bizzXceleration: Performance, Value and Profit

Current Situation

NT Week-in-Review After the November elections, the National Bureau of Economic Research will tell us what we and the Fed already know – the U.S. economy currently is in a recession. Industrial commodity prices appear to have peaked, which will begin to moderate the trend in headline U.S. inflation in a couple of months. Businesses have little pricing power at the consumer level. There is no evidence of a wage-price spiral. The inflation-expectations’ anchor does not appear to be dragging. The dollar appears to have stabilized, in large part because of economic growth in the rest of the world appears to be slowing significantly. Losses continue to mount on the books of financial institutions, which will inhibit credit creation. Is the Fed going to raise its funds rate target over the remainder of 2008? Not bloody likely! Essentially, economic growth has slowed over the past two years (see chart 20). We have gone down the laundry list of the different components of GDP and concluded that it is unlikely that any one sector can possibly give a lift to economic growth in the near term.

If It Walks Like A Recession And Talks Like A Recession, It Must Be A Recession. (NT) the past 12 months, private nonfarm payrolls have declined by a net 535,000. In the past 12 months, the so-called birth/death adjustment has added a net 853,000 jobs. If the birth/death adjustment is excluded, private nonfarm payrolls declined by 1,388,000 in the 12 months ended July 2008 (see Chart 4). If the birth/death adjustment is inaccurately biasing upward private nonfarm employment, then all of the other government economic statistics that are derived from nonfarm payrolls also are inaccurately biased upward. Without the birth/death adjustment, perhaps the U.S. economy might not look quite as “resilient” as it allegedly is thought to be by The Wall Street Journal and its op-ed contributors.

Outlook for Consumer Spending Remains Gloomy   Nominal consumer spending increased 0.6% in June, following a 0.8% jump in May. These headlines overstate the strength in consumer spending. After adjusting for inflation, consumer spending fell 0.2% in June after a 0.3% increase in May. On a year-to-year basis, consumer spending sowed to a 1.2% increase in June, the smallest gain since October 2002. In June, purchases of durables declined 1.6% and that of non-durables was down 0.4%. Outlays on services increased 0.2%. The level of real consumer spending in June is below the second quarter average, which is arithmetically unfavorable for third quarter consumer spending. In addition, auto sales in July fell to an annual rate of 12.55 million units, the slowest sales pace since April 1992. An exceptionally robust growth in consumer spending will be necessary to offset these two negative factors in the third quarter. Moreover, wage and salary growth is not supportive of strong gains in consumer spending. Inflation adjusted wages and salaries fell 0.5% in June, after two consecutive monthly declines, albeit smaller in magnitude. Given the weakness in labor market conditions and the absence of the one-off tax rebate check, consumer spending will most likely decline in third quarter. In Retail Sales, More Signs of a Slowdown

• Economic Review [08-05-08 10:40 AM] Linda Nazareth reports on a report showing the U.S. service sector shrinking in July.
• Global Economic Outlook Kathleen Stephansen, head of global economic research at Credit Suisse, has cut her outlook for global growth. She tells CNBC's Maria Bartiromo why.
• Earnings, Economy & the Fed A look at today's market and economic highlights, with Ron Insana, of Insana Capital Partners, and CNBC's Steve Liesman & Dennis Kneale
• Economic Slowdown Just Getting Started, Says Credit Crisis 'Prophet', 'Accounting Games' Mask True Financial Pain, Says Housing Seer Rosner

Consumer Recession Looming? The U.S. economy is at the onset of the first consumer recession since the early 1990s, and it's facing headwinds comparable to the six-quarter recession that pushed the Standard & Poor's 500 Index down 40 percent in the 1970s, said David Rosenberg, chief North American economist for Merrill Lynch. "We've gone from housing to credit to employment, and now I think we're going to start to see some negative consumer spending numbers now that we're past this fiscal stiumulus program," Rosenberg said, in an interview on CNBC. Rosenberg's economic outlook turned negative when housing began to roll over, he said, comparing it to the 1980s crisis that ultimately led to lower consumer spending. Even the positives the economy has seen, such as better-than-expected report on gross domestic product growth and corporate earnings reports, were purely due to leverage, he said. "Amidst one of the biggest tax stimulus of all times, companies liquidated $62 billion inventory in the second quarter," he said. "I think that what we're trying to do is come to grips with the end of a 20-year secular credit expansion that went parabolic in the past six years," he said.

• The Frugal Future: Thoughts on the future of the economy, with David Rosenberg, Merrill Lynch North American economist.
• Final Thoughts: The U.S. Economy: David Rosenberg, of Merrill Lynch, discusses his outlook on the economy and the housing market.
• Where the Markets are Headed: Discussing the economy and stocks, with Matt Zeman, LaSalle Futures Group; David Rosenberg, Merrill Lynch; CNBC's Rick Santelli & Steve Liesman

 Strategic Outlook

U.S. Economic & Interest Rate Outlook: Base Case vs Checkmate (NT): Our base case economic scenario is that the U.S. economy entered a recession in early 2008, will remain in a mild recession throughout 2008 and will begin to experience an anemic recovery in the first half of 2009. The base case includes a sharp deceleration in inflation in the not-too-distant future as energy prices stabilize and then retreat due to a slowdown in the growth of global demand for energy. The Federal Reserve will maintain the federal funds rate at 2% through the first half of 2009. In the second half of 2009, when economic growth picks up enough to stop the upward trend in the unemployment rate, the Fed will start raising the funds rate. Our risk case scenario is that the U.S. dollar begins to fall precipitously coinciding with a rise in Treasury bond yields. U.S. inflation does not moderate because of the depreciation in the dollar. As a result, the Federal Reserve is forced to raise the funds rate even in the face of a rising U.S. unemployment rate. This would be “checkmate” for the U.S. economy, turning a relatively mild recession into a severe one. Why might the dollar dive? Because the U.S. Treasury is forced to issue more debt in order to recapitalize either Fannie/Freddie/ the Federal Home Loan Bank System/FDIC, and the rest of the world balks at being the buyer of last resort for U.S. government debt.

Thoughts on U.S. Economic Recovery Macroeconomists, like medical scientists, use case studies to teach their students about the maladies to which the system is susceptible. For supply shocks and stagflation, the example is the 1970s. The financial dislocations that occur when bubbles burst are illustrated by the Great Depression and Japan’s problems in the 1990s. The importance of central bank credibility in resisting inflation emerges from discussion of the experience of the late 1960s and the 1970s. What is most remarkable and troubling about our current difficulties is that all these elements – supply shocks, financial dislocations and concern about rising underlying inflation – are present at once. Moreover, the crisis is global in scope. Perhaps unsurprisingly in the face of so many adverse surprises, the policy debate has become cacophonous. Equally unsurprisingly given the chaotic debate, policymaking has become increasingly reactive and erratic, with a growing tendency to repeat traditional errors. While US policymakers have long cited Japan’s indecisiveness with respect to troubled financial institutions, its resort to gimmickry and market manipulation, and its lack of transparency in the management of financial crisis in the 1990s as a negative example, they are increasingly repeating Japan’s errors. The best available estimates suggest that the American economy is operating between 2 and 2.5 per cent below its sustainable potential level. This translates into more than $300bn, or $4,000 for the average family of four, in lost output. Even if, as I think unlikely, recession is avoided, growth is almost certain to be so slow that the gap between actual and potential output comes close to doubling over the next year or so. Given that unemployment peaked nearly two years after the end of the last recession, output and employment are likely to remain below their potential levels for several years in the best of circumstances.Given the combined impact of rising commodity prices, falling house prices, reduced availability of credit and rising uncertainty, it is surprising that the economy has shown as much strength as it has in recent months. While it is possible that this speaks in some way to its enormous resilience, the preponderant probability is that, as the effects of tax rebates wear off and those of tighter credit conditions feed through, the economy will take another downwards turn. Alan Greenspan has been fond of explaining that the resilience of the US financial system and economy results from reliance on two pillars: banks and capital markets. When the banks were in trouble, as in 1991, capital markets took up the slack; when the capital markets were in trouble, as in 1998, the banks took up the slack. Unfortunately, today both the banks and the capital markets show signs of crisis.The point can be put in another way. Four vicious cycles are simultaneously under way: falling asset prices are forcing levered holders to sell, driving prices further down; losses at financial institutions are reducing their ability to finance investment, which in turn reduces asset values, causing further losses; the weakness of the financial system is reducing growth, which in turn weakens the financial system; and falling output is hitting employment, which in turn leads to reduced demand for output. Without active efforts to interfere with these mechanisms, there can be no basis for confidence that the American economy will recover even in the medium term.

Data Indicators

Retailers May Flunk Back-to-School as Costs Soar, Consumers Slow Spending Retailers in the U.S. may be dreading the approach of the school year almost as much as kids, given a forecast for the worst back-to-school season in seven years. Even with projections for almost no growth, stores need to raise prices, says Burt Flickinger, managing director of Strategic Resource Group, a New York retail consulting firm. Otherwise, higher costs for everything from cotton, to shipping, to labor in China will eat away at already narrow profit margins, he said. Sellers and buyers are up against similar economic realities. Retailers such as J.C. Penney Co. in Plano, Texas, San Francisco-based Gymboree Corp. and Cincinnati-based Macy's Inc. must cope with higher costs and a U.S. dollar worth 9 percent less than a year ago. Their customers are confronting $4-a-gallon gasoline and food price increases amid a housing market decline, falling asset values and job losses.

• Wal-Mart: The end of stimulus Wal-Mart Stores Inc. on Thursday reported a smaller-than-expected increase in July sales at U.S. stores open at least one year, a signal that gains from the government's stimulus program have run their course.Wal-Mart CEO Eduardo Castro-Wright said the impact from the stimulus checks had dried up by July, and that many of the shoppers are holding off on spending until payday.
• Every hour a store is closed as 4,975 go bankrupt Over the past 217 days, at least 4,975 stores have been closed. That's about store an hour, or 23 a day. So far we are nearly double the rate of 12 a day we saw in 2007. And I doubt my list is as thorough as the experts. The recession of 2008 is causing a tremendous shake out in retail. Retailers that survive this storm, will be able to take market share left up for grabs by the departure of nearly 5,000 stores. 

Jobless claims surge: Highest level in 6 years The number of newly laid off people signing up for jobless benefits last week climbed to its highest point in more than six years as companies cut back given the faltering economy. The Labor Department reported Thursday that new applications filed for unemployment insurance rose by a seasonally adjusted 7,000 to 455,000 for the week ending Aug. 2. The increase left claims at their highest level since late March 2002.A program to locate people eligible for jobless benefits played a role in the increase, a Labor Department analyst said. However, the analyst couldn't say how much of a role. The latest snapshot of layoff filings was worse than analysts expected. They were forecasting new claims to drop to around 430,000.

ISM up but is it good news? ISM non manufacturing survey is out and the news is better at 49.5 but still in recession territory.  But once again is the headline number giving us a false impression?  I'll walk thru the components in 4 categories on the Non-Manufacturing side. 1) Up but not good news - This is the head-fake category:     a) Supplier Deliverers - normally slower deliveries are a good thing as it means the roads are so crowded the trucks can't get thru, but we have actual data that overall road congestion is significantly down.  Overall reason given for slower delivery?  High gas prices.   Truckers can't do much to save gas, but driving at 55mph instead of 75mph gives them big mpg savings. (I've moved the rest of this discussion to it's own post, ISM up because Truckers are slowing down)  b) Inventory and,  c) Inventory Sentiment - Inventory rising is not a good thing.  Here's my latest post in inventory. 2) Down and bad news (no explanation needed) Business Activity, New Orders, new export orders, imports 3) Down and good news Prices, but at over 80 are still sky high and still dragging the overall index up 4) Up and good news: Employment, very curious as we know service jobs were down in July Backlog of orders, hard to understand this.  Perhaps companies are cutting back as they expect orders to be cut in the future?  And with inventory sky high, they can certainly meet the demand.

Housing

Zillow Finds Homeowners Confident in Own Home Value Forget the phrase “Not in my backyard.” These days, homeowners are thinking “Not my house!” That, at least, is the sentiment revealed in a survey from the real-estate data company Zillow.com, which each quarter conducts a survey to gauge homeowner confidence in the health of the housing market. Zillow.com, based in Seattle, is a website that tracks home values across the country. In its second quarter survey, 62% of the 1,361 homeowners who responded to the survey by Zillow said they believe the value of their own homes has increased over the past year. But according to Zillow, that high level of optimism is out of sync with reality. The company’s research shows that the 77% of U.S. homes depreciated in value over the past year. Only 19% appreciated and five percent remained the same. Stan Humphries, Zillow’s vice president of data and analytics, said in a statement that the gap between what consumers believe their homes are worth and actual values is due to “a combination of inattention and a fair bit of denial that causes people to believe their home is insulated from the woes of the market that affect others, but not them.” The survey also found that people who thought their home’s value had increased were more likely to make improvements. About 56% of all respondents said they would be spending money on home improvements. Of those, about 17% said they would be spending money on major improvements, such as replacing a roof or remodeling a kitchen; 49% said they would be investing in minor improvements, such as repainting a room or installing a garbage disposal.

Pending Home Sales Rise in June (by CalculatedRisk) From the NAR: Pending Home Sales Rise The Pending Home Sales Index, a forward-looking indicator based on contracts signed in June, rose 5.3 percent to 89.0 from a downwardly revised reading of 84.5 in May, but remains 12.3 percent below June 2007 when it stood at 101.4.The pending home sales index has been between 83 and 90 for almost a year. This shows the impact of foreclosure sales - according to the NAR, "short sales and foreclosures [account] for approximately one-third of transactions". This foreclosure activity will probably keep existing home sales (and the pending home sales index) elevated for some time.

• June Pending Home Sales Up Unexpectedly

Who Doesn't Understand the Pending Home Sales Index? I'll make this as simple as possible. (If you are a journalist that covers this area, you best read and UNDERSTAND this). The NAR release makes clear (in the footnotes) that the Pending Home Sales Index was a NEGATIVE REPORT. This was not a positive, despite what you may have read. Here are 4 details you need to understand: 1. The Pending Home Sales Index is down 12.3% Y/Y. As the NAR notes itself, it is the annual data, not the monthly number, that matters most. 2. 30-40% of these pending sales were distressed/foreclosure sales. Many of the ‘pendings’ are short sales -- bought for much less than the amount owed amount owed on the mortgage. The majority of these will not get approved by either the seller (REO Bank) or the financer (mortgage orignator). 3. There is a growing gap between PHSI and actual closings (See NT chart below). 4. The monthly rise is nothing more than regular seasonality.

Credit  Conditions

Mortgage Delinquencies Accelerated During 2007 Mortgages issued in the first part of 2007 are going bad at a pace that far outstrips the 2006 vintage, suggesting that the blow to the financial system from U.S. housing woes will be deeper than many people earlier estimated. An analysis prepared for The Wall Street Journal by the Federal Deposit Insurance Corp. shows that 0.91% of prime mortgages from 2007 were seriously delinquent after 12 months, meaning they were in foreclosure or at least 90 days past due. The equivalent figure for 2006 prime mortgages was just 0.33% after 12 months. The data reflect delinquencies as of April 30. Yet the data from the FDIC and others suggest that lenders didn't substantially tighten standards until at least July or August 2007, when credit jitters hit Wall Street and financial stocks began to swoon. Until these bad loans are fully digested, "foreclosures will remain at record highs, the financial system will be under severe stress and the broader economy will sputter," said Mark Zandi, chief economist of Moody's Economy.com. One piece of good news, he said, is that loans originated in the fourth quarter of 2007 and early 2008 appear to be performing better.

Morgan Stanley Freezes Home-Equity Credit Lines for Thousands of Customers Morgan Stanley, the second-biggest U.S. securities firm, told thousands of clients this week that they won't be allowed to withdraw money on their home-equity credit lines, said a person familiar with the situation. Most of the clients had properties that have lost value, according to the person, who declined to be identified because the information isn't public. The New York-based investment bank will review home-equity lines of credit, or HELOCs, monthly from now on, the person said yesterday. Wall Street firms including Morgan Stanley are ratcheting back on risks after the collapse of the subprime mortgage market and ensuing credit contraction saddled banks and brokerages with almost $500 billion of writedowns and losses. Consumers fell behind on home-equity credit lines at the fastest pace in two decades in the first quarter, the American Bankers Association reported last month.

• AmeriCredit: Auto Loan Originations Down Sharply