WRFest 23Feb08(Economy): Bottoms Are Muddy, Is the Water Clear
The last Readfest boiled down the dilemma to the Street's apparant consensus being that it was time to go bottom-fishing verses the question of where we're at in what kind of a business cycle (we might also mention, again, that this has been a very different kind of cycle and NOBODY has factored in the consequences into their strategic thinking yet). Now that's the classic dilemma that's always with us of course but this time it's moved from background to foreground because of a widespread sense that we are at a cusp point where we're going to change from one regime to another.
A central and critical question we've taken two major passes at in the last week, both with our own postings and charts plus some key article excerpts. One that particularly got a lot of attention is Martin Feldstein's WSJ editorial warning that if this does tip it will likely because as bad or worse than anything we've seen since 1980 because of the differences in the Housing and Credit Market situations. Which is really a debate at which business cycle we're on, i.e. it's shape, and where we're at - which is discussed in an earlier post excepted below. Along with a post trying to summarize all the risks factors, their status and likely future course in one chart. If you look at nothing else read those.
In addition you'll find excerpts on the Fed's lowering of it's outlook, which was already low, and the Housing market, which is beginning to look like it's in a feedback loop where bad news triggers more problems leading to more bad news. There's also some interesting excerpts on the situation and consequences for parts of the Int'l Economy, particularly China and on the situation with supplies. In this case growing problems with finding oil that's readily accessible, affordably developable and not subject to the vagaries of ill-behaved governments (think Chavez or Nigeria). And with agricultural commodities which are beginning to enter their own boom and as a result are hurting the world's poor and beginning a shift from world-wide disinflation to inflation.
US Economic Cycle
Our Economic Dilemma Although it is too soon to tell whether the United States has entered a recession, there is mounting evidence that a recession has in fact begun. Key measures of economic activity stopped growing in December and January or actually began to decline. The collapse of house prices and the crisis in the credit markets continue to depress the real economy. The sharp reduction in the federal funds interest rate and the new fiscal stimulus package may, of course, be enough to avert a downturn. Many forecasters still predict that the economy will just slow in the first part of this year and then rebound after the summer. But the hope that monetary and fiscal policies would prevent continued weakness by boosting consumer confidence was derailed by the recent report that consumer confidence in January collapsed to the lowest level since 1992. If a recession does occur, it could last longer and be more painful than the past several downturns because of differences in its origin and character.
Debating the Business Cycle: Alternatives, Risks & Catastrophes Yesterday we put up a post trying to summarize our sense of the congeries of problems (the problem portfolio as it were), what they are, what stage their in and likely to be and how they're likely to play out .The key starting question was whether or not the Economy was at a slipping point. In an earlier post on the alternate views of the Business Cycle we posted a graphic representation of the situation, what the different paths were/are and which are most likely. And discussed the policy challenges. We've also updated that original graphic to reflect a little something we neglected to mention - namely where are we at. Which, along with these story excerpts goes a long way to making our key point here. Reasonable people can debate whether or not we're in a Recession and will be for some time. What is absolutely clear is that the Economy is slowing. AND that the rate of slowing is increasing. AND that the risk factors of tipping over into something more severe are high to very high. No pleasant reading for sure but necessary - and we've never considered it our purpose to deny reality (other than in our personal live of course where fantasy is the rule :) ). Updates, Refreshes and Gurus: Feldstein on Facing Realities
Filterring the Non-Linearities: Sorting the Risk Factors A few posts back we jokingly referred to the various reactive posts that went up last week because of the flood of important news stories. Those included real retail sales, Buffett's buyout offer for the bond insurers, GM's really terrible earnings and more. In trying to make sense of that swirl we referred to all the "non-linearities" where one thing was linked to another. We thought it might be helpful to have a single point-of-view where all that discombubulation was brought together in one place so here it is. The chart below looks at the major problem categories and then briefly summarizes their status thru several stages. First stage is the basic situation, second is the next level of concern and impact and so on. Each cell here probably deserves its' own post, and in fact has already gotten several. But then we'd back to multiple inter-twining issues and seeing the whole picture where everything's linked to everything else would be difficult. Maybe even impossible. Let's see if this helps. Click on the graphic for a larger picture of course.
Fed Officials Cut '08 Growth Projections to Range of 1.3%-2.0% Federal Reserve officials cut their forecasts for economic growth this year by about a half percentage point and raised unemployment projections after the housing recession and financial-market turmoil deepened. Fed policy makers now expect U.S. gross domestic product to increase by 1.3 percent to 2 percent in 2008, compared with the 1.8 percent to 2.5 percent they predicted in October. The fourth-quarter jobless rate will be between 5.2 percent and 5.3 percent, up from a range of 4.8 percent to 4.9 percent in the last forecast. Inflation, excluding food and energy, will run at 2 percent to 2.2 percent this year, compared with 1.7 percent to 1.9 percent projected in October. Total consumer prices will rise by 2.1 percent to 2.4 percent; the FOMC projected an increase of 1.8 percent to 2.1 percent three months earlier. Fed Saw Need for `Relatively Low' Rates for Some Time, Fed Sees Rate Low `for a Time,' Then Chance of `Rapid' Reversal
Housing Cycle in Vicious Circle Housing is caught in a loop where one problem creates behaviors that make it worse. For example, falling home prices give borrowers incentive to walk away from mortgages. The trick for policy makers is to break the negative-feedback cycle. Economists have a term to describe what it means when things keep going from bad to worse: negative-feedback loop. One day's problems create a broad set of behaviors that only make the problems worse. Consider housing. As home prices fall, more families see the values of their homes decline to less than the amount of money they have to pay back on their mortgages. That gives them an incentive to walk away from their mortgages and leave their homes empty, which puts more downward pressure on home prices, drawing more households into the loop. Housing turmoil, in turn, causes consumers to pull back, hurting the broader economy, which puts more downward pressure on home prices. Banks, worried about mortgages going bad, tighten lending standards, shutting some new buyers out of the market and further depressing home prices. Negative-feedback loops can be pernicious when an economy depends heavily on borrowed money.
Yield Curve Concerns, Keynesian Fixes, Broken Models: Shifts in the relationship between U.S. government bonds with different maturities are semaphoring a warning that inflation may accelerate in the world's biggest economy even as growth deteriorates. The two-year Treasury note yield has more than halved since Sept. 18, the day the Federal Reserve started cutting its key interest rate. The current yield of about 1.92 percent is far enough below the Fed's 3 percent rate to suggest investors expect additional moves from the U.S. central bank. It's a different story at the other end of the yield curve. At about 4.6 percent, the 30-year bond yield is only 15 basis points lower than it was when the Fed downshifted into easing mode. As a result, the yield curve has steepened, driving the gap between the two- and 30-year securities to its widest level since July 2004 at about 268 basis points. So-called breakeven rates, which measure the yield gaps between those Treasury bonds that pay returns tied to the inflation rate and those that don't, are starting to signal a change in the inflation outlook. The gap between five- and 20-year breakevens has widened to 65 basis points, the most since at least August 2004 and more than double the 2007 average. While slower growth is likely to restrain consumer prices past the turn of this decade, Fed policy may be stoking the fires of future inflation.
International Economies
Central China blazes own path China’s economic ”miracle” has so far been largely confined to the country’s east coast. This is mainly due to the ease of shipping export goods manufactured in the Pearl River and Yangtze River deltas out of ports in Shanghai, Ningbo, Guangzhou, and Hong Kong. Facing wide regional income disparities, the central government is looking for ways to spread of economic development into places like Anhui and Jiangxi – two inland provinces that sit nestled like twin ice-cream scoops in the bowl of rich coastal provinces such as Jiangsu, Zhejiang, Fujian, and Guangdong. In the next five years, central China will grow rapidly, in part by imitating east China’s development model - Jiangxi and Anhui are already capturing the low end of export-processing industries crimped by rising input costs on the coast. But mimicking east China’s export-led approach will not be central China’s main growth engine. Instead, Anhui and Jiangxi aim to become “China’s China” – suppliers of low-cost goods to the rest of China (especially its wealthy east coast) just as China as a whole supplies low-cost goods to the world.
China Inflation Is Fastest in 11 Years as Snowstorms Drive Up Food Prices China's inflation accelerated to the quickest pace in more than 11 years after the worst snowstorms in half a century disrupted food supplies. Consumer prices rose 7.1 percent in January from a year earlier, the statistics bureau said today, after gaining 6.5 percent in December. That was more than the 7 percent median estimate of 23 economists surveyed by Bloomberg News. Food prices soared 18 percent after blizzards paralyzed transport systems and destroyed crops. The government faces the challenge of curbing inflation without derailing the expansion of the world's fastest-growing major economy. Soaring prices have the potential to lead to social instability, as illustrated by the Tiananmen Square protests and crackdown of 1989. The World Bank estimates 300 million Chinese people live in poverty. In the 1990s, China swung between deflation and an annual inflation rate as fast as 24 percent in 1994. Central banks across Asia face the choice of tackling slowing growth or rising inflation. Lehman Brothers Holdings Inc. last week cut its forecast for 2008 growth in the region, excluding Japan, to 7.3 percent from 7.6 percent and raised its inflation estimate to 4.6 percent from 4.2 percent. China's government may use more currency gains and curbs on bank lending to restrain price increases. It has also imposed food and energy price controls. So far, the government is letting the yuan gain at a faster pace versus the dollar than it did last year. The currency has climbed 2 percent after rising 7 percent in 2007. A stronger currency would push up export prices and make imports cheaper
Bernanke's Rate Cuts Force Asia to Turn Back to Price Controls, Subsidies Under Bernanke's chairmanship, the Federal Reserve's steepest interest-rate cuts since 1990 are limiting his Asian counterparts' options to curb inflation. Instead of raising their own borrowing costs or letting their currencies appreciate faster, governments are resorting to regulating meat and egg prices in China, stockpiling cooking oil in Malaysia and subsidizing utility bills in Indonesia and the Philippines. Such measures may backfire. Artificial price curbs and subsidies only feed more demand for oil and other commodities, and ultimately will make it harder to contain inflationary pressures worldwide… Stockpiling, subsidies and price controls do nothing to rein in excess demand in Asia's fast-growing economies, which is already pushing up food and energy costs worldwide. The G-7 in Tokyo said governments should avoid steps to artificially lower energy prices. The Fed's rapid rate-cutting leaves Asia's policy makers with few good alternatives. China and other export-driven economies have tried to limit the appreciation of their currencies to keep their goods competitive in world markets, at the cost of higher inflation at home.
Other Factors
Finding oil: A global challenge The oil is out there. The hard part is getting it to consumers. Tight supplies and rising demand for crude. As a result, executives said, the industry faces serious challenges getting oil to market. The consensus among participants at the conference is that the world has enough oil to meet growing demand, but that the industry must focus more attention on harvesting the oil. Rising income of consumers has propped up demand even as crude prices have spiked five fold in the past six years. Runaway growth in oil use in India and China - the two countries are expected to boast a combined 1.2 billion vehicles by 2050, up from 20 million a few years ago - is expected to push demand above supply sometime between 2015 and 2020, Hess said. A small but growing number of analysts disagree with Hess' assertion that there is enough oil in the ground. They say production of oil has peaked or will peak soon, followed by a slow but steady period of decline that could cause major social unrest. Oil executives, while acknowledging that crude deposits are ultimately limited, said that new technologies should keep crude production rising for at least several decades. But much of what remains lies in remote places, Albers noted. He said producers have to work closely with countries that hold a significant chunk of the remaining supplies.
Wheat Shreds Goldman, USDA Forecasts as Global Demand Drives Record Prices The biggest rally in the history of wheat trading defied even some of the best conventional wisdom, humbling forecasters from Goldman Sachs Group Inc. to the U.S. government. Wheat has more than doubled since May, reaching a record $11.53 a bushel on Feb. 11 and driving up costs for everything from Eggo waffles and Italian pasta to Pakistani flatbreads and Japanese pastry. This month the world's biggest securities firm scrapped projections for a price drop within 90 days, and the U.S., the biggest exporter, said it would ship 23 percent more than originally estimated before summer. Wheat set a record 16 times since September, resonating around a world that relies on the grain more than any food crop except rice. Exporters Argentina and Russia halted sales or raised taxes to protect dwindling reserves. Pakistan boosted imports as inflation in January rose 12 percent, the most in 33 months. Farmers aren't keeping pace with the diets of a burgeoning middle class in India and China. The Department of Agriculture predicted Feb. 8 that U.S. stockpiles for the 12 months through May will drop 40 percent to the lowest since 1948 as global production lags behind consumption for the seventh year in eight. Droughts and rain damaged crops in Australia, France and the U.S. last year, thwarting bets that higher prices would reverse the trend by encouraging bigger harvests.