Oil Prices and the Recovery 2

- by New Deal democrat

Last week I said that I was re-evaluating my overall view of where the economy was heading for the first time in over a year. Having put some further thoughts into the matter, and having exchanged several fruitful emails with Professor James Hamilton of Econbrowser and Bill McBride a/k/a Calculated Risk, I do feel that I have a better grasp of the situation.

I do believe the economy is at something of a crossroads. In terms of reading the tea leaves, we may well have the crucial information that will determine its direction within the next several weeks.

In general, the economy is being buffetted by at least 5 more or less coincidental events: the crisis in the Euro, the ending of the home buying credit, the Oil cataclysm unfolding in the Gulf of Mexico, the withdrawal of stimulus from the states and from the long term unemployed, and the aftereffects of the run-up in the price of Oil in the last 18 months from $37 to $88 a barrel.

I've addressed the issue of the crisis in the Euro already, and my thoughts there haven't changed. Today I want to take a further look at the effects of the price of Oil on the recovery.

It has been noted by Oil analyst Steve Kopits, as shown in the graph below, that when the price of Oil causes consumption expenditures to exceed 4% of GDP, a recession has always followed:



That didn't happen now, but we came within a whisker for a few weeks in April. So I wondered if a similar situation -- of Oil approaching but not crossing 4% of GDP -- had occurred in the past. The answer is staring us in the face in the above graph: it did, and it wasn't long ago, either -- a very similar thing happened in 2006.

First off, here is a long term graph of GDP (red) and the inflation-adjusted price of Oil (blue), normalized so that the two lines cross at the 4% mark (which happened exactly at the height of the oil shock in 1990 when Saddam Hussein invaded Kuwait (essentially this shows the same information as the graph above, but in slightly different form, and updated through April 2010):



You can see the two Oil price shocks in the 1970s, and the similar shock in 2007-08. Here is a close-up of the same graph, for the last 5 years:



You can see that the price of Oil came quite close to 4% of GDP in mid-2006 before suddenly declining through November -- a very similar value, and a very similar move to what is happening now (note that since we don't yet have the CPI for May, the Oil price graph does not reflect the nearly $20 decline in the price of Oil last month.

In addition to the price of Oil, growth in "real" M1 and M2 were similar to what they are now:

The difference being that in 2006, real M1 was negative and real M2 was barely positive. This year real M2 is negative, and real M1 is positive but decliningly so since February.

Professor Hamilton has generally indicated that the effects of changes in the price of Oil show up first, after just a few (3 or 4) months, in auto purchases, and PCE's in about 6 months. These in turn have the maximum effect on GDP about 6 months later, or 12 months after the change takes place.

In that regard, here is a graph of the price of Oil (blue) and absolute real GDP (red) for the last 5 years. Note that in 2006 as the price of Oil approached the 4% of GDP mark, real GDP stalled for one quarter, literally growing at almost an exact 0% pace, before accelerating again as Oil prices fell going towards the end of the year:

Although I haven't reproduced the graph here, employment growth also nearly stalled, with several months of about 50,000 in gains just as the price of Oil hit its peak.

In other words, all else being equal, we should expect GDP to nearly stall either this quarter or next quarter in response to Oil prices being in the $80-$90 range in March and April. Should the decline in prices last for at least several more months, all else being equal we should see increase auto sales and a re-acceleration of GDP.

Of course, not everything else is equal, for the reasons stated at the outset of this post. In a day or two, I'll explain what data will be most important to me in the next couple of weeks that may tell us in which direction the economy will likely proceed.

Yesterday's Market

Last week the markets were in complete flight to safety mode. The dollar and bonds were the top performing sectors. Internally, we saw consumer staples, health care and utilities in the top five performing industries. Finally, the long-end of the treasury curve outperformed the shorter end, indicating both safety concerns and a need for safety.

In the markets we had the following developments.


The euro's drop -- which started this situation -- continues. Prices broke through the 121.50 area where there was a fair amount of technical support. This ends the double bottom theory for the chart discussed last week.


The technical internals are terrible. The the EMAs are moving lower, indicating a bearish orientation in the short, intermediate and long-term time horizons. The money flow is dropping (b) although the CMF is slightly positive and the MACD is now negative.


On the long-term chart, notice that prices are at the lowest levels in two years.



Conversely we have the dollar, which moves inversely to the euro. Last week I was discussing the possibility of a double top - which is now no longer a possibility a prices have broken through resistance at the 25.50 area. Money is flowing into the market (a) but not strongly (b). While the MACE has given a buy signal (c) the index is already extended. Finally, the EMA picture is still bullish (d) with the short, intermediate and long-term trends increasing.



Turning to industrial metals, is it possible to argue the chart is really a double top? i don't think so. Look closely at the volume of both peaks (a and b). It this were a double top we would see the end of a rally with a buying climax and (a) followed by a lower volume level on (b). Instead, we see the higher volume occur on the sell-offs rather than the peaks.



The being said, prices are currently in a downtrend outlined by lines (a and b). The WEMA picture is bearish -- the shorter trends are moving lower and prices are below the 200 day EMA. The volume indicates (d and e) indicate money is flowing out of the market, which momentum is giving a sell signal (f).


With the Treasury market, the general working theory was we were seeing an island reversal (a). This was confirmed by the decreasing market participation (c and d) and the sell signal from the MACD (e). So far, that theory is still in place but is is weaker due to the euro's drop and dollar's rise. The long-end of the Treasury market is a clear flight to safety benefactor.

Weekly Indicators for June 4, 2010

- by New Deal democrat

Monthly data as usual was headlined by the jobs number, am extremely disappointing +20,000 without census jobs. The internals -- overtime, hours worked, income, temp jobs, and the unemploymnent rate -- were generally better, but 300,000 people left the work force, and the situation is still intolerably bad.

On the other hand, both the ISM Manufacturing and Non-Manufacturing Indexes showed continued growth indicating the recovery does continue. May monthly same store sales wer up +2.6% YoY. Auto sales were also up 19% over last year's awful numbers, and up MoM from April, to approximately 11.6 million on an annulalized basis.

Turning to the weekly indicators:

The ICSC reported that year over year sales were up 2.5% from last year for the week ending May 29th. They were also up +0.6% from the previous week. Shoppertrak reported that YoY retail sales increased 6.0% for the week ending May 29, and belatedly reported that YoY sales were also up 3.9% for the previous week.

The price of Gas fell again to $2.73, a decline of $0.17 or about 6% from its high of $2.90 three weeks ago. The 4 week average of usage last week is virtually identical to last year. The price of a barrel of Oil is now only about 5% higher than last year at ~$72/barrel.

The BLS reported 450,000 new jobless claims last week. The inability of this indicator to decline below 440,000 suggests this aspect of recovery is stalling. Unfortunately we have no way of knowing from what sector this continued elevated level of layoffs is coming from, but the suspicion is that it consists of construction jobs post expiration of the housing credit, and state and municipal workers.

The American Staffing Association's weekly index of temporary employment yet again, up 1.23%.

Rail traffic remains up from last year, but its comparative increase has stalled for four weeks in a row now, indicating a pause in the recovery.

Daily treasury receipts were up for the first 3 days of June, $34.2B vs. $31.2B a year ago. May finished just barely ahead of last year, $126.8B vs. $126.0.

In the last 2 weeks of May only $69.0B was collected vs. $71.2B a year ago -- and last year was awful.

The last few weeks have shown all the signs that another spasm of deflation is underway -- driven by Europe, a decline from April's near $90 price of Oil, the expiration of the $8000 housing credit, and the Oil cataclysm in the Gulf of Mexico. As of now, however, I continue to think this will just be a slowdown in growth rather than an actual double-dip into negative GDP.

Further notes on the Employment Report

- by New Deal democrat

(N.B.: I'll put up the Weekly Indicators post tomorrow).

I was out this morning but have now had a chance to look at the May employment report. My main impression is that just as April's report was probably an outlier to the good side, this is probably an outlier to the down side in a noisy series.

A few points of interest in the underlying data are worth emphasizing:

1. The housing credit - and its expiration - are playing havoc with housing and construction statistics. Just as housing permits and starts have surged and crashed in the month before and after the expiration of the housing credit - twice! - so construction jobs appear to have been similarly affected. In March 27,000 construction jobs were added; in April 14,000. In May, by contrast, 35,000 construction jobs were lost. This is a swing of 56,000 jobs down from the average of the last two months.

2. State and local budget pressures are showing up in government jobs. In each of the last three months, about 10,000 to 25,000 non-census government jobs were lost. These always lag, but are particularly bothersome now, because Federal aid to the states is ending.

3. The BP oil cataclysm may be showing up in leisure and hospitality jobs. 23,000 were added in March, and 35,000 in April, but only 2,000 in May, a decline of 27,000 from the average of the last two months. This may also have had some affect on retail jobs, which after advances of 23,000 and 19,000 in March and April, respectively, declined 7,000 in May, a loss of 28,000 from the average.

Despite the fact that the employment number obviously disappointed compared with expectations, there are some absolute good points:

1. Aggregate hours worked, the ultimate coincident incidator, increased 0.3%, the third month in a row of a good advance. Overtime also increased 0.2 hours to 40.1 hours. Simply put, work is being added into the economy.

2. The average workweek added 0.1 hours, but more importantly, the factory workweek added 0.3 hours. This is one of the 10 Leading Economic Indicators. If M2 continues to increase sufficiently for all of May - with one week's data remaining - and if building permits hold steady, we may yet see a positive LEI for May despite the stock market correction.

Employment Increases 431,000

From the BLS:

Total nonfarm payroll employment grew by 431,000 in May, reflecting the hiring of 411,000 temporary employees to work on Census 2010, the U.S. Bureau of Labor Statistics reported today. Private-sector employment changed little (+41,000). Manufacturing, temporary help services, and mining added jobs, while construction employment declined. The unemployment rate edged down to 9.7 percent.

Let me get this off my chest. This report sucks. The majority of job creation came from Census hiring -- the private sector was non-existent.

Let's look at the data:

The civilian labor force decreased by 322,000 and the number of unemployed decreased by 287,000. This lowered the unemployment rate to 9.7%.

The labor force participation rate decreased .2% because of a drop in the number in the civilian labor force.

The employment to population ratio decreased .1%.

This means that fewer people participated in the labor force last month and the percentage of people employed as a percentage of the civilian labor force decreased.

Total private jobs created were 41,000. Goods producing industries increased 4,000, with an increase in manufacturing and mining offset by a drop in construction.

Service employment increased by 37,000. With the exception of financial services (which decreased 12,000), all sectors saw growth. Just not much growth.

Simply put, the private sector dropped out of the equation last month. Period. Unfortunately, this report comes at the worst time possible -- when the markets are already shaky. In addition, the initial unemployment claims numbers -- which have dropped the last two weeks -- are still high. This is not a good combination.

Several weeks ago, I wrote an article titled Storm Clouds on the Economic Horizon. In that article I wrote the following:

[Going forward] the economy needs to keep up its current pace of job creation. Last month we had a great employment report. That needs to be repeated in the next report.

This is the worst possible jobs report we could have in the current environment. Now -- this is just one report. The record indicates things are moving in the right direction; this could be nothing more than a speed bump. But, this is a most ill-timed speed bump.

Yesterday's Markets

Let's start with the Treasury market.


The daily (5-minute) chart shows that prices are slowing moving lower. This chart gives us the best view of the Island reversal for last week.


The technical side of the market says we're moving lower. Prices formed an island reversal (a) and then moved below the upward sloping trend line (b). We've seen money flow out of the market (c and d) and the MACD has given us a definite sell signal.



Yesterday, gold broke it's recent uptrend at (c). As I observed yesterday, the GLD chart is a bit weaker on its recent rally, with smaller bars and weaker technical indicators (MACD and CMF).



However, the Treasury market is not the only safe haven market. The dollar has also risen. But there are problems with the rally.


While prices have found upside resistance right around the 25.50 area (a), notice the number of fairly extreme selling events over the last 10 days.

b.) Prices gap higher but them move lower for the entire day.

c.) prices open lower, rally, but then drop massively.

d.) Prices gap higher but then move lower throughout the trading day.

e.) Prices gap higher, but then move lower throughout the day.

There are at least 4 daily moves where prices moved higher but then went lower. That is not bullish.

The above chart also shows the triangle consolidation pattern prices are currently forming.

Industrial metals are extremely concerning:



We've seen two price advances stall at the 19.50 level(a and b). For the last three days, prices have gapped lower (c, d and e), even with one day (d) showing an incredibly strong advance.



Oil has been trading in a range for the last 5 days.


Oil's daily chart shows some strength. After hitting bottom, prices have rebounded and are consolidating (a). Notice the short-term trend (the 10 day EMA) is now moving with a slight uptrend, although all the other EMAs (b) are bearish. But money is moving into the market (c and d) and the MACD has given a buy signal (e).

In a quandary

- by New Deal democrat

You may have noticed, I haven’t posted much in the last couple of weeks. That is partly because real life sometimes intrudes, and when it does this must obviously take a back seat. Partly, however, it is also because for the first time in over a year, I have been seriously rethinking my outlook – but have come to no firm conclusions. So, better not to write anything, rather than write something that is half-baked and foolish.

Still, it is worthwhile to let you know what I am looking at. Consider this post nothing more than “thinking out loud” for your own consideration.

Looking at the economy, here are the good points:

Real retail sales still suggest strong hiring in the months ahead, and most likely decent advances in personal income.

The price of Oil has come down significantly, putting more money in consumers’ pockets to be spent domestically.

Coincident indicators, like payrolls, ISM manufacturing, and auto sales, are all continuing to show decent improvements (although we’d all like them to be stronger).

Bank loans, one of the last lagging indicators that was still declining, have turned up strongly in the last month.

Construction spending, also a big laggard, had a nice increase last month.

On the other hand, here are the bad points:

The Euro scare may affect exports substantially, as may any slowdown in growth in China.

Real M2 money supply is negative year-over-year. It has been declining since February, and is one big reason for the waning of the Index of Leading Indicators.

Real M1 money supply is still positive YoY, but it too has been declining on a monthly basis since February. Given Ben Bernanke’s fealty to Milton Friedman’s monetary explanation for the Great Depression, what on earth is Bernanke thinking?!?

The hiring index of the Chicago PMI turned negative for May.

Payments of withholding taxes came to something of a screeching halt in the last two weeks of May (the month just barely eaked out a YoY gain from May 2009, after a strong start).

The long end of the yield curve flattened in response to the Euro crisis.

The stock market has suffered a 10% plus correction (meaning a strong likelihood of the second consecutive monthly decline in the LEI).

One of the main reasons for my quandary is that economic indicators simply behave differently in periods of deflation vs. periods of inflation. The shape of the yield curve is an excellent prognostication device during inflation, but fails during deflation (except that an inverted yield curve in times of deflation is really, really, really bad). Similary, monetary indices are leading indicators during inflation, but seem to be coincident indicators during deflation (I did a detailed report on this about 18 months ago, looking at Economic Indicators during the Roaring Twenties and Great Depression).

Housing seems to operate similarly during both inflation and deflation, but we have only annual data until after World War 2.

Other leading indicators similarly weren’t published in the pre-World War 2 deflationary era.

And we are almost certainly going to have a brief bout of deflation, due mainly to oil prices. The $10+ decline in May is probably going to lead to a CPI of something like -0.5% for the month. April already showed a -0.1% decline. The best comparison periods are during the last decade (especially late 2006) and the Roaring Twenties, which similarly had a number of deflationary recessions.

Professor Hamilton’s studies on the effects of Oil prices suggest that the sharp percentage and $ per barrel increases in the price of Oil are probably having the maximum impact right about now, if I read them correctly.

One take on this data is that we are just beginning to enter a period of weakness which will intensify in the coming months. But another take is that to the extent there is weakness, it is happening more or less now and for the next couple of months, after which if Bernanke decides to reinflate, and the price of Oil cooperates, we will see renewed or expanded growth.

As you can see from the above, a fair amount of the answer to this question seems to depend on political rather than strictly economic decisions, coming out of Europe, the Congress (think: aid to the States, continued extended unemployment benefits), and the central banks.

Hence my quandary. In general, I am leaning towards the second scenario, where the relative weakness is happening right now. For example, the "shock" of $80 vs. $40 Oil from last year may be reflected in the plateauing - but not declining - auto sales now. If Europe stabilizes, the possible pause in hiring in late May might resume just as strongly as in March and April. As my thinking becomes clearer, I will post more.

ADP +55,000

From ADP:

Nonfarm private employment increased 55,000 from April to May 2010 on a seasonally adjusted basis, according to the ADP National Employment Report^®. The estimated change in employment from March to April 2010 was revised, from an increase of 32,000 to an increase of 65,000.

May’s rise in private employment was the fourth consecutive monthly gain. However, over these four months the increases have averaged a modest 39,000. The slow pace of improvement from February through May is consistent with the pause in the decline of initial unemployment claims that occurred during the winter months.

Let's take a look at the data


All of the gains came from the service sector, which added 78,000. Also notice that small and medium businesses added the preponderance of the jobs.

While the overall total is disappointing, the increase in jobs in the small and medium businesses is encouraging.

Yesterday's Markets

Let's start with a look at the euro and the dollar, because it is the inverse relationship between the two that is at the heart of current market action. Remember:

1.) The euro dropped because of the Greek situation

2.) As a result the dollar and US Treasury Bonds rose in a flight to safety, and

3.) Stocks and commodities fell as money fled risk assets.


For awhile, it appeared the dollar might be forming a double top. But while the dollar appears to topping, the formation how appears to be a triangle (e). Note that prices have found resistance in the 25.50 area on several advances. While the short, medium and longer-term trends are still bullish (d) (the 10, 20 and 50 EMAs are all rising), the A/D and Chaiken Money Flow are weakening (a and b) and the MACD has given a sell signal (c).


The euro appears to be bottoming (a), finding support at the 121.50 area. And while all the trends are still negative (e), the A/D and CMF indicate money is flowing into the ETF (b and c) and the MACD has given a buy signal (d).

So - the currency situation really hasn't changed. Technical indicators say the securities want to reverse, but we're still waiting for a fundamental catalyst to complete the reversal.



In the equity markets, notice that price action has really stayed in a pretty narrow range for the last 10 days.



On the daily chart, notice that money really hasn't left the market (a) and the CMF hasn't really moved negative in a big way (b). Also note the MACD has given a buy signal (c). While the longer trends are still negative (the 20 and 50 day EMAs are moving lower) the 10 day EMA has moved higher (e). Finally, notice some of the large candles within the sell-off (d) indicating there is a tremendous "buy on the dip mentality" going on.


In the Treasury market, I've been working on the thesis that prices formed an island reversal (a) and are now going to move lower as the safety bid leaves the market. That still appears to be happening, as also indicated by the declining A/D and CMF (c and d) and the sell signal given by the MACD (e).



The daily chart shows the island reversal area in a clearer light (a), but also shows that prices have been in a fairly tight range for the last few days (b).


The 5-minute GLD charts shows a strong uptrend (b) with several gaps higher (a).


But on the daily chart, notice weakness of the bars printed over the last few weeks (a) -- they're smaller and tighter. Also note that the A/D line (d) is advancing at a lower angle and the CMF (b) and MACD (d) are both in a sell position.

Employment Picture Improving

From Bloomberg:

Job cuts announced by U.S. employers declined in May, indicating the labor market is improving.

Planned firings dropped 65 percent to 38,810 from 111,182 in May 2009, according to figures released today by Chicago- based Challenger, Gray & Christmas Inc.

Companies are retaining workers and starting to hire as they boost production and spending to meet improved demand in the U.S. and abroad. An improving labor market will help the economy withstand challenges posed by the European debt crisis and growing U.S. state and local budget deficits.

“Announced job cuts have, for all intents and purposes, returned to pre-recession levels,” John Challenger, chief executive officer of Challenger, Gray & Christmas, said in a statement. “What makes the low job-cut totals we have seen this spring particularly remarkable is that we still have not reached what is the slowest downsizing period of the year, which typically occurs during the summer months.”

From the AP:

Jobless rates fell in more than 90 percent of the nation's largest metro areas in April, the government said Wednesday. That was better than March, when rates fell in about 69 percent of metro areas.

Treasury Rally Catches Street Flat-footed

From the WSJ:

Many have been caught flat-footed by the sudden move into Treasurys because it has been driven by a rush to safety amid the ballooning euro-zone debt crisis, a stampede that was difficult to predict a few months ago. As buyers piled in, prices rose and yields—which move inversely to prices—fell.

Treasury yields are now trading near their lowest levels in a year, the bottom of a trading channel that has persisted for about 12 months.

That has upended the widespread view at the beginning of the year that Treasurys would seem less attractive amid a recovery in company profits, a rebounding U.S. economy and an avalanche of Treasury debt issuance. Less than two months ago, the 10-year yield was flirting with 4%.

"A lot of people didn't see the latest rally coming," said Zach Pandl, economist at Nomura Securities International. Nomura in mid-April was one of the first of several so-called primary dealers—banks authorized to deal directly with the Federal Reserve—to cut its year-end forecast for the 10-year Treasury yield, to 3.75% from 4%.

Since late March, most primary dealers have cut their year-end predictions for 10-year note yields, according to a survey by The Wall Street Journal, driving the median forecast to about 3.75% from 4.15% at the end of March.

RBC Capital Markets and Jefferies & Co. Inc. cut their forecasts for the 10-year note on Tuesday. Bank of America Merrill Lynch and UBS cut their forecasts last week.

"What we did not anticipate was that 10-year notes and 30-year bonds would become the global safe haven during the European crisis," said Jefferies chief economist Ward McCarthy, who said he believes yields will soon resume their rise.

Count me in the crowd that didn't see this coming.

Both the dollar and Treasuries have caught a very strong safety bid from all comers over the last few months. What is interesting is this runs counter to the politically driven narrative that the US is the next Greece. If that were true, we wouldn't be seeing the same safety bids we're seeing now.

However, let's take a look at the long-term chart to see how strong this rally really is:

At point (a) we see the Lehman rally -- that rally that occurred during the financial collapse. Unless we see similar financial conditions develop, it's doubtful we'll see this type of rally again. The latest rally is currently hitting resistance at previously established highs (b). Momentum is positive (c) and we are seeing a large inflow of cash (d and e) into the market. Notice the A/D line is higher now than it was during the Lehman crisis. Also notice the huge volume spike (f) as well.

ISM Increases

From the Institute for Supply Management:

The report was issued today by Norbert J. Ore, CPSM, C.P.M., chair of the Institute for Supply Management™ Manufacturing Business Survey Committee. "The manufacturing sector grew for the 10th consecutive month during May. The rate of growth as indicated by the PMI is driven by continued strength in new orders and production. Employment continues to grow as manufacturers have added to payrolls for six consecutive months. The recovery continues to broaden as 16 of 18 industries report growth. There are a number of reports, particularly in the tech sector, of shortages of components; this is the result of excessive inventory de-stocking during the downturn."

The report also contains anecdotal statements from participants:

• "Tight supply conditions exist for electronic components." (Computer & Electronic Products)
• "No signs of the ramp-up abating anytime soon." (Machinery)
• "Volatility of steel and steel-making components is forcing us to raise prices on our shipped goods to automotive customers." (Fabricated Metal Products)
• "Aftermarket sales increased 25 percent during the past quarter." (Transportation Equipment)
• "Sales exceeded budget for the fourth consecutive month." (Food, Beverage & Tobacco Products)

All of those statements are bullish.

Here is a chart of the overall number:


Simply put, that's a very strong and encouraging graph of numbers, and it indicates the manufacturing sector is doing very well.

Yesterday's Markets

Remember that yesterday I noted a split in the fundamental/technical analysis. Technically, the markets were moving into an undoing of the recent damage but fundamentally there was no driver.


Yesterday prices gapped lower at the open, buy quickly rebounded (a). They spent the rest of the day trading in a range (b), but then moved lower at the end of the day on news of more violence in the Middle East (c).


Treasuries were the exact opposite. gapping up at the open (a), then trading in a range a bit above the previous days close (b) before rallying into the close (c) on the same Middle East news.



The daily chart for the TLTs still shows a security that wants to reverse with an island reversal pattern (a) decreasing momentum (c and d) and a sell signal from te MACD (e).

Yesterday, Bloomberg had a very interesting article about the commodities markets:

The Journal of Commerce Industrial Price Commodity Smoothed Price Index reflects clearer signs of supply and demand than futures markets because half the items it tracks don’t trade on exchanges used by speculators, said Lakshman Achuthan, the managing director at the New York-based Economic Cycle Research Institute. The gauge dropped to 25.97 on May 28 from 60.56 on April 30.

In June 2008, a month after the index reached its peak, the Paris-based OECD said the U.S. would grow at a 1.1 percent rate the following year. Commodities continued to drop, and in October 2008, the index fell at a 56 percent annual rate, which was then the lowest level since 1949.

Almost two months later, the National Bureau of Economic Research, the panel that dates American business cycles, said the U.S. was in a recession. The world’s largest economy shrank 2.4 percent, the worst contraction since 1946.

Now, “the collapse in the commodity index is telling us that the peak in global industrial growth is imminent, it’s here right now,” Achuthan said. “Markets are going to have to deal with the reality of a slowdown.”

Manufacturing Indexes Slide

China’s Purchasing Managers’ Index slid to 53.9 from 55.7 in April, the Federation of Logistics and Purchasing said today. That was less than the median 54.5 estimate in a Bloomberg survey of 18 economists. A monthly gauge of manufacturing in the euro region fell to 55.8 from 57.6, Markit Economics said. The Institute for Supply Management said its U.S. factory index dropped to 59.7 in May from 60.4 in April.

Europe’s debt crisis is only starting to weigh on global growth, said Michael Aronstein, a strategist at Oscar Gruss & Son Inc. who predicted the 2008 commodity plunge and is betting against a rally this year.

It's important to remember there are two parts to the commodities markets: traders, who are simply looking to make a profit and industry participants who are looking to hedge their future risk through the use of futures. Regardless, consider the last article in conjunction with these two charts of industrial and agricultural commodities:


Industrial metals are in a clear downtrend with line (a) being the primary reason for the drop.


Agricultural commodities are also dropping and have three downward sloping trend lines.

A Closer Look at First Quarter GDP

On Friday, the BEA released the second revision of first quarter GDP. These are great reports because they provide a good snapshot of the overall economic situation. As such, a closer look at the data is warranted. All charts below are from the St. Louis Federal Reserve and are in chained (inflation-adjusted) 2005 dollars. You can click on all the charts to get a larger chart.

Personal consumption expenditures (PCEs) comprise the largest part of GDP. Here is a chart of overall PCEs for the last year.


Overall PCEs (which comprise 70.7% of real GDP) have been increasing for the last year and they increased slightly last month.


Services comprise the largest percentage of PCEs at 65.4%. They have been increasing for the last year at a consistent rate.



Non-durable goods' expenditures -- which represent 22% of PCEs -- have been increasing for the last year as well, although they dropped last month.



Durable goods -- which comprise the smallest percentage of PCEs -- increased sharply at the end of last summer thanks to the cash for clunkers program. After dropping the next few months they have rebounded at a solid rate.

The next largest percentage of GDP is investment which comprises 12.6% of real GDP.


Real gross private domestic investment picked-up strongly in the 4th quarter and moved up in the first quarter as well.


Residential fixed investment (which accounts for 21% of investment) dropped in the first quarter, although it had been rising for the preceding two quarters. However, the best way to describe the last year's action is a sideways move.


While business investment in real estate (which comprises 20.6% of all investment) has decreased for the last four quarters, investment in equipment and software (which accounts for 56.4% of all investment) has increased strongly over the last two quarters.

There is good and bad news in the import/export figures.


The bad news is that collectively, the trade balance is again moving in the wrong direction -- that is, the US is net importer.



Imports are increasing, which indicates the US is again a net importer, but this also indicates personal consumption expenditures are increasing.



And while they are less than imports, the overall pace of increase in exports is also very encouraging. In fact, manufacturing has been a key component of the recovery.

Finally, there are federal and state expenditures.


Real federal expenditures have actually been moving nearly sideways for the last two quarters, while



real state consumption expenditures and investment have been decreasing for the last three quarters.

The most striking feature of the data is the lack of contribution of growth from government expenditures -- which is caused entirely from the decrease in state and local expenditures. This means growth for the last two quarters is coming almost entirely from the private sector. In addition, the largest part of GDP -- PCEs -- have demonstrated a consistent rate of growth. Additionally, private investment is picking up as are exports. In conclusion, the economy grew for the last three quarters, which is a required development for lowering the unemployment rate.

Yesterday's Markets

Starting mid-week, it appeared the markets were moving in a position to technically rebound. First, let's revisit the chain of events that got us here. Fear of EU problems leading to a big economic drop caused a drop in the euro. This led to an increase in the dollar, which led to a drop in commodities. Stocks dropped out of concern about corporate earnings. US Treasuries caught a safety bid, driving down US interest rates.


The euro looks to be forming a double top. However, the EMA picture is still very weak with the shorter EMAs below the longer EMAs, all the EMAs moving lower and prices below all the EMAs. But technical indicators are pointing to a reversal. Money is flowing into the security (b and c0 and the MACD is pointing to a reversal of momentum.


Conversely, the dollar appears to be printing a double top. But the EMA picture is still bullish with the shorter EMAs above the longer EMAs, all the EMAs moving higher and prices above all the EMAs. Technical indicators are pointing to weakness. Money is flowing out of the security at the peak (b and c) and momentum is decreasing, especially on the second top of the double top (d).



The long-end of the Treasury market has caught a safety bid, driving prices higher. But, prices may have formed an island reversal (a). While the EMA picutre is still bullish, it is weakening a bit with the 10 day EMA starting to move sideways and prices a bit below the EMAs. Also note the decrease in the A/D and Chaiken Money Flow indicators, which indicates people are selling (they are probably taking profits). Finally, the MACD is giving a sell signal (e).



Oil dropped hard on the EU news, but it to appears to be rebounding. Prices have clearly reversed (a), printing several strong bars with gaps. While the EMA picture is still negative (b), we are seeing a reversal in the shorter EMAs. The A/D line and Chaiken Money Flow indicate money is flowing back into the security and the MACD has given a buy signal (e).




Finally, we have the equity markets. While the price picture is still negative, notice the A/D and Chaiken indicators (a and b) tells us the sell-off didn't drive investors away from the markets. Also note the MACD is close to giving a buy signal (c).

The above is a technical reading of events. Given the severity of the sell-off we would also need a fundamental driver for the markets to truly reverse. So far we have had the EU creating the $1 trillion dollar bail-out fund. But traders are concerned this plan is not yet fully developed and therefore not credible. In addition, there is the issue of coordinating the plan among the EU nations which is a bit like herding cats. In other words, so far there isn't a strong fundamental reason to reverse course.