EconomPics of the Week (1/27/12)

Your EconomPic links for the past two weeks...

Economic Data

• GDP Print Okay, Composition Disappointing
• Durable Goods Grip It and Rip It in December
• The New (and Improved) Leading Economic Indicators
• European Manufacturing Feeling the Downturn
• CPI Steady in December
• Do Initial Claims Matter?
• China's Growth in Perspective
• Checking In on Capacity Utilization

Asset Classes

• S&P 500 / VIX Matrix
• The Treasury Rally that Keeps on Trucking
• China Still Buying Treasuries
• The Impact of Low Rates Through 2014
• Apples Numbers Were B-A-N-A-N-A-S
• Existing Home Sales Rise

And your video of the week... a song I can't get out of my head. Gotye with 'Somebody That I Used to Know' (found it from this viral video cover of the song)

GDP Print Okay, Composition Disappointing

Peter Boockvar (via The Big Picture) details this quarter's GDP print (slightly edited / reformatted):

After three quarters (in a row) that averaged just 1.2%, fourth quarter GDP grew 2.8%, a touch below expectations of 3.0%, but Nominal GDP grew well below forecasts. Because the price deflator was up just 0.4% vs the estimate of 1.9%, Nominal GDP was up 3.2% vs the estimate of 4.9%.

• Personal Consumption rose 2.0% vs the forecast of 2.4%.
• Fixed Investment rose 3.3% (helped by a 5.2% increase in equipment and software spending and residential construction rose by 10.9%).
• Trade was a slight drag on GDP growth and government spending was as well, led by a 12.5% decline on national defense spending.
• State and local government spending fell by 2.6%.
• Inventories added almost 2% to growth and, taking out this influence, Real Final Sales rise just 0.8% vs 3.2% in Q3.

Thus, inventories were a large swing factor in the Q4 rebound. Bottom line, Real GDP was near estimates, but nominal GDP was the weakest since Q3 ’09 and Real Final Sales were the 2nd softest since Q1 ’10.

Details below... we can see the HUGE impact of inventory rebuild (potential is there for this to be a HUGE drag in Q1 '12) and the continued drag of local government (i.e. austerity measures).



The below chart shows the longer term breakdown of GDP, showing the importance of consumption on growth. We can see the huge shift in consumption from goods (i.e. things) to services (i.e. outsourcing of "actions" to make out lives easier). Of note, for all the chatter about how large government has become, the Federal government (excluding defense) has not really become a larger as a component of GDP.

Source: BEA

Durable Goods Grip It and Rip It in December

Reuters details:

New orders for U.S. manufactured goods rose in December and a gauge of future business investment rebounded, showing the U.S. economy ended the year with more momentum than previously thought.

Commerce Department data showed orders for durable goods climbed 3.0 percent last month. That was likely boosted by a surge in orders at aircraft builders like Boeing. Economists had forecast orders rising 2.0 percent.

Strong month, but note that excluding the highly volatile nondefense aircraft component, the index would have been up a (still healthy, yet not as impressive) 1.6%.

Source: Census

The New (and Improved) Leading Economic Indicator Shows Expansion

Bloomberg details:

The Conference Board’s gauge of the outlook for the next three to six months increased 0.4 percent after climbing 0.2 percent in November, the New York-based group said today. The median forecast of 44 economists surveyed by Bloomberg News called for a gain of 0.7 percent.

The article also outlines a change in a major component of the index (the first change in the index since 1996):

Changes in the components of the leading index were announced earlier this month. Instead of the inflation-adjusted money supply, the Conference Board used its own Leading Credit Index, which aggregates measures of the yield curve, interest- rate swaps and the Fed’s senior loan officer survey. The Institute for Supply Management’s supplier deliveries gauge was replaced by the group’s index of new orders.

The change from money supply to credit index is a major change, removing a component that was directly in the hands of the Fed (money supply), with one that is only partially in the hands of the Fed (credit index). Note that in past months, EconomPic has removed the money supply component, as well as stock and interest rate components, for an index excluding Fed involvement.

A comparison of the new (revised) index, the old index, and the "EconomPic" index that excluded Fed control is shown below. What we see is the new index is much more aligned with one excluding the Fed's control and shows the index likely overstated underlying economic strength over the summer.

Source: Conference Board

The Impact of Low Rates Through 2014

Bloomberg details the latest from the Fed:

Chairman Ben S. Bernanke said the Federal Reserve is considering additional asset purchases to boost growth after extending its pledge to keep interest rates low through at least late 2014.

Policy makers are “prepared to provide further monetary accommodation if employment is not making sufficient progress towards our assessment of its maximum level, or if inflation shows signs of moving further below its mandate-consistent rate."

The immediate market reaction was a risk asset rally, a huge rally in gold (per Calculated Risk: Bernanke made it clear that even if inflation moved above the target - and unemployment was still very high - the Fed would only slowly pursue policies to reduce the inflation rate), and a rally at the belly of the yield curve (the yield curve flattened out to five years... shorter rates couldn't fall as they are already at or near zero). Why? The "late 2014" date is much later than the June 2013 date previously projected by Bernanke last summer.

The impact of this announcement (and the previous projected rates) can be seen in the chart below that shows the Fed Funds rate curve (implied by EuroDollar futures) for March 2013 through December 2014, as of various dates over the past year.

What do we see? We see an initial drop between March and June of last year as Bernanke indicated low yields for the foreseeable future, then a huge drop (mid-summer) after Bernanke stated rates would remain zero through June 2013. Today's announcement really did nothing through June 2013 (that was already projected), but was felt further out along the curve.

The key question is what is the Fed trying to accomplish?

In "normal" times, low yields = cheap financing = increased consumption (it creates an incentive for individuals to borrow and banks to lend), but in today's zero-bound world the impact is minimal. Increased consumption is limited as individuals are trying to rebuild their own balance sheets and those that might benefit most from borrowing, don't necessarily have the credit to qualify for a loan. In terms of impact on unemployment, GYSC (of Economic Disconnect fame) states:

Unemployment is a structural problem, not a cyclical one, but the FED is still stuck in the past.

In addition, there are some theories that consumption may actually be negatively impacted by zero bound rates. As I outlined over the summer, I think it is possible that negative real interest rates may actually cause individuals to save more, while Kid Dynamite outlined yesterday that low rates forecasted may cause individuals to hold off from making a loan fueled purchase:

Let me explain: right now, one appealing factor of home buying/selling decisions is that interest rates are very low – you can afford to buy more house. If I think that interest rates are going to remain low for a long period of time, I will be in no hurry to lock in this low rate on the debt I’m borrowing – I will be in no hurry to go out and buy a house.

So what is it then? Corporations!

There is one sector that I think will be positively impacted by the latest announcement.... corporations. Don't let their record profits as a percent of GDP (while personal income is at record lows) fool you into thinking they don't need help at the populations expense. Seriously though... my initial reaction upon hearing that rates would be held down near zero through 2014... buy credit... WITH duration out to around ten years (the secondary impact is positive for equities, as explained below).

While Treasury yields are at all-time lows, corporate spreads remain at elevated levels (when yields fell during the summer when we had to deal with the US downgrade and Europe, spreads widened significantly).

In "normal" times, when markets calm these spreads would be expected to narrow, which I still believe is the case. One would also "normally" expect Treasury yields to rise as investors shift out of Treasuries, causing the hard interest rate component of corporate yields (rate + spread = yield) to rise, but this risk has been removed for the foreseeable future out to around ten years. The result is that corporate bonds seem like a very safe investment. This decreased risk should mean even cheaper financing for longer dated maturity corporate bond issuance.

So will this finally set off a round of corporate fueled expansion? If they don't see aggregate demand improving, then I don't see how this will impact the underlying economy. But, with the cost of equity high (i.e. what I perceive as fair to cheap equity valuations) and cost of debt low (i.e. these lower yielding corporate bonds), we may see significant change in capital structures (perhaps via private equity).

Source: Barclays Capital

European Manufacturing Feeling the Downturn

Marketwatch details:

Industrial orders in the 17-nation euro zone fell 1.3% in November after a 1.5% rise in October, the European Union statistics agency Eurostat reported Tuesday. Compared to November 2010, orders fell 2.7%, the agency said. Economists had forecast a 2.3% monthly decline and a 2.8% year-on-year fall.

Since the European crisis re-emerged in mid-summer, the European core has seen a rather sharp drop off in new industrial orders, while Emerging Europe (and the UK / Ireland) have shown strength (note that Greece didn't release data for November, but was down 5% from July through October).

Source: Eurostat

Apples Numbers Were B-A-N-A-N-A-S

Before jumping on the Apple bandwagon, I'll turn it over to Tadas of Abnormal Returns fame who summarized Apple's blow out earnings with the following powerful statement:

Apple’s results highlight this simple fact: no one knows nothing. The most followed (and analyzed) company in the world was able to exceed even the most bullish analysts’ estimates by a wide margin. If this can happen, then it should remind us that anything, good or bad, can happen in the markets. Any one telling you they know something will happen for certain, just remind them about Apple 2012 Q1 results.

Now to the blow out earnings.... just a part of the exponential growth the firm has seen over the past eight or so years.

Data shown is from quarterly financial statements

Billions of this size is hard to grasp, so the following chart attempts to put it in perspective. Apple's sales over the last twelve months are equal to almost 1.2% of all U.S. personal consumption over that time (yes, I know Apple has sales outside of the U.S., but think about how much stuff 1.2% of everything U.S. citizens consume is) and around 2% of last quarter's consumption.

Data shown is rolling twelve month

Source: BEA / EDGAR

Existing Home Sales Rise

Bloomberg details:

Sales of previously owned U.S. homes rose for a third month in December to the highest level since January 2011, a sign the housing market ended last year with momentum.

Purchases increased 5 percent to a 4.61 million annual rate, the National Association of Realtors said today in Washington. The pace was less than the 4.65 million median forecast of economists surveyed by Bloomberg News. The gain helped push down the inventory of homes for sale last month to the lowest level since 2005. Purchases in 2011 climbed 1.7 percent from a year earlier as prices fell.

Historically low mortgage rates and a pickup in employment may be giving Americans the confidence to purchase homes that have fallen in value. At the same time, another wave of foreclosures may inhibit a faster recovery in real estate as more distressed properties are put on the market.

Looking at the data, it appears sales are on the rise as prices are creeping lower (to a level where demand is finally meeting supply). My guess is the reason higher priced home sales are less is two-fold... they don't qualify for conforming loans and prices are being reduced (i.e. houses formally in the $500k-$750k "bucket" are now in the $250k-$500k bucket).

Source: Realtor.org

CPI Steady in December

CNN Money details:

Inflation overall held steady last month, as declining gas prices balanced out higher prices for other items.

The government's key measure of inflation, the Consumer Price Index, showed prices were virtually unchanged from November to December. It marked the second month in a row CPI has barely moved.

In the past 12 months, prices rose 3%, a slowdown from a 3.4% annual inflation rate in November. The numbers are seasonally adjusted.

Source: BLS

Do Initial Claims Matter?

Fox Business details:

New applications for unemployment benefits dropped to a near four-year low last week, a government report on Thursday showed, pointing to continued improvement in the labor market.

The Labor Department said initial claims for state unemployment benefits dropped 50,000 to 352,000, the lowest level since April 2008 and the biggest drop since September 2005. The prior claims data was revised up to 402,000 from the previously reported 399,000.

Good news, no doubt. BUT, initial claims SHOULD be falling (and falling dramatically). According to the BLS, we still employ less than 5 million people from the peak employment achieved in late 2007. Initial claims simply tell you the number of new people filing for unemployment benefits (i.e. those just laid off). If you have already shed 5 million people, this number SHOULD be falling (there are less people to lay off) even without an improved underlying economy.

The following chart in no way is intended to be a good measure of normalized initial claims, but it is meant to make that point. It shows the initial claims figures (through December) as an absolute figure and relative to the number of new jobs made over the previous 95 months (an arbitrary number that is the length of time from the bottom in employment during the '01 - '02 recession and the latest recession) and shows that the reduction in initial claims is less apparent when you take in account the sluggish employment growth.

So do initial claims matter? You sure don't want to see them rising. But. there is only a limited amount of information in the data when an economy has experienced the type of employment recession the US has faced the previous 4 years.

Source: DOL / BLS

Checking In on Capacity Utilization

Source: BLS / Federal Reserve