August 13, 2009

Recovery to stall?

I'm typically an optimist - a glass half-full sort. But when you are faced with reality, you have to temper optimism with a healthy dose of reality. When it comes to the economy, optimism is nice, but it isn't useful. If you can't find reality, if you aren't cautious, you can make a bad situation a lot worse. With that in mind, I've come to a glass half-empty conclusion.
This recession thing isn't over yet.
True, unemployment has dipped by 0.1% month over month, and the second quarter is looking better than the first quarter. But that's not enough. Call it a bear bounce on the market, call it what you will, but the reasons for glee just don't add up to a recovery yet. Not when you start to take into account some other factors.

And some key players are starting to bear this point out (pardon the pun);

After predicting a torrid "relief rally" over the early summer, Bob Janjuah at Royal Bank of Scotland is advising clients to take profits in global equity and commodity markets and prepare for another storm as winter nears.

"We are now in the middle of a parabolic spike up," he said in his latest confidential note to clients.

"I expect this risk rally to continue into – and maybe through – a large part of August. What happens after that? The next ugly leg of the bear market begins as we get into the July through September 'tipping zone', driven by the failure of the data to validate the V (shaped recovery) that is now fully priced into markets."

The key indicators to watch are business spending on equipment (Capex), incomes, jobs, and profits. Only a "surge higher" in these gauges can justify current asset prices. Results that are merely "less bad" will not suffice.

RBS is no unimportant player in the global scene. In 2008 it was the world's 6th largest bank by shareholder equity. So this is no fly-by-night prediction. Janjuah's warning should be taken seriously. And he's hit on the the key factors in a couple of short paragraphs. The markets are banking on a V-recovery. But the facts aren't necessarily going to support that level of optimism. There's a number of reasons for that. One big concern is that profitable numbers from large cap companies don't equate to a return to revenue. Rather they reflect in many cases, the result of prudent cost cutting measures to shore up the bottom line. In other words, layoffs. Less payroll means less overhead, which means less cost and healthier bottom lines. Except you can't continue to layoff employees quarter after quarter. Inventories will start to deplete, and production costs will start to rise again, eating into those margins. And with national savings rates on the rise, and unemployment at an unhealthy 9.4% sales aren't ready burst out in a big uptick. Don't expect to see the Q2 numbers repeated in Q3.

Furthermore, home foreclosures are still on the rise. That temporary respite from payments that the White house wants to promulgate can't go on forever.

WASHINGTON – The number of U.S. households on the verge of losing their homes rose 7 percent from June to July, as the escalating foreclosure crisis continued to outpace government efforts to limit the damage.

Foreclosure filings were up 32 percent from the same month last year, RealtyTrac Inc. said Thursday. More than 360,000 households, or one in every 355 homes, received a foreclosure-related notice, such as a notice of default or trustee's sale.

That's the highest monthly level since the foreclosure-listing firm began publishing the data more than four years ago.Banks repossessed more than 87,000 homes in July, up from about 79,000 homes a month earlier.

Meanwhile, housing prices are still declining.
Aug. 12 (Bloomberg) -- Home price declines in the U.S. accelerated in the second quarter, dropping by a record 15.6 percent from a year earlier, as foreclosures weighed on values.

In other words, the housing bubble trouble hasn't gone away just yet. Nor will it soon. if there were an easy fix, like throwing several hundred billion dollars at the problem, it would have been over and done with. Short of the government eating every high risk mortgage to bail out the banks and reward high risk home owners, this problem is going to have a lingering effect on the national economy. Don't think V-shaped recovery, think hockey stick, or a very slow, lazy slope up - one you could scale in a wheelchair, with one hand.

And there's even reason to cast some doubt on the positive numbers being spun by everyone from the White house to the media. Dave Lindorff at Counterpunch throws some cold water on the near-euphoria;

The “happy talk” campaign in the US media and coming from the White House is just that: Happy Talk.

To get a real picture of what is happening with this economy, here are a few things to keep in mind.

Yes, the rate of decline in economic activity has slowed. But that is to be expected. When an economy is going at full tilt, as the US economy was doing in early 2007, a slowdown of any significance yields huge numbers, in terms of falling production, falling factory utilization, falling car sales, or, this time around, falling housing prices.

But once you get to the same period in 2008, you’re already in a deep recession, and there really isn’t that much farther to fall. If, for example, the car makers have basically shut down by fall of 2008, and are just working off huge inventories, then you are not going to see more factory closings and further reductions in production (how do you reduce production below zero?).

It's not a bad question, Bert. [Bet you weren't expecting that link, were you?]

So what's holding back real recovery? Business Week summed it up best, pointing to 5 key factors.
  1. Unemployment - those out of work can't spend, those still employed are saving. -- no new consumer spending
  2. Spare capacity - companies won't hire or buy capital equipment when they have so much slack right now. -- no new business spending
  3. Debt - household debt has soared and people are trying to pay down that debt rather than consume. -- no new household spending, they're paying for their previous demand levels
  4. Bond markets - government deficit spending may scare investors, who will sell their bonds, thereby driving up interest rates. That in turn drives up savings and lowers spending, especially on credit. -- FYI, another reason health care makes ZERO sense right now.
  5. Double dip - The GDP recovery could be a bump on the path because the impact of the stimulus tax cuts will begin to fade. [Add to that the fact that the stimulus spending is 2010/11 loaded, means there's a gap, even if Keynes was right about spending, which he wasn't]
So what now?

Keep a close eye on your portfolio if you still have one. Another dip could very well be on the way. As for the federal government, they have control over the stimulus spending and tax cuts - they should be using them a little more cautiously. They have indirect control over the bond market - by curbing spending they can keep pressure off the bond market.

They also can impact unemployment and spare capacity by enacting tax cuts. They won't, but they could. The only real conundrum is the debt. Consumer debt is way too high. And in that sense a recession was due. People needed to ease off on their spending for a bit, and a recession should have helped weed out some of that bad behavior. Bailouts have rewarded both business and consumer lending and spending habits. Recessions are a natural part of the economic cycle that helps clear deadwood.

The government doesn't see it that way. It's political. Consumers want government to be fiscally responsible but don't want to be so themselves. If you were a politician trying to get elected or re-elected, would you point out the hypocrisy? Or would you offer bromides and assurances that you'd take care of the other guy who is the real problem? Look who is in power and you have your answer.

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