Saturday, May 5, 2012

Weekly Indicators: the Oil choke collar works like a charm edition

  - by New Deal democrat

The big monthly number this week was, of course, April's relatively poor +116,000 jobs report.  The internals were generally better, with all of the leading components such as temporary jobs and manufacturing jobs and hours, improving.  The employment participation ratio, however, continued to be cause for consternation, as was the flat average hourly earnings.  In other monthly reports, auto sales improved over March and were only below February's pace.  Income and spending were positive, with income less than spending for a change.  ISM manufacturing for April came in stronger than expected.  Factory orders for March were weaker.  Construction spending was flat, due to a decline in government spending.  Both private residential and non-residential spending were up significantly.  ISM services came in weak but still positive.

In summary, the weakening payrolls numbers in particular show that the Oil choke collar is working exactly as advertised.  Any time the economy shows signs of sustained recovery, the collar kicks in and chokes it off - leading to a decline in energy prices and renewed strength in the economy.  Since gasoline prices are seasonally strong in the spring and weak in the fall, the economy weakens in the spring and strengthens in the fall.  I am surprised that mainstream economists haven't picked up on this, as it explains so much.  I'll have an extended commentary at the end of this post.

First, let's turn to the high frequency weekly indicators .  Thankfully, these are showing no sign whatsoever of the economy rolling over, although a few are weak.

Let's start with energy prices, as the Oil choke collar remains engaged:

Gasoline prices fell for the third straight week, down .04 to $3.83.  Oil fell sharply, down $6.44 for the week on the poor payrolls report, to $98.49.  Oil remains at, and gasoline above, the point where they can be expected to exert a constricting influence on the economy.  The 4 week average of Gasoline usage, at 8692 M gallons vs. 8943 M a year ago, was off  -2.8%.  For the week, 8661 M gallons were used vs. 9084 M a year ago, for a decline of -4.7%.  Note that these comparisons are vs. YoY declines from 2010 to 2011 as well.

Unlike the monthly jobs report, Employment related indicators were all positive:

The Department of Labor reported that Initial jobless claims fell 23,000 to 365,000 last week, the lowest reading in 4 weeks.   The four week average rose by 750 to 383,500.   As I said last week, for the entire last year the YoY% decrease in initial claims has been between 8% and 12%.  So far we have stayed stay in that range, so it seems more likely that we are seeing a quirk of seasonality (the seasonal tightening of the Oil choke collar?) than a more ominous sign.

The American Staffing Association Index rose two more points to 93.  It is just two points below the all time records from 2006 and 2007 for this week.  It is possible that it could exceed all readings but those of 2006 by June sometime.

  The Daily Treasury Statement finished April at $148.6 vs. $138.4 B for April 2011.  For the last 20 reporting days, $134.7 B was collected vs. $131.5 B a year ago, an increase of $3.2 B, or +2.4%.  This is a weak showing for the 20 day average.

Housing reports were once again positive:

The Mortgage Bankers' Association reported that the seasonally adjusted Purchase Index increased +2.9% from the prior week, and was also up 3.0%  YoY.  The Refinance Index fell -0.7%.This index is at the upper end of its 2 year generally flat range.  Because the MBA's index was substituted for the Federal Reserve Bank's weekly H8 report of real estate loans in ECRI's WLI, I've begun comparing the two.  This index had been negative YoY for 4 years, until turning positive one month ago.   This week, real estate loans held at commercial banks declined -0.3% w/w, but remained up, +0.7% on a YoY basis.  On a seasonally adjusted basis, these bottomed in September and are now up +1.4%.

YoY weekly median asking house prices from 54 metropolitan areas at Housing Tracker  were up +4.2% from a year ago.  YoY asking prices have been positive now for close to 5 months.  Trulia's seasonally- and inventory-adjusted list price index also turned positive YoY in April.  The seasonally adjusted index bottomed in January.

Sales were once again solidly positive.

The ICSC reported that same store sales for the week ending April 28 fell -0.3% w/w and +4.2% YoY.  Johnson Redbook reported a 2.9% YoY gain.  Shoppertrak did not report.  The 14 day average of Gallup daily consumer spending  remained favorable at $69 vs. $63 in the equivalent period last year.  Consumer retail spending has been a consistent and important positive sign for the economy for well over a year.

Money supply was mixed for the week, but remains positive for the month and year:

M1 rose +0.4% last week, and was up +1.9% month over month.  Its YoY level increased to +18.3%, so Real M1 is up 15.7%. YoY.  M2 declined -0.4% for the week, but was up +0.4% month over month.  Its YoY advance fell slightly to  +9.6%, so Real M2 was up 7.0%.  Real money supply indicators continue to be strong positives on a YoY basis.

Bond yields fell and credit spreads widened slightly again:

Weekly BAA commercial bond rates were flat at 5.15%.  Yields on 10 year treasury bonds  fell -.02% to 1.98%.  The credit spread between the two widened to 3.17%.  Falling bond yields and widening spreads, as has happened for the last month, are a sign of weakness, although we remain significantly under the October maximum credit spread. 

Rail traffic turned slightly positive this week.

The American Association of Railroads  reported a +0.1% increase in total traffic YoY, or +600 cars.  Ex-coal, non-intermodal traffic was down by 12,100 cars, or -4.1% YoY.  Intermodal traffic was up 12,700 carloads, or +5.5%.   Railfax;s graph of YoY traffic continued to show that rail hauling of cyclically sensitive materials remains in strong improvement.  Coal remained the weak point, down 20,500 carloads, although 7 other of the 20 total types of carloads declined. 

Turning now to high frequency indicators for the global economy:

The TED spread rose .01 to 0.390, near the bottom of its recent 2 1/2 month range.  This index remains slightly below its 2010 peak.  The one month LIBOR remained flat at 0.239.  It is well below its 12 month peak set 3 months ago, remains below its 2010 peak, and has returned to its typical background reading of the last 3 years.

The Baltic Dry Index at 1157 rose only 1 point from one week ago.  It is now about 1/3 of the way back from its February 52 week low of 670 to its October 52 week high of 2173.  The Harpex Shipping Index rose 12 to 428 in the last week, and is up 53 from its February low of 375. 

Finally, the JoC ECRI industrial commodities index rose very slightly 124.96 to 124.99.  This indicator appears to have more value as a measure of the global economy as a whole than the US economy.

In summary, there is some weakness in withholding tax collections, bond yields and credit spreads, and rail traffic, although none are actually negative.  Every other weekly indicator remains solidly positive.

Usually in these weekly posts I try to keep it as exciting as watching paint dry, with a minimum of commentary.  That way even if you disagree with my summary, you still have the numbers to bring you right up to date on the pulse of the economy.  With the recent spate of "misses" in the monthly reports, I want to re-post a little of my commentary over the last 5 months, because this weakness wasn't just foreseeable, it was foreseen and most of it is perfectly explainable by the Oil choke collar.

In early December, with signs of a strengthening economy all around, I concluded my weekly column with the following:
With the vital exception of real wage deflation, the picture now is very similar to that of a year ago. Having dodged a double-dip recession, the economy then showed signs of becoming a self-sustaining recovery, only to be strangled by the Oil choke collar (with an assist by the tsunami in Japan) in March. It looks like we've dodged another bullet, but the Oil choke collar is tightening again.
In my January outlook for 2012, I wrote:
for the second half of 2012, the indicators are really in agreement -- there will be growth....  my best judgment is that we will avoid recession, but that at least one quarter of negative GDP, with the likelihood greater in this quarter than the second quarter, can't be ruled out.
Then at the end of February, with initial jobless claims at new lows but gasoline at new highs, exactly as they had been in February 2011, I wrote:
Last year [this same weekend] I concluded my column by saying that I expected Oil to win its duel with initial jobless claims. It did as initial claims flattened and then rose in the summer. I expect the same result this year. While as I said yesterday I expect U-3 unemployment to decline to under 8% by May, that is a lagging indicator. Consumers are better able to handle $4 a gallon gasoline than they were in 2008, but depleted most of their savings since then last year. If an Oil shock is going to bring on more than a stall this spring and summer, watch the weekly same store retail sales comparisons. They held up well all last year. If their YoY readings start going under +2%, that will be a danger sign. If consumers also retrench further than they already have in terms of gasoline usage, i.e., a one week YoY usage decline of more than 10%, or a 4 week YoY decline of more than 7.5%, that would be another strong danger signal.
Obviously the non-winter winter helped us with the first quarter, but the weakness began one month ago with the March payrolls number and has only intensified since.  The effect of the Oil choke collar is perfectly predictable, it worked like a charm in 2011 and it is working like a charm this year as well.

On the bright side, neither danger signal I wrote of above has materialized other than briefly.  G*d bless the American consumer, who continues to spend like a champ.  And gasoline usage except for one week hasn't dipped precipitously.  I expect the weakness to continue, I expect the Oil choke collar to loosen, and then I expect the economy to pick up again as a result.

Friday, May 4, 2012

Weekend Weimar, Beagle and Pit Bull

It's that time of the week again. NDD will post the weekly numbers tomorrow; we'll all be back on Monday. Until them .....

Housing prices: a rebuttal to Barry Ritholtz, part 4

  - by New Deal democrat

As I said in part 1 of this series, Barry Ritholtz' argument that house prices will decline further rests generally on three arguments:
     (2) there is a large overhang of "shadow inventory" most especially including but not limited to foreclosures, which are primed to put renewed downward pressure on prices; and
     (3) potential buyers, especially younger buyers, are fearful of the potential immobility that comes with owning a house vs. renting.

In part 2 I addressed the affordability issue.  In part 3 I looked at the issue of shadow inventory.

Barry Ritholtz's last argument that we are not at or near a bottom in house prices is the fear of young, potential first time buyers. He asserts four points:
   1. Owning an asset class that is still falling in price; the fear of a continuing price slide remains....
   2. Being stuck with a property you cannot sell; if you may need to sell your property ... less than 5 years after purchase – there is a possibility that the home will sell for less than the purchase price. ... Even worse than the dollar hit is the situation of not being able to sell the house at any price.
   3. Losing one’s job; If one were to lose one’s job, a home mortgage and sale becomes a burden. ...
   4. Impact of rising Interest Rates on prices; ...

 Let me take these out of order.

 Number 4 is the weakest point of Barry's whole arugment. If I fear rising mortgage rates in the future, I'm going to do everything I can to buy NOW -- as in now when we've just set yet another all time low in 30 year interest rates. Waiting till my prospective mortgage payment rises is the last thing I want to do.

 Numbers 1 and 2 are circular. If prices are falling, therefore potential buyers won't buy, therefore prices will continue to fall. Of course, that also means that if prices are stable, the two fears disappear, and so prices presumably remain stable -- like they have become in the last year by virtually all measures except repeat sales indexes. Just yesterday the Trulia list price index, which does adjust for type of houses for sale, turned positive YoY. What Barry's argument really means is that price stability won't come because young buyers decide to jump in -- and it hasn't. Stability in most house price indexes has come because of the large number of cash buyers at the low end, as Barry himself conceded in one part of his series, when he said:
  lower prices can bring out buyers. ... we can see signs of bargain hunters in the statistics. All-cash sales rose to 33% of transactions (NAR), with investors purchasing 23% of all homes. 
 With those prices becoming stable, expect more young buyers to take the plunge.

 That leaves us with number 3. It's a valid concern, but it is by no means universal that young buyers are fearful, especially those who are college graduates and are employed, for whom the unemployment rate is considerably less than others. 

To the contrary, I believe Barry has overlooked one crucial fact: demography is destiny.

As I pointed out a couple of years ago, there actually is pent up demographic demand. People usugally buy their first home at approximately age 30. According to records of births available in the Statistical Abstract of the United States, from the mid-1970's through the early 1990s' the wind was at housing's back, as Boomers, with over 3.9 million births a year from 1952 through 1964, entered that age group. From then until the peak of the housing bubble, the reverse was true, as the Baby Bust a/k/a Generation X, with less than 3.6 million births from 1967 through 1979 (including a low of 3.144 million births in 1975) entered the target age. By 1989 and ever since, there have been over 4 million births a year. What this means is that every year since the peak of the housing bubble, a larger and larger cohort has reached prime first time home buying age. 

 Not only are those larger cohorts of young adults going to buy houses, but the group which delayed household formation during the years of the housing bust and great recession will also ultimately heed the call of nature. All of that means a very significant upsurge in demand for housing.

Further, renting may make excellent financial sense -- until you get tired of listening to the marital quarrels on the other side of the wall, or the a**h**e upstains who insists on blasting music at 2 a.m. on a worknight.

As I said above, demography is destiny.  With home prices stabilizing due to cash buyers at the lower end, and a pent-up demographic surge in the age group of first time home buyers, psychology should favor rather than inhibit first time home buying.


 In this series I have shown than none of Barry Ritholtz's arguments against a housing bottom actually require house prices to fall further.

 As to long term ratios of house prices to household income, the broader indexes show that we have already declined to the median. Further declines in the ratio can occur via declines in inflation-adjusted prices even after the nominal bottom occurs. Further, mortgage rates at multi-decade lows, even adjusted for household income, make housing costs more affordable than it has been in at least 30 years.

 Shadow inventory has been predicted for at least two years to be on the verge of creating a redoubled downturn in housing. It hasn't happened yet, and if the increase in foreclosures following the mortgage settlement is sufficiantly drawn out in time, it can be expected to exert only an influence on the rate of any increase in house prices, rather than a change in direction to a renewed downturn.

 Finally, demographics argues strongly in favor of an increase in demand from young first-time home buyers, with stability caused by cash buyers alleviating any fear of a continuing decline in prices.

 As I said at the outset of this series, my general approach, like CR's, is inductive. I look at past business cycles in terms of what change in A led to a change in B. My default position is that this time it's NOT different. In order to overcome that default setting, you'd better have arguments that go way beyond the preponderance of evidence. They had better be extremely convincing and not subject to equal counter-arguments. I've seen way too many deductive rational arguments that read persuasively blow up completely in the light of subseqent data (as, for example, the "foreclosure tsunami" piece I cited from 2010). While Barry Ritholtz's arguments are intelligent, rational, and sensible, they are not so compelling as to cause me to believe that the counter-arguments won't ultimately be proven true.

 So I am sticking with my inductive reasoning. Of course, it could be that CR and Barry and I are all correct, if prices decline in real terms by another 10% after establishing a nominal bottom in the next few months. But this isn't personal. If CR and I are wrong, and Barry Ritholtz is right, than kudos to him!

Japan, Part II: Lack of Demand

The above chart shows the total retail trade for Japan going back 40 years.  We can break this chart down into three areas:

1.) 1970-1990: increasing retail trade and demand in the economy
2.) 1990-1997: stagnation of activity around the 110 level
3.) 1997-today: stagnation of activity around the 100 level, although recent events are encouraging.

The above shows the total private final consumption expenditures for Japan.  This chart shows the stagnation in demand as well.

The above charts couldn't be clearer: the lack of overall demand in the Japanese economy is a big reason for their sluggish overall GDP  growth of the last 20 years (for more on this, see this post from yesterday).

Once Again Zero Hedge is Completely Clueless

In a new post up today, Zero Hedge claims that (from Zero Hedge):

"The seasonal addback in April was +22K, a rapid break from the last 3 years when April saw a negative seasonal adjustment following the traditional huge positive adjustments in the January-March period, which in turn means that the record warm winter give back has not even started! As a result, the seasonal addbacks in 2012 are now a massive 4,499,000 jobs: jobs that have not been added but are expected to materialize based on historical seasonal patterns."

Read that again.  Yes, in fact the geniuses at Zero Hedge essentially admit that they can neither read a report, nor do simple third grade math.  In FACT, only the January report has added jobs through the seasonal adjustment.  In February the NSA number was +902,000 (vs a +259,000 seasonally adjusted number), ie the seasonal adjustment SUBTRACTED 643,000 jobs in February AND in March, the NSA number was +811,000 (vs a +154,000 seasonally adjusted number), ie the seasonal adjustment SUBTRACTED 657,000 jobs in March, and finally for April, the NSA number was +896,000 (vs a +115,000 seasonally adjusted number), ie the seasonal adjustment SUBTRACTED 781,000 jobs in April.  Thus, the seasonal "addbacks" for the year are now a NET of 862,000, not 4.5 million (which will come out over the remainder of the year).  Quick intelligence test for Zero Hedge, you do realize that the seasonal adjustments essentially zero out every year right?

Chalk this up as yet another reason to NEVER, EVER listen to Zero Hedge when it comes to interpretations of statistical reports.

Employment Report -- "Healing Slower Than Paint Drying"

From the BLS:

Nonfarm payroll employment rose by 115,000 in April, and the unemployment rate was little changed at 8.1 percent, the U.S. Bureau of Labor Statistics reported today. Employment increased in professional and business services, retail trade, and health care, but declined in transportation and warehousing.
OK -- that alone is enough for me to say "underwhelmed."  Essentially, we're already back to a period where we're growing, but barely.

From the household survey, we do have some good news.  The long-term structural issues -- long-term unemployed, employed part-time for economic reasons etc.. -- are stabilizing.

The establishment survey shows gains in most areas -- professional services, retail trade, health care and manufacturing.  The problem is the gains simply aren't enough to indicate that the economy is healing at a "faster than paint drying" pace.

As to the workweek and wages, we have this:

The average workweek for all employees on private nonfarm payrolls was unchanged at 34.5 hours in April. The manufacturing workweek edged up by 0.1 hour to 40.8 hours, and factory overtime rose by 0.1 hour to 3.4 hours. The average workweek for production and nonsupervisory employees on private nonfarm payrolls was unchanged at 33.8 hours. (See tables B-2 and B-7.)

In April, average hourly earnings for all employees on private nonfarm payrolls rose by 1 cent to $23.38. Over the past 12 months, average hourly earnings have increased by 1.8 percent. In April, average hourly earnings of private-sector production and nonsupervisory employees rose by 3 cents to $19.72. (See tables B-3 and B-8.)
Again -- a very slow and painful healing process.
NDD here with some additional comments:

While the headline number was poor compared with recent reports, the internals were actually pretty good.

Let's start with the leading indicators in the report:
  - the manufacturing workweek increased by 0.1 hours
  - temporary help added 21,000 jobs
  - manufacturing employment went up 16,000 jobs
  - while construction decreased slightly, -2,000, for the third month in a row, building materials and garden center jobs increased.  This is added evidence that the housing market is slowly turning.

Other good news: 
  - both February and March were revised higher.  This is what happens in recoveries, not heading into recessions.  February's number is now +259,000.  March is now +154,000.
  - aggregate hours increased 0.1 to 96.0.  This is again confirmation of an improving job situation.
  - U3 unemployment dropped to 8.1%.  You probably recall my graphs showing that the initial jobless claim rate leads the unemployment rate, and that an unemployment rate under 8% was likely within the next few months.

There was some tepid or disappointing information as well:
 - average hourly earnings only increased by one cent.  YoY hourly earnings have only increased 1.8%.  Absent mortgage refinancing, where exactly is continuing spending going to come from?
 - the broader U6 unemployment rate, which includes involuntary part time workers, was flat at 14.5%
 - the household survey actually showed a loss in jobs for the second month in a row, down 169,000.  While this series is more volatile, it does have a tendency to lead at turning points. This is an important sign of weakness.
 - more government layoffs, -15,000. Teachers and firefighters are consumers too.
 - the labor participation rate dropped 0.1% to 63.6%. Those not in the labor force increased 522,000.  This is sure to continue the debate about how much is due to Boomer retirements vs. discouraged workers.

All in all, the internals were better than the headline, especially as to leading indicators, but there were several yellow flags.

Morning Market Analysis

Despite breaking the long-term trend line earlier this year, gold prices are still finding support at the 50 week EMA.  But, momentum is still weakening and money flowing into the market is weak.

The gold ETF is trading at the 50% Fib level established from the rally of January 1 - Feb 29.  A move below the 157.5 area would make the January 1 level the natural, short-term price target.

The equity markets are still in a constrained position.  The IWMs and SPYs are trading in a range, (78-84 and 136-142.5, respectively), while the QQQs are below late February/early March levels.  Most importantly, on all three charts we see declining momentum over the last few months, which is not positive going forward.

Despite the recent 50 BP rate cut, the Australian market is still trading in a pretty tight range.  Prices have moved lower, finding support at the 10 day EMA, but momentum is pretty weak, and the volume indicators aren't showing much pop. 

Thursday, May 3, 2012

Professor John Taylor Is Wrong Regarding Economic History

Professor John Taylor has been writing about the weakness of the latest recovery (which, admittedly, we all have).  However, he continually compares the current recovery to the Reagan recovery.  I would argue that he is wrong in this comparison for the reasons listed below.

First, see his latest post on the subject here, where he compares the potential and actual GDP growth of the 1980s and the 2000s, along with the growth rate of real GDP.  He makes the same comparisons here.

There are several problems with this comparison, the first of which is the cause of each respective recession.  The recession of the early 1980s was caused by the central bank raising rates to lower inflation, as evidenced by the following chart:

The above chart compares the effective federal funds rate (left scale) with the year over year rate of inflation (right scale)  Note especially the spike in the federal funds rate starting in 1981, when Volcker kept the interest rate incredibly high to lower inflation.  This had two effects.  First, it was a primary cause of the second recession which started in mid-1981.  Secondly, it clobbered inflation by the mid-1980s.

Compare that to the start of this recession, which was started by a near collapse of the financial system.  Taylor admits that causal relationship in this post, although he argues that government intervention made the situation worse (which I disagree with).  A great explanation of the events leading up to first round of the crisis is presented in the following video:

Simply put, the causation of each respective recession is entirely different.  The recovery from the Volcker style recession is far easier to deal with: the fed lowers interest rates, which increases demand and thereby increases economic activity.  This relationship is part and parcel of economic knowledge (for a simple explanation, read Martin Zweig's Winning on Wall Street).

The recovery from a financial system shock is far more complicated.  First, while the Fed may lower interest rates to simulate the economy (which happened), the transmission system for that policy action was greatly hampered.  Consider the following charts from the FDIC's quarterly banking profile:

In 2008, the banking system was awash in bad loans. The top chart shows quarterly net charge offs for the banking sector, along with the change in non-current loans.  These figures continued to increase until the end of 2009, and were still high in 2010.  The loss provisions/net charge offs chart show the same thing -- that financial intermediaries were in serious trouble for the first 2-3 years of this recovery, meaning they could not transmit monetary policy (by making more loans) into the economy in nearly as effective a manner.

Just as importantly, the demand for loans during the latest recovery was far lower.  Consider this chart comparing total household debt outstanding and total nominal personal income:

In the early 2000s, total household debt became larger than personal income, meaning there was more household debt in the economy than income.  Put another way, the household debt/personal income ratio increased to over 100%.  This means that households were incredibly indebted, and thereby unable to take out additional loans.  Also note that since the start of the great recession total household debt has been decreasing, telling us that households are not talking out more loans, but instead paying that debt off.  Or, put another way, not only are banks unable to make loans because of a hampered financial condition, but consumers are paying down debt instead of increasing their debt.  This further hampers the transmission of Fed policy because loan demand and supply is simply weaker.

The current recovery is best explained by this paper from Irving Fisher, titled The Debt Deflation Theory of Great Depressions (PDF)As such, The  most appropriate time comparison is the the Great Depression, especially considering the severity of the financial shock that caused the recession.

For the above stated reasons, Professor Taylor's comparison to the 1980s economy is wrong. 

Great interview with Jamie Galbraith on income inequality

- by New Deal democrat

Terrific interview by Brad Plumer of the Washington Post with Prof. Jamie Galbraith on his extensive research,  here. It's global, it is concentrated in just a few sectors, it has a lot to do with finance, and it is correlated with high unemployment, among other things.

(P.S. You could copy and paste as much as you can get away with, summarize the rest, insert BREAKING in the title, and probably get yourself on the Wreck list at DK.)

Housing Prices: a rebuttal to Barry Ritholtz, part 3

  - by New Deal democrat

As I said in part 1 of this series, Barry Ritholtz' argument that house prices will decline further rests generally on three arguments:
     (1) housing is not actually affordable by traditional measuresDown payments remain unrealistically high, and buyers cannot qualify for mortgages;
     (2) there is a large overhang of "shadow inventory" most especially including but not limited to foreclosures, which are primed to put renewed downward pressure on prices; and
     (3) potential buyers, especially younger buyers, are fearful of the potential immobility that comes with owning a house vs. renting.

In part 2 I addressed the affordability issue.  In this part let's look at the issue of shadow inventory.

At least as far back as two years ago, based on data showing the mortgage resets and recasts peaking in the 2010-12 time frame, commentators were calling for a foreclosure tsunami to strike imminently.  That prompted me to keep score of Realty Trac's monthly foreclosure report.  It quickly became clear -- even before the robosigning scandal broke -- that no such tsunami was materializing

At the end of 2010, I asked if it was time to start looking for the end of the housing bust?, concluding that
My best guess is that the national low for the Housing Bust is still several years away.

Yet the low real prices and declining inventory in some of the most severely impacted cities argues that we should start to look for a bottom in at least some of those locales within the next 6 to 12 months.
Sure enough, the first of the 20 metro areas tracked by the Case Shiller index bottomed the next June, and by the end of 2011 seven of the metro areas appear to have bottomed.

In mid 2011, based on second derivative improvement in list prices (i.e., less bad declines),  I said that
housing prices have already "faced the brunt of market forces" without support for a full year, as a result of which they have been falling closer and closer to equilibrium, the rate of decline is abating, and actual real time data shows that nominal if not inflation adjusted stability may indeed be reached as soon as early next year.
When this was published in June of last year, one of the very first comments was
What the author fails to consider is the enormous shadow inventory held by the banks which, at some point, will either hit the market or be bulldozed due to vandalism or deterioration from lack of regular maintenance.
A similar scenario has played out month after month since then.  The YoY comparisons in list prices got ever less negative, and finally turned positive at the end of November.  Every month I would point this out.  Every month I would be told that shadow inventory was all set to overwhelm the market.  Well, here we are almost a year later, and as I discussed last week, all of the list prices indexes and all but one of the median/mean sales price indexes appear to have bottomed.  Additionally, one of the repeat sales indexes has bottomed, although the most famous - the Case Shiller index - is still down on a YoY basis.

In other words, month after month for at least two years now, the fabled foreclosure tsunami has failed to appear - including in the months before the robosigning scandal ever appeared - and for months leading up to the federal mortgage finance settlement as well.  The settlement was signed on April 5, so we are running out of excuses for the so-far-iinvisible tsunami.

As to foreclosures, Barry Ritholtz's argument is
For the past year, while the Robosigning giveaway settlement was being negotiated, Banks had voluntarily stopped most of their foreclosure machinery. Those departments have since been revamped (now, mostly legal !) and are starting to process delinquencies and defaults again. Thus, we should expect to see a significant increase in foreclosures as a percentage of total existing sales (in 2011, foreclosures were 24% of EHS).

If there is a silver lining, its that lower prices can bring out buyers....  But bargain hunting and a sustainable turnaround are two different things. There are many good reasons to believe that the 5.5 million foreclosures we have so far brings us only to the 5th inning of this real estate cycle. We are, in my best guess, barely halfway through the full course of foreclosures.
Barry makes a similar argument with regard to other "shadow inventory" and in particular those houses whose owners are "underwater," i.e., owe more in a mortgage than the house is now worth.  He says:
Shadow Inventory includes: Bank owned Real Estate (REOs), distressed homes not yet for sale, including short sales and delinquencies not yet defaulted. Various properties in different stages of Foreclosure are also in the shadow inventory.

This definition still yields a broad range of potential shadow ... inventory from 1.6 million homes (CoreLogic) to 8.2-10.3 million .... But ... I include in my definition of shadow inventory the enormous overhang of underwater homes ....

... That’s between 12 – 18 million houses as potential supply at higher prices.

The key question for the Housing Recovery case: What happens if and when prices begin to rise? .... [It] is reasonable to assume that many of these homes would be put up for sale and become inventory.
(my emphasis)
There are two important points to be made about Barry's argument. 

The first is that here Barry is actually arguing a second derivative, i.e., not the direction of prices, but the amount of increase.  He says that lower prices will bring out more buyers, but he questions if there will be a "sustainable turnaround."  Similarly he believes that more shadow inventory will hit the market "when prices begin to rise."  Thus his argument on its own terms is about the amount of a rise, not that prices will necessarily fall further with more foreclosures and/or underwater owners putting their houses on the market.

Secondly, consider the following two extreme hypothetical scenarios for foreclosures:  (1) all 10 million foreclosures are immediately processed and all come on the market in the same month; vs. (2) foreclosed properties continue to come on the market in dribs and drabs of 100,000 a month for the next 10 years.  The outcome as to prices would be wildly different.  In the first scenario, it is easy to imagine a crash in prices, that would end relatively quickly as the supply of foreclosed properties was sopped up.  In the second, the increase in the number of properties entering the market at any given time would be so small that it would likely make a very small impact on overall price, and almost certainly not change the direction at all, although its slight dampening effect would last for a very long time.

The question becomes, which scenario is closer to the truth?  Assuming the numbers to be correct - which isn't necessarily so - depending on how fast and furious foreclosed properties enter the market, there will either be a renewed downturn in price, or else there will simply be a slight dampening in the direction of prices.  If prices increase, under this scenario, the additional properties on the market due to foreclosures simply lessen the amount of the bounce off the bottom. Calculated Risk made a good presentation of the present state of foreclosures yesterday.

Given the continuing failure of the predicted foreclosure tsunami to appear for over two years now, the most likely outcome in my opinion is closer to the second one.  Foreclosures and other shadow inventory will enter the market, but at a sufficiently subdued pace that it only causes a dampening effect on price movement -- i.e., it affects the second derivative as opposed to the first.  Barry may well be right that this shadow inventory prevents a "sustainable turnaround" as additional shadow inventory enters the market "when prices begin to rise."  But that by its terms means that prices do, in fact, rise in nominal terms.

Next:  psychology and demographics

Economic wanker of the day

  - by New Deal democrat

"recessions are not a bad thing - they are simply the pause that refreshes the economy."
Lance Roberts, Street Talk Live

Tell that to the 5 million Americans who lost their jobs in the last recession and still haven't found work, you asshole.

P.S.:  Yes I do know they're not all the same people.
From Bonddad:

First, I have a distinct feeling that Mr. Roberts has a high net worth and, in general, has felt no pain as a result of the last four years.

Secondly, I have a feeling that Mr. Roberts probably doesn't know anyone who has truly suffered over the last 4 years.

Third, I would add that Mr. Roberts is a self-centered and selfish ass.

Morning Market Analysis

All sectors of the treasury market are still at short-term highs.  The only good news here is that the MACD's may all be about to give a sell signal.  However, even then, prices will have to drop to short-term lows before there can be any celebration.  In short, the treasury market is telling us that there really isn't much hope for a strong equity market rally soon.

Both the junk bond markets, and the high quality corporate markets are taking money as well.  Notice that both have tremendous upside room based on the lower MACD reading. 

All of these charts tell us that investors are looking for yield right now, which means money is coming out of the equity markets.

Wednesday, May 2, 2012

Bonddad Linkfest

  1. German unemployment at 6.8% (FSO)
  2. EU PMI hits three year low (Markit Economics)
  3. EU unemployment at 10.9% (Eurostat)
  4. EU unemployment leads to questions about austerity (FT)
  5. US PMI at 54.1, an increase from previous month (ISM)
  6. US construction increases slightly (see charts) (CR)
  7. Australian rate cut 1: Low Australian inflation (Marketwatch)
  8. Australian rate cut 2: weak GDP (Marketwatch)
  9. Australian rate cut 3: April 3 minutes released (RBA)
  10. Australian rate cut may hurt carry trade (FT)

Japan, Deflation and Some Very Bad Charts And Numbers

This chart is by far the most important piece of information about Japan: inflation - or, more specifically, the lack thereof.  While no one wants hyper-inflation, some inflation is actually a good thing, as it indicates that demand is increasing a bit faster than supply, or that supply is somewhat constrained and therefore needs to increase prices because it can't adequately supply the market.

The above chart shows the YOY percentage change in Japanese CPI for the last 20 years.  Note the following:

1.) In the early 1990s, we see a continual decline until 1995.
2.) From 1995 until 200, we see a spike to over 2%
3.) We see some YOY increases from 2005-2009.
4.) The most recent spike is as much due to statistical issues (low previous year comparisons) as economic activity.

For the rest of the time, Japan was in a period of deflation.  Let's explain why this is bad, with hep from the economic dictionary at the Economist:
Deflation is a persistent fall in the general price level of goods and SERVICES. It is not to be confused with a decline in prices in one economic sector or with a fall in the INFLATION rate (which is known as DISINFLATION).

Sometimes deflation can be harmless, perhaps even a good thing, if lower prices lift real INCOME and hence spending power. In the last 30 years of the 19th century, for example, consumer prices fell by almost half in the United States, as the expansion of railways and advances in industrial technology brought cheaper ways to make everything. Yet annual real GDP GROWTH over the period averaged more than 4%.

Deflation is dangerous, however, more so even than inflation, when it reflects a sharp slump in DEMAND, excess CAPACITY and a shrinking MONEY SUPPLY, as in the Great DEPRESSION of the early 1930s. In the four years to 1933, American consumer prices fell by 25% and real GDP by 30%. Runaway deflation of this sort can be much more damaging than runaway inflation, because it creates a vicious spiral that is hard to escape. The expectation that prices will be lower tomorrow may encourage consumers to delay purchases, depressing demand and forcing FIRMS to cut prices by even more. Falling prices also inflate the real burden of DEBT (that is, increase real INTEREST rates) causing BANKRUPTCY and BANK failure. This makes deflation particularly dangerous for economies that have large amounts of corporate debt. Most serious of all, deflation can make MONETARY POLICY ineffective: nominal interest rates cannot be negative, so real rates can get stuck too high.
The above definition gives us same very good information.  The top concept -- that some deflation can be good -- is something we don't talk too much about, but it's an incredibly important and valid point.  When technology advances in a manner that lowers prices, yet at the same time incomes are advancing in some degree, we get a very beneficial economic environment.  For example, in the1990s, the world economy experienced a huge explosion in technology and the like.  This had the overall effect of increasing productivity, thereby lowering costs.  At the some time, we also had the last big income advance of the baby boomers (as people get older, their income typically increases), increasing incomes.  The combination was great.  (As an aside, this also explains part of the US' CPI calculation which tries to adjust for advances in technology.)

Conversely, deflation can also mean slack demand or excess capacity.  If that is the case, it tells us that the economy is in trouble.  People aren't spending as much, so the demand curve moves to the lest, lowering prices.  As people spend less, businesses start to lower their capacity, which in turn lowers employment, which lowers demand, etc... At this point, you get the idea: it's a very bad development.

Overall, here is the end result:

20 years of very sub-par economic growth.  And that, is a terrible thing.

Housing prices: a rebuttal to Barry Ritholtz, part 2

  - by New Deal democrat

As I said yesterday, Barry Ritholtz's argument that house prices will decline further rests generally on three arguments:
     (1) housing is not actually affordable by traditional measuresDown payments remain unrealistically high, and buyers cannot qualify for mortgages;
     (2) there is a large overhang of "shadow inventory" most especially including but not limited to foreclosures, which are primed to put renewed downward pressure on prices; and
     (3) potential buyers, especially younger buyers, are fearful of the potential immobility that comes with owning a house vs. renting

Today we'll take a look at affordability.  Barry makes 3 important assertions to justify his opinion that house prices must go lower, because they still aren't affordable enough:
  1. the home price to median household income ratio is still higher than the norm.
  2. Home buyers don't have sufficient savings to come up with a $40,000 down payment to afford the median priced house
  3. The NAR's "housing affordability index" fails to take into account household income and savings

 I addressed all of these issues several months ago in How affordable is housing?   I encourage you to read the whole piece, but I'll restate it in condensed form here.

Over the long term the median house has cost about 2.7 to 2.8 times median family income (sorry, I don't have a more updated graph to show you, but I'll set forth the more recent data immediately below):

Median family income differs from median household income in that the latter includes one-person households, the former does not. According to the NAR's existing home sales report, the median home purchased cost about $165,000. Meanwhile the median family income is about $60,000. That means it costs about 2.75 times median income to purchase the median priced house -- in other words, right at the long term average.

 Barry highlights median household income vs median NEW home prices:

Admittedly that has not declined to its long term average, but new homes are only a small share of the overall market. I don't know why housing prices should be decided based on that slice alone. When you consider the broader range of houses available, per my discussion above, we have already declined to the long term average.

 Further, Barry's chosen metric fails to take into account mortgage rates. In 1980 mortgage rates were running at about 20%, In 1990 they were about 10%. Now they're about 4%. That means the monthly carrying cost of a mortgage on an identically priced house is only 1/5 what it was in 1980.

Put another way, the same nominal disposable income today can support 5 times the mortgage amount as it could in 1980. That means, at any given home price, there should be a much higher level of demand. By simple operation of supply and demand, we ought to expect that home prices must be significantly higher to bring supply into equilibrium with that heightened demand. That explains a great deal of the generally positively sloping ratio between house prices an median income shown in the graph Barry relies upon.

CR also makes the point in response that there has been a slight upward slope in the price of housing over the long term, as the US population has increased by 50% in the last 30 years, but God isn't making any more land.

 Barry's second point is that households can't come up with a $40,000 down payment for the median house. Presumably he is thinking of 20% of $200,000. But again, the median existing home sells for about $165,000. 20% of that number is $33,000.

 Beyond that, he makes in my opinion an important mathematical error. First time home buyers aren't the ones buying the median priced house; rather, "move up" buyers do.  First time buyers buy starter homes, and so don't have to come up with the down payment for the median priced house.  Throughout the last 6 years, houses at the 25th percentile have featured list prices of about 2/3 of the median home. Using that as our estimate, a first time home buyer only has to come up with about $22,000, or 20% of $110,000. If they have trouble with $22,000, there is every reason to think they will do what I did when I bought a starter home long long ago in a galaxy far far away. I put up 10% and obtained loans from family members for the other 10%. Once we start thinking in terms of coming up with $11,000 to put towards a starter home, it is much more doable, even in today's depressed climate.

For the same reason, move-up households only have to come up with about $11,000 ($33,000 - $22,000) after selling their starter home.  I will grant that families who bought houses anywhere near the peak of the market will have a hard time moving up, since their equity has declined, in some cases probably to zero. But any family which has owned its home for 10 years and resisted the siren call of home equity withdrawal should have no problem.

Indeed, contrary to Barry's argument that households do not have the savings to come up with a down payment, while the personal savings rate at less than 4% may not be stellar, the amount of savings that households have stashed away since the onset of the last recession is considerable, and indeed is generally better than at any point in the last 20 years:

Barry's final argument as to affordability is that the NAR's affordability index doesn't take into account household income. That's easy enough to do, however.  We start out with the interest rate on a 30 year mortgage and divide that by the Case Shiller 20 city average house price.  That gives us a general affordability rate.  When we divide that number by average hourly earnings, we can easily see how affordable it is for a family earning the average hourly wage to afford the typical mortgage payment for a typically priced house.  That is exactly what this next graph shows us:

The above graph tells us that, despite lackluster wage growth, the renewed decrease in mortgage rates, together with the steep decline in housing prices, have made mortgage payments far more affordable than at any point in the last 25 years.

Finally, Barry says that house prices, like other asset bubbles, typically overshoot the median on the way down. That's very true, but that doesn't mean that it must be accomplished by nominal prices. Rather, if nominal prices rise, but at less than the rate of inflation - and generally remain flat for a very long time after they bottom - then the overshoot can be accomplished in real terms without nominal prices declining further at all.

In summary, Barry's argument about affordability does not necessarily imply any further decline in nominal, as opposed to real, house prices.

 Next: Shadow inventory and foreclosures

Morning Market Analysis

Today, let's take a look at the currency charts to get an idea for that's happening.

The euro and dollar are trading in a range, with the euro trading between 130-133.5 and the dollar between 21.75 and 22.3.  Notice the large number of similarities: both are trading at or around the 200 day EMA; both are showing low volatility from the narrow Bollinger Band width; both are showing a fairly constrained EMA picture.  However, the dollar is showing weaker volume numbers, while the euro is showing stronger numbers.

The pound has broken out of its range, but not because the UK economy is doing well; instead, the pound is benefiting from not being the euro, and being close enough to the EU to be readily accessible to traders located in the continent.

Both the rupee and the real are moving lower, largely because of the faltering of their respective domestic economies.  India is slowing as a result of near gridlock in the political system, while Brazil is slowing because it is a net exporter of raw materials, and is therefore suffering from lower global demand.

The Australian dollar has decreased, largely because of a slowing economy.  However, prices are now right above the 200 day EMA, moving sideways.  Also note that prices are near multi-year highs right now.

The yen sold off starting in February, after the BOJ announced that they were thinking about engaging in another round of easing.  However, since the, the yen has rallied as traders have questioned the BOJ's resolve.

What do these charts tell us?

1.) Traders are moving assets away from emerging markets because of weak growth.
2.) The US and the EU are in a "jury's out" position.
3.) Traders are having a hard time believing the BOJ's statements.
4.) The Australian dollar is actually in the best position of them all -- at least from a trading perspective.

Tuesday, May 1, 2012

Bonddad Linkfest

  1. It's all the Republicans fault
  2. Maybe not
  3. Canadian GDP decreases .2% in February
  4. Real DPIs up .2; Real PCE up .1 (BEA)
  5. Chicago PMI at lowest level since September 2009 (ISM Chicago)
  6. RBA lowers the rate 50 BP (RBA)
  7. Chinese manufacturing number increases (Marketwatch)
  8. UK Manufacturing slows (FT)
  9. China makes big corn purchase, bolstering the market (Agrimoney)
  10. Soybean prices may make another record this year (Agrimoney)

Current Accounts, Trade Deficits and Petrodollars

So -- who are the bigger importers and exporters of the larger economies?  Let's take a look.

First, in talking about the current account as a percentage of GDP, it's important to understand what we're talking about.  From the Economists' Economics Dictionary:

The total of all the money coming into a country from abroad less all of the money going out of the country during the same period. This is usually broken down into the current account and the capital account. The current account includes:

*visible trade (known as merchandise trade in the United States), which is the value of exports and imports of physical goods;

*invisible trade, which is receipts and payments for services, such as banking or advertising, and other intangible goods, such as copyrights, as well as cross-border dividend and interest payments;
*private transfers, such as money sent home by expatriate workers;

*official transfers, such as international aid.

The capital account includes:

*long-term capital flows, such as money invested in foreign firms, and profits made by selling those investments and bringing the money home;

*short-term capital flows, such as money invested in foreign currencies by international speculators, and funds moved around the world for business purposes by multinational companies. These short-term flows can lead to sharp movements in exchange rates, which bear little relation to what currencies should be worth judging by fundamental measures of value such as purchasing power parity.

What's important to remember is that all of these totals eventually have to balance out -- that is, if one country is a net importer than other countries have to be net exporters, with the grand total eventually hitting 0.

Let's start with the big net importers:

The US is obviously the world's largest importer.  However, notice that this number has weakened over the last two years in the aftermath of the recession.

The UK is also a large importer.  While their imports have not risen to the GDP level of the US, they are still high.

The EU and Brazil have bounced between net importer and exporter over the last 10 years. 

The exporting juggernauts of the top 10 world economies are Japan and China, both of whom who have modeled their economies to become net exporters.  Overall, their respective philosophies can be partially characterized as mercantilist, which is defined thusly:

Mercantilism is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and military security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy and discourse from the 16th to late-18th centuries.[1] Mercantilism was a cause of frequent European wars in that time and motivated colonial expansion. Mercantilist theory varied in sophistication from one writer to another and evolved over time. Favors for powerful interests were often defended with mercantilist reasoning.


Neomercantilism is a 20th century economic policy that uses the ideas and methods of neoclassical economics. The new mercantilism has different goals and focuses on more rapid economic growth based on advanced technology. It promotes such policies as substitution state taxing, subsidizing, spending, and general regulatory powers for tariffs and quotas, and protection through the formation of supranational trading blocs

What started me on this thought process was the following chart from the Free Exchange Blog:

When we think about the entire global balance system, it's easy to start thinking in the US/China/EU paradigm, while forgetting about the importance and overall impact of the oil exporting countries.  It's the oil exporters who, by far, have the strongest current account position; money literally flows into these countries on a daily basis, leaving them with the big question: what do we do with all of this money?

FIRST, the good news: China, the country at the centre of the debate about global imbalances, has a current-account surplus that has fallen sharply over the past few years. Now the bad: China was never really the prime culprit when it comes to imbalances at the global level. The biggest counterpart to America’s current-account deficit is the combined surplus of oil-exporting economies, which have enjoyed a huge windfall from high oil prices (see left-hand chart). This year the IMF expects them to run a record surplus of $740 billion, three-fifths of which will come from the Middle East. That will dwarf China’s expected surplus of $180 billion. Since 2000 the cumulative surpluses of oil exporters have come to over $4 trillion, twice as much as that of China.

One reason why this enormous stash has received much less attention than China’s is that only a fraction of it has gone into official reserves. Most of it is in opaque government investment funds. Middle Eastern purchases of Treasury bonds are often channelled through intermediaries in London, hiding their true ownership. A lot of money has been invested in equities, hedge funds, private equity and property, where ownership is harder to track. Oil exporters’ surpluses are also proving much more durable than those accumulated after previous oil-price shocks. This is partly because the tightness of oil supplies has kept prices high, and partly because oil exporters have spent less of their windfalls on imports than in previous booms.

Perhaps a better way to think of global trade flows is that the world is divided between oil importers and oil exporters.