bizzXceleration: Performance, Value and Profit

 

Those are actually pretty amusing, especially since this round's intermediate chart shows almost exactly the same things: the market bubbled up briefly over the upper bound of the downtrend which coincided almost exactly with a Fib limit. At the same we said if you were in the Markets you were trading or speculating and betting on a very fragile continued speculative bubble carrying up over those lines of resistance into a new Fib-box. It turns out being a sceptic was the right call, so far. The question is, having failed at those points, how much farther might the markets fall - bearing in mind the current outrageous long-term PE valuations? We won't read off the Fib limit resistance lines since you can do that but notice the congruences between short-term and long-term again. Yet S&P sees the markets finishing around 1215 for the year! Which is not much of a rebound but at minimum tells us that we're facing a lot of volatility and no fundamentals. At least IOHO!

Economic Fundamentals

With the first release of Q409 GDP just behind us, the new employment numbers just out, coupled with a massive re-basing of the employment data that increased total jobs lost from 7+ million to 8+ million we should ask where are we at? And what's going on? An earlier chart on GDP, Consumption and Employment is here, and as you can see by clicking thru, things have indeed turned the corner. We'll embed more on GDP and Consumption in the charts we will look at but our primary focus is going to be on Employment and Demand. The thing that the Markets, and decision-makers for that matter, seem to have so much trouble wrapping their heads around.

As the top sub-chart shows three different measures of Employment have all turned up but are still in seriously negative territory. The really important point is the second sub-chart which contrasts GDP and cumulative job losses. With the data revisions we went from being ~13 million jobs in the hole to being 14.2 million in the hole. Something we've discussed previously is that we'll need 20 million new jobs to get back to breakeven and offset labor force growth. At a likely 2.5% GDP growth rate it'll take about SEVEN years to get Unemployment back down in the 5% range. Talk about your weak recoveries!

Job Growth Realities: Negative Job Growth

Bearing in mind that even with the improvement in decreasing losses we still lost jobs, particularly in the private sector. So let's remind ourselves of what that means by looking at Private job creation over the last decade+.

In some ways the important chart here is the bottom one, which shows private jobs in total. It also shows that no new jobs have been created since Q498! In other words in eleven years the US economy has created NO new jobs! How abysmal is that?

The top chart is a repeat but let's take a closer look. We've been beating our and your chops about the last "recovery" not being organic, that is it never reached a point of self-sustaining growth where new consumption created new investment created new jobs and so forth. If you look at the top chart you can see where ALL the employment indicators reached a peak in Q106 and started dropping and then started falling off a cliff in Q407/Q108, which is exactly when the NBER called the start of the recession. Yet as late as the early Fall08 we were still arguing with people about whether or not we were in a downturn, let alone how serious it was going to be. What kept things up at all last time was the Housing bubble and home equity ATM - what're the chances for that coming back do you think? De Nada we'd say.

Demand and LT Issues: Policy, Politics and Unintended Consequences

The two poles of the economic field in the NN are the poor recovery picture in the developed world and the resulting re-balancing of the global economy. Meaning, as we argued thruout the last two posts, that the export-led economies in the rapidly emerging world would have to undergo major shifts from an external dependency to an internally-driven economy. Something which they acknowledge, claim to be working on but are not working hard or fast enough to address. Yet adjustment to the NN is NOT voluntary. Right now the geo-political pressures on China to adjust its exchange rate and growing pushback on trade are symptoms of this on-coming tsunami.

The other thing that's going on is that this is a VERY policy-dependent economy. Part of the fragility and turbulence, which the markets allowed themselves to ignore or neglect, is that meant that low rates, quantitative easing to subsidize l.t. rates and help banks re-build balance sheets (which btw they haven't but instead are paying themselves bonuses, doing the grossly inprudential thing in the jargon) and stimulus spending. Now to make it even more fun various political actors have been raising the specter of excessive deficits and debts at precisely the wrong time. That's a 3-phase problem. In the emergency massive stimulus, in the intermediate term the total debt levels in the US are manageable and the economy is still vulnerable and in the long-term (beyond 2016) and after recovery is back on its feet would be the time. Instead government is being forced to rein in stimulus. Managing all the moving parts of this transition is going to be, in a different way, as difficult and challenging as saving the world in the first place. Made more complicated by all the conflicting political partisans.

Which sets up this next chart. Our favorite indicator of future demand is the sum of the growth in Employment and Real Wages. The downturn caused a major drop in inflationary pressures, particularly as Oil prices dropped, which created a surge in real wages. Now Employment pressures are having the opposite effect. So in the bottom sub-chart you can see GDP and Employment turning up but Wages+Employment not only turning down, we're past that. Instead it's dropping and getting pretty negative. In fact about as bad as it's been for thirty years! Though not quite in the same range as it was during the brief but serious downturn in the 1980 downturn. But then we had a pretty good idea it was temporary. This time?

So there you have it. Market's delusions being stripped away a tiny bit, policy realities setting in and the prospects for demand growth rather poor on the evidence to date. And with mounting political pressures to tighten budgets - which is the same recipe that destroyed the nascent recovery from the GD in 1937. Ought to make you wonder where we'll end up, eh? But, just for the record, we're hardly alone in our views on the influences of policy on the markets and economy. For one thing you can re-review the post on Davos. Or watch this edition of Wealthtrack which digs into all the sudden structural shifts that are on transitional cusp points.

Markets

Previous Posts

• Markets & Economy: Noise, Signal, Some Worrisome Signs
• Review & Outlook: Economy, Markets and Business in the New Normal
• Chaos, Turbulence and Policy: Market Lookback, Outlook & Risks

Readings

Stimulating debate AS JANUARY goes, so goes the year. That old stockmarket saying does not augur well for 2010, given that the MSCI World index fell by 4.2% in the month, the biggest decline since February 2009, and emerging markets dropped by 5.6%. Although markets rallied a bit in early February on better-than-expected economic data, the poor start to the year reflected an inherent contradiction to the rebound of 2009. That rally seemed to be dependent both on extraordinary stimulus measures by governments and central banks, and on a vigorous economic recovery. But both cannot co-exist for long: either the recovery will not last or, if it does, the stimulus will be taken away. In addition, governments’ ability to provide that stimulus is dependent on the markets’ own willingness to fund huge deficits at very low yields. But why would investors accept meagre yields if they expected a vigorous recovery? In a sense, the market seemed to be hauling itself up by its own bootstraps. Sure enough, the bullish story has started to unravel, if only at the edges. In the developing world China has attempted to tighten monetary policy. That has caused some alarm because China was acting as the engine of global growth. And in the developed world investors have started to question the ability of governments to keep financing their deficits. The authorities face a dilemma. Reduce the stimulus now and they risk plunging the economy back into recession, as happened in America in 1937 and Japan in 1997. But leave the stimulus in place for too long, and they risk damaging long-term growth prospects. The bulls hope that the economy can escape from this trap by the simple expedient of private-sector growth. That is why they welcomed the rise in manufacturing activity signalled in this week’s latest purchasing managers’ indices. If the private sector rebounds of its own accord, unemployment will fall and budget deficits will decline. But hopes for a strong private-sector recovery are undermined by the data on credit growth. In the year to December, the broad measure of money supply fell by 0.2% in the euro zone and grew by just 3.4% in America. In Britain the annual growth rate is higher (6.4% in December), but David Owen, an economist at Jefferies International, estimates that quantitative easing (QE), whereby central banks create money to buy assets, has been boosting the figure by an annualised rate of 10%. If the Bank of England stops QE entirely, the credit-growth rate could collapse. For the stockmarket rally to resume properly in 2010, economies in the developed world need to show they can stand on their own two feet.

Beware the 4 new asset bubbles Less than two years after the housing market collapsed, the U.S. economy is threatened by a new bubble in asset prices. This time, four billowing balloons are hovering: two commodities -- gold and oil -- stocks, and government bonds.Don't be fooled into thinking that last week's 5% drop in the S&P, and the recent sell-off in oil, remotely makes them fairly valued, let alone bargains. Equities and commodities, as well as Treasuries, which actually rallied as stocks dropped, still have a long way to fall. The reason: They've already seen huge run-ups that put their prices far above their historic averages, and far above the levels justified by fundamentals. Two examples: Most companies can't possibly grow earnings fast enough to support their lofty valuations, and oil and gold are so expensive that we'll see what high prices always bring, a surge in new supply. That makes a price-pounding glut inevitable. Since the start of 2009, oil has returned to the danger zone by jumping 63% to $75 a barrel, and gold has risen more than 20% to set astounding new records by climbing above $1,100 an ounce. After briefly returning to historically normal valuations in March, stocks are now selling at price-to-earnings multiples 40% above their historic range of 14, and 10-year Treasuries are so pricey that they yield 1.5% less than they did in 2007. What's causing this resurgence of speculative fervor? One view blames the same policy that caused the real estate rampage -- incredibly low interest rates that are flooding the banks with cheap funds that, in theory, are available for loans. (The current Fed target rate is between 0 and 0.25%.) The one asset that definitely isn't bubbling is housing. There, prices have fallen to a level where new buyers buy a house for the same total monthly cost as rental. That's gravity operating. So how do you spot a bubble? My view is that we're now seeing the same signs that exposed the frenzy in real estate: prices flying far above their historic averages, measured either in inflation-adjusted dollars (commodities) or as a ratio of the income they produce (stocks and Treasuries). Watch for gravity to take over, just as it did in housing.

• Stocks, Commodities Drop on Concern U.S. Unemployment to Derail Recovery
• Commodities Tumble the Most Since August on Concern Consumption May Falter
• Oil falls 5 percent in steepest drop since July
• Get your portfolio ready for the profitless global economic recovery

End of TALF Means Bond Sales With Spreads Five Times Wider: Credit Markets  The end of a Federal Reserve program that helped unlock credit markets is spurring sales of asset- backed bonds with relative yields five times wider than on debt secured by car loans. The expiration of the Fed’s Term Asset-Backed Securities Loan Facility is driving companies to sell bonds tied to loans that would otherwise require higher yields. Borrowers are offering bonds backed by subprime auto loans, mortgage-servicing payments and assets that have proved hard to sell after the worst credit seizure since the Great Depression. “What we are seeing in the last couple of rounds are issuers in non-traditional asset classes and weaker issuers looking to fund as much as they can before the window closes,” said James Grady, a managing director at Deutsche Asset Management in New York. The firm has $240 billion in assets under management, including asset-backed securities.

Bernanke's Exit Strategy: Tighter Reserve Requirements Phase one of the recovery is certainly complete. Since September 2008, the Fed has bought mortgage-backed securities and Treasurys, and increased the monetary base to $2 trillion from $850 billion. The flood of dollars has bank profits booming. Sadly, banks still have all those underwater mortgage-backed securities and derivatives, but Mr. Bernanke is assuming they will just earn their way out of this problem. Banks also are not lending enough to get the job-creation engine rolling again—though sooner or later they will, at which point inflationary pressures will build tremendously. So every currency trader, bond buyer and man on the Street wants to know one thing: "What's the exit strategy, Ben?" Raise interest rates, shrink the money supply and risk cratering the economy, or keep rolling along and risk a collapsing dollar? My guess? Mr. Bernanke will leave the money out there but restrict banks' ability to create more out of thin air. He'll be called crazy. Crazy like a fox. The Fed has a once-in-a-millennium opportunity to do away with banking panics. Investors will rejoice, but Wall Street firms are not going to like it one bit. Our banking system has changed little since the days of Elizabethan goldsmiths writing more gold receipts (aka banknotes) than they had gold in their vaults. This "fractional reserve banking" system has caused every major panic in this country—I've counted at least 16 of them since 1812. Whatever the era, the story is always the same. Banks keep small reserves, and then invest in supposedly safe "sure things" to generate profits beyond the interest paid to depositors. Sure things can be real-estate loans, home equity, credit card and commercial debt. But bankers are terrible investors. There are no sure things. You do need lending for an economy to function, but you don't need all that much leverage. Increased reserves may be the best financial reform we can hope for without politicians mucking it up. No need for pay czars and repressive rules. Even a whiff of lower leverage and increased reserves will create a dollar rally, as inflationary fears—that banks will create too much money when the economy gets going again—subside. Oil at $50? Gold at $700? If I'm right, banks and Wall Street are going to scream bloody murder at their new shackles. But so what, they've had plenty of time to recapitalize themselves and show record profits and compensation, a gift of Mr. Bernanke's zero-interest-rate policy. Tighter control of money supply would mean the Fed no longer has to guess if banks are creating too much or too little. Lower leverage would keep bubbles from forming in the first place. Crazy.

Financial turmoil strikes as G-7 officials gather A bout of turmoil in global markets has provided sobering reminder to global financial leaders that the aftershocks from the worst recession in seven decades are far from over. Finance ministers and central bank presidents from the world's seven major industrial countries -- the United States, Japan, Germany, France, Britain, Italy and Canada -- were scheduled to arrive Friday for discussions in this small snow-swept Canadian town about 200 miles south of the Arctic Circle. The talks are expected to be dominated by the question of how much longer extraordinary government stimulus should be provided to lift economic growth. The risks still facing the global economy were highlighted dramatically after bad economic news sent markets plunging around the world on Thursday. The Dow Jones industrial average fell by 268 points or 2.6 percent, its biggest one-day loss in seven months. The slide had begun in Europe over concerns about high debt levels in Greece, Portugal and Spain. Worries in those countries set off broader concerns that government will have difficulty containing rising debts and borrowing more money to help revive their economies.

• Fraying at the Edges
• Investors Fear Europe’s Woes May Extend Global Slump
• European crisis highlights fragile global recovery

Mohamed El-Erian: Tough times ahead Geoff Colvin: We've had one quarter of solid economic growth. Is the recession over? Mohamed El-Erian: Yes, but an important, qualified yes. We've had one quarter of economic growth, which is probably going to be revised down, but it's going to be in the 2½% range for the third quarter. The fourth quarter will probably be in the 3% range. The question is, Can we sustain growth in 2010? And our worry is that it's going to be very difficult. What does it depend on? It depends on this handoff from very artificial sources of growth, first and foremost the stimulus. We've had the biggest stimulus in history, fiscal and monetary, and we're feeling the benefits of that. And there's a natural inventory cycle -- you come to a point where inventories are run down, and some building up begins. That's what the second half of 2009 is. These are not permanent sources of growth. So you need to hand off to the private sector -- to consumers and companies -- and for that to happen, a lot of very positive things have to occur, and they are unlikely to occur. What are the most important things that individual investors need to do differently? The average investor has two issues today. First, the average investor is too U.S.-centric. There's a reason for that; the behavioral finance people will tell you that we like the familiar, so we tend to invest in names that we know, that give us comfort. The problem is that you don't want to be too U.S.-centric in a globalizing world where the center of gravity is shifting. So the first thing for the average investor to recognize is that the asset allocation of tomorrow is much more global than the asset allocation of yesterday. Second, most of us have been very lucky -- we haven't had to worry about inflation for a long time. We're moving toward a much more fluid world in which, at some point, inflation will come back.

• Investing in a complicated world In a multimedia feature, Pimco CEO Mohamed El-Erian talks about the post-Lehman, globalizing economy.
• Investing in Turbulence: EMH, Irrational Markets & Pragmatic Decisions
• Active Allocation, Active Investing: Investing Guidelines for Lost Decade #2
• Meet the market's 10 biggest losers

Stockpickers suckered HOW do you pump up the value of your company in these difficult times? One tried and tested way is to hoodwink equity analysts, according to a new study* of 1,300 corporate bosses, board directors and analysts. The authors found that chief executives commonly respond to negative appraisals from Wall Street by managing appearances, rather than making changes that actually improve corporate governance: boards are made more formally independent, but without actually increasing their ability to control management. This is typically done by hiring directors who, although they may have no business ties to the company, are socially close to its top brass. Depressingly, these market-distorting shenanigans are part of a pattern. An earlier study found that public companies commonly enjoy lasting share-price gains from plans that please analysts, such as share buybacks and long-term incentive schemes for executives, even when they fail to follow through on announcements. Another concluded that the further a firm’s profits fall below consensus forecasts, the more favours its managers bestow on analysts—such as recommending them for jobs and even securing club memberships for them—and the lower the likelihood of a further downgrade. If investors rated analysts, those taken in by such blatant attempts at manipulation would surely earn a “sell”.

Economy and Policy

BizzX Economic Whitepapers

Dealing With the New Normal: Economic Situation, Market Outlook and Business Performance We barely survived a very difficult downturn but are now facing a sustained period of sub-par growth, poor job creation, major changes in consumer demand and related challenges. Meanwhile Markets are over-valued and anticipating a return to the old normal - raising the risks of poor returns. At the same time businesses are struggling to catchup to the surprises of the downturn, improve performance and re-position themselves. Any stakeholder needs to under the relationships between the economy, markets and business performance and assess which ones are likely to well in this new environment compares to the many who will not. Whether your an investor, employee, executive, customer or business partner you will have to cope with these challenges and should consider adjusting your decisions in line with the situation we see emerging.

Chaos, Turbulence, Fragilities: Defining the New Normal, Blueprinting Business Performance In an exchange with a friend on business performance in the new normal, despite several months of back and forth, most of what we'd been saying about the next decade hadn't really sunk home but we finally managed to get the other shoe to drop. His reaction was somewhere between Wow and OMG! What that exchange makes clear to us is that, in line with our expectations, most businesses haven't a clue as to what's coming at them. So those issues (defining the New Normal benchmark and assessing business preparation and performance outlook) define our endpoints. At the same time we had an amazing, in many senses State of the Union and Davos 2010 kicked off. This environment has moved from Chaos to Turbulence and is still very Fragile - and will remain both Turbulent and Fragile for the decade as deep structural adjustments in the global economy, governance (corporate and public) and geo-politics that will radically alter the deep foundations we've taken for granted for the last three decades are changed in response to the crisis and governance and performance failures. Those changes are a central theme of this year's conference.

Readings

Labor Market Shows Signs of Rebirth in New Data The unemployment rate unexpectedly dipped to 9.7 percent in January, from 10 percent in December, the government reported Friday, buoying hopes that the worst job market in at least a quarter-century is finally improving.But a different survey in the Labor Department’s report found that the economy lost 20,000 net jobs during the month, muddying the picture and underscoring the formidable struggles still confronting millions of Americans. Yet with the pace of decline slowing, most experts focused on signs that the economy was recovering after the longest recession since the Great Depression. Manufacturing added 11,000 jobs in January, the first monthly increase since November 2007, while the length of the average workweek rose slightly at factories. The economy added 52,000 temporary workers, and average wages increased modestly, amplifying the view that commercial activity is reawakening after two years of hibernation.

•  Is America experiencing a jobless recovery?
• Off the Charts: A Recovery That’s Factory-Built and Gaining Speed, Manufacturing Output and Employment
• Unemployment Drops to 9.7%, Employment Report: 20K Jobs Lost, 9.7% Unemployment Rate
• Employment-Population Ratio, Part Time Workers, Temporary Workers, Dissecting the NonFarm Payroll Data

Can the Chinese consumer save the global economy? All the world has to do is wait, and the Chinese consumer will pick up the shopping bags dropped by exhausted U.S. consumers and spend the global economy back to prosperity. At least that's how the hopeful story goes. But a new study from consulting company McKinsey makes me doubt exactly how much global lifting China's consumers will be able to do over the next couple of decades. The big obstacle is the heavy structural emphasis in the Chinese economy on exports and government-led investment. In 2007, China was the fifth-largest consumer market in the world, behind the United States, Japan, the United Kingdom and Germany. But consumer spending accounts for a much lower percentage of the economy in China -- just 36% in 2008 -- than in the United States (71% of gross domestic product in 2008), the United Kingdom (67%) or Japan (55%). China's consumer-consumption-to-GDP ratio is low even for the developing world. Brazil's ratio came in at 65% in 2008, India's at 57% and Thailand's at 54%. As McKinsey points out, China has the lowest consumption-to-GDP ratio of any major world economy except Saudi Arabia, where oil exports account for a huge share of the economy. In fact, China's consumer has been losing ground since 1990, when consumer consumption accounted for 51% of GDP.

China’s Strategic Outlook(Stratfor) Both investors and countries whose economies are dependent on China start February increasingly worried about the direction of the Chinese economy. Monetary tightening and misallocation of resources mean that present growth expectations are unsustainable.

China/US Relations For the first time, China has threatened to sanction U.S. arms manufacturers linked to a $6.4 billion defense deal for Taiwan. The response signals a new level of tension in the complex web of Sino-U.S. relations, analyst Matt Gertken says.

• China isn’t an asset bubble waiting to burst–it’s worse
• Time to stop believing that capitalism will liberalize China’s society
• The rout in global stocks is a tempest in the teapot of China’s command economy
• Biggest Bubble in History Is Growing Every Day: William Pesek
• Never short a country with $2 trillion in reserves?
• The myth of China’s blithe consensus
• China Rejects U.S. Complaints on Its Currency

Fiscal Scare Tactics These days it’s hard to pick up a newspaper or turn on a news program without encountering stern warnings about the federal budget deficit. The deficit threatens economic recovery, we’re told; it puts American economic stability at risk; it will undermine our influence in the world. These claims generally aren’t stated as opinions, as views held by some analysts but disputed by others. Instead, they’re reported as if they were facts, plain and simple. Yet they aren’t facts. Many economists take a much calmer view of budget deficits than anything you’ll see on TV. Nor do investors seem unduly concerned: U.S. government bonds continue to find ready buyers, even at historically low interest rates. The long-run budget outlook is problematic, but short-term deficits aren’t — and even the long-term outlook is much less frightening than the public is being led to believe. So why the sudden ubiquity of deficit scare stories? It isn’t being driven by any actual news. It has been obvious for at least a year that the U.S. government would face an extended period of large deficits, and projections of those deficits haven’t changed much since last summer. Yet the drumbeat of dire fiscal warnings has grown vastly louder. Let’s talk for a moment about budget reality. Contrary to what you often hear, the large deficit the federal government is running right now isn’t the result of runaway spending growth. Instead, well more than half of the deficit was caused by the ongoing economic crisis, which has led to a plunge in tax receipts, required federal bailouts of financial institutions, and been met — appropriately — with temporary measures to stimulate growth and support employment. The point is that running big deficits in the face of the worst economic slump since the 1930s is actually the right thing to do. If anything, deficits should be bigger than they are because the government should be doing more than it is to create jobs. True, there is a longer-term budget problem. Even a full economic recovery wouldn’t balance the budget, and it probably wouldn’t even reduce the deficit to a permanently sustainable level. So once the economic crisis is past, the U.S. government will have to increase its revenue and control its costs. And in the long run there’s no way to make the budget math work unless something is done about health care costs. But there’s no reason to panic about budget prospects for the next few years, or even for the next decade. Consider, for example, what the latest budget proposal from the Obama administration says about interest payments on federal debt; according to the projections, a decade from now they’ll have risen to 3.5 percent of G.D.P. How scary is that? It’s about the same as interest costs under the first President Bush.

• The Real SOTU, RDPs, Go-Forward Strategies and Your Country
• Reality, Politics, Policy & Partisans: the Undiscovered Country

Q&A: Carmen Reinhart on Greece, U.S. Debt and Other ‘Scary Scenarios’ WSJ: The market is asking, ‘Who’s next?’ REINHART: There are a lot of scary scenarios out there. Take governments that were virtuous governments, and continue to be virtuous. I’m talking about Ireland now. Their public debts were trending down and they have acted quickly and they’re credible. But external debt in the private sector is huge, more than 300% of GDP. In a crisis environment, private debts become public debts pretty quickly. Who knows what will happen with the Iceland referendum, and whether they vote to default on the Danish and the Brits. WSJ: Are we seeing a second-wave of financial distress? REINHART: Ken and I have been arguing fairly forcefully that historically, following a wave of financial crises especially in financial centers, you get a wave of defaults. You go from financial crises to sovereign debt crises. I think we’re in for a period where that kind of scenario is very likely. I don’t think a repeat of the fall of 2008 is at stake here, where it looks like the world is going to end. But I do think there is still, for reasons that are beyond me, quite a bit of complacency out there. Eastern Europe is another source of concern, and Europe has limited resources. You can rescue one. You can maybe rescue two. But you can’t rescue all of them. The Baltics are very vulnerable. Romania is vulnerable. Hungary is vulnerable. Problems in these countries feed back to their lenders. Austrian bank exposure to Eastern Europe is great. The Italian exposure to Eastern Europe is great. The Swedish exposure is non-trivial. You started out with a major financial crisis in 2007 and 2008, in which some of these countries have seen their worst recessions, in a way that really harms fiscal sustainability, even if you were in a good shape fiscally at the outset of the crisis. It is the pattern that has been prevalent in the past, that these major financial crises have been followed by an afterwave of debt crises.

• Debt Problems Chip Away at Fortress Europe
• Debt Crisis in Euro Zone Is Severe Political Test for Bloc