We've had our nose in the history books for the past couple of episodes. Today I thought we'd look out the window. Catch some of the data that is blowing by.
The huge tragedy in the Gulf will mean a significant bump to GDP. This is a result of the tremendous mitigation effort that will be necessary, a likely dip in oil prices, and the conversion of resource dollars to labor dollars. The price of oil normally carries the fewest jobs per dollar of any good or service. One imagines BP will be employing a lot of extra people, voluntarily or not. This environmental bad in the oil disaster being chalked up as an economic good by its influence on GDP is exactly what the Sarkozy Report has been talking about. And we'll have the next installment in that series at the end of today's podcast.
Next, the Greek Tragedy. David Rosenberg said yesterday in his market musings newsletter
Of course there was going to be a Greek bailout package! Combined, European and American banks have $1.7 trillion of debt exposure to Portugal, Ireland, Greece and Spain (the PIGS) with over half of that among German and French lenders. No wonder this process is being led by the EU — it has to be.
Once again, we are seeing governments intervene to socialize potential losses (but allow the gains to be privatized ... no wonder the Volcker plan is gaining some legs in Congress). Think of Greece as the subprime problem in 2007 or the Thai baht devaluation in 1997 — likely the start of a whole new domino process. Both started off as seemingly small contained events, but proved to be the canary in the coal mine.
Demand Side still sides with Joseph Stiglitz that the Greek drama is an attack by casino market players looking for profit from financial games, not productive investment. We predicted a spread of this through the market, not by any rational mechanism, abetted by the nefarious credit default swaps.
Looking a little further in Rosenberg's newsletter, quote
TEN REASONS FOR A DOSE OF CAUTION
- Markets were unimpressed with the size of the just-announced $145 billion rescue package or the ability of Greece to meet the terms. A bailout of all Club Med countries would, according to estimates I’ve seen, approach $800 billion. This is bigger than LEH.
- China raised reserve ratio requirements 50bps for the third time this year (to 17%). A decisive slowing in China and the U.S.A. is a crimp in the near-term commodity price outlook.
- Australia just unveiled a massive new mining tax. This is weighing on material stocks overnight.
- Possible criminal probe on Goldman weighing massively on the stock price; financials being re-rated by rising spectre of financial re-regulation. Shades of Sarbanes-Oxley. There has never been a financial crisis that was not met afterwards with regulatory reform — it’s how the SEC was created in the first place.
- ECRI leading economic index just slipped to a 38-week low. With the restocking phase complete and fiscal stimulus waning, prospects of a second half slowdown loom large. Buy the recovery story when ISM is at 30 and policy stimulus in full swing (13 months ago); fade it when ISM approaches 60 and stimulus subsides. Market Vane sentiment is pushing towards 60% too — yikes! Too much priced in. As for the macro scene, the U.S. economy is barely growing at all, net of all the federal stimulus (+0.7% SAAR in Q1). And net of housing impacts, neither is Canada … should set us up for a fascinating second-half.
- Attempted terrorist attack in Times Square a reminder that geopolitical risks have not gone away.
- Treasury yields have collapsed nearly 35bps from the nearby highs and are not consistent with the recent move by equities to price in peak earnings in 2011. Junk bonds trading back to par for the first time in three years.
- The U.S. implicit GDP price deflator receded to its slowest rate in 60 years in Q1 (+0.4% from +2% a year ago) in a sign that this profits recovery is still being underpinned by cost cuts, tax relief and accounting shifts than by anything exciting on the pricing front.
- The latest Case-Shiller house price index confirmed that we are into a renewed leg down in home prices. Financials, retailers and homebuilders are not priced for this outcome.
- Initial jobless claims, around 450k, are not consistent with sustained employment growth, notwithstanding what nonfarm payrolls tell us this Friday. A new peak in the unemployment rate and a new trough in home prices stand as the most pronounced downside surprises for the second half of the year.
We won’t deny that we have a statistical recovery on our hands in the U.S. — after all, if the economy was not managing to expand at all with all the massive policy stimulus in the system then that would truly be a disaster.
The question is what happens once the stimulus cupboard is bare. At least heading into 2003 we had a massive credit expansion and huge housing inflation to spur on the economy, even if it was a truncated five-year business cycle.
DEFAULTS PROVIDE A BOOST?
Indeed, a Morgan Stanley study found that 12% of all mortgage defaults in February were "strategic" in the sense that folks simply decided they could get away from paying off their monthly obligation. This is unheard of but it has certainly managed to free up anywhere from $100 to $200 billion of money to spend on other goods and services, which helps explain why retail sales have been holding up so well.
Rosenberg of Glusken Scheff has been as gloomy as demand side.
Highlighting a couple of the points he makes.
Let's not bother with the ECRI leading indicators. They should be called coincident indicators at best, since they missed the start of the recession by a couple of months. They are weighted heavily to market indicators, which are famously skewed at present by the attempt to right the casino at the expense of the rest of us.
GDP on Friday was announced at plus 3.2 percent for the first quarter of 2010, down a bit from the 5.6 percent announced for the fourth quarter of '09, and marking the third straight quarter of positive GDP numbers. Thus Rosenberg's "technical" recovery. Real disposable personal income was flat for the quarter, that is, zero point zero. For the fourth quarter of 2009, it was 1.0, and the previous quarter minus 3.6. So there has been no consecutive quarters of positive real income growth.
Personal consumption expenditures, however, are in positive territory, though below the GDP numbers, as perhaps gasoline extracts money from the savings rate.
Gross private domestic investment slumped again after a bump off its bottom in quarter four. The number is better than that quarter, but still in negative territory relative to a Q4 2008.
Calculated Risk has a chart up showing the investment contributions to GDP, which we attempt to reproduce on the blog along with the link to CR's site. His view is that the traditionally leading investment sector -- residential investment ... well, let's just quote
Investment Contributions to GDP: Leading and Lagging Sectors
The following graph shows the rolling 4 quarter contribution to GDP from residential investment, equipment and software, and nonresidential structures. This is important to follow because residential investment tends to lead the economy, equipment and software is generally coincident, and nonresidential structure investment trails the economy.
Residential Investment (RI) made a small positive contribution to GDP in the second half of 2009, but was a drag in Q1 2010. The rolling four quarter change is moving up, but as expected there has been no strong boost to GDP from RI.
Equipment and software investment has made a positive contribution to GDP for three straight quarters (it is coincident).
Nonresidential investment in structures continues to be a drag on the economy, and as usual the economy is recovering long before nonresidential investment in structures recovers.
The key leading sector - residential investment - is lagging the recovery because of the huge overhang of existing inventory. Usually RI is a strong contributor to GDP growth and employment in the early stages of a recovery, but not this time - and this is a key reason why the recovery has been sluggish so far.
Our view is that a helluva lot was done to stimulate residential investment -- including a trillion and a quarter in Fed purchases of mortgage backed securities and a home buyers tax credit that cost a lot more than the sticker price -- which programs have gone away. Residential investment is not going to lead us anywhere but down.
Equipment and software has benefitted from tax rules and from the stimulus spending. Commercial real estate, which includes apartments, and nonresidential structures are way overbuilt and likely to be ground zero for another crisis in the smaller and regional banks.
That said, the bounce in investment along with the Gulf disaster and the timing of the stimulus spending could well support the superficials well enough for incumbents to do well in the fall elections. The political business cycle strikes again.
Back to the data:
Again to personal income. February's real disposable income was zero, March's came in at plus point two (0.2) This echoes the generally flat nature of personal income versus the more positive note from GDP. We suggest the former is better describing the flat bouncing along the bottom we are experiencing in our economy.
What else, oh, here is a chart, also from calculated risk on the subject.
Real personal income less transfer payments as a percent of the previous peak.
Unlike the recovery in GDP, real personal income less transfer payments has barely increased and is still 6.6% below the pre-recession level.
The peak of the stimulus spending is in Q2 2010 (right now), and then the stimulus spending starts to taper off in the 2nd half of 2010. So underlying demand better increase soon - and that means jobs and incomes going forward.
This shows the effect of unemployment insurance and social security payments, among other things. It is a dreadful signal for the future. And if you look at the chart, it is a dreadful falling off a cliff with only a tiny -- a dead cat -- bounce at the bottom.
Elsewhere, CR, Case-Shiller and First American CoreLogic also show significant weakness in house prices going forward.