down at all; we simply need to grow GDP (faster than our growth in debt) to bring the ratio back down to sustainable levels.

But several well respected economists beg to differ.  They point out the obvious differences in context between 1945 and today.   James Hamilton notes that over 75% of the federal spending in 1945 was defense related; and clearly, when the war ended, defense spending could be (and was) slashed to collapse the deficit. 

Today, and over the next seven years, mandatory (entitlement and interest) spending makes up almost 75% of the federal budget.  This spending CAN”T be slashed to collapse the deficit.  Hamilton concludes that the government is digging a hole for itself–a serious political and financial hole.

Ironically, even Krugman once thought that big deficits were dangerous, potentially leading to a Latin American style financial crisis.  He made this warning when the annual deficit was only in the $400 billion range.

How can this be?  Well, he made this warning in 2004, when the Republican party was in power.  Suddenly, after the Democratic party won the White House, Krugman tells the country not to worry about $2 trillion deficits at $9 trillion of additional debt.

Krugman is beginning to speak not like an economist but more like a typical politician.

Housing Bouncing Back?

August 22, 2009

The S&P500 pushed higher 2.2% last week, even though VIX (the fear index) jumped up 3.1%.  This is a highly divergent outcome because normally the S&P500 falls when VIX rises.  Volume was light, dominated primarily by highly traded and speculative issues such as Fannie Mae and Citigroup.

The economic data, although still weak, did not seem to matter much to the equity markets.  On good news (the Philly Fed was better than expected), the market rallied.  On bad news (pretty much all other data for the week), the market rallied as well.  Housing starts and permits were lower than expected–in fact both fell when they were expected to rise.  Producer prices (like CPI in the prior week) showed no signs of upstream inflation; on a year over year basis, prices are actually falling slightly.  Jobless claims were worse than expected, as was the leading economic indicators index.  Existing home sales will be addressed below.

Technically, the daily and now the weekly charts point to a severely overbought condition.  The monthly charts are still in bear market territory when viewed over an 18 month horizon.  This is true primarily because of the cliff diving that took place in the fall of 2008.  So even the sharp rebound off the March 2009 lows has not decisively broken the multi-year downtrend.

On Friday, the mainstream media celebrated the existing home sales data.  The good news centered around the 7% jump in units sold in July over the prior month.  The pundits jumped on this rise as evidence that the housing market is bouncing back from its long-term crisis.

Why is the housing market important?  Because it is ground zero for the Great Recession; it’s the largest part of the credit and asset bubble that burst in 2007 sparking a financial crisis and later, a massive recession, the one we’re still suffering from right now.

So if housing is recovering, the thinking is that this could pave the way for a true rebound in the economy itself.

The problem?  This report was not properly interpreted and is really supporting NO end to the housing crisis. 

Why?  Well, the reasons are so numerous, here they are a few in list form:

1. Were it not for a mysterious 16,000 jump in condo sales in the northeast, the existing home sales figure would have fallen.

2. Sales of single family homes (ex-condos) did fall in July.

3. Sales were propped up (unsustainably) by the $8,000 housing credit set to expire in November.

4. Investors (speculators?) were behind an unusually large portion of the sales.

5. About 30% of the sales were distressed (foreclosed homes or short sales)

6. Foreclosure and mortgage delinquency levels jumped UP in the second quarter 2009 reaching record highs in this epic housing bust cycle.

7. Existing home inventories spiked up 7.3% (or more if unlisted REO is considered)

8. Hundreds of thousands (perhaps over a million) of homes are lurking in the shadow inventory category–banks and would-be sellers are waiting for the right time to dump these homes on the market over the next one or two years.

9. Prices are still down 15%-18% from a year earlier.

And there’s more, but the point is that anyone who proclaims that we’ve turned the corner in the housing market is either confused or intentionally trying to mislead the public. 

The National Association of Realtors, for example, called the bottom in the housing market in 2007, 2008 and again in 2009.  In a year–or two–perhaps they will finally get it right.

Savings: It’s Not Different This Time

August 15, 2009

The S&P500 slipped 0.6% last week mostly on fears that the much anticipated bounce back in corporate earnings this fall may not be such a sure thing.  New data sparked concerns that consumers may not resume their old buying habits–just as they did in most of the previous U.S. recessions.

First some data.  Productivity skyrocketed for corporations in the first quarter of 2009.  The good news for firms–it helps them prop up profits, even as sales drop.  The bad news for workers and consumers–it reduces the need for labor (unemployment goes up), so incomes fall; this means people can’t consume as much.  The Treasury deficit in July was a record $181 billion, up from $103 billion in July 2008.  Retail sales fell–when they were expected to rise.  The same thing happened with consumer sentiment.  Initial claims came in higher than expected (558,000) and continuing claims also remained near record highs.  And CPI fell 2.1% on a yoy basis, the largest drop in inflation in 59 years (since 1950).

Rebecca Wilder presented an observation about the savings rate during this recession (in the RGE Monitor).  She noted that the current trend in savings, starting at the beginning of the recession in October 2007, was UP and pointing upward for the near future.  Then she observed that the savings trend during the last seven recessions (since 1960) was down and continued downward during the subsequent recovery periods. 

She concluded that this is odd, representing perhaps behavior that is different–this time.

But what Ms. Wilder did is make the same mistake that almost every analyst makes when comparing the current recession to ANY recession since the Great Depression.  They’re comparing apples to oranges.

All of the post-Great Depression recessions were of the inflation control type where demand exceeded supply in a cyclical fashion, causing inflation to rise.  The government (usually the Fed) would slow down the demand with counter-cyclical measures (such as interest rate hikes) causing the overheated economy to slow down (mild recession), paving the way for resumed growth.

This recession, much like the Great Depression, resulted from the bursting of a credit bubble, which developed over a secular 25+ year period.  The root causes and many of the outcomes are not similar to those in typical inflation control recessions.

From this perspective, it makes a lot of sense that savings are soaring today.  In past recessions, credit remained plentiful and household wealth was not severely impaired, so people saved less–temporarily during the recession–to maintain lifestyles until the inevitable recovery arrived and unemployment fell.  And household debt to GDP was typically between 40% and 60%–a manageable level.

In this recession, consumer credit is being curtailed (more stringent criteria for mortgages, credit cards, student loans, auto loans, home equity loans, etc.) and household wealth is being obliterated (home equity depletion is growing and retirement savings lost in the stock markets are still down 30%).  Households are sensing (correctly) that this is a permanent shift–not something that will recover in the near future.  And household debt to GDP is 100%–a crushing debt level that must be reduced (through savings).

So today’s savings uptrend is not surprising.  Households will increase their savings rate (perhaps back to the 10% levels maintained over many decades in the mid 20th century) and reduce their spending–prolonging and deepening the very recession that caused this savings to rise in the first place.

This IS what happens in credit bubble recessions.  It happened in the Great Depression; it’s happening in Japan today. 

It’s not different this time.

Jobs Down, but Unemployment Rate Up?

August 9, 2009

The melt-up in the S&P500 continued last week.  The index closed up 2.3% primarily on news that the economy only lost 247,000 jobs in July, not as many as feared.  The VIX eased but remained poised to jump up at the slightest hint of trouble.

The fundamentals were still not strong.  Corporate earnings for Q209 have had a strongly recurring theme:  sales for most companies are down, anywhere from 5% (eg. Kraft) to 40+% (eg. Caterpillar) year over year; but profits are down much more.  In terms of profits, the market is cheering that many firms are “beating” the trampled “expectations” which were set way too low.  Profits are getting crushed, but because they’re not getting crushed as much as anticipated, the market smiles.

Economic data continue to struggle.  ISM manufacturing is still in contraction mode.  Personal incomes came in below expectations.  Initial claims were 550,000–still very weak.  And continuing claims rose to 6.3 million; again, this number would be much higher were it not for the loss of benefits (ie. folks are leaving the continuing claims pool because they’re running out of benefits, not because they’re getting jobs) .

Speaking of jobs, how can it be that the July figures reported a LOSS of 247,000 jobs and yet the unemployment rate DROPPED to 9.4% from 9.5%?  This rate was also cheered as a sign of good news.  But is it really as good as it seems?

In fact, given how the unemployment rate is calculated, it is perfectly possible to show a lower rate (good) even when jobs are lost (bad).


Let’s pretend that the economy has 100 people, all of whom are either working or unemployed (but looking).  Let’s assume that, out of these 100 folks, 9 are unemployed (but looking) and 91 are employed.  In this case, the unemployment rate would be 9.0% (9/[9+91]). 

If one person loses their job, and joins the ranks of the unemployed (but looking), then the rate rises from 9.0% to 10.0% (10/[10+90]).

But what if two people from this group of 10 unemployed (but looking) STOP looking–during same month the one person lost their job? 

Well, these two people would drop out of the equation completely.  In this case, the ratio changes to 8/[8+90] and presto, the unemployment rate DROPS to 8.2%–lower than the original 9.0%!

This is exactly what happened in July.  While 247,000 lost their jobs, 422,000 stopped looking and left the pool entirely. 

Not so good.

Other disturbing trends: 

The ratio of people unemployed longer than 27 weeks ROSE to 34% of all unemployed (but looking)–the highest percentage on record.

The ratio of employed people relative to the entire adult population (looking or not) FELL to 59.4%, the lowest level since the early 1980’s.

The bottom line with jobs is that people are still losing jobs at a staggering rate.  They’re not getting hired.  They’re losing their unemployment benefits.  They’re giving up looking.

How can this labor situation propel consumption (70% of our economy) to create a true sustainable recovery, a recovery that can gain traction without the herculean (but utterly unsustainable) boosts from our federal government?

Give up?  So do I.

Demographics: Adding Insult to Injury

August 2, 2009

The S&P500 inched up 0.8% last week yet the VIX or volatility index shot up over 12%.  This is not a signal confirming the recent move up in the S&P; instead it implies that traders are buying insurance to protect against a drop.

Economic data continued to show signs of strain.  Consumer confidence fell, when it was expected to rise.  The Case-Shiller home price index reported an annual drop of 17%; although better that yoy drops over the last six months, this is still market where home prices (as opposed to the number of units sold, which may be showing signs of bottoming) are nowhere near a bottom.  Durable goods orders also plunged 2.5% when there were expected to slip only 0.5%.  Initial jobless claims jumped to 584,000 almost back to the awful 600,000 range that dominated the first half of 2009.  Continuing claims fell to 6.2 million–again because benefits are expiring (a bad omen for the millions of long-term unemployed whose benefits are set to expire over the next five months), not because folks are returning to work.  Q209 GDP came in at -1.0% but the Q109 figure was lowered to -6.4% (from -5.5%).  And the five year U.S. Treasury auction–ominously–almost failed.

Technically, the daily charts are positive, but the long-term monthly charts are still in a bear market, primarily because of the carry through from the 2008 crash that shoved the long-term moving averages downward so forcefully.

BusinessWeek recently ran a cover story that  profiled the the change in the behavior of the baby boomer generation (those born between 1946 and 1964) as a result of the current recession.   It’s not a coincidence that the baby boomers’ peak earnings and spending occurred when America’s bubble economy went parabolic (1995 to 2005).  Since consumption represents 70% of the U.S. GDP, it makes sense to study the demographics of the baby boomers to get an insight into their impact on the economy going forward.

The results aren’t pretty.

As a backdrop, BusinessWeek reminds us that this group of 79 million people represents nearly a third of Americans.  But because they’re in their peak earnings period, they represented almost 50% of the national income during the bubble years.   Yet they contributed only 7% of the national savings and almost 70% are not financially prepared for retirement. 

The bottom line?  If you’re counting on the baby boomers to lead the economy out of the recession, you’re making a big mistake.  They’re about to start retiring and will need to SAVE, not spend, much more than they did during the bubble years just to prepare for retirement.

How about the next generation, Generation X, born between 1964 and 1980?  Here’s the simple but powerful demographic problem:  this group is about one-third SMALLER in size than the baby boomer group.  There will simply not be enough Generation Xers to replace the huge spending of the baby boomers.

Couple this shrinking demographic problem with the current and well known recession problems (baby boomers are losing incomes through job losses and are maxed out on their debt loads–mortgages, HELOCs, credit cards, auto loans, student loans, etc.–from the credit bubble) and you get a very powerful argument against any possibility of a consumer led recovery. 

It simply cannot happen.  It’s anybody’s guess when this reality will get reflected in the equity markets, but it’s highly likely the markets won’t take this news in stride, when if finally happens.