EconomPics of the Week (Recession Special Edition)

BIG week of economic data. I will be traveling early next week, so you may see limited posts until Wednesday (tear).

Economic Data
GDP Price Index Turns Negative: Stimulus on the Ch...
Government Spending on the Move
GDP Down 3.8%... Beats Estimates
New Home Sales Drop to Lowest Ever Recorded
"Are We Going to War?" Durable Goods Edition
Cargo Plane Traffic... Crash
European Capacity Cliff Dive
Used Car Sales Suffering Too
Deflation: Front, Center, and Even Down Under
Consumer Confidence to New Historic Low
Case Shiller Price Index (CSCPI) - November
Another 74k Jobs Cut
Leading Economic Indicators: Green is Good (or at ...
California Unemployment Rockets to 9.3%

Greed
Shameful Bankers / Investment Banker Bonus Matrix

Corporations
Earnings Roundup
GE Rated Aaa = Aaa Joke

Fixed Income
California Munis are "Whispering" Buy
Oxymoron of the Day: A Public, Private Equity Shop...
Long Bond Drops Most in 22 Years... A Trend or Volatility.

Other
Stimulus Timeline

GDP Price Index Turns Negative: Stimulus on the Cheap?

For more details on the GDP Price Index (i.e. GDP Deflator), see GDP Deflator De-Mystified.

Bespoke details:

While the markets have been focused on the better than expected GDP report for the fourth quarter, the GDP price index was potentially even more notable. While economists were looking for a quarter/quarter annualized increase of 0.4%, the actual level was a decline of 0.1%. This negative print is only the seventh time since the end of WWII (and the first time since 1954) that prices decrease based on this measure. For now at least, the Fed's view that "inflation pressures will remain subdued in coming quarters" appears to be right on target.

The greatest impact on the GDP deflator (i.e. when negative it is the GDP inflator) were consumption prices (makes sense). What doesn't ring a bell is the decline in prices involved in government spending. Is it that this slowdown has made any stimulus plan more inexpensive to implement?

Source: BEA

Government Spending on the Move

Expect this figure to fly in coming quarters / years...



Source: BEA

GDP Down 3.8%... Beats Estimates

Marketwatch reports:

The U.S. economy contracted at a 3.8% seasonally adjusted annual rate in the fourth quarter, the Commerce Department estimated Friday. This is the largest contraction since the first quarter of 1982. Economists surveyed by MarketWatch were expecting a negative 5.5% growth rate in the fourth quarter.

The weakness in the fourth quarter was masked by a buildup in inventories, which adds to output even if they are unwanted. Real final sales for domestic product, which excludes inventories, decreased 5.1% in the fourth quarter. This is the biggest drop since 1980.

Breakout of the Components

Contribution of the Components

Nominal GDP Crushed (the problem here is debt is nominal)

Source: BEA

Shameful Bankers: Bonuses Down ALL THE WAY to a Level Not Seen Since.... 2004?

I was ready to rant, but I saw President Obama already took care of it on my behalf:

When I saw an article today indicating that Wall Street bankers had given themselves $20 billion worth of bonuses -- the same amount of bonuses as they gave themselves in 2004 -- at a time when most of these institutions were teetering on collapse and they are asking for taxpayers to help sustain them, and when taxpayers find themselves in the difficult position that, if they don't provide help, that the entire system could come down on top of our heads," the president said, "that is the height of irresponsibility. It is shameful.

To me this is more than shameful. I'd go with outright criminal to those determining and approving bonuses of this level, in this environment, and with taxpayer money. Lets hope (make that pray) that Christopher Dodd makes good on his promise:

"I’m going to be urging — in fact not urging, demanding — that the Treasury Department figures out some way to get the money back. This is unacceptable."

Because apparently, the Investment Banking Bonus Matrix we detailed back in November is all too accurate:



Source: OSC.STATE.NY.US

Cargo Plane Traffic... Crash

IATA reports (hat tip Calculated Risk):

In the month of December global international cargo traffic plummeted by 22.6%compared to December 2007. The same comparison for international passenger traffic showed a 4.6% drop. The international load factor stood at 73.8%. For the full-year 2008, international cargo traffic was down 4.0%, passenger traffic showed a modest increase of 1.6%, and the international load factor stood at 75.9%.

“The 22.6% free fall in global cargo is unprecedented and shocking. There is no clearer description of the slowdown in world trade. Even in September 2001, when much of the global fleet was grounded, the decline was only 13.9%,” said Giovanni Bisignani, IATA’s Director General and CEO.” Air cargo carries 35% of the value of goods traded internationally.

I don't want to about global decoupling for at least 5 years...

Earnings Roundup

Source: The Big Picture

New Home Sales Drop to Lowest Ever Recorded

Bloomberg reports:

Sales of new homes in the U.S. fell in December to the lowest level on record, creating an unprecedented glut of unsold properties that casts doubt on any recovery in the industry this year.

Purchases dropped to an annual pace of 331,000, lower than all 70 forecasts in a Bloomberg News survey, Commerce Department figures showed in Washington. Other reports today said orders for durable goods slumped for a fifth month and a record number of Americans were collecting jobless benefits.

Yes, the lowest on record... all the way back to 1963.

"Are We Going to War?" Durable Goods Edition

The latest figures from the Census for Durable Goods show further deterioration and a huge spike in spending on Defense:

New orders for manufactured durable goods in December decreased $4.7 billion or 2.6 percent to $176.8 billion, the U.S. Census Bureau announced today. This was the fifth consecutive monthly decrease and followed a 3.7 percent November decrease. Excluding transportation, new orders decreased 3.6 percent. Excluding defense, new orders decreased 4.9 percent.

Month over Month (Seasonally Adjusted)

Year over Year (Full Year 2008 vs. 2007)

California Munis are "Whispering" Buy

Now for what seems like my weekly California update:

Housing continues to deteriorate (per Bloomberg):

California home prices plunged 42 percent in December from a year earlier as the U.S. housing slump deepened and foreclosures hit record levels.

The median price for a single-family home in the most populous U.S. state dropped to $281,100 from $480,820 a year earlier, the Los Angeles-based California Association of Realtors said today in a statement.

The price decline is in part due to foreclosures:

Foreclosed properties tend to sell at a discount of 25 percent or more, and California home sales rose 85 percent in response to last month's drop in prices, the Realtors association said.

Assuming every sale was a foreclosure (and sold at a 25% discount), this indicates the average non-foreclosed price was $374,800 or a 22% drop. Knowing that "only" ~50% of sales were foreclosures, that means most sales were at the "lower-end" of the price spectrum.

As the housing market goes, so goes California Munis:

Municipal General Obligation "GO" bonds (i.e. bonds backed by the taxing authority of states) have historical traded at yields less than Treasuries (due to the high-quality nature and tax benefits of Muni bonds). Rather than track California GO bonds to Treasuries, below is the ratio of California GO bonds to the Muni GO bond index.



This past week hasn't been kind. The ratio of California Muni bonds to those in the index is almost 1.4x (and this chart is for bonds with just five years to maturity). If / when state funding troubles are addressed with Federal money, I expect this ratio to come back down. For investors dieing to make a "whopping" non-taxable 2.9% return (hey... much better than Treasuries!), I'll call this a "whispering" rather than "screaming" buy.

Speaking of that 2.9%... for all the trouble California is facing, the financing cost for the state is still down a full percent since the turmoil began.

European Capacity Cliff Dive

We've discussed the issues facing Ireland and Spain in the past, and now we'll show that things aren't much better for Italy and France. FT Alphaville reports:

French and Italians quarterly production utilization figures are out and they're not pretty.

The chart below details the percent change we've seen in capacity on an annual basis (i.e. if it was 80% and is now 70%, the decline is 10%... not a percent of a percent).

Used Car Sales Suffering Too

I would have thought buyers would be "downsizing" to used cars with all the market turmoil. Apparently not, as Autonews reports:

Used-vehicle prices have fluctuated so much recently that dealers say they are having trouble choosing which used cars and trucks to buy and how to price them at retail.

The chief culprit, dealers say, is the price of gasoline, which has swung from about $3 a gallon a year ago to more than $4 last summer to less than $2. As gasoline prices drop, dealers say, used-vehicle customers are more interested in trucks and less drawn to fuel-efficient cars. When fuel prices spiked last year, they say, the preferences were reversed. Those changes affect used-vehicle sales and prices.

Compounding the problem, dealers add, are the decreased availability and higher cost of floorplan loans, which make decisions about used-vehicle inventory even more critical.

Fortunately, there may be some relief on the way for sellers:

Tom Webb, chief economist at Manheim, the nation's largest auto auction company, says relief is on the way. Gasoline prices are stabilizing and lenders are making more floorplan credit available to dealers, he says. Both factors should moderate swings in wholesale used-vehicle prices, he predicts. "January will be a pretty good month on the upside," Webb says. "A lot of volatility has passed."

Source: Manheim Consulting

Deflation: Front, Center, and Even Down Under

Across the Curve details some more deflationary news:

Australian consumer prices declined 0.3 percent in the most recent quarter after rising 1.2 percent in the previous quarter. It was the biggest drop in the index in 11 years. Leading Indicators in Australia fell 1.0 in November to 253.5. Toyota, Honda and Nissan slashed global production last month by 25 percent, 7.5 percent and 36 percent, respectively.

While longer term (i.e. at some point), I view the all the stimulus as inflationary, those trillions of dollars are no match for a global slowdown in the short-run.

Oxymoron of the Day: A Public, Private Equity Shop

Oxymoron:

A figure of speech that combines two usually contradictory terms in a compressed paradox.

When Fortress Investment Group became the first hedge-fund/private-equity group to list in the US back in February of 2007, it stormed out of the gate:

In the most widely anticipated public offering of the young year, Fortress Investment Group (FIG), the first U.S.-based hedge fund to go public, stormed the ramparts. The shares opened trading at $35. At that level the company had a market capitalization of more than $12 billion. A group of five company insiders hold more than three quarters of the company's shares.

In a recent article, the Wall Street Journal detailed just how much Fortress' five principals were able to extract from the firm prior to the IPO:

The firm's five principals -- led by founder Wesley Edens -- cashed out just prior to the IPO, selling 15% of the company to Nomura Securities for $888 million. On top of the Nomura proceeds, the principals received an additional $409.2 million in distributions from the company just before listing.

That adds up to almost $1.3 billion... and it was just in time. Less than two years later, the market valuation of Fortress has since crashed 95%.

That leaves the current valuation of the entire firm at about half of the $1.3 billion the principals were able monetize for a mere ~15% stake just two years ago. The performance (or lack there of) was not a complete surprise to those that thought strategically about what this all meant. Dealbook reported just prior to the IPO:

A hedge fund manager interviewed by The Los Angeles Times sounded even more skeptical about the Fortress offering before it began trading: “These are very smart guys,” he said. “If they’re selling, I probably don’t want to be buying.”

And a finance professor had this observation for MarketWatch’s David Weidner: “When the smart money is pulling out, it’s time to start selling to the dumb money.”

Maybe only in hindsight it was obvious, but why would anyone believe that a company (known for taking publicly traded companies private), was going public for the benefit of anyone except themselves?

Stimulus Timeline

CBO reports the time path of estimated outlays on government purchases under the proposed stimulus bill.

Assuming enactment in mid-February, CBO estimates that the bill would increase outlays by $93 billion during the remaining several months of fiscal year 2009, by $225 billion in fiscal year 2010 (which begins on October 1), by $159 billion in 2011, and by a total of $604 billion over the 2009-2019 period.

Is this too long a time frame to cause any benefit?

Yes, according to the tone of Greg Mankiw (maybe I'm reading too much into the "So"):

So only 8 percent of this spending occurs in budget year 2009, and only 41 percent occurs in first two years.

No, according to Paul Krugman:

By my count, 70 percent of the Division A stuff and 91 percent of the Division B spending comes within the fiscal 2009-2011 window. If you go up to the end of calendar 2011, we’re probably up to about 77 and 96 percent. That’s not at all bad.

Consumer Confidence to New Historic Low

The Conference Board details:

The Conference Board Consumer Confidence Index, which had decreased in ecember, inched lower in January and continues to be at a historic low. The Index now stands at 37.7 (1985=100), down from 38.6 in December. The Present Situation Index declined slightly to 29.9 from 30.2 last month. The Expectations Index decreased moderately to 43.0 from 44.2.

Case Shiller Price Index (CSCPI) - November

For more information on what the Case Shiller Price Index is and why it may be an important measure, check out this old post.

The Case-Shiller Price Index (an adjustment to CPI) turned severly negative year over year, down 4% from November 2007 as home prices, a global slowdown, and the reversal in energy prices severely impacted price levels.



Update (jvanginneken comments):

Jake, it's a very interesting graph, I think it would be interesting to also see a graph of the difference.

Here it is...

Source: BLS / S&P

GE Rated Aaa = Aaa Joke

In my post regarding the shift in the composition of the Barclays Capital Investment Grade Index, I was asked:

Any idea why most recent data points show Aaa at higher yields than Aa??

In fact, I do... the Aaa (FYI- Barclays Capital refers to this ratings 'tranche' as Aaa, not AAA) is made up predominantly by GE Capital (predominantly is an understatement).



And since mid-2007, spreads on GE Capital bonds have blown out, especially after the Lehman failure in mid-September 2008.



A 450+ bp spread for the CDS (as wide as 600 bp) on a Aaa rated security? As a refresher, an S&P triple A rating is saved for:

The best quality borrowers, reliable and stable (many of them governments)

So why are spreads so wide? According to Morgan Stanley (in reference to GE):

“Investors do not want to own a stock with dividend cut risk. Investors do not want to own a stock with rating agency risk. Investors do not want to own a stock where substantial earnings tailwinds come from past tax reversals. And lastly, investors do not want to own a stock with a financial sub, particularly one which is substantially under-reserved.”

This doesn't sound like a "best quality" "reliable" "stable" or "government-like" entity. Surely the ratings agencies must think differently. Lets get the opinion of S&P analyst Robert Schulz:

The quarterly results show that 2009 may be more difficult than expected for GE Capital. The financial arm makes loans for everything from consumer credit cards to big commercial energy projects.

How difficult? According to Schulz:

Credit losses are now expected to be $10 billion, $1 billion more than GE forecast in December. Losses in the company's real estate portfolio are also expected to reach $4 billion, compared with a $2 billion gain.

So, in the worst financial crisis since the Great Depression, S&P's own analyst declared that after GE needed a $139 billion in FDIC backed debt just two months ago, was put on negative outlook in December, and has its hands in everything from consumer credit cards to big commercial energy projects (again, in the worst financial crisis since the Great Depression) they still deserve a triple A rating.

And this is why the most recent data points show Aaa at higher yields than Aa.

Another 74k Jobs Cut

Chron reports another ugly day on the employment front:

Caterpillar Inc., Sprint Nextel Corp. and Home Depot Inc. led companies today announcing at least 73,900 job cuts as sales withered and construction slowed amid a global economic recession that may persist through 2009.

“Certainly since 2001, with the dot-com collapse, we haven’t seen these kinds of large cuts,” James Pedderson, a spokesman for Challenger Gray & Christmas Inc., a Chicago-based provider of executive-outplacement services, said in an interview. “In terms of the number of companies and the number of cuts, this morning is certainly unusual.”

Leading Economic Indicators: Green is Good (or at Least Positive)

Barry (i.e. The Big Picture) beat me to the punch:

The surge in real money supply growth added a full percentage point to the headline number. From September til today, this has added between 0.4ppts and 1.0ppts to each month’s gain. The artificial boost to the LEIs has not translated into increased lending from the banks.

Over the least year, the increase in money supply has been the only leading economic indicator with a significant positive contribution.



Source: Conference Board

Long Bond Drops Most in 22 Years... A Trend or Volatility?

According to Brad Setser (former staff economist at the Treasury and current fellow at the Council of Foreign Relations):

In 2007, my best estimate is that China accounted for $120.3b of the $247.2b increase in the outstanding stock of marketable Treasuries not held by the Fed. China absorbed 49% of the net increase.

In 2008, my best estimate is that China bought $374.6 billion of the $1684.8 billion increase in the outstanding stock of marketable Treasuries not held by the Fed. China absorbed 22.2% of net issuance.

Thus, while China is an extremely important player in the Treasury market, purchasing 3x more Treasuries in 2008 than in 2007, they became a smaller relative player as demand from non-Chinese sources grew astronomically. So while there has been a media frenzy over Treasury Secretary Geithner's comments regarding Chinese currency manipulation and how China might react, it may be the lesser concern (back to Brad):

Obviously, it would be a big deal if China stopped buying and started selling. But it would be much bigger deal if private investors lost their appetite for Treasuries.

This past week we saw a massive sell off of long-dated Treasuries, supposed proof that this appetite is waning relative to the expected supply. According to Bloomberg:

Treasuries fell, with 30-year bonds losing the most this week in 22 years, as the U.S. readied $78 billion in debt sales over the next five days to finance fiscal stimulus spending projected to swell the deficit to $1 trillion.

While it is important to take note of any movement not seen in 20+ years, one week does not make a trend. In looking at the chart below, which details the historical 'week over week' change in the yield of the thirty year bond (in relative terms as a 30 bp move is obviously more drastic when yields are 2.9% vs. 10.6%), we see just how large an outlier this past week's move was (hint- the top right dot).



However, this chart also details how volatile the long bond has been... far more volatile in 2008-09 than at any other point in recent history and in both directions. The only previous time since 1980 the yield jumped or dropped at a similar magnitude was the week following Black Monday, October 1987. But that 100 bp drop (from ~10.2% to ~9.1%) was in response to a massive liquidity injection by Alan Greenspan following the 22.6% drop in the Dow on that single day.

Thus, while it is important to keep an eye on the long bond to see if the recent sell off does become a trend, please don't declare victory on your long Treasury shorts yet. Just remember, the Fed has another "weapon" available... the outright purchasing of Treasuries which may be on the way...

California Unemployment Rockets to 9.3%

Businessweek reports:

The jobless rate announced Friday by the state Employment Development Department represents a jump from the 8.4 percent figure in November 2008.

Excluding farmworkers, California lost 78,200 jobs in December as employers sliced payrolls to deal with the slowing economy.

California's unemployment rate hasn't been at this level since January 1994, when the state was coming out of its recession in the early part of that decade, said Stephen Levy, senior economist for the Center for Continuing Study of the California Economy.

Source: BLS

EconomPics of the Week: Global Edition (1-23-09)

Global Economy Coming to Halt
Don't Mention Decoupling in Asia
Chinese Unemployment Projected at 30 Year High
Spain Downgraded... Ireland to Follow?
UK GDP Down at Lowest QoQ Level in 29 Years
Russian Reserves Sink
Global Banking Sector Struggles

Asset Classes
Is Oil Ready to Crash?
Real Yields Matter
California Freeze Up: Are Munis Still Safe?
Not All AA Bonds are the Same
Investment Grade Bonds: Attractively Priced, But With Reason
Spreads: Not Seen Since the Great Depression
From "Crowding Out", to "Running Away"

Hype
Beware the Media's “Obama Rally”
Out With the Outgoing Overly Optimistic View on the Economy

Greed / Newspapers / The Feel Bad Rainbow
"Pimp My Ride": Thain's $1.2 Million Office Remodel
Death of the Newspaper
A Feel Bad Rainbow: Job Cuts YTD

From "Crowding Out", to "Running Away"

While I don't agree with the entire piece, the following portion of Hoisington Investment Management Company's The Great Experiment caught my attention :

If there is a desire to increase government spending, the federal government must either increase taxes on the far larger private sector, an option that would presumably be precluded under the present circumstances, or borrow funds in the financial markets that would have gone to the private sector. At this point we have to ask which sector has the better track record of growing the economic pie—private or government expenditures? The private sector has demonstrated the greater flexibility and creativity to expand the economic pie, increasing productivity and thereby improving living standards for all. The risk is that increased federal borrowing will stunt the private sector's ability to grow.

In other words, the attractiveness of Treasuries has increased relative to U.S. equities and corporate debt. As of 2007 (the latest data available), Foreign investors owned $9.1 Trillion in Long Term (i.e. more than 1 year) U.S. Securities, split almost evenly between equities, private debt, and public (Treasury / Agency) debt. If the blue portion of the pie is growing, it is coming at the expense of the red, which explains part of the pressure on corporate spreads and equity prices.



But as Interest Rate Roundup details, there is no such thing as a "free lunch":

You can't simply bail out anyone and everyone, especially when you're a debtor nation, and expect your creditors to just grin and bear it forever.

Now investors seem to be waking up. Treasuries have been getting mauled this week, losing value every single trading day this week (Long bond futures are going for around 128 21/32 vs. 136 7/32 last Friday). Yields on 10-year Treasury Notes have shot up to 2.68% from their December 30 low of 2.06%.

The problem is that while investors are fleeing Treasuries, they aren't flying back to private securities, as both equities and corporate debt are down on the week. In other words, they may just be selling all of the above outright, but what are they buying? Mike Larson at Interest Rate Roundup seems to believe it is the old doomsday standby:

I have a thesis that might explain what's going on: Global investors are starting to sour on government debt all around the world. They can see that the cost of bailing out banks and economies here in the U.S., in Asia, and in Europe is spiraling out of control. They know that means governments are going to be issuing trillions of dollars in new debt, driving down the price of existing securities. Result: They’re flocking to alternative stores of value -- including silver and gold.

Source: InvestorsInsight

Oil Ready to Crash?

The following adds a little more color to last week's post Oil Tankers are a Banks Best Friend. For those that missed it, factors have appeared in the oil market that make it attractive for investors to buy oil in the spot market, store it, and sell through the (higher priced) oil futures market. Now that storage is reaching capacity, there is a significant possibility the spot price of crude will "tank" as a source of demand (storage) is no longer available. This is especially true for WTI crude, which is delivered in Cushing, OK and HAS reached its limits according to Marketwatch:

Inventory levels at Cushing, Okla. -- the delivery point for Nymex oil futures -- rose by 0.2 million barrels to a record 33.2 million barrels, the EIA reported. Platts estimates that maximum storage capacity at Cushing is about 42.4 million barrels, but only 80% of that is considered operable.

This suggests that maximum operating capacity is about 34 million barrels, meaning there is little room to add to storage tanks out in Cushing, according to Linda Rafield, senior oil analyst at Platts.

Assuming that 34 million barrels is an accurate level of the maximum capacity in Cushing (i.e. 98% of the capacity is filled) this explain why the price of WTI crude has fallen so much relative to Brent and makes the case for a potential crash in the WTI crude spot market.

Source: EIA

UK GDP Down at Lowest QoQ Level in 29 Years

FT Alphaville reports:

The UK's in recession and it's worse than we thought. The quarterly figure is the biggest (decline) since Q2 1980, while full-year GDP is the weakest since 1992. The standout disaster was manufacturing, down 4.6 percent on the quarter.

"Pimp My Ride": Thain's $1.2 Million Office Remodel

Naked Capitalism reports John Thain spent upwards of $1.2mm on an upgrade of his "suite" upon joining Merrill Lynch. After all, what's a million here and there when you're losing 10-50,000x that (yes... 50,000x that). Below is a breakout of ~$400k of that total (rumor has it the other $800k was to hire celeb designer Michael Smith).



But really... who doesn't need a $1400 parchment "waste can"? At least it's not a $1400 "garbage can", that would be insane.

Speaking of cans, I look forward to seeing the size of Thain's exit package for getting "canned".

I'll set the over / under at $30mm.

Russian Reserves Sink

The AP reports:

Russia's Central Bank says it will widen the ruble's trading range to allow an effective 10 percent devaluation of the national currency. Analysts said the move would prompt an immediate drop in the currency's value. The bank said the limit of the band, measured against a two currency "basket" of dollars and euros, will be set at 41 rubles as of Friday.

Why? For one to be more competitive, but as important to protect their reserves. Bloomberg reports:

Russia’s international reserves tumbled $30.3 billion last week, the second-biggest drop on record, as the central bank accelerated the pace of the ruble’s devaluation and sold more foreign currency to manage the decline. The value of the stockpile, the world’s largest after China’s and Japan’s, fell to $396.2 billion, after dropping $11.7 billion between Dec. 26 and Jan. 9, when there were 2 1/2 official currency trading days.

“The central bank was intervening heavily on the market last week, selling foreign currency,” said Natalia Orlova, chief economist at Moscow’s Alfa Bank, the country’s largest privately owned lender. “They quickened the pace of the step-by-step ruble depreciation, so everyone rushed for foreign currency.”

Beware the Media's “Obama Rally”

The market is down. It must be Obama.

The market is up. It must be Obama.

Tuesday, after the market sold off more than 300 points the Kansas City Star reported:

The dawn of the Obama presidency could not shake the stock market from its dejection over the rapidly deteriorating state of the banking industry.

While the Wall Street Journal went the opposite direction:

Problems with overseas banks contributed to weakness in U.S. stocks, said Alan Valdes, a floor trader with Hilliard Lyons. "It's an aberration -- I think we're going to get an Obama honeymoon rally," he said.

And after yesterday's big rally, Bloomberg hinted the honeymoon has official begun:

U.S. stocks rebounded from a two- month low, led by the biggest gain in financial shares in a month, on speculation a plan from President Barack Obama will shore up banks.

Please take this all with a grain of salt. Why? Maybe an example is needed... This past Friday, the day after the remarkable / amazing landing of the US Airway plane into the Hudson River, the Wall Street Journal declared:

US Airways Group Inc. shares rose 13% to $8.53 Friday in New York Stock Exchange trading Friday, outpacing gains in other carriers' stocks.

Accidents with fatalities can dent airline's reputations in the short term. But an outcome like the one with Flight 1549, which is being praised as an example of superior airmanship and crew training, appears to have prompted a rally.

If that is what prompted the rally (it didn't), it was short-lived. Since that Friday level (which just allowed the stock to bounce back to a pre-crash price), US Airways Group stock is... down 12%.

So... in a nutshell. Take everything you hear from financial TV, or newspapers (or even this blog) with a grain of salt. In the end, take in all the relevant information (most isn't) and proceed cautiously...

Don't Mention Decoupling in Asia

FT's Alphaville details:

The bottom dropped out of Japan's export industry in December, with exports diving a record 35 percent year on year.

China's economy grew at the slowest pace in seven years as the global recession dragged down exports, increasing pressure for more government spending and lower interest rates. Chinese GDP grew 6.8 percent in the fourth quarter from a year earlier.

However, as Yves over at Naked Capitalism points out:

If you believe the China fourth quarter GDP release, I have a bridge I'd like to sell you.

The 6.8% figure just "happened" to match the median estimate of 12 economists surveyed by Bloomberg News. A look at Chinese exports (as measured in yuan) shows how far things have fallen.

Spain Downgraded... Ireland to Follow?

Last week I detailed the struggles Spain is working through, specifically a tumbling housing market and frozen credit markets. Throw in Spain's dependence on the ECB to enact policy across the Eurozone and no flexibility with their currency (i.e. the Euro) and it's not surprising they were under pressure. This ultimately led to S&P's placement of Spain on negative watch and days after my post, S&P downgraded Spain to AA+ from AAA (per the Irish Times):

The cut in Spain’s rating to AA+ from AAA, a level Spain had held since late 2004, sent the euro to a session low against the dollar as investors feared Portugal and Ireland would suffer the same fate after receiving SP warnings.

As detailed on Across the Curve, the debt of "have nots" in Europe (including Spain and Ireland) continue to sell off:

Yields on Italian Spanish and Greek bonds have widened by 7 basis points, 4 basis points, and 10 basis points respectively against Germany. Irish bonds have widened by 26 basis points versus Germany.

In looking at Ireland, we see a country that like Spain depended on the financial sector and an asset bubble to fuel growth. While the Irish economy boomed through mid-2007, the money supply grew even faster, at a rate of between 15-30% annually from 2004-2007. This added fuel to the fire and created an asset bubble of mammoth proportions. According to Professor Morgan Kelly (i.e. the Irish Dr. Doom, who like the Roubini is looking smarter EVERY day):

Back in 2000, lending to construction and real estate made up only 8 per cent of Irish bank lending, much like other European countries. Now it has risen to 28 per cent. By comparison, just before the Japanese bubble burst in late 1989, construction and property development had grown to a little over 25 per cent of bank lending.

Now, we see that process in reverse. When credit ran dry, the bubbles (both housing and economic) popped. The economy, in desperate need of liquidity to help slow the unwind, has seen its money supply (in terms of M3 which literally doubled from July 2004 - August 2007), decrease year over year at a rate of more than 10%. Back to the Irish Times:

Ireland's economy will contract faster than most EU economies this year and its budget deficit will be the highest in Europe in 2010, according to new forecasts published by the European Commission. Brussels predicts Irish economic output will fall 5 per cent in 2009, unemployment will rise to 9.7 per cent and the deficit will reach 13 per cent of gross domestic product (GDP) by 2010 in the face of the world’s worst recession since the second World War.

Just to see how different the situation can be with a country that has control of their money supply, below is a chart detailing that of the UK. While the UK had its own asset / credit bubble, they had a more controlled increase in money supply (a still too high for the time 10-15% vs. Ireland's 15-30%), but importantly they have been able to increase this level to almost 20% as the economy has become in desperate need of liquidity.

Source: CSO

Death of the Newspaper

Financial Times (hat tip Felix' Market Movers) reveals that News Corp may have been a bit too early with their acquisition of Dow Jones (i.e. the Wall Street Journal), though it is important to note that the value of News Corp stock (it was a stock acquisition) is down 2/3 since the 2007 acquisition:

The $5.6bn Rupert Murdoch’s News Corp paid in 2007 for Dow Jones, owner of the Wall Street Journal and several local papers, would now be sufficient to buy Gannett, the New York Times, McClatchy, Media General, Belo and Lee Enterprises, even at twice their current share prices.

Investment Grade Bonds: Attractively Priced, But With Reason

While the Barclays Capital Investment Grade Index has rallied significantly over the past few months (from slightly more than 9% to just over 7%), the yield is still significantly higher than it was pre-financial crisis, presenting what appears to be a great investment opportunity.



While a portion of this is due to the sell-off across investment grade corporate bonds, another explanation lies in the composition of the index. Since January 2007, the composition of the index has stayed relatively static with regards to holdings of Aaa and Baa rated securities. However, there has been a 7% shift by market value from Aa rated to A rated securities due to downgrades (in addition there have been downgrades from A to Baa, and Baa to high yield, which brings up survivorship bias, but that is another post altogether).



The relevance? Since early 2007, the yield of Aaa and Aa securities has stayed flat (though spreads to Treasuries have widened significantly). On the other hand, A and Baa Investment Grade corporates are 140 and 240 bps wider respectively in that period (note the crossing pattern of Baa and A yields in September / October and Aa and Aaa yields currently due to the market's disagreement with the agencies ratings, specifically financials).



In other words, a lot of the increase in 'absolute yield' levels of Investment Grade Corporate Bond indices are due to a worsening of credit, not necessarily pure market opportunity. While I personally find value at these levels, it is important to understand what risks you are taking as an investor.

Chinese Unemployment Projected at 30 Year High

Some more bad news ahead of tomorrow's Chinese GDP release. Bloomberg (hat tip Naked Capitalism) reports :

China’s official urban unemployment rate jumped for the first time since 2003 and may climb to an almost 30-year high as exports slump and a slowdown deepens in the world’s third-biggest economy.

A rate as high as the government’s 4.6 percent target for this year, which was announced by Yin today, would be the worst since 1980, official data show. Premier Wen Jiabao said yesterday that the government must do more to preserve social stability in the face of a “very grim” job outlook.

California Freeze Up: Are Munis Still Safe?

This is a recycling of a previous post, which again becomes relevant given the new issues facing California. CNN reports:

The check isn't in the mail, and it's not going to be for at least 30 days, California will start telling some of its creditors in February.

The state, facing a $42 billion deficit, will delay some crucial payments to stay liquid, state Controller John Chiang announced Friday.

Among those who will be left waiting for checks are thousands of businesses that provide services and products to the state; more than 1 million aged and disabled Californians who need to pay for rent, utilities or food; and individuals and businesses awaiting tax refunds to the tune of $1.91 billion.

While the state has too many issues to discuss in a single post, is California's debt still likely to be paid back? As seen below, the state's general obligation bonds have sold off significantly more than the index in recent months (peaking at the end of December).



Not to worry says Investor Nirav:

They asked the California state treasurer Bill Lockyer whether the California public debt was completely safe. “Absolutely, the only way we’re going to default is if there’s a thermonuclear war.”

So there’s no doubt that California will pay back the debt. In the worst case, the Federal Reserve would just bail the state out. If they’re willing to bail out car companies, I’m sure they’ll step in for California.

I agree... and I'll also agree with the article's obvious finishing comment.

But if there’s more bad news, the yields could go higher still, and the prices of the bonds could fall in value.

In other words, be prepared to face volatility / uncertainty in any investment in the current environment.

Not All AA Bonds are the Same

According to Moody's, Aa Bond:

Obligations rated Aa are judged to be of high quality and are subject to very low credit risk, but "their susceptibility to long-term risks appears somewhat greater".

In other words, while they are not bullet-proof like Aaa's, they should have a minor chance of default. Given the current market condition, it is not surprising that financial and insurance company bonds have sold off more than other AA corporates, but it is pretty wild by how much.



The reason? Ignoring the thought that financial bonds have a higher likelihood of default (I can see both sides of this... on their own yes they do, but government assistance will greatly help), it has become painfully clear that the recovery value of these financial bonds given default is slim (Lehman junior debt is trading at close to nil, while CDS on the senior debt paid out less than 10 cents to the dollar).

Out With the Outgoing Overly Optimistic View on the Economy

EconomPic Data reader Alan directed me to the NY Times 'Economix' post which details the recently released Economic Report of the President. This report is the outgoing administration's view / forecast for the economy. As the NY Times reports, the forecast is that things won't be pretty:

Net job losses in 2009 will be more than twice those in 2008. (Also note that these numbers are based on data collected as of Nov. 10, and do not reflect reports that have come out since then.)

While Alan "gasped" at the bottom chart detailing consumption vs. wealth, I am more taken aback by what I feel is an overly optimistic forecast within the Council of Economic Advisers report. Although some may give the outgoing administration the benefit of the doubt as a lot has happened since November 10th (the date in which the data for the report was finalized), these figures, while ugly, were extremely optimistic even at that date.

As can be seen below, projections are not only for a significantly improved economy by 2010, but an economy growing above levels we have seen over the ten years leading up to this crisis (i.e. when the term "Goldilocks" was running amok). This seems extremely hopeful given recent economic news releases and the uncertainty easily witnessed in the global economy.



GDP: projections are for positive growth in 2009 (highly unlikely) and a bounce back to 5% real growth in the next two years (vs. a 2.8% 10 year average)

CPI: projections are for a "Goldilocks" 1.5% - 2% CPI rate each year from 2010-2014. This versus a 10 year average of 2.5%. If / when we are able to move from the deflation threat, I don't see how inflation doesn't move well above these levels given the flooding of liquidity already witnessed and massive stimulus to come.

Unemployment Rate: projections are for a spike to 8% in 2009, but a retrace to the 10 year average (5%) by 2012. Most optimistic projections I've seen now call for a 9% peak, while 12% targets are now making the rounds. Either way, 5% by 2012 would be a dream come true.

Non-farm Payroll Growth: While the NY Times remarked that 2009 expectations are for net job losses twice that of 2008, these figures are WAY too low. In December alone, we saw the number of those employed down almost 1,000,000 IN ONE MONTH on a non-seasonal basis. Add the birth /death adjustment that may add ANOTHER million in coming months and their figures are a joke.

While optimists have their place in society (heck, I wish I was an optimist), they don't belong in policy making when the downside risks of getting this wrong are so large. I am hopeful that the new administration is as realistic and open as they have appeared to be leading up to tomorrow's historic inauguration.

Spreads: Not Seen Since the Great Depression

JG provided an interesting insight in the comments section of my "Real Yields Matter" post. Credit risk premium, as defined by the difference between the yield of the Moody's Baa and Aaa rated indices (more detail regarding Moody's here), recently moved above 3%. What is the significance?

As of Nov. ‘08, the Baa-Aaa risk premium moved above 3.0%, to 3.07%; in December, it was 3.38%.

When were the last times that the Baa-Aaa risk premium rose above 3.0%? August ‘31, October ‘32, October ‘33, and March ‘38, in the depths of the Lesser Depression (first two) and its protracted recovery (last two).

We are one year into The Greater Depression.

In plotting the data, JG is correct. Although we were awfully close in the early 1980's and 338 bps is a a lot smaller than the 560+ bps we saw in 1932, this does put the current crisis into the correct context.

Source: St. Louis Fed (BBB) / St. Louis Fed (AAA)

Real Yields Matter

Paul Krugman comments:

The really striking thing about corporate borrowing rates isn’t that they’re high by historical standards, although they are, but the fact that they’re high even though interest rates on government debt are very, very low. Below I show the spreads on AAA and Baa debt against 30-year Treasuries: they really have spiked.

Also bear in mind the decline in expected inflation: real corporate rates are very high.

That last sentence is key. Even though Treasury rates have rallied significantly in nominal terms over the past 1 1/2 years, they still yield more in real terms than when the financial crisis began. Corporates, as Paul points out, are the greater issue. Real yields on Investment Grade Corporate Bonds are now 2.5x higher than they were just six months ago.



Throw in a declining economy and the diminished end-user demand we are witnessing across industries, and it is very easy to see why corporations are having such a difficult time.

A Feel Bad Rainbow: Job Cuts YTD

CNN reports:

The job market is off to a terrible start this year, with companies announcing more than 80,000 job losses so far, in one of the most painful symptoms of the ongoing recession.

Circuit City Inc. is the biggest culprit of 2009. The bankrupt retailer said on Friday that it is shutting down because of dried-up consumer spending and liquidating its 567 U.S. stores, dooming some 30,000 jobs.

Global Banking Sector Struggles

The following chart (hat tip Paul @ Infectious Greed) details the percentage of companies in the banking sector that are on negative watch (per Fitch) by country as of now (January 2009) and then (January 2007).

"The stresses in Europe" received Paul's attention, the relative strength in Latin America and developed Asia received mine.

EconomPics of the Week (1-16-09)

Going Global
Help Jake Understand: Is it Possible that a Country Will Leave the Eurozone?
The Irish Dr. Doom... or Just an Exaggerating Economist?
Irish Home Prices... In Gold
Chinese Exports Plunge

Economic Data
Consumer Price Index (December)
Inventory / Sales Ratio Spikes
Deficit as a Percent of GDP
Producers Price Index Breakdown (December)
Retail Crushed
U.S. Trade Deficit Down Most in 12 Years
Wholesale Trade: Sales Cliff Dive
Recession Defined... Capacity Under-utilized

Bailout / Stimulus
Stimulus Projected to Save 3.675mm Jobs... 3mm Too Little.
Draft of $550 Billion in Government Stimulus Spend
First Third of TARP Could Cost Taxpayers $64 Billion

Banks / Corporations
JP Morgan 'Fee Income' by Business Segment
Alcoa $1.19 Billion Loss vs, Commodity Markets
Oil Tankers are a Banks Best Friend

Credit
Loose Credit and Autos
Auto Bubble Breakdown
Receipts Down, Outlays Up = Soaring Deficit
Fixed Mortgage Rates at Less than 4.5%

First Third of TARP Could Cost Taxpayers $64 Billion (i.e. a 26% Loss)

WSJ reports:

CBO said the $64 billion figure generally represents the difference between what Treasury paid for the investments or lent to firms and the market value of the transactions. This difference, called the “subsidy rate”, was 26% for the first third of the TARP funds.

Recession Defined... Capacity Under-utilized

Source: Federal Reserve

Irish Home Prices... In Gold

There is an interesting thread over at Politics.ie that links to a post showing UK/London/Scotland home prices in 'ounces of gold' and requests:

I love to see a chart on Irish house prices - anyone?

Here it is... less of a bubble than London, but more than Scotland.

Oil Tankers are a Banks Best Friend

According to Wikipedia, contango is:

a term used in the futures market to describe an upward sloping forward curve (as in the normal yield curve). Such a forward curve is said to be "in contango" (or sometimes "contangoed").

Formally, it is the situation where, and the amount by which, the price of a commodity for future delivery is higher than the spot price, or a far future delivery price higher than a nearer future delivery.

How large "should" this contango be? Back to Wikipedia (bold mine):

A contango is normal for a non-perishable commodity which has a cost of carry. Such costs include warehousing fees and interest forgone on money tied up, less income from leasing out the commodity if possible (e.g. gold). The contango should not exceed the cost of carry, because producers and consumers can compare the futures contract price against the spot price plus storage, and choose the better one. Arbitrageurs can sell one and buy the other for a risk-free profit too.

Based on this expectation, the current contango witnessed is EXTREMELY excessive. As of the latest figures, contango (as measured below by the spot rate vs. the futures rate 6 months out), the difference is ~15% annualized. This against some of the lowest short-term financing rates we've seen in years (i.e. this is a huge arbitrage opportunity).

Why does this contango exist? My theory is oil producing countries NEED money (budgets were based on $60, not $30 oil) so are willing to sell at whatever the current market price is. And speculators / arbitragers are willing to buy at this price knowing they can sell for a higher amount in the futures market and deliver that oil when / if necessary. This tells me that there is actually artificial demand even at these low prices (from those storing vs. those using the oil) and prices can / will go even lower once storage capacity is completely filled as the market becomes flooded with this stored oil.

And this is exactly what is happening (per Bloomberg):

Morgan Stanley is seeking a supertanker to store crude oil, joining Citigroup Inc. and Royal Dutch Shell Plc in trying to profit from higher prices later in the year, four shipbrokers said. The bank has yet to find a suitable vessel, said one of the brokers, all of whom asked not to be identified because the information is private. Carlos Melville, a spokesman for Morgan Stanley in London, declined to comment. “There’s a lot of people looking for storage,” Denis Petropoulos, London-based head of tankers at Braemar Shipping Services Plc, the world’s second-largest publicly traded shipbroker, said by phone.

Update: Mish has a great explanation for the current dislocation between WTIC and Brent Crude.

As long as storage is available at Cushing -- and given the steep rise in inventories reported by the Energy Information Administration today, storage clearly has been available -- excess oil will go to where it is easiest to take advantage of the contango structure in the market. The eye-popping contango of almost $13/b between February and August WTI is a direct result of the overhang of oil on the market, and the fact that there was available storage at least through last week brought the world's excess oil overhang.

With 32.182 million barrels now sitting in Cushing, the market appears poised to test the limits of storage capacity there. So it's WTI that's reflecting what is going on in the world: the collapse in demand, oversupply and a resulting enormous contango that is encouraging storage. On this one, WTI is ahead of the curve, not behind.

Consumer Price Index (December)

BLS details:

The CPI-U decreased 0.7 percent in December, the third consecutive decline. The index is now only 0.1 percent higher than in December 2007. Declining energy prices, particularly for gasoline, again drove most of the decline. The energy index declined 8.3 percent in December. Within energy, the gasoline index fell 17.2 percent and accounted for almost 90 percent of the decrease in the all items index. The index for household energy declined 0.7 percent. Excluding energy, the index was virtually unchanged for the third straight month. The food index declined 0.1 percent in December, the first decrease since April 2006, as many meat, dairy, fruit, and vegetable indexes decreased.

Contribution



By Expenditure

JP Morgan 'Fee Income' by Business Segment

Felix at Market Movers details those losses by JP Morgan that reduced their profit (still impressive given the environment - if you believe the #'s) to $702 million:

Interestingly, the bulk of those losses -- $2.9 billion -- came from writing down the investment bank's leveraged loans. During the boom years, it was an article of faith that investment banks needed huge balance sheets, because no one would use their M&A advisory services if they couldn't get cheap loans at the same time.But looking at the scale of these losses, it seems clear that no amount of M&A advisory fees could make up for them: JP Morgan would have been better off financially just simply axing its M&A department altogether.

Breaking out JP Morgan's 'Fee Income' by business segment, I am surprised at how well most have done.



In coming months, we'll see if these other sources of income are enough to outpace what I expect to be growing losses in trading.

Draft of $550 Billion in Government Stimulus Spending Released

A draft of how ~$550 Billion of the $850 Billion stimulus has been released (hat tip How the World Works).



Source: Committee on Appropriations

Help Jake Understand: Is it Possible that a Country will Leave the Eurozone?

I must admit that I am no expert in the field of International Economics (in fact I do not understand it), but I am trying to grasp some of the consequences that a single currency (either through the adaption of the Euro or a fixed exchange rate) has on a country when it limits that country's monetary policy. For all those that understand this topic much better than I, PLEASE POST AND HELP ME OUT.

Point (the case for a Eurozone breakup)

Ben Bittrolff at the Financial Ninja kicks off the discussion:

Abandoning the USD in favor of the higher yielding Euro is a dangerous trade. The risks of the Euro unraveling are growing larger by the day. Recent volatility in the foreign exchange markets should definitely raise eyebrows. In the end, the USD is still the undisputed reserve currency of the world. Spain and Italy are the most likely candidates for sovereign default.

The Short View: “If the eurozone could find a way to deal with a member country’s national default, that might confirm the euro’s status as the world’s next reserve currency. But if a solution could not be found, and a country exited, any such ambition would be over, says John Authers.”

Tuesday night, I saw an eerily similar post over at Across the Curve. Before diving in, a little background on the ERM (European Exchange Rate Mechanism) which is discussed below, via Wikipedia.

The European Exchange Rate Mechanism, ERM, was a system introduced by the European Community in March 1979, as part of the European Monetary System (EMS), to reduce exchange rate variability and achieve monetary stability in Europe, in preparation for Economic and Monetary Union and the introduction of a single currency, the euro, which took place on 1 January 1999.

In a nutshell, before the ERM (or European Monetary Union “EMU”, which in its third stage introduced the Euro as the real currency), a country controlled their own monetary policy and could devalue their currency when the situation deemed appropriate. No longer… as a result we see a growing divergence between the haves and have-nots. To Across the Curve:

Belgian 10-year spreads over Germany have widened 16 bp over the past five days in line with Spanish spreads. Dutch spreads have widened 10 bp over the same period, in line with Italy and in sharp contrast to the 2bp widening by France. On a three month basis, Belgian spreads have widened 37bp, also in line with Spain and vs. 32 bp for Holland and 21 bp for France. As we noted yesterday, part of the widening of Spanish - and also Belgian - spreads may reflect liquidity premiums but, at least for Spain, also likely reflects competition. Prior to ERM , a devaluation of the Spanish currency enabled the country to boost its competitiveness.

It appears to me that the ERM and/or the EMU has limited the ability of a country, such as Spain, to react to the specific situation occuring in their economy, as each country is forced to accept the monetary policy best suited for the union as a whole. In other words (back to Across the Curve):

ERM membership blocks / eliminates that policy action and risks a deeper economic crisis.

Spain, which is under severe economic strain, cannot respond with a devaluation of their currency and a flooding of liquidity, as they need to move forward with a policy best meant for the larger powers (i.e. Germany), which have not experienced the same home boom / bust and are still worried about reigniting inflation after all they went through in the 1930's.

In fact, just the reverse situation has occurred... the money supply in Spain (as measured by M3) has actually decreased over the past three months, just as the country is in desperate need for liquidity.



And things seem unlikely to improve anytime soon. As Forbes reports:

Restrictions on foreign financing have collapsed Spanish housing and consumer spending booms and sent unemployment to the highest rate in the European Union at 13.4 percent in November. S&P saw the risk of prolonged weak growth after the Spanish economy entered its first recession in 15 years during the fourth quarter.

Counter-Point (no breakup)

The counter-argument comes from Willem Buiter (hat tip Naked Capitalism):

Three issues are being linked in this passage. The emergence of high levels of sovereign default risk premium differentials between different eurozone member states, the external value of the euro and the likelihood of the eurozone breaking up. There is no self-evident link between these three issues. The first is neither necessary nor sufficient for the second or the third. More than that, the threat or reality of sovereign default by a eurozone member state is much more likely to reduce that country’s incentive to leave the eurozone than to increase it....

Why?

Would a eurozone national government faced either with the looming threat of default or with the reality of a default be incentivised to leave the eurozone? Consider the example of a hypothetical country called Hellas. It could not redenominate its existing stock of euro-denominated obligations in its new currency, let’s call it the New Drachma. That itself would constitute a further act of default. If the New Drachma depreciated sharply against the euro, in both nominal and real terms, following the exit of Hellas from the eurozone, the real value of the government debt-to-GDP ratio would rise.

Go read the whole thing, but to say I'm uncertain would be an understatement...

Producers Price Index Breakdown (December)

Year over Year



Month over Month



Historical Year over Year

Source: BLS

Deficit as a Percent of GDP

On Tuesday, I posted a chart showing the growing budget deficit and received this request:

Better yet, show outlays and receipts as % of GDP and take it back to 1945.

Unfortunately, I only was able to dig out budget data going back to the early 1980's, but it does have an interesting story to tell. Over the past 12 months, the deficit has grown to ~6% of nominal GDP (for December 2008 I assumed nominal GDP decreased -1% QoQ).



At first glance I was relieved that we were only in a situation as bad as that of the early 1990's, but then I forgot this deficit doesn't yet include any of the new stimulus plan.

Even scarier (at least to me) is looking at the budget surplus / deficit as a percent of receipts, the pre-stimulus deficit is now a whopping 33% of total receipts.

Inventory / Sales Ratio Spikes

Forbes details the latest Inventory / Retails Sales figures:

The Good:

Business inventories fell 0.7% in November, a bit more than the consensus 0.5% decline and the largest drop since November 2001. IFR was expecting a 0.8% drop.

Inventories were down in all major sectors but fell 1.3% among retailers, the biggest drop since July 2005. Auto dealer inventories fell 1.7%, so total retail inventories excluding auto dealers fell 1.0%, lower than the overall retail inventory drop but still a record.

The Bad:

November business sales fell a record 5.1%, and are down 8.9% from November 2007. The prior record was October's 3.9% decline.

What it Means:

As sales are falling faster than inventories, the current level of inventory on hand is increasing relative to sales. In fact this measure increased almost 17.5% from a year ago. This means there is less need for a businesses to reorder (there is already plenty in their inventory), which means new orders, although already awful, are likely to get worse going forward.



Source: Census

Retail Crushed

CNN details the horrific results:

"Holiday sales posted the biggest decline on record falling around 3.5%," wrote Anika Khan, an economist for Wachovia. "Sales have been primarily driven by extensive discounting which is hurting retail profit margins."

Some of the decline in sales can be attributed to falling prices. The figures are not adjusted for price changes, but they are adjusted for seasonal variations. Economists believe consumer prices fell 0.8% in December; U.S. inflation data will be released on Friday.

Retail sales last month were down a record 9.8% compared with December 2007, the Commerce Department's data showed. Sales excluding autos fell a record 6.7% in the past year.

Below is a chart of December '08 vs. December '07 (not seasoanlly adjusted).



What's up with that huge spike in health care? I hope it's not those recently unemployed rushing to buy supplies while they still have coverage...

Loose Credit and Autos

Googling the following term 'Loan to Value Auto' and the first applicable result (3rd overall) is a page at RoadLoans. This site provides an explanation as to what Loan to Value "LTV" means, using an example of an individual borrowing more than the value of the car.

LTV is a calculation that shows the amount you borrow as a percentage of the book value of the vehicle* you are purchasing. For example, if you borrow $15,000 on a vehicle with a value of $13,000, the LTV would be 115.3% ($15,000 divided by $13,000).

And that is exactly what happened. In September 2006, the AVERAGE loan was larger than the value of the underlying vehicle for the first time on record, which in turn helped the auto companies sell vehicles to those who probably couldn't afford the actual car and led to strong business at the autos (GM stock doubled between March 2006 and November 2007).



That is until the house of cards came tumbling down.

Source: Federal Reserve

The Irish Dr. Doom... or Just an Exaggerating Economist?

Professor Roubini has nothing on Professor Morgan Kelly from the University College Dublin. Back in February 2007, Prof. Kelly predicted:

The expected fall in average real house prices is in the range 40 to 60 per cent, over a period of around 8 years. Such a fall would return the ratio of house prices to rents to its level at the start of the decade.

By January 2008, Professor Kelly felt this 50% decline was overly optimistic:

Writing in this newspaper a year ago, I suggested that, in the light of past property booms abroad, Irish house prices were at risk of falls of around 50 per cent in real terms. At the time I imagined, again based on what had happened elsewhere, that selling prices would stabilise at their peak values for a year or two, and then fall slowly by a few per cent a year for up to a decade.

My forecast has turned out to be wildly optimistic.

And now? According to the Irish Times (bold mine):

Ireland will see more demolition than construction of houses over the next decade, as the economy struggles to recover from the collapse of the housing market and the emergence of “zombie” banks, UCD economist Morgan Kelly told the conference.

In a presentation that drew several collective intakes of breath, Mr Kelly predicted that house prices would fall by 80 per cent from peak to trough in real terms.

An 80% decline in nominal terms would be extreme (it would bring home values back to levels seen in 1993), but Professor Kelly's 80% decline in real terms means home prices will drop to a level not seen since.... well I can't find data going back that far, if it even exists.

Receipts Down, Outlays Up = Soaring Deficit

CNN Money reports:

The federal budget deficit expanded by $83.6 billion in December, the Treasury Department reported Tuesday, bringing the total deficit for the first three months of the 2009 fiscal year to $485.2 billion. By comparison, the budget deficit for all of fiscal year 2008 was $455 billion. In fiscal 2007, it was $161 billion.

Over the last 12 months, the deficit is an astounding $816 Billion, which will seem small all too soon.

Source: Treasury

U.S. Trade Deficit Down Most in 12 Years

Paul over at Infectious Greed points out the strange reaction to this morning's trade data.

Trade data today was one of those outrageous sorts of crazy thing that happen lately, and yet causes no-one to blink an eye. We had a nearly 30% drop in the U.S. trade deficit, one of the largest percentage drops of all time, and yet it really didn’t matter in some sense.

Why? Because both imports and exports tumbled too. There was a 12% (!) drop in imports -- almost $25-billion, off the top. Admittedly, that was driven by both oil prices and declining consumer demand, but it was eye-popping. And exports fell too, but not on the same scale, with them tumbling a mere 6%.

note: the U.S. has a trade deficit for goods and a trade surplus for services, thus the chart below shows a drastic reduction in net imports for goods and a slight increase in net exports for services.



Source: Census

Chinese Exports Plunge

Bloomberg reports:

Threats to the world economy are already building. Chinese central bank governor Zhou Xiaochuan said Jan. 12 that there are downside risks to the government’s 8 percent growth target for this year. Chinese exports fell for the first time in seven years in November, imports plunged and industrial output gained the least in almost a decade. Economic growth may slow to 7.5 percent this year, the World Bank estimates.

Fixed Mortgage Rates at Less than 4.5%

Update: Tom O points out in the comments that EconomPic is slacking with regards to timely info, which I will agree with (meant to post this last week...)

A little behind the time. Conforming fixed 30-year mortgage rates in CA for prime borrowers have been around 4.5% at a point (under 4.7 APR)for the last week or so.

Per Bloomberg:

The largest U.S. banks are starting to offer fixed home loans below 5 percent after the government began buying mortgage securities to bolster the housing market.

JPMorgan Chase & Co. is advertising 30-year mortgages as low as 4.75 percent on its Web site, Wells Fargo & Co. has an offer for 4.875 percent and Bank of America Corp. has rates at 5 percent. The offers are for borrowers with excellent credit who put 20 percent down.

Felix of Market Movers even shows a 4.375% 15-Year rate from Chase.

Looking at historical 15-year rates and using those rates to calculate monthly payments on a 15-year $200,000 mortgage, we see monthly payments down almost $250 / month. This hope is this brings in the marginal buyer.



Too soon to tell, but it does seem like a positive sign. Of course, in an environment marked by 20-50% declines in home values there are always secondary effects to worry about.

Wholesale Trade: Sales Cliff Dive

I'll file this as a "better late than never post". Reuters reported last Thursday:

U.S. wholesale inventories fell in November while sales posted a record decline, a government report said on Friday.

The Commerce Department said U.S. November wholesale inventories fell 0.6 percent after a revised 1.2 percent decline in October. November wholesale sales plunged a record 7.1 percent after falling a revised 4.5 percent in October.

Wall Street economists surveyed by Reuters expected wholesale inventories to fall 0.8 percent in November. A month earlier, the department reported October inventories were down 1.1 percent while sales fell 4.1 percent.

Looking at the rolling 3-month change in wholesale trade sales, we see levels down almost 50% on an annualized basis.



Breaking out the sales by sector, we see there was "nowhere to hide" with petroleum and autos leading the way.



The drop appears to have surprised businesses, as inventory spiked which will add to the deflationary pressures we've seen over the past few months (PPI should verify this with Thursday's release) as businesses attempt to shed these excess inventories as a discount.



Why the huge drop in sales? Consumers are less willing (or able) to borrow to make purchases. MSNBC reports:

Consumer borrowing dropped by a record $7.94 billion in November, a Federal Reserve report showed on Thursday, the latest evidence that households were unwilling or unable to take on more credit.

That was the biggest decline since the data series began in January 1943, and was far steeper than the $0.5 billion dip that economists polled by Reuters had expected.

The November decline represented a drop of 3.7 percent, the largest percentage fall since January 1998, when it was down 4.3 percent.

Source: Federal Reserve, Census

Alcoa $1.19 Billion Loss vs, Commodity Markets

AP:

Alcoa Inc., the world's third-largest aluminum company, said Monday it lost $1.19 billion during its fourth quarter as prices and demand for the metal plunged in a troubled global market. Alcoa's loss highlighted the impact of the weakening world economy on key aluminum markets, such as the construction and auto industries. Prices of the metal, used in everything from cars and aircraft to window frames and beer cans, have fallen steeply along with other commodities since mid-2008.

Auto Bubble Breakdown

Cheap financing led to soaring loans.



The same chart with the financing rate axis reversed shows the strong correlation between the financing rate and size of the historical loan value.



This created an environment in which the consumer could borrow more, but pay the same amount (i.e. cheap financing meant monthly payments stayed relatively flat after accounting for inflation).



This has unraveled in recent months as consumers not only realized they didn't need a new car every 30,000 miles, but they also found it difficult accessing cheap credit as lenders reigned in lending (i.e. GMAC refused to lend to any borrower with a FICO score under 700). The obvious result... auto sales collapsed, which in turn led to the GMAC bailout to pump the bubble back up (per PoAC):

At the start of last week, the U.S. Treasury bought $5 billion in GMAC stock and loaned GM $1 billion to invest in GMAC Financial Services LLC.

The next day, GMAC announced zero percent financing on some models of GM cars and doubled the number of potential buyers qualifying for loans.

Source: Federal Reserve

Stimulus Projected to Save 3.675mm Jobs... 3mm Too Little?

Christina Romer and Jared Bernstein have released projected jobs created / saved due to the Obama stimulus plan... a cool 3.675 million. The charts below show where these jobs are projected to come, by sector and by method (i.e. direct or indirect).

The most jobs, not surprisingly, are in construction. Other top sectors include retail (from stimulating consumption), leisure (gotta do something when laid off right?), and manufacturing.

Table 2:



How? Well, the majority are expected to be indirectly created not from the plan itself, but by the recycling of dollars / demand created from those created directly. Projections are for state relief (i.e. fund projects that would otherwise be cut) to save / create the most, followed by the protection of those jobs vulnerable in the downturn, and tax cuts.

Table 5:



The question is obvious... is this enough? According to Christina Romer and Jared Bernstein's "R/B" own conclusion:

• The recovery plan needs to be large to counter the tremendous job loss that is likely to occur

So is it? Paul Krugman says it clearly is not:

Here’s one way to look at it: R/B show the effects of the plan rapidly fading out during 2011. Yet at the end of 2011 the unemployment rate is still 6.3%. Meanwhile, the CBO estimates the natural rate, aka “full employment,” at just 4.8%. Why does the plan go away with the job undone?

In other words, R/B and Paul all conclude that the plan needs to be large enough to offset the jobs lost, but R/B themselves project that it won't. By their own analysis, employment is expected to rise to 9% with no stimulus. Comparing employment figures from December 2007 (unemployment at that time was 4.8%, which equals the CBO "full employment" level) with the projected employment figures for 2010 using R/B's 9% unemployment figure, I project the those unemployed to rise 6.7mm from December 2007. This is 3mm higher than the number of jobs the stimulus plan is projected to create / save (the difference between the loss in employment and gain in unemployment is the population growth) or to be blunt, not enough.

EconomPics of the Week (1-09-09)

Employment
Unemployment Way Worse than 7.2% Due to Birth / Death Model
Broader Unemployment to 13.5%
Employment by President
Less Educated Hurt More... Everyone Unemployed Longer
Additional Employment Breakdown (December)

Asset Classes / Returns
The Good / The Bad: Time to Buy Equities?
The Ugly: P/E Multiple
Are Treasuries Really in a Bubble?
Long Bonds / Short Equities Redux
Huge Mortgage Rally... Thanks Government!
Another Post on Swaps????
2008 Hedge Fund Breakdown... Where's the Hedging?

Economic Data
Same Stores Sales... Down, but Not Out
ISM Services (December)
Auto Sales Continue to Crumble
Construction Spending November

Bailout Nations
Federal Reserve Bank Credit Down $125 Billion
Bank of England Cuts to Lowest Rate Since 1694.
Budget Deficit... Overly Optimistic and Still Ugly...

Gold
Fun with Gold
Global Demand for Gold on the Rise

Housing
Forget the Term Foreclosure, this is More Like Fiveclosure

Employment by President

I understand this is not completely due to GB II (the business cycle dominates a lot of this), but...

WSJ:

President George W. Bush entered office in 2001 just as a recession was starting, and is preparing to leave in the middle of a long one. That’s almost 22 months of recession during his 96 months in office.

His job-creation record won’t look much better. The Bush administration created about three million jobs (net) over its eight years, a fraction of the 23 million jobs created under President Bill Clinton’s administration and only slightly better than President George H.W. Bush did in his four years in office.

I've also added a line showing the difference between the jobs growth and population growth. Any negative figure means jobs grew at a slower rate than the population... not a good thing.

Long Bonds / Short Equities Redux

Back in October, EconomPic Data presented some amazing data that showed there had been no equity premium over the previous 11 3/4 years (i.e. no excess return for equities over bonds). With the continued sell-off in equities and a rebound in credit markets, the Lehman Barclays Capital Aggregate Bond Index has now provided an equal return to the S&P 500 over the PAST 19 YEARS INCLUDING REINVESTED DIVIDENDS / COUPONS!

Employment Recap

Phew... I think my unemployment analysis is over. Here is a recap:

Less Educated Hurt More... Everyone Unemployed Longer
Employment Breakdown (December)
Unemployment Way Worse than 7.2% Due to Birth / Death Model
Broader Unemployment to 13.5%

Less Educated Hurt More... Everyone Unemployed Longer

Source: BLS

Employment Breakdown (December)

Source: BLS

Unemployment Way Worse than 7.2% Due to Birth / Death Adjustment

The Birth Death Model once again overstates employment. In other words, things are a lot worse than the 7.2% rate presented to us. Per The Big Picture:

Since 2003, the B/D adjustment has been part and parcel to BLS' Current Employment Statistics (CES) program, the official measure of US employment. In brief, the Birth Death adjustment imagines (hypothesizes) how many jobs were created by companies too new and/or too small to participate or be found by CES. The model attempts to create what is perceived as a BLS error at the start of any recovery, when many new jobs are created but missed by BLS.

Does anyone think small businesses have really added 53,000 jobs to the financial sector over the past 12 months (and 18,000 last month)? Get ready for a severe reaction next month when it snaps back (the annual correction to the B/D figure is made in January's release - coming in February).



Source: BLS

Broader Unemployment to 13.5%

Source: BLS

Federal Reserve Bank Credit Down $125 Billion

Some good news ahead of the bloodbath that will be reported at 8:30 ET this morning... Calculated Risk reports:

The Federal Reserve released the Factors Affecting Reserve Balances today. Total assets declined $125 billion to $2.14 trillion. This is a little improvement ...

Source: Federal Reserve

Same Stores Sales... Down, but Not Out

According to CNN Money:

Despite a startling miss by Wal-Mart Stores Inc. (WMT), overall December same-store sales are tracking ahead of analysts' projections. Virtually all retailers have posted sales drops from a year ago, but for almost two-thirds of them the decline wasn't as much as expected, according to data tracker Retail Metrics.

Huge Mortgage Rally... Thanks Government!

FT reports:

The Federal Reserve on Monday kick-started its latest unconventional programme to boost the US economy, this time targeting mortgage-backed securities to help the slumping housing market, reports Reuters. The Fed plans to buy back as much as a ninth of outstanding, mortgage-backed bonds sold by mortgage giants Fannie Mae, Freddie Mac, and Ginnie Mae. The aim is to encourage buyers to return to the housing market or cut payments on existing home loans. The New York Fed began buying MBS guaranteed by Fannie, Freddie and Ginnie on Monday, part of a programme of as much as $500bn.

Nice rally! Now all the government needs to do is buy equities, credit, and commodities / hire everyone currently unemployed... almost there!

Bank of England Cuts to Lowest Rate Since 1694 Inception

Bloomberg reports:

The Bank of England cut the benchmark interest rate to the lowest since the central bank was founded in 1694 as policy makers tried to prevent the credit squeeze from deepening Britain’s recession.

The Monetary Policy Committee, led by Governor Mervyn King, trimmed the bank rate by a half point to 1.5 percent. The result matched the median forecast of 60 economists in a Bloomberg News survey. The pound rose against the euro and the dollar.

Forget the Term Foreclosure, this is More Like Five-Closure

First, my apologies about that headline... not enough sleep. Bloomberg details:

Almost half the homeowners who bought in 2006 now owe more on their mortgages than their houses are worth, making it difficult for them to refinance without bringing cash to the closing, according to Seattle-based real estate data company Zillow.com.

Forty-one percent of October home sales in Los Angeles and Phoenix were foreclosure auctions or financial firms trying to recoup lost loan value, Radar Logic said.

U.S. foreclosure filings increased 71 percent in the third quarter from a year earlier to the highest on record, according to RealtyTrac Inc., a Irvine, California-based provider of default data.

Think that's bad? Try this on. Aon (hat tip Infectious Greed) details the top ten foreclosure counties in California.



Foreclosures in these counties were up a whopping 2120% in 2008 as compared to 2006.

Budget Deficit... Overly Optimistic and Still Ugly

The CBO released their latest budget projections and although expected, it ain't pretty. Off-budget surplus relates to surpluses in the Social Security trust funds as well as the net cash flow of the Postal Service, while the projected on-budget deficit is an unreal $1.34 Trillion (or $1.19 Billion net the off-balance sheet item). But that's not all. According to Interest Rate Roundup:

Here's the really fun part: The CBO estimate doesn’t even include any potential stimulus package from Congress and the Obama administration. We haven’t gotten the final details of the plan, but it could cost anywhere from $675 billion to $1 trillion. That means the ultimate 2009 deficit could end up being larger by 60% ... 70% ... 80% ... or more.

And the reported figure is based on what seems to be highly optimistic economic growth. Real GDP is projected to be a little below -2% in 2009, then snap back to 1.8% by 2010. I don't buy these numbers and Paul Krugman details why this projection is overly optimistic based on the estimated GDP Gap and stimulus plan stated (bold is me).

The new CBO budget and economic outlook is out. Above (go to the post) is its forecast for the GDP gap — the hole stimulus has to fill. I’d guess that the CBO estimate, which has unemployment averaging 8.3 percent in 2009 and 9 percent in 2010, is actually too optimistic, but even so it puts the Obama plan in perspective: a 3% of GDP plan, with a significant share going to ineffective tax cuts, to fill an 8% or more gap.

Real GDP is projected at 4% each year from 2011-2014 and 2.5% each year from 2015-2018. This in a world in which the U.S. economy will no longer be levered up. Please note that all of these 2011+ projections are higher than what was projected back in September in growth terms, but they are based on a lower beginning value (and total GDP is down in each year than was projected in September).

Even with these optimistic numbers, the U.S. projects $400 billion a year in deficits for the next 10 years. We have to pay for this somehow (i.e. borrow), which goes completely against my case in a previous post that Treasuries may not be in a HUGE bubble (though I do think they are over the longer term).

Fun with Gold

Update: These ARE NOT charts of cumulative or relative return. They simply show how many ounces of gold were required to buy the S&P 500 or a home at each point in time against how much the S&P 500 or a home cost in dollars. The post doesn't say the word 'return' once and for any snap shot of cost at any point in time, rental earnings, dividends, or opportunity cost are irrelevant.

So, we all know housing and equity markets have been hit hard after many years of gains... in dollars that is. How would each market look in terms of the hardest of currencies... gold (note that October dates were used as that is the last Case-Shiller print and the long-term trend is what I was looking for).

The housing market is interesting. From 1987-1997 the housing market went nowhere in dollars, but started to see the beginning signs of the boom, in gold, beginning in 1997. From 1998-2005, we saw a bubble form in both dollars and gold, but that's where we see a huge divergence. Gold rallied hard starting in 2005, "predicting" the fall. It now takes roughly the same amount of gold to buy a home as it did back in 1997... dollars are another thing altogether.




The equity market is even more interesting (to me). Since 1994, the S&P 500 has roughly doubled in dollars. In gold, the market has gone... well nowhere.

Global Demand for Gold on the Rise

Bespoke has an interesting post showing how much gold has rallied in recent years relative to silver. Gold Research and Statistics details where the demand has come from:

Gold demand, in tonnage terms, rebounded strongly in Q3 after several quarters of weakness. Identifiable demand totalled 1,133.4 tonnes, up 170.1 tonnes (18%) on the levels of a year earlier. In US$ value terms, this represented a 51% rise to $31.8 billion, an all-time record high and a 45% leap from the previous record set in Q2. The recovery in demand was triggered by a fall in the gold price, which coincided with sharply escalated levels of economic and financial uncertainty.

After briefly testing levels above US$950/oz early in the quarter, the gold price fell back, briefly touching levels under $750/oz in mid-September. Nevertheless, the average for the quarter, at $872/oz, was 28% higher than Q3 2007’s $680/oz.The biggest contributor to the increase in total identifiable demand in Q3 was identifiable investment, up 137.5 tonnes (56%) relative to year-earlier levels. Jewellery demand rose 45.5 tonnes or 8%, while industrial and dental demand declined 11%.

It will be interesting to see what happened in Q4. My guess? Demand for jewelry is down a ton, but demand from bar hoarding and ETFs is up dramatically.

Source: World Gold Council

ISM Services (December)

Bloomberg reports:

U.S. service industries contracted in December for a third consecutive month as consumers retrenched and the housing slump worsened.

The Institute for Supply Management’s index of non- manufacturing businesses, which make up almost 90 percent of the economy, rose to 40.6, higher than forecast, from a record-low 37.3 the prior month, figures from the Tempe, Arizona-based ISM showed today. Readings below 50 signal contraction, and this month’s reading is the second lowest since records started in 1997.

Source: ISM

The Ugly: P/E Multiple

In response to yesterday's EconomPic post detailing the "Good and the Bad" of the equity market, reader "dblwyo" comments:

You should have gone ahead with "The Ugly" on future outlooks to complete the trifecta :) ! You might also want to re-visit Graham-Dodd's valuation formula where PE = (8.5 + 2 x G) x (4.4 / Y), where G = earnings growth and Y = AAA bond yield.

Great idea... for those unfamiliar with the Graham-Dodd P/E formula (or interested in seeing a full matrix), go here. Also, before I dive in... be forewarned that it is just a model. As Paul states over at Infectious Greed:

I don’t buy trough P/E, or recession length, or relative valuation, or interest rate, or sectoral rotation arguments, or… you get the picture. I love data, but I’m increasingly close to being an outright nihilist when it comes to over-reliance on historical financial data without any truly coherent supporting rationale.

Now that I've given proper warning... lets go to what this formula tells us.

Current yields on AAA corporate bonds are a little over 5%, down from over 7% just a few months back as rates and spreads have rallied. This is great for the P/E multiple, as we multiply (4.4% / AAA Bond Yield) against the first component of the formula, thus a lower yield increases the P/E multiple and a higher P/E multiple = a higher price of equities. Why this 4.4% rate? Back to RBCPA:

The original formulation was made at a time when there was very little inflation, and growth could be assumed to be real growth; the AAA corporate bond interest rate prevailing at the time was 4.4%. In later years, the formula was adjusted for higher current interest rates that contained an inflationary component.

Assuming a 5% earnings growth rate for the next five years (I do not think we will have 5% growth for the next five years for reasons detailed later), the current AAA corporate yield predicts a 15x P/E multiple, much lower than the current P/E ratio implied by either backward or forward looking earnings (roughly 19x and 22x each based on S&P earnings estimates).



But what annualized earnings growth should we expect over the next five years? Not 5% according to dblwyo for the following reasons:

If the economic outlook is for 2-2.5% growth on average over the next five years (IMF) at best and we presume a 5% yield a PE multiple of 10-12 becomes appropriate. Given that the markets were held up by leverage applied in one form or another (buybacks, housing ATM,et.al.) consider a go-forward regime where a 15 historical average PE is inappropriately optimistic!

Agreed, but I'll let each of you use any figure you want... the next chart shows what inputs are needed for the model to spit out the "inappropriately optimistic" 15x P/E multiple or the unreal 22x forward P/E .



With the current 5.2% AAA Corporate Bond Yield, earnings need to be at least 5% to justify a 15x P/E multiple (as detailed above), which would still imply equities are currently overvalued by 30%. For current equity valuation (22x), we need 9% growth... FOR EACH OF THE NEXT 5 YEARS. A more likely outcome that gets us to our current market valuation is for AAA corporate bonds to continue the recent rally. However, based on a 2.5% earnings growth rate, the rate needs to approach a measly 2.5% AAA yield. Highly unlikely...

2008 Hedge Fund Breakdown... Where's the Hedging?

Naked Capitalism points out the troubles ahead for hedge funds (the crazy thing is the poor returns all around may save them):

It is hard to work up much sympathy for newly-less-well-off hedge fund managers, given how rich the good times were. Nevertheless, they face continued pressure from redemptions, and (for most) high water mark provisions mean that they will probably get no or little in the way of upside fees (the 20 of the "2 and 20" formula) this year.

In the past, when that happened to hedge funds, they often imploded, as did Julian Robertson's Tiger Funds, because the staff decamps to funds where the funds aren't in a performance/fee hole and they stand to share in fat performance fees. But with the whole industry contracting, and many funds suffering fee pressure, mobility is not likely to be great.

Source: Barclays Capital

Auto Sales Continue to Crumble

Great info as always from Auto Blog:

The U.S. auto industry hasn't experienced a worse year of sales in recent memory, so it's fitting that 2008 should close with December sales data that's no better than the previous disappointing months.The only green you'll see below is next to MINI, which beat out December 2007 sales by only four vehicles. Every other automaker and its brands sold fewer cars this past month than the year prior.

That's right, the MINI is the only brand up year over year in December, up a whopping 0.1%!



Full year 2008 vs. 2007 figures are slightly less horrendous.

Month over month sales (do not use month over month for anything except relative performance as sales are extremely seasonal) show some high-end brands did "relatively" well. Holiday present perhaps?

Are Treasuries Really in a Bubble?

A Barron's video posted at The Big Picture warns to 'Stay Away From Treasury Bonds'. I'll agree that Treasury bonds look awfully rich and I have no intention of going long, but I do feel there is danger to outright shorting treasuries in this environment (though as I post this, 30 year yields have blown out 20 bps today). First lets look at some data that shows at a minimum long bonds (i.e. 30 year Treasuries) appear rich.

30 year treasury yields have rallied dramatically over the past 25+ years, but the most recent rally is unprecedented over that time.



In terms of pricing, long bonds have rallied more than 30% in the past 3 months. Supporting the case that these bonds are ready to sell off... long bond prices have historically sold off ("mean reverted") following smaller, yet similar rallies.



However, it is important to remember that the current market is not "normal" and mean reversion is not a certainty. Off the top of my head, I can think of many reasons why long bond yields may not only stay at current levels, but may actually continue to rally.

1. Real yields are not abnormally low (a deflationary environment makes those puny yields much better in real rather than nominal terms)
2. The Fed can (and will likely be) purchasing Treasury bonds to keep rates artificially low; likely starting in the 5-7 year space, but possibly out along the curve
   
3. The economy can continue to get worse / companies will default in the coming year at substantial levels, creating the possibility of another "flight to quality"

As Larry MacDonald states in his post Shorting The Bond Bubble? Hold On:

Shorting government bonds would thus appear to be a no brainer as risk appetite responds to signs of an upturn in economic growth and inflation worries arise anew. But what might not be so obvious is the timing of the trade.

Lags in the impact of stimulus measures could mean deflationary news will linger for awhile yet. More importantly, the Federal Reserve has stated it is committed to buying Treasuries to keep interest rates low until the crisis and economy stabilizes. China too will likely be a buyer of U.S. Treasuries as part of its strategy of suppressing the yuan to enhance the competitiveness of its exports.

So watching from the sidelines may be the strategy for now.

Update: My post was all set to go when I saw Credit Writedowns had an eerily similar post. Always nice to be in good company.

Construction Spending November

Per Interest Rate Roundup:

The latest figures show construction spending was down, but not out, in the month of November. Total spending declined 0.6% against market expectations for a decline of 1.4%. October's decline was also revised to just -0.4% from a previously reported drop of -1.2%.

The residential market continues to be a lead anchor, with private residential spending down 4.2% -- the biggest decline since July's -6.2% reading. Private nonresidential spending, on the other hand, increased 0.7% after a 0.4% decline in October. Within the private nonresidential sector, spending on lodging was up 0.7%, spending on office property rose 0.9%, spending on transportation projects jumped 3.2% and spending on power facilities climbed 5.3%.

Looking at the longer trend (year over year rather than month over month), residential construction has gotten absolutely crushed. One area of huge growth has been manufacturing, which I have no explanation for. It looks like the media is confused as well. See if this commentary by Zacks makes any sense:

Construction in manufacturing also increased by 61.5% over the past year, as the manufacturing sector had been struggling during this economic recession, as evidenced by the ISM Manufacturing announcement on Friday, a 28 year low.

Source: Census

Another Post on Swaps????

I admit it... I've posted WAY too much about swap spreads, but in my last post on the subject of the 30 year swap spreads (defined here), I received this comment:

Not sure why this is considered good or bad. Seems indifferent to me as banks are basically an extension of the Fed balance sheet and federal government for all intents and purposes now. This doesn't have any impact on credit to the real economy. Just filling in holes of the banks balance sheets.

How's this for importance? For the past 8 years (I could only find data going back 8 years) 30 year swap spreads have followed equities with alarming regularity (I smoothed the changes by averaging the change over the past month):


HOWEVER, over the last month, 30 year swap spreads have rallied significantly more than the equity market.



Will swap spreads lead the market higher or should we view this recent rally in credit markets as short-lived? Or should we ignore it altogether. Interesting post at Infectious Greed about just that. According to Paul:

The risks of financial history are higher than ever though. We have more data, better analytical tools, and more people crunching the data, so we can expect to see data on pretty much anything we want to see. There will always be someone tearing apart something to find something interesting, so something interesting will be found. My friend James Altucher has always been great on this subject, ripping holes in pretty much every data-driven rule of thumb by which people claim to trade and/or find market tops and bottoms. They mostly don’t work.

Agreed.

Time to Buy Equities?

The Good

The Big Picture details performance of the S&P 500 in the five years following each of the 10 worst performing years for the S&P 500.



In each instance, the following 5 years brought varying, yet positive, annualized returns.

The Bad

John Mauldin's recent Newsletter '2008: Annus Horribilis, RIP' traces earnings estimates for calendar year 2008, revealing that estimates were far too optimistic ($92 in early 2007, down to a current $48 projection). Projections for 2009 are even lower, currently sitting at $42.



Putting those earnings estimates in the chart above, against the value of the S&P 500 Index at the time of each estimate, we can see how the price to earnings multiples "P/E's" have shifted / grown over time. The latest earning estimates puts the trailing P/E at ~19x, while the forward P/E ratio is even higher, at roughly 22x.



As John Mauldin points out:

That doesn't look like value at all, when the historical average is closer to 15.

The obvious question becomes, how low can earnings get and what is a proper level for the S&P given those levels?

In 2001, as-reported earnings were $24.67. Operating earnings in 2002 were $27.57. Does anyone think the current recession will be milder than the last one? Or shorter?

And it gets worse. Core earnings, which take into account pension and other under-reported liabilities, were less than $16 in 2001, and so P/E on a core earnings basis topped out at 71, and on an as-reported basis were as high as 46!

So lets be optimistic and say the current $42 earnings projected is the worst case scenario. Putting the historical 15x multiple average on those earnings (along with earnings, who knows where the multiple will be) gets us to 630 or a drop of another 33% (or about 15% less than November lows), while a multiple of 18x gets us to around 750, or a 20% drop.

While I actually expect the rebound to continue in the near term for technical reasons, fundamentals sure don't look attractive.

Update: Posted 'the Ugly' side of equities (i.e. P/E multiples) as requested.

EconomPics of the Week (New Years Edition)

Opinion
Happy 2009
Information Warfare and the Wall Street Journal's Demise
California: Too Big to Fail?
In Excel this is called a Circular Reference Error...

Music
Is the Album Dead?
Is the Album Dead (Part II)?

Returns
Equities: Another End of Month Rally
Harvard Endowment's Historical Returns
Equity Forecasts: Bullish and Highly Uncertain

Economic Data
ISM Manufacturing Below Expectations
Case-Shiller Price Index (October)
"Scariest Housing-Related Chart Ever"
Euro Approaching Parity with Pound Sterling
Real GDP Per Capita
Japanese Industrial Output Down to Levels Seen 5 Years Ago
The Emerging... 'Emerging Market' Crowd Out
Armageddon Index Crushed, but an Improved Outlook

Is the Album Dead (Part II)?

Following this morning's Albums Sales Breakdown, here is another chart showing just how fast sales have declined across all genres.



Surprising to me was the drop in classical music. I would have guessed incorrectly that the classical base would not have shifted away from physical CD's.

Source: Yahoo!

ISM Manufacturing Below Expectations

ISM sinks again to 32.4, well below expectations. ISM reports:

Economic activity in the manufacturing sector failed to grow in December for the fifth consecutive month, and the overall economy contracted for the third consecutive month, say the nation's supply executives in the latest Manufacturing ISM Report On Business®.

In December, none of the manufacturing industries reported growth.

Take a look at new orders and pricing... yikes.

Equities: Another End of Month Rally

As I laid out in last month's post Pension Plans, the Equity Market, and Irrational Behavior that equity markets have rallied at the end of each month, right when pension plans tend to rebalance to equities. The trend continued in December.

Is the Album Dead?

Looking at top 10 album sales from 2008 vs. 2000, we see sales 1/3 the level from those just 8 years ago.

Click for ginormous chart



The Big Picture asks:

How many of these do you own the CD of? How many do you own legally? How many have you borrowed or downloaded?

The bigger question inferred... is the album dead?

Source: NY Times / EW

Harvard Endowment's Historical Returns

We've detailed Harvard's Endowment's struggles in recent months. New expectations are the reported 20+% decline was highly optimistic. Looking at Harvard Endowment's historical returns, we can guess why the deflationary environment we've experienced would cause the portfolio so much pain.



Harvard's endowment has become increasingly reliant on capital gains vs. income over the past 20 years, with income returns accounting for less than 2% of total returns in 7 of the past 8 years. In an environment characterized by asset deflation and equity market collapse (i.e. the past 6 months), capital gains get crushed.