Saturday, August 13, 2011

Watch Consumer Spending

- by New Deal democrat

With consumer confidence plummeting, several bloggers have pointed out that such a plunge usually coincides with a recession. That's true, but the latest plunge can be traced directly back to the shameful display in Washington during the debt ceiling debate much moreso than direct economic data. S&P was far from alone in concluding that the outcome demonstrated and entrenched the empowerment of a veto-wielding minority of economic lunatics.

But consumer confidence is only one metric that signals an oncoming contraction. Simply put, you must watch consumer deeds at least as much their stated intentions.

Prof. James Hamilton has highlighted how consumer over-reactions to Oil price shocks bring on recessions:

[W]hen energy prices go up, consumer spending falls. But there are two surprising things about the quantitative character of this response. The first surprise is the delay-- energy prices go up at time t, but the biggest consequences for consumption spending aren't seen until [ ] 12 months later. The second surprising feature of these results is the magnitude. If consumers continued to purchase the same number of gallons of gasoline as they had before, a shock of the size analyzed in this graph would require them to reduce spending on other items by 1%. Yet eventually they historically would be predicted to reduce spending by 2.2%. ... [C]onsumers cut spending by [ ] much more than the shock itself."
(my emphaisis)

Several years ago I wrote about how critical the severe consumer spending retrenchment was, in the wake of the 1929 stock market crash, in 1930. There I documented how:

What made matters worse was a big drop in U.S. consumer spending—far more than can be explained by the stock market crash. The drop may have been a backlash to the rise of installment lending (for cars, furniture, and appliances) in the twenties. The prevailing practice allowed lenders to repossess an item if the borrower missed just one payment. People may have stopped making new purchases to reduce the risk of losing things they already had bought on credit. Whatever happened, the slump soon fed on itself. Weak spending depressed prices, which meant that many farmers, businesses, and nations couldn't repay their debts. Rising bad debts prompted banks to restrict new loans and sell financial assets, usually bonds. Scarce credit led to less borrowing, less spending, lower prices, and more bankruptcies.

A similar dynamic played out in September 2008. In response to a daily diet of cataclysm, consumers simply froze.

The bottom line is, it is the reaction - even over-reaction to events - by consumers in their spending that proclaims the downturn. And so far, that hasn't happened.

Let's start with the graph of consumer confidence as measured by the University of Michigan, showing its cliff-dive in the last two months (h/t

The sentiment bar (gold) is one of the 10 LEI, and will have a significant negative impact of the July report, along with the negative stock market.

But now let's pair that with consumer spending as measured by real retail sales (Note: since July inflation hasn't been reported, retail sales data (red) ends with June. By agreement with the U. of Michigan, the Fred graph only shows consumer confidence (blue) through last December):

While consumer confidence has tanked (see first graph), spending is still going strong.

Even more up-to-date graphs can be found at Gallup. First of all, here is their poll of consumer sentiment through Friday August 11, showing the same precipitous decline as in the U. of Michigan data:

But now here is the consumer spending data from the very same Gallup poll:

Notice that consumer spending is at its highest peak in over a year. Only last Christmas was higher, and this August is significantly ahead of last August. (As an interesting aside, Gallup consumer spending was cited once by the Pied Piper of Doom: heralding that "consumer spending [has] collapsed" on January 16, 2011. This was smack in the middle of the three worst days period of the last 2 years. Yes, he unintentionally bottom-ticked it! For some reason he hasn't mentioned it since ....)

In short, if consumers feel no confidence in their government to do the right thing for the economy, it isn't showing up in their wallets yet. Unless and until it shows up in their wallets, it is unlikely that a contraction has started.

Weekly Indicators show continued stabilization edition

- by New Deal democrat

There was little monthly data released this week, but there were two very big numbers - in opposite directions. The big positive was retail sales, up .5% in July. June was also revised up from .1% to .3%, and May was revised higher as well. Q2 productivity declined, so maybe firms could hire a few more workers instead? Consumer sentiment for the end of July, on the other hand, plunged to multi-decade lows, mirroring and almost certainly a direct result of the lunacy in Washington and the crashing stock market.

For the third week in a row, however, the high frequency weekly indicators show a halt in the trend towards contraction.

First, let's look at the positive signs in order of their magnitude:

Money supply -a leading indicator - has been surging lately. M1 increased 1.1% w/w, and also increased 1.6% m/m, and 14.7% YoY, so Real M1 was up 11.3%. M2 increased 0.2% w/w, and also increased 2.0% m/m, and 7.9% YoY, so Real M2 was up 4.5%. Comparing the entire month of July m/m and YoY, M1 was up 2.5% m/m and 10.6% YoY, so Real M1 was up 7.2%. M2 was up 2.2% m/m and 7.6% YoY, so Real M2 was up 4.2%. In short, both Real M1 and Real M2 are solidly bullish.

The Oil choke collar has loosened again, with the usual positive result. Oil finished at $85.37 a barrel on Friday. This is the lowest price since last November, and is nearly $10 below its recession-trigger level. Gas at the pump fell $.04 to $3.67 a gallon. For the first time in 7 weeks and for only the 4th time in 5 months, gasoline usage was higher than a year ago: up 0.1% at 9244 M gallons vs. 9236 a year ago.

Initial jobless claims - another leading indicator - have clearly reversed their April - June upturn and are solidly trending back downward. The BLS reported Initial jobless claims of 395,000. The four week average decreased to 405,000. Jobless claims have decisively broken to the downside from their recent range, and with the exception of 7 weeks in February - April of this year, are lower than they have been in 3 years.

Despite nearly universal opinion "knowing" to the contrary, Housing - a third, and major, leading indicator - continues to trend positive. As to sales, the Mortgage Bankers' Association reported that seasonally adjusted mortgage applications decreased 0.9% last week. For the 10th time in 11 weeks, however, the YoY comparison in purchase mortgages was positive, up 4.9% YoY. Refinancing also increased 30.4% w/w due to cliff-diving interest rates.

As to housing prices, YoY weekly median asking house prices from 54 metropolitan areas at Housing Tracker showed that the asking prices declined -2.9% YoY. This is the smallest YoY decline since May 2007. The areas with double-digit YoY% declines decreased by one more to 6. The areas with YoY% increases in price increased by one more to 11. This again continues the record of improving YoY comparisons in this series. Just a couple of months ago only 3 or 4 areas had actual increases, and well over 10 had decreases. At the beginning of this year, only one metro area was showing YoY increases.

Retail same store sales continue to perform well. The ICSC reported that same store sales for the week of July 30 increased 4.0% YoY, and increased 0.3% week over week. Shoppertrak reported a 4.1% YoY increase for the week ending July 30 and a WoW increase of 0.5%. This is the sixth week in a row of a strong rebound for the ICSC, joined for the third week by Shoppertrak.

None of the four remaining series are negative, although they are just above a stall. Only one subindex was negative.

The American Staffing Association Index for the third week in a row is at 88. This trend of this series for the year is worse than 2007, and is now equivalent to the first half of the recession year of 2008 - and just slightly better than a complete stall.

Weekly BAA commercial bond rates decreased .34% to 5.38%. Yields on 10 year treasury bonds fell a nearly identical .35% to 2.62%. This indicates a significant increase in the fear of deflationary, but no relative distress in the corporate market. If the market feared rising corporate defaults, this spread should be widening.

Adjusting +1.07% due to the 2011 tax compromise, the Daily Treasury Statement showed that for the first 8 days of August 2011, $59.3 B was collected vs. $58.7 B a year ago, for an increase of $0.6 B. For the last 20 days, $129.0 B was collected vs. $126.7 B a year ago, for an increase of $2.3 B, or 1.8%. Collections faded this week from their strong July rebound, but are still positive.

The American Association of Railroads reported that total carloads increased 0.3% YoY, up 1500 carloads to 533,300 YoY for the week ending August 6. Intermodal traffic (a proxy for imports and exports) was up 4400 carloads, or 1.9% YoY. The remaining baseline plus cyclical traffic was up 1100 carloads, or 0.4% YoY%. This series returned to gains after 2 of the last 5 weeks were negative. Railfax graciously gave me their breakdown of baseline vs. cyclical carloads, which shows that baseline traffic was down 3700 carloads, or -2.0%YoY, while cyclical traffic was up 4700 carloads, or +4.6% YoY.

In summary, the last three weeks of high frequency data have suggested an end to the March - July declining trend into contraction in the data sets, chiefly Oil prices and gasoline usage, but also rail traffic and initial jobless claims. Additionally, BAA bonds in comparison with treasuries have gone from negative to neutral. Real M2 has improved, as have same store sales, and housing prices continue to move towards stabilization. Real M1, retail sales, and purchase mortgage applications remain solidly positive. Temporary staffing and rail traffic in particular continue to be areas of concern, and whether there has been any important positive trend break in gasoline usage will be watched closely.

Have a nice weekend!

Friday, August 12, 2011

SPYs Looking Like A Bottom

The above chart is a 10-day, 5-minute chart of the SPYs. Notice that from Monday through Thursday we have a rounding bottom. Now we're waiting to see if we have a handle for a cup and saucer formation.

The key level the market needs to break through is 119.

If A Recession Comes, Blame Washington

Earlier this year, NDD noted that Washington was a big negative wild card for the economy. Not being that politically astute I read over that statement, frankly not really knowing what to think. However, his statements to that effect now show a prescient reading of the landscape; Washington is indeed a huge problem and their current policy choices indicate they are as much the problem -- if not the primary problem -- in the current environment.

At the beginning of the year, the general economic consensus was for growth to start picking up. However, the EU crisis and the Japanese earthquake hammered growth in ways not anticipated. This was evidenced by the large downward revision to the first two quarters of 2011 growth, which printed two sub 2% quarters. This is a very discouraging sign.

Now, we have Washington focused on the need for "deficit reduction." Yet their solution -- which is disproportionately focused on cutting spending instead of a balanced approach between raising revenue and cutting spending -- is occurring at exactly the wrong time. This is born out by recent market events. Consider this chart:

The debt deal was signed on August 2. Since then, the stock market has tanked hard. Notice the massive volume on the sell-off and the incredibly strong downward sloping bars. Where is the euphoria? Where is the, "they got it right, the economy will now grow at strong rates so we should start buying shares" rally? Nowhere. In other words, the deal accomplished just the opposite of what the market wanted.

"But Bonddad! The economy is heading towards a double dip recession! We're doomed" As I've shown, there is little possibility of a double dip without recent events because there isn't much lower the economy can go. It's hard to see the economy dropping without a commensurate drop in housing. Yet housing is already bouncing along a bottom. And from an employment standpoint, it's hard to see how companies could cut any more employment fat from their budgets. The recent initial unemployment claims reading shows that companies are nowhere near the record lay-offs that occurred during the recession. Gas prices have dropped sharply, which is a boon to consumers. And consumer spending is moving sideways, not crashing. In short, the underlying data point to a 0%-2% GDP growth situation.

The problem with the debt deal is it took government action off the table at a time when governmental action is needed. Instead of borrowing at insanely low rates, investing massively in a degrading US physical and intellectual infrastructure, Congress is taking action off the table. Remember that governmental spending is a component in the GDP equation -- a fact lost in Washington policy debates, as is the different between consumption and investment. In short, Washington is focused on exactly the wrong thing at exactly the wrong time and as such should bear the brunt of any economic slowdown we face.

Thursday, August 11, 2011

Friday Dollar Analysis

Last week I didn't write on the dollar, instead focusing on the turmoil in the market. Since the last time I wrote about the dollar we've had two dollar negative developments. The first was the 2nd quarter GDP report, which printed a very weak number. Secondly, the Federal Reserve announced they would leave interest rates low until 2013. Both of these events should have been dollar negative. The weak GDP report would lead investors to look for higher growing economies while the Fed's announcement would mean the interest rate return for investment parked in dollars would be little to none. However, the dollar instead continues to move sideways:

The dollar ETF is trading in a roughly 80 cent range, between 20.90 and 21.7 and has been for several months. The volume indicators have a slight negative bias, but nothing strong enough to indicate mass selling. The MACD shows little to no direction at all.

What's interesting about the last two weeks events is they should have sent the dollar tumbling. A weak GDP report indicates there is little reason to park dollars in the US; the Fed decision indicates there is no interest rate incentive to buy dollars. And the S&P downgrade correctly pointed out that the US political system is a wreck more interested in partisanship than solving problems. Yet, the dollar didn't crash, instead continuing to form a solid base. The dollar is -- at least, so far -- the least ugly of several options. However, keep a strong eye on the 20.9 area; a move through that would be a problem.

A Quick Look At The Treasury Market

Earlier today I looked at the stock market. Let's look at the other, more conservative side of the investment coin -- the bond market.

The 10-day, 5-minute chart is still rallying. However, prices are just about to move through a shorter term (3 1/2 day) trend line. In addition, prices have been consolidating in a fairly tight range over the last day or so. Also note the higher volume level over the last three 3 1/2 days (follow the blue line). This might indicate a buying climax.

The daily chart and its respective indicators are very bullish. All the EMAs are moving higher with the shorter above the longer. The A/D and CMF both indicate money is still flowing into the market and the MACD is still very positive, telling us the market's momentum is still strong. However, notice the candles are a bit above the EMAs, indicating the market may be slightly over-extended at this point. A pullback to the 10 day EMA would make tremendous sense, especially as people start to take some profit off the table.

However, there is still no indicator of a sell-off developing.

Large cap stock dividends look compelling

- by New Deal democrat

I've had drafts of several lengthy pieces prepared discussing the fundamentals of the US economy, but instead of those long posts, let me just say instead that whatever has been driving the stock market crash of the last two weeks, it isn't US domestic economic data, because with the exception of the Oil choke collar I've been writing about, the only other series to actually turn down recently are consumer confidence and the new orders component of the ISM manufacturing report. Every other data series is either continuing to improve or is going sideways - and that includes the majority of the Leading Indicators. For example, this morning's initial claims number of 395,000 is - with the exception of 8 weeks earlier this year - the best in the last 4+ years.

In other words, the cliff-diving of the stock market has been a solo performance.

So let me turn to a by-product of that cliff-diving. Suppose you had $10,000 that you had saved and were sure you wouldn't need for ahwile. Where would you put it?

You could put it in a bank. What sort of rate of return would you get? According to Bankrate, here is the best return you could get on various CD terms:

3 month 0.81%
1 year 1.27%
5 year 2.40%

Or you could invest in government bonds. According to the US Treasury, here is the interest you would make:

1 month 0.02%
1 year 0.09%
5 year 0.93%
10 year 2.17%

With inflation currently running over 3%, unless you think we are going to be in outright deflation or very close thereto for the next few years, both savings CDs and treasuries amount to "Certificates of Confiscation" as they used to say in the 1970s.

Now, let me show you the dividend yields on 17 of the 30 Dow Jones Industrial stocks as of yesterday:

AT&T 6.28%
Verizon 5.94%
Merck 5.10%
Pfizer 5.04%
Intel 4.37%
General Electric 4.24%
Johnson & Johnson 3.87%
Procter & Gamble 3.74%
Dupont 3.66%
Home Depot 3.65%
Kraft Foods 3.54%
Chevron 3.51%
Wal Mart 3.36%
McDonalds 3.15%
Coca-Cola 3.03%
Microsoft 3.02%
Boeing 3.00%

As of last Friday, the DJ yield gap - the comparison of yields between best quality bonds and stock dividends - had fallen to a nearly unprecedented 1.76%. Unless you think we are facing economic Armageddon - that could result in dividend cuts as well as plunging share prices - in other words, that people will stop using computers and electronics, not buy consumer products or appliances, and not use gas, or else high inflation is right around the corner - these are compelling values. You are getting paid a rate higher than any relatively safe bond investment, and higher than the rate of inflation for most of the last decade, simply to own a small slice of some of the biggest and most stable companies on the planet.

And they're on sale at 20% off.

Even if you think the prices of these shares will continue to fall in the near future, you are getting paid a dividend over and above the rate of inflation while you wait for your capital investment to break even at some future date.

Let me emphasize that I am not offering investment advice here. Everyone must do their own due diligence. But as of Thursday morning, August 11, 2011, the risk/reward profile doesn't look even remotely symmetrical.

A Look at Technical Support Levels for the SPYs

The above chart is a weekly chart of the SPYs with two sets of Fibinacci levels. But use the early 2009 lows but one top is from late 2007 and the other is from mid-2011. I've also drawn a tight rectangle from price levels established earlier this year.

The point of the above chart is we are right in an area where various models would place important trading levels for various reasons. That doesn't mean we will, mind you, but the possibility is there.

Notice on the 10-day, 5-minute chart that prices are moving sideways for the last two and a half days. Again, that doesn't mean we'll stay here, but it does look like the market is looking for a bottom at these levels.

Thursday Oil Market Analysis

Last week, I wrote the following about the oil market:
The next key level of support is 90/bbl. Should prices move lower, we'll have to go back on the chart to fine support and resistance.
The market has done just that -- moved lower. So let's take a look at the 1-year chart to see where support and resistance are:

On the 1-year chart, we see that prices were this low nearly 1-year ago.

The 6-month chart shows the latest downward move in more detail. After moving higher, prices first dropped lower at the beginning of May when them moved down sharply and found support near the 200 day EMA. Prices next moved sideways using the 200 day EMA as technical support, but then moved lower again in mid-June. Prices dropped then rallied again until mid-July when they just barely got through the EMAs. Now prices have dropped lower again, this time very sharply. Also note the shorter EMAs are all now moving lower and have moved through the 200 day EMA. Momentum is clearly negative as well.

On the 5-day chart, we see a rising wedge pattern; prices are moving higher but have hit upside resistance in the 85/85 price area.

The oil market is now near a 1-year low, indicating the fears of a slowing economy and the commensurate drop in demand are driving trading decisions. While the long-term supply/demand imbalance is still very bullish (which I have thought would dominate trading decisions over the last month and a half or so), the short term trading environment is clearly bearish. Right now prices are looking for a bottom on which to create a base.

Wednesday, August 10, 2011

How China's Economy Works

From the WSJ:

Can China rebalance away from investment and toward domestic consumption as the main engine of growth? Yes, but with great difficulty. Chinese households consume only about 35% of gross domestic product (GDP), far less than any other country. Such a large domestic imbalance has no historical precedent.

Some in Beijing understand how lopsided their development has been. So over the next 10 years, policy makers have said they will try to raise consumption to 50% of GDP. Even that is a low number; it would put China at the bottom of the group of low-consuming East Asian countries.

But achieving this goal is problematic, since it requires that household consumption grow four percentage points faster than GDP. In the past decade, Chinese household consumption has grown by 7% to 8% annually, while GDP has grown at 10% to 11%. If one expects Chinese GDP to grow by 6% to 7%, Chinese household consumption would have to surge by 10% to 11%.

Such consumption growth is unlikely because powerful structural factors work against it. The Chinese growth model transfers income from households to the corporate sector, mainly in the form of artificially low interest rates. These sharply reduce borrowing costs for the state-owned companies that funnel this easy money into mega-investments. The easy financing also gooses banks' profit margins and allows them to resolve bad loans with ease.

This cheap borrowing comes at the expense of depositors. Low yields on deposits force them to sacrifice consumption, to save more. This results in a sharp decline in consumption's share of GDP. If China is to replace investment with consumption as the engine of growth, this process of financial repression has to be reversed. Households must get a rising share of overall growth.

This reversal is inevitable, but it will not come easily. Wasted investment and excess capacity translate into growing amounts of bank debt, meaning continued wealth transfers are necessary to keep the banking system viable. But if households continue to pay over the next few years, as they have in the past, China will be stuck in the same model.

2.22% For Infrastructure Investments -- What A Wasted Opportunity

From the Financial Times:
“The US electrical grid has been plagued by ever more and ever worse blackouts over the past 15 years,’’ according to a report by Massoud Amin, director of the Technological Leadership Institute at the University of Minnesota – Twin Cities.

The Texas grid operator instituted Thursday power cuts to big industrial customers and warned of potential rolling blackouts to others. It said all power sources were being tapped to meet record demand amid an unrelenting heatwave that knocked out power from 20 plants.

The crisis follows three months of record power demand amid 100 degree Fahrenheit temperatures. In February, the Electric Reliability Council of Texas was forced to institute rolling blackouts amid a winter freeze.


“The power grid continues to struggle to keep pace with growing demand.”

Many coal-fired plants date back to the 1940s. Dozens of nuclear reactors are 40 years old, with no new plants built in 30 years. Many of the country’s transmission lines were built 50 or more years ago, before the boom in personal computers and flatscreen televisions that has put a strain on the grid.

I live in Houston, Texas. This time of year we are hot -- as in 100+ degrees for most of August and early September. So heat is nothing new. Yet our power grid -- which we know will be hit by massive demand considering we're growing at a strong pace -- is of poor quality.

At the macro level, this is absolutely amazing. We are the largest economy in the world, and yet countries like China -- supposed "developing countries"-- engage in massive infrastructure projects that help to make their economy that much more competitive and capable of dealing with international competition. Here we, well, don't. And that's eventually going to shoot us in the foot big time.

In the last Texas state legislative session -- when we faced a massive deficit of over $25 billion -- there were no new tax increases. Instead we cut such unnecessary programs as education - which makes complete sense considering we already perform poorly in things such as graduation rate and have a school board that spent the better part of a year debating whether to include religious dogma in scientific text books.

It's situations like the above that make the current austerity debate in Washington so incredibly counter-productive and downright stupid. Right now, we could borrow at 2.22% for 10 years and rebuild our infrastructure. The rate of return in terms of growth far outweigh the costs. This would ultimately increase the denominator of the debt/GDP debt ratio calculation (I know -- math is a bit difficult for most people now). We could solve some of the basic problems faced in the jobs market. And yet, here we are doing the exact opposite. Thanks to the idiots in Washington, we're stuck with a crumbling infrastructure. As such, we're left with the following:

We now also understand that the US is not going to make meaningful investments in its economic future. The conservative position that all spending is evil obliterates any distinction between investment and consumption, between the long term and the short term. The US suffers with an increasingly third-world level of infrastructure, third-tier education system and enormous gaps in the preparedness of its workforce. The debate has now ended; money to upgrade those faltering systems will not be forthcoming. And by the way, the US is not going to take on any other major problems either – immigration, tax reform or climate change, for example. It is not going to do so for the same reason it has failed at sensible economic management: because the Tea Party has a veto.

Breaking: THE BOTTOM IS IN !!!

- by New Deal democrat

Both the King of All Doomers and the Pied Piper of Doom have triumphalist pieces up this morning.

If their past performance is any guide, this means that the bottom of the stock market correction was yesterday afternoon after the Fed announcement.

This has been a public service message. I now return you to regular progammed blogging.

UPDATE: 30 minutes after the market close. Yes, I was being sarcastic, but on the other hand, even though we had a bad day today, yesterday's intraday low was not breached. It is still the bottom.

Tuesday, August 9, 2011

Wednesday Commodity Round-Up

Let's take an in-depth look at gold to get a better idea for the safety bid in the market.

Above is a three year chart of the GLD ETF. Notice that the overall trend is up, using the 200 day EMA as technical support. Along the way we see various consolidation patterns, but always resulting in a technical bounce from an important technical indicator. But also note the large number of upward resistance points what will provide downside support when gold moves lower. Over the last few years, there have been several consolidation areas where traders "caught their breath."

The above chart shows the more recent price action in detail. The EMAs are bullishly aligned -- all are moving higher, the shorter are above the longer and prices are above all -- and prices are using the EMAs for technical support. Also note that aside from the last two days of trading, the candles have consolidated in tight patterns, indicating that traders are waiting and not panicking. However, the A/D and CMF have been declining during the latest rally, indicating prices are not being supported by new money coming in. But, we're still seeing momentum increase.

The lack of incoming money over the latest rally indicates the market may be getting a little tired. But gold is proving to be a great safe haven for investors. While the market is weak, I wouldn't be shorting.

Pricing a Collapse That Isn't There

Recent market events have become a bit of a self-fulfilling prophecy: as the market drops, people panic and start to sell not because of fundamental reasons but because everybody else is. The mob takes over, forcing a mass liquidation. However, the economic fundamentals point to a weak economy with growth hovering around 0 rather than an imminent collapse. Let's look at the data.

Let's start with the basics - the Leading Economic Indicators:
The Conference Board Leading Economic Index® (LEI) for the U.S. increased 0.3 percent in June to 115.3 (2004 = 100), following a 0.8 percent increase in May, and a 0.3 percent decline in April. The largest positive contributions came from money supply, the interest rate spread, and building permits.
Rates are now incredibly cheap and the money supply is expanding. In short, there is money to lend at very cheap rates.

Second, it's hard to imagine a collapse without a massive drop in real estate. However, the housing market is already in a multi-decade low, meaning a collapse is not in the cards.

The above chart of new housing sales shows a pace of activity which is near the lowest on record; it really can't get much lower.

The existing home sales market has been fluctuating around the 5 million homes/year mark for a little over two years (this is when you count the spike and contraction associated with the new housing credit). While this chart could drop to the 4 million/year level, it's hard to see that drop when interest rates are dropping like a stone.

The housing market has been bumping along the bottom for the better part of two years now. It's hard to see how it could get worse, especially in such a low rate environment which is bound to spur at least some demand.

Manufacturing has taken a hit over the last few months. Some of this is the result of slowing demand and some of this is a natural drop from high levels. However, despite a continued effort to put on the brakes, Asia is still growing smartly. Cheaper oil will lower shipping costs, making US production that much more attractive. The supply chain disruptions caused by the Japanese earthquake are now being solved. It's difficult to see this area of the economy dipping much beyond a shallow contraction for a few months at this point.

Total nonfarm payrolls printed a massive collapse during the last recession. However, this leads to a somewhat morose counter-factual: how much more employment fat could be cut from US payrolls at this point? While it's always possible we could start to see massive lay-offs again, the above chart tells me that US businesses are already staffed to the bone and have very little more to cut while still keeping the doors open.

The 4-week moving average of initial unemployment claims is hovering around 400,000, which does not show a massive spike to imply we're about to see a jump in unemployment. While the indicator has been at the aggravating 400,000 level for most of this year, we haven't seen a big spike up to imply a massive increase in unemployment.

In addition, consider these observations from Capital Observer:
  • Credit spreads for corporations are relatively tight now. In 2008 spreads blew out to historic levels.
  • In 2008 companies were raising capital every chance they had. Today corporations are buying back stock.
  • In 2008 there were systemic issues after Lehman Brothers collapsed. The ECB seems to have Europe under control for the time being. There has yet to be a Lehman Brothers.
  • Corporations are wildly profitable right now. In late 2008, when the collapse occurred profits had already imploded.
  • There are far fewer over leveraged corporations today.
  • While it certainly feels like there are forced liquidations occurring it does not seem like it is on the same scale as 2008.

The bottom line is while the underlying data is weak, it's not crashing and shows no signs of collapse, massive stress or even turning over in a significant way. The numbers are showing an economy fluctuating right around 0% growth, with a slight positive bias. But, again, I think the markets are pricing in a recession or collapse that just isn't in the data right now.

The Oil choke collar in one easy graph

- by New Deal democrat

Oil analyst Steven Kopits, along with Prof. James Hamilton, are the two leading experts on how Oil shocks result in recessions. I have been referring to Mr. Kopits' metric every week in my "Weekly Indicators" summations. Kopits says that every time Oil prices rise to a level of 4% or more of GDP, a recession has followed.

Occasionally even the most popular economic bloggers, including top flight professors, express mystification at why the economy doesn't seem to be able to generate a self-sustaining liftoff. In response thereto, I give you the following graph, in which Oil prices as a percent of GDP are shown in blue (inverted, left scale), and quarterly GDP changes in red (right scale):

A little explanation is in order. The left scale is set to show the divergence in price from Kopits' inflection point of 4% of GDP. Thus the left scale result, n, equals 4 minus Oil price/GDP. If Oil price =5% of GDP, then N = 4-5= -1. Contrarily, if Oil price = 3% of GDP, then N = 4-3 = +1. Also note that since the graph had to be done quarterly, it does not reflect the decline in Oil prices since June 30.

As you can see, since the price of Oil approached the inflection point in 2005, it has predicted GDP changes very well. And it does not bode well for revisions to Q2 2011 GDP or the third quarter either.

Just to put this in longer perspective for you, here is the a bonus graph - the same relationship expanded to the last 50 years.

The only good thing here is that the public can become habituated to a certain high level of energy prices, and adjust their spending accordingly (this is an insight from Prof. Hamilton). Since we just had $4 gas two years ago, the expected impact on consumer spending isn't as great as if we had never seen this spring's $3.90 gas before.

Overnight Oil went as low as $75.71, which is its lowest price since September 2009, nearly 2 years ago. Proving once again that the remedy for high prices is, high prices (but it's painful).

It's the 1998 Asian currency crisis - in reverse

- by New Deal democrat

It's a mug's game to comment on major market moves while they are occurring, so take this with multiple grains of salt, but here are some thoughts for your consideration:

1. How much of the moves are real, i.e., real human moves prompted by greed or fear, and how much is computer-driven? Last year's flash crash and the 1987 crash were mainly computer driven, or synthetic. They weren't "real." Once humans realized that, the effects wore off. Some part of the moves in the last week smell computer-driven.

2. Margin calls at 3 p.m. may be driving the late afternoon swan dives, just as they did at the October 2008 climax.

3. As just about everybody has pointed out, this isn't a panic move away from US Treasuries. The better explanation, given the behavior of gold, is that the S&P "really" downgraded the US dollar.

4. In that vein, this crash is similar to the 1998 Asian currency crisis, but in reverse. In 1998, a number of Asian countries could not support their currencies' peg to the US dollar, and their markets tumbled like dominos. Here it is the US dollar that cannot retain its value, and the Euro, which may not be able to retain its existence.

5. That global economic leadership has been transferred to Asia was confirmed overnight. In 1998, the 20% global selloff, in which markets fed off each other's decline, was halted by a reversal day on Wall Street. Stocks sold off big, and then sharply rebounded. Overnight, that's exactly what happened in Asia.

6. There has been some weak economic data recently, but very little has actually rolled over into negative territory. If we don't start seeing actual contractionary numbers, this is just a correction, albeit a particularly severe one.

Monday, August 8, 2011

Review Of Recent Market Events

Over the last week or so, we've had a tremendous set of events in the market. Instead of looking at the Treasury Market in particular today, I'm going to look at the inter-relationship of the markets and macro events to show what the markets are telling us. The short version is this: the markets are at best signaling slow growth and an increasing possibility of a recession.

First, the markets are being hit by a cross section of events. As I pointed out last week, these can be summed up thusly:
1.) The EU Commission President stated the EU issues were no longer contained to the periphery. There are a lot of issues between the various countries here that are beyond my knowledge, but Spain and Italy are now having problems with their respective bond yield (their yields are blowing out) indicating investors are concerned about those economies.

2.) The US economic news has been growing increasingly negative for the last few months. This started with the US manufacturing sector, which was hit by the supply slowdown that started in Japan. Then we had the last two employment reports, which were far weaker than anticipated. This was followed by a massive downward revision to first quarter GDP and a weak 2 quarter GDP print. We've also seen consumer spending slow. However, as I noted yesterday, the overall economic numbers show a weak US economy at this point, but not a recessionary environment.

3.) Market participants have uniformly panned the debt deal package as counter-productive in the current economic environment. Once the debt deal was signed, the markets started tanking -- and have been ever since.

4.) Several markets were already through important technical levels, which aggravated the market's weak position and accelerated the selling. This led to computerized sales adding further downward pressure.
All of these factors led to the sell-off. In addition, since I wrote the above statement, we have S&P issuing a downgrade of US debt largely based on political factors -- an analysis I agreed with.

Now, let's also assume that during different periods in the ideal economic cycle, various markets behave in certain ways. For example, as it looks like the economy is starting to slow, traders sell equities and commodities (because these are risk based assets whose value is largely derived from economic growth) and buy treasuries (because inflation is low or non-existent and there is no possibility of the Fed raising interest rates).

Let's take a look at some year long charts:

Stocks have sold off massively on huge volume and are now just below year ago levels.

Treasuries have rallied for the exact opposite reason as stocks -- they are considered a safe haven during times of uncertainty, which we definitely have right now.

Oil has dropped like a stone on the assumption that a slower economy will lead to lower oil demand. The good news here is that lower oil prices mean less of a drag on US consumer spending.

The dollar is still consolidating at the bottom of a long, multi-year sell-off.

While copper has dropped with the equity markets, wheat and corn are sill in fair shape.

Let's take a look in more detail at the markets.

From its recent highs of approximately 134.75, the SPYs are now down a little over 17.25%, which is quickly approaching bear market territory. The volume is massive (nearly three times the previous levels) and the downward bars are incredibly strong. Simply put, this is a massive sell situation that has wiped out a major amount of market value.

Conversely, the IEFs have staged a massive rally on volume that is nearly 3-5 times the levels of the previous month. The market has printed some incredibly strong upward bars compared to the previous three months. From their recent level of approximately 97, prices have rallied almost 5%. While this is not a rally in commensurate response to the stock market sell-off, it's a big rally for the stodgy fixed income world.

These two charts show an incredibly clear shift in investing trend from risk acceptance to risk avoidance. Traders are dumping stocks (risk based assets) and plowing the proceeds into US government bonds.

Let me add a few personal observations. This equity sale looks overdone. As I pointed out on Friday, the data is pointing to a slowing economy with both the manufacturing and service sectors still expanding. While the manufacturing sector will probably print negative next month, I don't see an imminent crash, especially with car production and sales picking up post Japanese earthquake recovery. While consumer spending is contracting, it is doing so at an incredibly slow pace; it's really in more of a stall in an upward trend rather than a falling pattern. The LEIs are still slightly positive, the Treasury curve is still very positive, initial unemployment claims -- while still elevated -- are moving in the right direction and the last employment report was fair. While I don't expect markets to act entirely rationally based on the data, these charts simply belies the underlying data as far as I can see.

Economic Week in Review

Consumer Spending: The BEA reported that real PCE decreased less than .1% in June, the second month of decline. The big drop occurred in durable goods. This means auto sales, which have dropped for two months. Part of the reason for this is the supply disruption issues in Japan, but there is also concern the consumer is starting to pull back on his spending. Auto sales were up a little over 6%, rebounding from two weak readings the previous two months, which was attributed to the Japanese earthquake an the fallout therefrom. This could lead to a decent rebound in PCEs next month. The BLS reported an increase of 117,000 jobs last month and a decrease in the unemployment rate to 9.1%. While not great, the report was not terrible either, placing in the luke warm camp of economic news.

Manufacturing: The latest ISM number printed a reading of 50.9, which is just above the level of contraction. However, the internals are slowing slowing down and the new orders number was below 50, indicating contraction. Part of this slowdown in US manufacturing is the result of a slowdown overseas. Both India and Brazil have printed an inverted yield curve recently, which is usually a good indicator of an upcoming slowdown and possible recession.

Service: The latest ISM reading printed 52.7, up slightly from the previous month. Both the new orders and employment numbers were positive, although they decreased from the previous month, indicating a slower rate of expansion. 13 industries were showing expansion and only 5 were showing contraction.

The sum total of last weeks' data is an economy that is slowing. However, note that both the manufacturing and service sector are showing growth, albeit it at a slow pace. The employment report tells us that employers are hiring, but reluctantly. But most concerning is the inversion in India's and Brazil's interest rate curve, which is not a good harbinger for their respective economies over the next 12-18 months.

7 positives in Friday's payroll report

- by New Deal democrat

First of all, let me say that I agree with the Krugman/Thoma/DeLong axis along with many others that the employment report essentially has us moving sideways. We added jobs, but not enough to compensate for entry into the work force due to population growth, and the employment to participation ratio sank further.

That being said, in the rush to be negative because the positive surprise wasn't good enough, a substantial amount of positive context was missed. Here are 7 positives from the report:

1. 17 months in a row of actual payroll growth.

First of all, let's state the obvious. Every single month beginning with March 2010 has given us a positive jobs number (ex-census). Here's the graph of private jobs:

Even subtracting non-census government jobs doesn't make any of those months negative.

2. Prior months' data revised upward.

In recessions, prior data tends to be revised downward. In expansions, prior data tends to be revised upward. Some months ago, I wrote several times about "The Disappointment Syndrome" in which a payrolls report would be deemed "disappointing" only to be revised substantially upward in the final analysis. This happened all through 2010 and earlier this year.

Friday we returned to that pattern, with both May and June employment numbers being revised upward by a total of +56,000 (although May's had previously been revised downward, so the net change since the initial May report was -1,000).

3. Manufacturing employment increased.

Prof. Geoffrey Moore's original index of leading economic indicators from the pre-WW2 deflationary period through the 1960's included changes in manufacturing jobs. Although on a secular basis, the US has been shedding jobs for decades, if we take into account that secular change (averaging 40,000 a month since the mid-1990's), this series is still very much a leading indicator of the overall jobs market. In July, manufacturing jobs outright increased by 24,000, continuing the trend of actual growth in manufacturing jobs since the end of 2009.

4. Manufacturing hours worked remained steady.

One of the 10 official components of the modern index of leading economic indicators is average weekly hours in manufacturing. It has remained steady in the last 3 months despite the disruptions due to the tsunami in Japan. Except for one month in 2010, this series remains at its post-recession high.

5. The trend in improving aggregate hours worked continues

In the 2008-09 recession, as in the two previous recessions, more hours worked were cut than actual layoffs. The pattern in those two recoveries was that hours worked had to make up their lost ground compared with layoffs first, before job growth would fully accelerate with hours worked. July showed that the trend in improving aggregate hours worked is intact, and remains on track to complete making up its lost ground, compared with layoffs, in the next 12-18 months.

6. Real average hourly income improved

With the exception of the mid 2000's housing bubble credit binge, the trend is that you do not get increased demand via consumer spending unless (1) interest rates decrease, and/or (2) real wages improve.

Leading up to the summer stall of 2010, as well as the stall this year, inflation (mainly due to the price of Oil) outpaced wages. This predictably led to a slowdown if not stall in consumer spending. This has now started to reverse. Average hourly income in July increased, and Oil prices have declined, which means that the pressure on consumers is starting to abate (note: the graph only shows inflation up through June. YoY inflation through July is likely to go back under 3%).

7. July's employment report is not consistent with the onset of a double-dip recession

Here is the update of my scatterplot graph comparing initial jobless claims with job growth/loss. In all cases, as a recession begins, the trend is sharply to the left of the trend when the economy is improving. This comparison was borne out in the "great recession."

The last three months are shown in pink. They have not broken from the previous blue trend line of the expansion. In the one post-WW2 double dip of 1980-82, the trend broke decisively and quickly back to the left. July's report, at least, is inconsistent with any imminent double-dip.

In summary, Friday's report showed that while once again in the last few months we have been battered with an Oil-and-government-idiocy-induced stall, the trends established during the recovery are intact.

Sunday, August 7, 2011

S and P Got it Right

The reaction to the S and P downgrade has been rather hysterical to watch. The Democrats are focusing on the statement regarding the lack of inclusion of new revenues and the inability to actually raise revenues as a reason for the downgrade, while the Republicans are focusing on the statement regarding entitlements. However, this tit for tat mentality exemplifies one of the central problems S and P is warning about.
The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.
The fact the debt debate went as hot as it it for as long as it did (over a month and a half) -- especially when it should have been a simple, up or down extend the limit vote -- tells volumes about where we are as a country. We are still the largest economy on the planet. The US Treasury market is the benchmark on which a vast majority of finance is based. The fact the US provides a "riskless" asset (Treasury bonds) to the financial world is built into a large number of basic financial models. And yet, we were pushed to the brink of not having a deal. The level of irresponsibility inherent in that statement speaks volumes about the complete and total lack of political will to actually solve problems rather than engage in the endless, 24-hour news cycle need for spin.

The Economist's website Free Exchange highlights these issues clearly:
Investors largely tuned out the debt-ceiling debate until its final days out of a belief based on long experience that for all the antics and rhetoric of the Tea Party, the people who actually run Capitol Hill would never compromise the country’s credit worthiness. After all, it was Mr Boehner who reminded his freshmen colleagues that on the debt ceiling they’d have to act like “adults.”

That is not what happened. As the fight dragged on, the leadership moved closer to the Tea Party, not the other way around. And they seem happy with the results. Why else would Mitch McConnell have promised on August 1st to do exactly the same the next time the debt ceiling must be raised?

It is striking that the proponents of this strategy seem so oblivious to its impact. Our economy is lubricated by a sophisticated and stable credit market whose most vital component is also the most ephemeral: trust. As the crisis amply demonstrated, when trust erodes, the system freezes up. America has built a reputation for responsible and credible management of its finances over the centuries, and that reputation has been reduced to a political football, like a federal judgeship. Henceforth a foreign pension fund or central bank that once mindlessly ploughed his spare cash into Treasurys will have to think twice.

The sheer stupidity of these people -- the downright ignorance (for which I'm sure they will express profound pride rather than any amount of shame) is breathtaking.

Back to the S and P release
It appears that for now, new revenues have dropped down on the menu of policy options.
The lack of inclusion of any revenues in the deal is utterly mind-numbing. Here is a chart of federal expenditures and receipts as a percent of GDP from Invictus over at the Big Picture.

Notice the incredibly wide chasm between taxes and expenditures. Logic (that pesky thing where we use our brains to actually solve problems) would indicate we should meet in the middle. However, that is not what happened because one party has no clue how to negotiate and another party believes in taking hostages to get its way irregardless of the cost. This also speaks to point number one as well.

In short -- despite the name calling and finger pointing at S&P (which they deserve for many reasons unrelated to the above points) they actually called this one correctly: considering the gap between spending and revenues we need to raise taxes but the dysfunction of our political system makes that an impossibility. And that dysfunction is itself a major problem.

Equity Week in Review and Preview of the Upcoming Week/Month

Last week, I wrote the following about the market:
When we pull back and look at the bigger picture, we see that all the major averages are trading in a price range, and have been doing so for between 4-6 months. This tells us that traders are "taking a breather." The sum total of the news is not sufficient to move the market higher nor lower. The good news is that there is still hope the current slowdown is temporary. However, the bad news is the market has little patience for poor performance.
After a two-year rally, the market hit a sideways top and consolidated gain. Last week, that ended, as the DIAs, SPYs, and IWMs all broke two year trend lines on heavy volume, printing strong downward bars. From the highs in early may, the SPYs are down 12.75%, the QQQs are down 9.75% (although their high was hit over the last few weeks) and the IWMs are down almost 18%. The heavy hit to the IWMs shouldn't be a surprise, as this is where the riskiest players would go. However, the size of the drop is nearing bear market territory. In addition, all the major average ETFs are below the 200 day EMAs, indicating they are now in bear market territory.

The 5 minute chart shows a clear downward path with prices continuing to move through support, hitting new lows.

The daily chart shows the sheer strength of last week's sell off. The bars are incredibly strong -- most of the bodies are long and there are several downward gaps. The volume continued to spike, hitting very high levels and the shorter EMAs are all moving lower with the 10 day already below the 200 day EMA and the 20 just about to move in that direction.

Last week's action was the culmination of several events that all hit at the same time: the EU admitting the debt problems had moved into the larger European countries, increasingly downbeat US economic news, the markets hitting and moving through important technical triggers, adding to the selling pressure and a budget deal that does nothing to deal with the real
issues facing the country.

The volume, price action and confluence of price action with fundamental events is a clear warning sign to the markets. I would expect some type of price rebound at this point, but traders have moved from their consolidation range to a period of selling. There is clearly concern on the part of market players about the fundamental economic events driving and backing the market. Expect the EMAs to provide upside resistance to any price advance.