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Economic Readings

Dispelling the Myths of Summer The current downturn — and I’d say the odds that it’s a true recession are about 75 percent — has no one dominant mythology. Instead, there are several different myths starting to make the rounds. Just like the one about Sept. 11, they tend to make the economy’s problems sound simpler than they really are. On Thursday morning, the Labor Department will release the latest jobs report, which is typically the most telling economic indicator. It covers the entire economy and gives a sense of how families are being affected by it. This week, economists are expecting yet another bad report, with a sixth straight month of job losses. But whatever the report shows, the job market is likely to remain weak through the end of the year, because employment generally continues to fall for months after a downturn has ended. But the long-term solution can’t revolve around efforts to slow globalization, technological change and other forms of economic churn. We need more churn, not less. … American prosperity of the 20th century sprang largely from the country’s longtime lead in educational attainment, a lead that has all but vanished. Future prosperity won’t be based on saving yesterday’s high-wage jobs, as Mr. Katz told me. It has to start with smarter, more strategic investments in education, physical infrastructure and other things that can create the high-wage jobs of tomorrow. The second big myth is the one that has been occupying Congress — the idea that the spike in oil prices is a big mystery that can be explained only by market manipulation. Other writers have done a nice job of debunking the manipulation argument. I’ll stick to the reasons why the run-up, abrupt as it may feel, isn’t mysterious. The low prices of the 1990s reversed those incentives. Americans fell in love with Hummers and pickup trucks, and the Chinese and Indian booms were fueled by cheap energy. Oil supplies, meanwhile, weren’t growing so quickly. It will stay expensive until the fundamentals — supply and (more important, for the sake of the planet) demand — change. Another cycle that still has a way to go is the housing bust. Prices have fallen by more than 20 percent in some cities, which has made renters (like me) more willing to buy again. These price declines have also led some experts to start proclaiming that the real estate market is close to the bottom. It isn’t. By any measure — prices relative to incomes, prices relative to rents, the number of homes languishing on the market — houses are still overvalued. Come Labor Day, prices will still be falling. In some places, they’ll still be falling by Labor Day 2009. The common thread in these myths is that they serve to minimize the scope of the economy’s weakness. They make it sound as if the problems are acute — job cuts, oil speculation, a little real estate overexuberance — rather than fundamental.

• There's a Price to Economic Pessimism, Behind the Bush Economic Bust, Hackononics, Part II, America's Human Capital Is Tested

Five phases to the current down-cycle There have been five phases to this current down-cycle – the first four are still in full swing, but it is the fifth that will very likely emerge as the most difficult stage of this economic downturn and bear market: 1) The first wave was the end of the housing cycle when starts peaked and began to roll over in the first quarter of 2006. 2) The second wave was the end of the home price bubble when the Case-Shiller index began to deflate in the first quarter of 2007. 3) The third wave was the end of the credit cycle when the interbank market froze in August 2007. 4)The fourth wave was the employment cycle, which peaked when payrolls did in December 2007, prompting the Fed to reluctantly embark on an aggressive policy easing course. 5)The fifth wave will be the end of the consumer cycle and the beginning of what may well prove to be the most significant recession since the mid-1970s, and while delayed by the tax rebates, this phase seems to have commenced in June when U of M consumer sentiment collapsed to its lowest level in 28 years. Prospects for a profit plunge are palpable In the final analysis, only two things go into the forecast for the S&P 500 –earnings and the multiple that investors are willing to pay for that future earnings stream. While it is normal to see corporate profits decline 30% in a recession, what makes the current and prospective backdrop more sinister is that we headed into this recession with profit margins at sky-high levels. The ratio of pretax profits to nominal GDP has already started to recede from its nearby 55-year high of 14% as we headed into recession to 12.2% currently, but consider that recession troughs usually occur just south of 7% on this metric. If we overlay this with S&P 500 earnings per share, what we are then talking about is the strong possibility that profits end up being cut in half during this bear market – which would mean an ultimate low of around $45 on operating earnings (in other words,we are only one-third of the way through the earnings turndown at a time when the consensus seems to priced for the bottom being right about now!).

Deepening Cycle of Job Loss Seen Lasting Into ’09 Experts say the troubles dogging the economy will be stubborn, leaving in place tight credit and scant job opportunities perhaps well into next year. Until recently, the weak labor market has been marked more by the reluctance of employers to create new jobs than by mass layoffs. Among economists, the sense is broadening that the troubles dogging the economy will be stubborn, leaving in place an uncomfortable combination of tight credit and scant job opportunities perhaps well into next year. “It’s a slow-motion recession,” said Ethan Harris, chief United States economist for Lehman Brothers. “In a normal recession, things kind of collapse and get so weak that you have nowhere to go but up. But we’re not getting the classic two or three negative quarters. Instead, we’re expecting two years of sub-par growth. Growth that’s not enough to generate jobs. It’s kind of a chronic rather than an acute pain.” Mr. Harris expects tepid economic growth and a shrinking labor market to persist through the fall of 2009. The slide in the labor market has become both symptom and cause of a weak economy, pulling many families into a downward spiral. Back when housing prices were still rising, Americans borrowed exuberantly against the value of their homes to finance renovations, vacations and shopping sprees. But that artery of finance has constricted considerably along with access to credit cards, forcing a reversion to the traditional limits of household finance. Millions of American families must now confine their spending to what they can bring home from work. With job losses growing and working hours shrinking, many paychecks are eroding, prompting millions of families to cut their spending. Soaring prices for food and gasoline are overwhelming modest wage gains for most workers, leaving households with even less money to spend. All of which deprives struggling businesses of sales, prompting them to shed more workers, sending the cycle down another turn.  Chart

• U.S. Economy Loses 62,000 Jobs, Sixth Straight Drop; Unemployment at 5.5%

• Long-Term Unemployment Rises (WSJ) The number of people unemployed for at least 27 weeks has risen 37% in the past year, according to a Labor Department, and is likely to increase even more.

(5*) James Grant, editor of Grant's Interest Rate Observer, and Brad Hintz, an analyst at Sanford C. Bernstein & Co. and a former chief financial officer of Lehman Brothers Inc., talk with Bloomberg's Pimm Fox in New York about the outlook for U.S. consumer spending, Treasury Secretary Henry Paulson's call for regulatory changes that would allow financial firms to fail without threatening market stability and the outlook for brokerages. VIDCLIP

Survey: US Econ. Will 'Stall' The U.S. economic expansion may slow to the weakest pace in six years in the fourth quarter, after the impact of federal tax rebates fades, according to a Bloomberg News survey. The world's largest economy will slow to a 0.5 percent annualized growth rate from October to December, down from a 1 percent estimate last month, according to the median forecast of 63 economists surveyed from June 30 to July 9. Analysts anticipate consumer spending will rise 0.2 percent next quarter, the smallest gain since 1991. Federal Reserve policy makers will forgo raising interest rates until next year as the expansion stalls, the survey shows. That contrasts with traders, who estimate 68 percent odds of at least a quarter point rate increase by year-end.

Monetarists Warn of a Deflationary Crunch The money supply data from the US, Britain, and now Europe, has begun to flash warning signals of a potential crunch. Monetarists are increasingly worried that the entire economic system of the North Atlantic could tip into debt deflation over the next two years if the authorities misjudge the risk. The key measures of US cash, checking accounts, and time deposits - M1 and M2 - have been contracting in real terms for several months. A dramatic slowdown in Britain's broader M4 aggregates is setting off alarm bells here. Money data - a leading indicator - is telling a very different story from the daily headlines on inflation, now 4.1pc in the US, 3.7pc in Europe, and 3.3pc in Britain. Paul Kasriel, chief economist at Northern Trust, says lending by US commercial banks contracted at an annual rate of 9.14pc in the 13 weeks to June 18, the most violent reversal since the data series began in 1973. M2 money fell at a rate of 0.37pc. "The money supply is crumbling in the US. There was a very sharp lending contraction in the second quarter lending. If the Federal Reserve is forced to raise rates now to defend the dollar, it would be checkmate for the US economy," he said.

ISM is up, but it isn't good news The Chicago survey of Purchasing Managers (PMI) jumped from 49.6 to 50.2, meaning the manufacturing sector went from recession territory to positive.  And keep in mind the survey was expected to fall to 49.  That sure sounds like good news, and many in the media (USA Today)  (NY Times) will tell you it's good news. But unfortunately it isn't.  The guts of the index tell a very different story. Orders were down from a month ago and are still in negative territory. This is now the 7th month in a row that orders have contracted. True, ISM said production was up this month, and that should be encouraging, but it all went into inventory.  In other words, companies are building at a healthy clip, but nobody wants it.  Manufacturing inventory spiked up and was so immense we had the first month since April of 2006 where most manufacturing companies said inventory was climbing. In the intervening two years the majority of firms said inventory had been declining.  But that isn't the end of the inventory story.  Purchasing managers said that their customers inventory went through the roof, not surprising as deliverers were up.  Their customers said their own inventory hadn't piled up like this since January of 2001.

Business Confidence at a 28 year low During the very worst of the 2001 recession in November of 2001 small business confidence as measured by the NFIB hit 97.3.  At the low point of the more serious 1990 recession confidence dipped even lower at 91.7 in January of 1990. The most current reading of June 2008 ?  It's much lower, only at 90.0.  Only during the very worst of the 1980 recession did business optimism drop lower than that. Regardless, businesses believe we are in a significant recession right now and their actions will reflect their belief. One way that is reflected is in their outlook for sales and purchases.  As seen here, today's reading of expected real sales volume (as a 6 month moving average) is in record low territory and it will rapidly move lower as the past two months readings have been -11 and the reading 6 months ago was +4, once that positive number drops out of the average the overall value will continue falling.

·         The Other Shoe Drops The consumer is down and out. The slide in auto sales and home sales make that clear. What about business investment in new capital goods? Unfortunately, new orders for nondefense capital goods have stalled, too. The Census Bureau reported May’s figure as 74.1 billion. Plug that number into the following chart, and you can see that business capital expenditures have stopped growing.

Credit Crunch in U.S. Is Worsening, Nomura's Diebel Says: Chart of the Day U.S. lenders are demanding higher borrowing standards and charging more for credit, which threatens to crimp growth and drive up unemployment, according to Charles Diebel, a strategist at Nomura International Plc in London. An index compiled by the Federal Reserve shows that companies are having to pay more for their money than they did when borrowing costs peaked in 1991 and 2001, Diebel wrote in a research note yesterday. ``This should not be underestimated in terms of the impact on the macro economy,'' he wrote. ``It poses a much higher running cost in general to any credit provision and, likewise, the lack of credit availability slows growth markedly. It always has and always will.'' The chart of the day tracks the Fed's loan officer surveys. The red line shows funding costs are at their highest level since the indexes began in June 1990, while the white line tracks borrowing standards, which are just shy of their peak. ``We are only now getting to such extremes and thereby the demand destruction process in the U.S. is only now reaching full intensity,'' Diebel wrote. ``It certainly argues against the Fed raising rates but more worryingly, suggests we could be set for further macro deterioration in terms of growth and employment into year-end.'' Chart of the Day

Incoming Data Present Discouraging Outlook for U.S. Exports For four consecutive years exports of the U.S. have accounted for a significant part of GDP growth (see chart 1). Embedded in forecasts of U.S. economic growth in 2008 and 2009 is an expectation that exports will continue to make a substantial contribution and be a partial offset to weakness elsewhere in the U.S. economy. Industrial production in Germany plunged 2.4% in May, inclusive of a 2.6% decline when construction is excluded (see chart 4). The weakness was concentrated in manufacturing output, which declined 2.6%, after smaller contractions in March and April. It is widely expected that GDP of Germany will fall in the second quarter after a 1.5% increase in the first quarter. The news from the U.K. was also grim, with industrial production excluding construction declining 0.8% in May. In light of the weakness in factory production, headline GDP growth for the U.K is also expected to show a minus sign for the second quarter. These reports suggest that forecasts of exports of the U.S. economy in the near term may have to be revised.