Potential For Worry - The Week Ahead

We’ve got a full week of economic indicators and the first ever post-meeting press conference given by a Fed president.

Indicators are important if they carry market-moving muscle. We’d rather our clients be armed up front, than not.

We have several housing related numbers this week (beginning with today’s March New Home Sales) but none of these carry much muscle.

March Durable Orders (new orders for hard goods) on Wednesday however carries plenty of muscle, and the greater potential to worry the market than to cheer it. This key number was off 0.9% in February when it was expected to be up 1.2%. A component of this release is so-called Non-Defense Capital Goods Shipments, something which is really a proxy for capital spending so it’s important. That February component was better by 1.1%. Thus, the February release was mixed but another decline in the headline number for March combined with a decline in the Shipments component will greatly worry the markets, indicating a stall.

Thursday’s Q1 GDP advance report is also key. Q4 was up 3.1%. Estimates for Q1 have been significantly reduced due to higher energy prices. Consensus is now + 2%. But even a number through expectations won’t cheer much because the market crowd is becoming a believer in our piano just overhead. Also key on Thursday is the Jobless Claims report. Recall that this number disappointed last week (higher than expected). An improvement is expected (390 vs 403). Both of these releases then carry more muscle to worry the market than to cheer it.

Wednesday we will have Bernanke’s testimony. The FOMC meets for two days this week (Tues, Wed). The policy statement will be released early (12:30 pm ET) then Bernanke’s press conference at 2:15. World markets will hang on every word. We’ll have a special issue prepping our clients for this event.


Robert Craven

Home Sales Tank / Mid Eastern Craziness - The Week In Review

We do not recommend trades in this report, not equity, fixed income nor foreign exchange. Our job is to identify near - to- intermediate term change in the economy, those events which are not yet priced in. We isolate these for our clients and they take it from there.

All of us know now that the US economic engine is accelerating. This was not as obvious months ago when we highlighted this prospect for clients. Sure, it has not all fed down quite yet, we haven’t all felt it, but it’s there and on the way (short of the potential Mid East retardant). This, in spite of the administration’s bungling. So this is a good thing.

Yet how can we say this when this very week we saw figures related to housing which were in the tank? Well, it is known this sector is going nowhere; it’s priced in. That is why New Home sales Wed at a record low did not stir the markets. And one reason for that it that banks are more immune to this reality, having raised $300 bln in new equity in the last two years.

Of course homeowners are not immune, which is why forecasters figured last year that massive imbalances in housing would dampen spending ahead. This, along with their lack of appreciation of traction to be secured by Nov/2, led to their forecasting mega miss. We advised our clients that homeowners would spend anyway, which they did.

Let us move to offshore.

Fiscal events in Japan have concluded quickly this week. A rescue package is gaining critical mass, the currency has stabilized.

US firms have very little equity exposure to Japanese companies, a good thing. Next, there will be disruptions in supply lines for sure, but these are already priced in. There will be internal argument over funding for resuscitation also. We predict the Bank of Japan will support the effort but they adamantly deny it at the moment. For the US the event will amount to either a wash or modest spark.

Finally, we know the Mid East, not EU considerations provides the primary potential retardant to US growth. To restate the obvious, it is foolish at the moment to be constructive on energy prices. Events this week simply support our view for an expanding transformation, one painful and destructive in its youth yet constructive for all of us as it approaches middle age.

Robert Craven

Feb Existing Home Sales - far below expectations. An Alert

After their recovery the prior 6 months, existing home sales for Feb fell by 9.6% to 4.88MM, far below expectations. These sales are now 2.8% below the year ago level, almost 33% below the Sep/05 record high. No doubt because of a still bloated inventory, prices are 2.7% below their year ago levels.

We are going nowhere on home prices until the inventory-to-sales balance improves and the number of distressed properties is reduced.



Robert Craven

The Week Ahead

Events offshore will muscle our markets this week, perhaps eclipsing domestic considerations. The Mid East was reviewed earlier. We take a look at Japan, following our guide to the week’s data.

We have Feb Existing Home sales on Mon (expected to be lower), Feb New Home sales on Wed (expected to be higher). We have Feb Durable Orders on Wed. This key number reflects orders placed with manuf’s for delivery of hard goods. The number is expected to be up 1.5% but the risk is for something more. The unemployment Claims release on Thus is also key. The risk is that this release will cheer the market, falling below expectations. The third revision for Q4 ‘10 GDP is on Friday - ancient history. Also on Fri we have the Mar Univ of Mich sentiment figure, something to be ignored by planners and traders as it carries few leading characteristics.

Now to Japan. Anyone who bets against Japan does so at their peril.

True to the anchor set earlier we can expect the nuclear emergency to continue to diminish, we can expect the gov’t to rapidly set machinery in place for resuscitation, a process that will flatten St estimates. GDP may take a hit near term (maybe 1%) aggravated by a temporary national power shortage, but can be expected to surge, Q4. A major rescue package is nearing completion, including tax breaks. We expect the Bk of Japan to monetize the deficits needed to fund construction (although they currently deny such a step) and with that, pressure the yen lower, also a plus.

Production constraints associated with the crisis will be concentrated in Asia. Observers have highlighted supply considerations for US manufacturers; there will be little impact on our economy in this regard as Japan’s competitors move quickly to fill the gap. Look for headlines this week to cooperate with that view. This tragedy will provide an immediate spark to US industry. There will be some added pressure to energy prices as Japan will rely more on natural gas for power generation, at least for the near term. There will also be added pressure to materials prices - cement and re-bar come to mind.

We likely over-estimated the US price risk associated with repatriation but we do know accompanying yen strength would have retarded the Japanese recovery. Japan requested and received G-7 assistance in this regard. That potential crisis has passed. Look for further weakening, this currency.

Longer term implications for the US will be determined by the extent the growth of nuclear projects worldwide is impaired. From the Telegraph, we understand that the world has 442 reactors, with 65 under construction. “They generate 372 GW, covering 13.8pc of global electricity. The share is higher in the rich world: France 75pc, Belgium 52pc, Ukraine 47pc, Korea 35pc, Japan 29pc, the US 20pc, and the UK 18pc. In China it is just 2pc.” In the most general sense, output was expected to double over the next twenty years. A set back obviously translates back to conventional energy prices. Our view is that after some examination, nuclear will recover.

Robert Carven

The good 'ol days

We've had our differences with Greenspan over the years. He could not be more correct however in a recent article in International Finance. Gov’t “activism” he said, including fiscal stimulus, housing subsidies, and the slew of new regulations on the employer, are holding back the recovery. Companies’ hesitation to hire and invest, “can be explained by the shock of vastly greater government-created uncertainties....”

The only difference we have with Greenspan on this one, is timing. This paragraph fit perfectly pre-Nov/2. Since then, damage has been stopped and efforts made at resuscitation. Consumers have taken note. Employers have taken note. This event - Nov/2 - explains more than any other single factor the surprising growth of recent months.

Buy holy moly folks, in the good ‘ol days, all you had to know was economics. Now you’ve got to have half of Washington wired and a spook or two in the mid east or you can’t make strategy worth beans.


Robert Craven

Perspective

Things have been a tad hectic, past days. Let’s step back.

The US economy is performing much better than most expected it would. We know now that manufacturing is especially vibrant by the way of new orders, order backlogs, jobs, exports, production; manuf’s have longer delivery times and their input prices are at the highest level since Jul/08 (when oil was surging).

Employment continues to lag a tad. Obama’s statist agenda has meant every new employee carries a larger liability than before. This means that employers have either permanently eliminated positions (productivity up) or put off that decision. Still, employment will gather strength in the months ahead as more of Obama’s policy is rejected.

Consumer activity (about 70% of GDP), after blowing off the charts has slowed at tad, Q1. We predicted more, so it would be easy to blame this all on weather. Some is weather but some is a deliberate pause on the part of the consumer. Nothing unhealthy about this. We have seen this pattern the many years we have followed this sector. Sure enough, pause over, we learn today that Feb vehicle sales rose to their highest level in more than 2 years.

If we were considering a longer-term prospective we would be compelled to examine Obama’s budget, which Newsweek’s Evan Thomas (whose past fawning towards Obama was better seen before dinner) described as a “profile in cowardice.”



The UK economy is hitting on 5 of 8; housing prices are better, construction activity has bounced back and manuf has shown a record start to the year. Germany? Germany is vibrant. And the entire Euro zone has seen manuf grow at the fastest pace in 10 years. Only some of the periphery credits are making little to no contribution. The whole 17-member Euro Zone may grow near 1.7% this year, with the likes of German, twice that.

China is braking a tad, still healthy. Japan, in a slumber for a decade, is showing signs of life with better exports and better industrial production.

Everybody is seeing price pressures. But then we knew that, didn’t we?



Eclipsing all of this is renewal in the Middle East. To appreciate this situation is to know that it’s not just about a despot here, a tyrant there. It is about a people who want what we have and have collectively gathered the courage to get there.

This presents a down side risk for the US economy over the intermediate term because of higher crude prices. We put that gain earlier at 30% which means about 120 +/- on WTI.

Hopefully we won’t get there at all but any investor or planner would be plain nuts to listen to authority figures who assure us that what we see is merely a blip.

Robert Craven

A Must Read for Obama

This week’s event calendar is light, primarily related to housing. We will also see Jan Durable orders on Thur. Durables is a key release but it’s so volatile recently that we can’t assign a risk to the number.

There is however something far more profound by the way of potential impact to US interests and prosperity than any number of key releases might ever be. That would be the eruption in the Mid East, the surging demand for consensual government.

We reprint in its entirety our sketch from May/06. Yes, we jumped the gun a tad. And yes, this administration has so far done nothing to foster democracy in this area. Nevertheless, we are witnessing the beginning of the end for a few, and the beginning of the beginning for many.

Obama needs only to let the four paragraphs below become his guide, and to sculpt US policy accordingly.



May/03/06:


Over the next 12 to 18 months we will witness a conflagration of sorts: Democracy will spread throughout the Middle East as a pace very few can now appreciate; with the encouragement of the US, dissidents will upset primitive, brutal, autocratic and theocratic regimes and replace these with a new beginning - the foundations for a responsive government.

Realists have maintained that the Mid East is the least hospitable place in the world for a democracy. They are mistaken. Arab countries have aped western ideas but sought to implement these through state power - failed capitalist dictatorships. The inevitable decay and failure, the brutality of rule have together bred a growing sub-surface counterculture of resistance. It is this reservoir of energy, before constrained or crushed by ruling thugs, that now will be married to an enlightened US policy, ultimately transforming the region. And so now we are witnessing the beginning of the end for the old order.

The Administration’s formula is a simple one. It begins with the truth that all men and women will chose self determination over a directed and compulsory existence. Next is the fact that the spread of consensual government is in the direct interest of the US. A free society is not a threat to its neighbors. Trade and enhancement of wealth are only furthered.

Finally, the US will promote democracy in nondemocratic regimes by linking our foreign policy, our money, expertise and markets to internal reform - how these societies treat their own. All the countries in the Mid East are dependent on the West. We have the leverage. Given the base of internal dissent a regime need only give a little, say in the election process in exchange for US trade preference, and the fissure provided will quickly open to unleash a torrent.

Robert Craven

Conspiratorial? Certainly Not!

We’ll see quite a little data this week folks. Some carries no mkt-moving potential. Some does, beginning with Jan Retail Sales tomorrow, then on to the Jan PPI, Housing Starts and Ind Production data, all on Wed., then finally to Jan CPI and the Phil Fed’s Regional Manuf’s Outlook survey on Thur.

By Friday we will have seen that core price pressures remain contained (because that which in not “contained” is ex’d out). We will see that consumer activity continues to grow, that manuf is booming. If longer-term interest rates where only impacted by this data, in isolation then they would be just a tad higher at the end of the week, and only a tad as the mkt crowd is told there is no inflation; they take that home with them.

We can peer offshore for just a moment however to see what would happen to US rates if the mkt view grew for inflationary pressures. The UK Gilt (10 yr UK obligation) is now 50 or so basis points (each “basis point” is .01 of 1%) higher that beginning year levels, last at 3.85%. The US 10 yr is only 30 bps higher for the same time period, last 3.66%. Measured inflation in the UK is almost double that in the US and the Fed-fueled spike in global commodity prices has had a heck of a lot to do with it (along with a weak currency). But Bk of Eng gov King won’t budge, won’t brake with a hike, parroting Benanke that inflation is near zero if one ex’s food and energy.

Well folks, we are not of a conspiratorial bent. However, if we were we might say that the Fed is going to extremes, looking for any excuse to keep rates in the cellar, because of its incestuous relationship with major St firms - the two are linked at the waist. We know from personal experience this to be a fact. Unusually and unnaturally low rates make a ton of $ for St firms; they can finance practically any inventory at a profit. There is a good part of your answer why the Fed, and maybe even the Bank of England are looking the other way.

Oh, but then we’re not conspiratorial. Forgot that.

Robert Craven

Thalidomide and the Fed

Until their plan to buy everything-under-the-sun the Fed provided (or extracted) liquidity mainly through an O/N market by the way of so-called “repos” or “reverse repos,” these with so-called registered dealers. The Fed fine-tuned with “Fed Funds” as the speedometer. FF’s is the rate prime banks charge each other for O/N money on which to make their required reserves good with their regulator. Some are flush, some aren’t. The hungrier banks are to make loans the more pressure on FF’s. If the Fed wants to slow things then they won’t meet the demand in that mkt; short term rates will spike, and in theory, economic activity will slow. If the Fed wants to be accommodative they supply more money to that market; banks take it as reserves and (Econ 101) the multiplier effect takes over.

Key here folks is that nothing was forced on the market, on the general interest rate environment; takers could come to or stay away from the trough, given demand or lack of in the economy. Longer-term rates ( 2 - 30 yrs) which impact all of us, were left to find their own level.

This worked fine until Q4 ‘08. Policy makers were desperate. Nothing in the medical cabinet would impact this new pathogen. Thus massive Fed intervention - no longer just short term operations, but buying long treasuries and mortgage paper, QE 1 (12/08 - 3/10) - was meant to 1) prevent a world meltdown and then 2) fire a recovery with lower rates. The meltdown was prevented. No one knew the side effects of this kind of medicine however.

Now there is no crisis but they’re at it again. We all know that Bernanke decided on the second major dose - QE 2, Nov ‘10 and plans to continue that medication to Q3 ‘11. Bernanke is now out of his league; if there is a Oath of Hippocrates for central bankers he hasn’t taken it.

Instead of a central banker he has become a government planner. QE2 is fraught with danger. His intervention is a useless as Obama’s attempt at gov’t planning, that which delayed the recovery. Bernanke is providing money which is not needed or wanted, except by the gov’t, banana republic style (The fed owns more Treasuries now than the Bank of China.) The US economy in not in need of liquidity.

The Fed’s program is meant to 1) feed the gov’t and to 2) feed the home market, a repeat mistake. It only penalizes the prudent - savers who would otherwise put their savings to more productive uses. This provides a distortion as these lower rates are purely artificial, driven by money created out of thin air. The Fed’s buying spree could create the very bubbles which brought us here in the first place. At the very least it is creating malformations on the US economic body.


Robert Craven

A SOUFFLE?

A growing chorus of observers sense a two-tiered recovery, one which they maintain is fragile and will eventually collapse on itself. Let’s take a look.

These observers admit that yes, the Dow is up, banking is cooking, corporations in general are more efficient than ever and cash rich to boot and that yes, manufacturing is actually booming. But these same folk claim that only 10% of the population - the moneyed class - have prospered. They maintain that’s not enough, thus this recovery is not sustainable. What is needed? Correct - government investment.

Reflect a moment folks: For two years Obama took water from one end of the pool and put it in the other, expecting something to happen. That was gov’t “investment.”

Then Nov/2 came along. We could predict ahead of that event that the consumer would be cheered. This was the result. Consumer activity, Q4 and so far Q1 has flattened estimates. We never claimed that the economy would catch fire, only that the St consensus was dead wrong about the consumer.

What did these economists miss? Half of them are fresh out of some Ivy League place where apparently all they learn about is ivy; not knowing any better they listened to consumer surveys, almost always a mistake. Next, even the seasoned forecasters did not account for economic traction obtained from Nov/2; they did not understand that 1) damage would be stopped pronto and 2) steps quickly taken for repair. Finally, they misjudged the average spender. Huge housing imbalances did not prove the hindrance to spending that they reckoned on. After all, most Americans have a job.

It’s very easy in this business to cherry-pick results to fit one’s forecast. We must remain sober in that respect. And in our sobriety we can say that the recovery ahead will not be V shaped for some and L shaped for most others. All will begin to prosper.

This recovery will not suffer the fate of the one and only souffle we ever made.



Robert Craven

Update

First, to spending. Last week we saw that consumer spending for Q4 ‘10 gained 4.4% (the most since Q1 ‘06 ) following a 2.4% increase Q3. We did not know at the beginning of Q4 that spending would print 4.4%, only that it would flatten St estimates. This was the result.

Look for any surprises over the near term to be to the side of more, not less vigor than forecast. This is the course-of-least-resistance for the US economy and it is especially true for discretionary spending. Thus planners in those businesses linked to such activity are to embrace the reality of more demand for their product, H2, not less.

Background: Most analysts missed recent vigor because they 1) did not fold results of Nov/2 and traction obtained into their models, 2) gave imbalances in housing and the mess in states’ finances too much weight and 3) took consumer confidence reports to heart.



Of course, there are always wild cards - those cataclysmic events which carry the hrsp to retard US growth. A closure of the Suez Canal is one. This brings to mind the current crisis.

We followed the Mid Eastern situation (including the Brotherhood from ‘06) in a separate blog. http://bobcraven.blogspot.com/

Better, see the recent article by Vic Hansen for a primer http://pajamasmedia.com/victordavishanson/whats-the-matter-with-egypt/.

After that exercise readers will understand the failure of Mid Eastern society, and, the West as the appointed scapegoat. Along comes the internet and anyone under 40 got jealous. Dictators stand in the way. Here is the cause of recent violence. The trigger however was food prices.

Some Western observers have blamed the Fed for the recent chaos and even deaths; they argue the US is an exporter of inflation expressed in the very commodity prices which triggered this deal. Let’s see what this is all about.

Sure enough, inflation in milk and flour prices triggered protests in Algeria that left 3 people dead. Then a food vendor in Tunisia set himself alight. Now Egypt is ablaze. Egyptians suffer for example because cereal grains are up 39% in the last year, oils and fat, up 55%. Going after the nearest bad-guy target - Mubarak - is understandable.

But is Bernanke also one of the bad guys? In the sense that he conducts US monetary policy without the interests of the developing world folded in, he is. But it takes two to tango and the complainer, the developing country must make the decision to import inflation to get things going!

Higher commodity prices are not just a monetary phenomena of course - witness the worst drought in Russia and the Black Sea region for 130 years, late rains in Canada, Nina disruptions in Argentina, and a series of acreage downgrades in the US. But what about money?

We know the Fed is flooding the world with $’s; the more of them the less they’re worth. And we know that an Egypt, or a China, or an Algeria or any other developing country must buy their food in $’s. But these guys are mostly exporters. What happens if the $ cheapens relative to their currency? Right, this dampens their exports (one $ buys less), their life blood. So what do their central banks do? They print their currency out of thin air and buy dollars. Why? To keep dollars expensive to the local currency. Thus, just like China is doing these countries make a choice or decision to import inflation. That is the core to their problem. At the expense of their own savers they flood their own mkt with their own currency. That’s about all there is to it.

An Egypt or China which may want to insulate itself from this food inflation has to appreciate its currency significantly. But then its exports would tank. No way they’ll do that. Or, they have to subsidize food prices - price controls. These measures always fail. Absent these two drastic measures, countries have to live with the implication of US monetary policy.

Robert Craven

Week Ahead

This week we’ll see a moderate flow of gov’t and private data related to consumer attitude (two surveys, both to be ignored as there is very little correlation between consumer response and spending activity ahead, our view), orders for so-called durable items or factory hard goods, unemployment claims, data on both new and pending home sales, and finally, the advance look at Q4 GDP. There will also be a two-day FOMC meeting ending Jan/26.

When the week is finished and the dust settles there will be further evidence to support our anchor - consumer activity will have exceeded expectations. Not robust, but certainly much stronger than practically anyone predicted end of Q3.

We should remain constructive on spending. Some of our clients are held hostage to consumer discretionary activity, something which evaporated ‘09. We predicted early Q4 for a resumption of this activity; that was the result. We can now expect a gathering of momentum for this sector. For example, HI vacation property sales, once moribund, will accelerate through H1 into H2.

On the whole any surprises over the intermediate term for the US economy will be to the side of more vigor, not less. We can say this despite still huge imbalances in housing, despite the well-publicized mess in states’ finances, despite surging commodity prices.



Background: Never during our time in this business have politics and economic reality ahead been so intertwined. Obama inherited a bad situation (in which he had a hand in creating) and then make it a lot worse.

Yet despite that and the housing mess, consumption began to recover into 2010. But it was the Nov/2/10 election results which fired employers and consumers, extending hope that individual tax cuts might be maintained, that corporate tax cuts might be initiated and that Obama’s smothering legislation might be overturned.

Now we see that Obama has suddenly switched from gov’t planner to pretended free-mkt maven. As a result employers have become even more optimistic.

Obama will never be a Reagan or even a JFK but with his re-election in mind he’s at least saying the right words, some of them. Immelt’s appointment leads one to question his actions, but at least Obama’s no longer an outright hindrance to the recovery.

Robert Craven

Update

We predicted early Q4 that economic reality ahead would broach expectations, especially payroll and discretionary consumer activity. That has been the result.

Some recent signals have appeared to contradict our view: 1) The last Payroll number was not especially buoyant. 2) A recent consumer confidence report (Conference Board) was lower. 3) Home prices fell again. This information is useful perhaps to set a better price or exploit crowd behavior but not useful as a guide.

Thus, clients are to remain anchored: 1) The last payroll result will very likely be revised higher. 2) The correlation between what consumers tell pollsters, and what they are about to do, is poor. We know from experience that consumers will tell the Conference Board that the world is about to end while on their way to buy a new b b’cue or maybe even a new car! 3) Lower home prices won’t hinder a recovery. Most economists exaggerate the importance of housing to overall wealth, and to spending. Anyway, GDP growth depends on new production. In November, housing starts were up 3.9% and new homes sales were up 5.5%.

Recent unemployment claims fell by 34M for the week ended Dec/25, vs expectations for no change; this is the lowest level of layoffs since July/08. This result is in line with our prediction that analysts have underestimated employment, and by extension, consumer activity.

Overlooked by many is that manufacturing activity has expanded for 17 consecutive months as of Dec following 18 consecutive months of decline. Why? Part we know is due to exports but - key - a growing share past two quarters is tied to domestic demand. The latest survey for the Chicago region blew through expectations, the fastest pace since July/88. The demand for manuf goods indicates that customers are buying again. Due to lean inventories production has improved with demand, as will hiring, as will income, then spending.

Indeed, retailers are reporting the best demand since before the recession began (Dec/2007). Even luxury retailers such as Neiman Marcus, Saks and Nordstrom have seen a surge in traffic and sales (aided by the reality of another two years of Bush tax cuts).

Clients dependent on discretionary spending are to plan for an expansion of that activity on the order of 20% by mid-year, 2011. Business planners are best advised to account for this reality.

Robert Craven

Wisdom In Insecurity

More have joined us in sensing vigor ahead. GDP estimates, especially estimates for consumer activity are now being revised higher, an event we predicted earlier.

One estimate is Greenspan’s; he now predicts a much higher 3.5% for 2011. Knowing his track record, this gives us pause! Maybe a second take is in order. Well, suppose we’ll be alright despite this endorsement. Thus, let’s look for more positive surprises in the near term.

Speaking of Greenspan, speaking of false prophets, careful with all of this. The media is quick to manufacture seers. It’s good business but dangerous for the listener/viewer.

If there isn’t a track record it’s just noise.

Some individuals are indeed given to profound insight, an occasional blockbuster. Soros in one of these. Bacon is another. Roubini is another. Recall that Roubini predicted the housing crisis of Q4 ‘08. The rest were looking in the other direction. Yet all great strategists realize the power of insight is ephemeral. No one has it all the time. The very best are just that because they respect their limitations.

Problem is that Roubini or Nassim Taleb (of Black Swan fame) or others can be caught in a vortex if they are not careful. The media gains ownership, making them out to be something they are not. Ego may cooperate. When for example Roubini was taken in by the fanfare, he shed his power. He forgot that though gifted, his gift is not for all seasons. Others too have made major calls, had major triumphs but when they misread this as a sign of omnipotency, they invariably met difficulty.

In forecasting, wisdom resides in knowing one's limitations, in never being just too secure, in acknowledging that the business of the future is to be dangerous.


Robert Craven

Week In Review

How did events this week support or amend our anchor, that of surprising vigor ahead, especially in payrolls and discretionary spending?

Well, it’s been fun folks. Obama quit his attack on the rich, triggering the F word from one of his fellow Dems. In fact, these loonies should have praised the guy. The tax bill, as it is this pm is not much. We get a two year break but are nailed with a $57 bln, 13 month extension of unemployment benefits that’s not paid for. So not much here to support our anchor, won’t hurt much either, perhaps a wash.

Real sector data was encouraging. Consumer Sentiment rose to its best level since June. Sentiment fell sharply in July, but has now regained all of that decline. Exports rose 3.2% for Sep and are now 15.9% above their year ago level. Jobless claims dropped by 17M for the week ended Nov/27. After being little changed for most of the year, claims for benefits have broken to the downside past 5 weeks. All of this data supports our constructive view.

The Fed continues to disappoint with this QE II business. We don’t need any more liquidity. The charge, from us and others, that the Fed is merely an extension of the administration continues to gain support.

And Nobel laureate Joseph Stiglitz reckons US banks will simply put the $ offshore, investing in so-called emerging credits, driving up these currencies, triggering all sorts of mayhem, including asset bubbles. May be. A Wild card? Stiglitz knows more about these things than we do.

But this week’s rout in the bond markets (yields spiking, prices dropping) may be the investment world’s way of issuing an inflation warning. Much more of that and we’ll have to moderate our view. Balance sheets, especially housing will not be happy campers.

Finally, and of course key - momentum continues to build in Washington to repair damage done earlier by BO, his making a bad economic situation much worse. Nov/2 was about stopping the destruction. Next year is about rebuilding. We’ll start with the health heist. The future costs of this statist president’s social agenda are no longer a given. This has greatly cheered employer and consumer alike.


Robert Craven

Employment - 2011

We know, you’ve already begun to doze off. Don’t. Stick with us. You need to know this stuff; then come 2011, tell the kids or spouse it’s how you had it figured all along.

We noted in an earlier sketch that the error to the consensus forecast for near term economic activity is to the weak side, our view. That is, there will be more vigor than expected in 2011, particularly more vigor in payrolls.


Let’s take a look at where we are now. The Fed recently surveyed all 12 of its districts so we don’t have to. The Fed compiles this survey ahead of each FOMC meeting.

Here’s what the districts reported: Overall economic activity continued to rise, but at a modest pace. Manufacturing continued to expand with production and new orders rising in most districts. Consumer activity was up modestly; even travel and tourism picked up a bit. (Did we not just read discretionary activity - travel and tourism? I think we did!)

Vehicle sales were up a tad. Housing remained weak with most districts reporting sales below year ago levels. Same for commercial construction.

Prices of goods and services - mostly stable. Wage pressures were minimal. No surprise as we know the labor market is weak (thanks, BO) which naturally dampens wage pressures. But the weak labor market does not reflect weak employers. Read on.

Reported company earnings for Q3 are blowing through expectations, both consumer and industrial related (ex, MacDonald’s & Caterpillar). And it’s not just due to cost cutting; it’s also due to increased sales. Granted, much of the sales improvement is offshore, esp emerging markets, but fine, we’ll take that too.

Companies are hugely more efficient now than they were two years ago. But the changes they have made will in fact reduce the number of employees needed to get the job done. Why not? There are too many BO-imposed burdens attached.

We read from this week’s UK Telegraph, “This lack of investment in new jobs isn't because companies lack the resources. Corporate America, as in the UK, has an embarrassment of riches on its collective balance sheet. But having come through the crisis lean and mean, chief executives intend to stay that way.”

The Telegraph continues, “When it comes to investing, the risk and reward equation is skewed away from creating jobs and more towards buying rival companies to boost growth (while often cutting jobs) or buying back a company's own equity to enhance shareholders' returns and management's own share-based incentive schemes. After all, according to corporate America, what's the point of starting a business to create jobs when it will be weighed down by health care costs, taxes and red tape?” Thanks again BO.

And this is exactly where Nov/2 comes in. Given the seers are correct (recall Harry Truman holding up the copy of the Chicago Trib to know that they might not be) then we will have a great wave of fiscal conservatism sweep the country. Efforts to slash perhaps $100 bln from the federal budget will commence in January. And personal initiative will be celebrated as 1) tax cuts are maintained and 2) business tax cuts initiated. Next, the health heist will be repealed. Cap & trade, comatose anyway, will be sent to sleep with the fishes. Employer and consumer alike will be cheered by all of this.

In short, already healthy employers will see the risk of government interference, the risk of sudden change to their operating theater, sharply reduced. Jobs will follow.


Robert Craven

Interest Rates III

Interest rates, continued.

The Term Funds market is the largest slush fund in the world. This is where US banks come to take care of business. Some banks are flush, some banks are short; they work things out. All banks have reserve requirements to meet and other short-term needs. Here is where they come to fund these liabilities. Maturities are from o/n to two weeks, some even longer. Banks lend/borrow to/from one another, without collateral. This is the heart of bank liquidity. Early Q4, 2008 this market seized up; it locked in place. As a result we were only weeks away from a free fall, one which would have made the Great Depression look like a party. Only thanks to the G-20's quick maneuvering were we spared.

In Q4, trust vanished. No single world institution trusted any other (notwithstanding decades worth of relationship). No one knew just how poisoned collateralized mortgage paper really was, or, who owned how much of it. The banks lied to each other, and, to regulators. Thus, even though funds extended in the term funds market are of a very short maturity, no one was sure if they’d get anything back.

We all remember that time. To most of us, there was an uneasy feeling, but of exactly what we weren’t sure. Major world financial institutions on the other hand, being players, feared they might not see another sunrise. They knew the implications. In what is called a "flight to quality" they sought shelter in short term US obligations - Treasury bills. These offered the least specific credit risk (visited earlier) of anywhere else in the world and no inflation risk. Recalling our anchor, prices erupted, and yields plummeted, so that the 90 Tbill yielded a tick or two away from 0%!

Next, the Fed came to life, pumping money into the system. To do this they target Fed Funds, the O/N rate in the term funds market, as a gauge of tension. The rate had been 2% end of Q3; the Fed cut it to 0.25%, effectively 0%. This means one thing - all the money you guys need is there for the taking. But, it did not help. It was, like the old saying goes - pushing on a string.

Finally, G-20 central banks guaranteed inter-bank transactions. Slowly, normalcy returned to the world’s liquidity situation. Since that time, the Fed has expanded its balance sheet, buying practically anything under the sun - they can buy a herd of longhorn steers if they want The Fed is using its balance sheet to support the housing market and economy generally (a process effective over the near term but fraught with danger).

This brings us conveniently to the Yield Curve - the pattern of US interest rates from O/N to 30 years. This is a very handy tool. We should all keep an eye on it. In Jan/08, FF’s were 3.5%, 90 day LIBOR (another short-term measure) was 3.31%, the 2 yr Treasury 2.19%, the 10yr 3.56% and the 30 yr 4.27%. At this writing, FF’s at 0.14%, 90 day LIBOR is 0.25%, the 2 yr, 0.85%, the 10 yr 3.55% and the 30 yr, 4.48%. Whoa! Quite a story this gives up. Observe how short rates out to 2 yrs are in the cellar compared to the period just ahead of sub-prime concerns, yet observe how the 10 and 30 yr yields are near the same levels. Given what we learned earlier what does this tell us? Easy. Everyone in the world wants to own short paper as is obvious by the exceptionally high prices, thus negligible yields. We know why. No one is investing, no one is hiring. Most are content to sit on it. Keep it short and safe. What about the long end, 363 basis points (a b.p. =’s one hundredth of 1%) over the 2 yr vs only 208 in Jan/08? That tells us that because short term rates are so cheap, the world’s markets are beginning to price in inflation, that is, an expansion of that component in the summary yield. This is the message of a steeper yield curve. This is not reality necessarily but consensus anticipation of reality, right now. The 30 year is cheaper (lower price, higher yield) than it was almost two years ago, but the economy is weaker. This should be the other way around should it not? If this situation continues, it will be a read flag to the Fed; for the moment however, the recovery is too fragile for the Fed to begin to reverse its past actions.

In the next and final sketch of this series we’ll look at more practical considerations, a tad closer to home.

Robert Craven

US Economy - Keep It Simple

We want economics to be friendly, easy on the temperament, not intimidating. We’re all capable of fetching what we need, gathering a little grounding, past the noise and bullets. Only those employed in the business want us to think it’s difficult. Naturally. We don’t need them. Let’s take a look.

Where are we now? We repeat from our sketch of Oct/2, because it remains accurate. Overall, we have an economy that is in a stage of self-correction, although one of a restrained variety. Free enterprise spawns creative destruction and then off we go. This time the threat of a tidal wave of interference rightfully dampens incentive to invest or hire.

There’s been modest improvement. The Fed’s act of flooding the markets with money is responsible for the hog’s share of it (and whether this flooding can be reversed in time is a subject we will visit later). In the meantime, businesses have become lean and mean, with radical cost-cutting of inventories, employment, and hours worked. "If she ain’t critical, shut her down," is the motto nowadays. That’s good for profits and apparently good for stocks, but, you need more if you own a small business, say a nursery, where demand is discretionarily oriented and as a result one finds one’s business on its rump. You need more spendable income in the hands of your (past) customers. But scared employers are making changes that will permanently eliminate job demand, thus spendable income.

We have the current administration to thank for this.

Let’s break, and look at some recent measures of the economy’s mph.

First, retail sales surprised on the up side in Oct., much of this strength due to rebounding vehicle sales. Retail activity isn’t booming naturally; Oct activity was still only a tad above Q3 averages but in fact, consumers are looking to spend a bit, and would spend faster if not for still rising unemployment, stagnant income growth and tight credit.

Next, industrial activity rose in October for the fourth consecutive month. This is impressive. The level is still depressed, sure, with a lot of excess capacity remaining, but a modest recovery is underway in this key sector (mostly due to exports).

Finally, but not so encouraging - housing starts tumbled in Oct. Home construction is still struggling at very low levels. Also of note, mortgage delinquencies rose again in Q3.

So this "recovery" very slowly ratchets ahead, very slowly. In the past, the more severe the recession, the more robust the recovery. This pattern has never failed. Not, that is, until this time. We all know why. The individual culprits preventing a full recovery are in full view. These we detailed in recent past reports.

We know also that there is a general fear in the real sector that the free-market principles of the last half century are being abandoned. One can make the argument that Obama is right, that we need less 1) free enterprise and more 2) government overlay, but if so, one must accept the flip side - a permanently crippled US economic engine which will impact his or her own personal lifestyle.
.
Robert Craven

Update

In the last Update we noted that although certain sectors of the economy are showing signs of renewed health (manufacturing for example), the jobs sector continues to provide a major depressant. We also noted then that this recovery will be much slower than that from the last major recession (1982), which only took 6 months. The reason - real or perceived retardants placed on the employer by the current administration. Proposed legislation - cap-and-trade and the potential health care mandate to name just two - discourage any sane employer from hiring. Instead, they will grow more efficient, initiating a ratchet effect of sorts - a permanent reduction in needed payroll.

Let’s see where we are now. We need not be economists to understand recent releases, nor to develop our own view of where we are headed over the intermediate term.

Today we received the key Employment report for Sep activity. Jobs fell more quickly in Sep, and losses were widespread. Since the beginning of the recession, Dec/07, 7.205MM jobs have been destroyed. However, as we highlighted earlier, the pace of job loss has slowed dramatically. The worst of job deterioration is over.

We also learned that the unemployment rate notched up to 9.8% overall, and, 10.3% for males, the highest since the Depression. But key - the rate climbed because job losses overwhelmed a plunge in the labor force. We may go even higher the next month or two. Even though the media and the masses lock onto this rate, its significance is limited.

We learned that despite a weak labor market, hourly earnings are still climbing, albeit slowly. Unfortunately, the work week retreated again.(We had looked for this measure to remain unchanged) Thus the combination of the two - weekly earnings - remains weak. So we know that real consumer spending will remain constrained, and for a long while, since housing no longer provides a spark.

Finally, we learned today that Factory orders fell in Aug for the first time in 5 months. But wait. Despite this month’s decline (due to a sharp drop in orders for civilian aircraft, which soared in July) new orders have been growing over the past 3 and 6 month periods. This sector has stabilized, believe it or not, although at a lower level. The trend to remain positive.

Overall, we have an economy that is in the stage of self- correction, although of a restrained variety. Free enterprise spawns creative destruction; aside from government interference, off we go (1982). This time the threat of a tidal wave of interference rightfully dampens incentive. Any fool can see that. And further, legislation designed to spawn a recovery - the stimulus bill, is at best a wash, perhaps even a retardant. We aired this view early on; others have come to agree with us. The latest is Harvard’s Robert J. Barro. (See "Stimulus Spending Doesn’t Work," 10/01/09 WSJ opinion, by Barro and Charles Redlick.)

The culprits to a full and vigorous recovery are in full view. We have detailed these in several past posts. Anything well help folks. For example, if Congress will reassure the business community of making permanent the Bush tax cuts, this will provide a major propellant; start up costs would shrink. Or, if health and the (ludicrous) cap-and-trade measures fail, are defeated, this too will provide a propellant - the threat of higher labor costs will vaporize overnight. But as long as employers suspect that Obama is dead set on nationalizing productive resources, is pre-programmed to do so, no way they’ll look to hire. Thus, despite modest vigor in other sectors, the jobs sector will dampen, restrain any correction.

Too bad. It didn’t have to happen.

Robert Craven

ENOUGH

This am we have a program from Treasury that appears to be constructive, and will go a distance in finding a home for the garbage on banks’ balance sheets. Next, to the broader picture.

We are forced to take much on trust. The band aid put in place by the G-20, Q4, prevented a world credit meltdown, or so we are told. We believe that is true. Now we are told that firms like AIG or Citi, or GM are too big to fail. But where do we draw the line, and how? When do we say "No" to further bailouts; when do we resist further government intervention in our marketplace? Or should we? How can we become empowered? How can we acquire a handle?

Two schools of thought come to mind, residing at opposite ends of the spectrum: 1) Socialists avow gov’t ownership of productive resources. Their answer is "Always", the more the better. Most Americans reject that premise. 2) The so-called Austrian School of Economics would answer "Never", not in any circumstance. Leave the economy alone, it is self-correcting. Certainly the process of creative destruction has placed the American free market first in the world; it is that process which Treasury Sect Andrew Mellon once said means, "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. Values will be adjusted, and enterprising people will pick up from less competent people." In other words, once the bust comes, the only cure is to let it run its course; allow the malinvestments to go bankrupt and let the market reallocate the capital to productive uses. Certainly this should apply to most portions of our economy today, our view, including the likes of GM. Anything else - simply a delay of the inevitable.

The glitch unfortunately, something neither Mellon nor the Austrian School’s von Mises nor others of this persuasion could have foreseen - the interlocking of the world’s financial/credit markets. Thus for some of these institutions (as detailed in earlier sketches) we need to bite the bullet, at least for now. But past that it is key that each and every one of us hold our legislators’ feet to the fire and say "Stop", enough is enough. First, turn these deals back to the private market as soon as possible. Next, do not nationalize resources such as medicine, energy and education; stop as soon as possible overriding contracts; above all, stop taking assets from competent people and giving them to incompetent people.

We have a right to be pissed. And we have an anchor in judging just what we will accept, and what we will not. It’s called common sense. We may not all be financial engineers nor have ever encountered a swap but so what? It is our $ being tossed around. We don’t know if we will get any of it back; our future and that of our offspring are at risk; we are darn sure fit to judge. Now is the time to draw the line and understand that it is not always better to do something than nothing, and insist that our elected officials understand likewise. That is, most interventions do more harm than good. A quick glance at economic history shows that substituting political agendas for business judgement during periods of panic is bound to fail. It never worked before and it never will.

But readers need not accept our word. A man who fought for this very thing, who championed the free market after the fall of communism, who never has taken capitalism for granted - Czech President Vaclav Klaus. Klaus said during a recent speech at Columbia Univ that massive gov’t spending in the US and tighter regulation will simply prolong the recession, and urged Obama not to endanger the free market in his response to the crisis. "I am therefore convinced that fighting for freedom and free markets, something we always appreciated here in this country (the United States), remains the task of the day," said Klaus.

Indeed it does.

Robert Craven