Monday, November 30, 2009

1.2% over 10 Years?

Per Bloomberg:

Japanese bonds rose, following their best monthly performance this year, after the Bank of Japan said it will hold an emergency policy meeting today in Tokyo.

Ten-year yields dropped to the lowest level since January on optimism policy makers will expand extraordinary measures to increase liquidity in the financial system. The central bank may consider increasing monthly debt buying from the current 1.8 trillion yen ($20.7 billion), said Christian Carrillo, a senior interest-rate strategist at Societe Generale SA in Tokyo.

“They cannot come out of that meeting without doing anything and my guess is that it will be more purchases of long- term JGBs,” Carrillo said. The BOJ may boost monthly buying of government bonds to 2.1 trillion yen, he said.

The yield on the 1.4 percent bond due September 2019 fell 3.5 basis points to 1.225 percent at the 11:05 a.m. morning close in Tokyo at Japan Bond Trading Co., the nation’s largest interdealer debt broker.
While the chart below is the 7-10 year Japanese Government Bond Index (rather than just the 10 year yield, which I was unable to find), it does show how low yields are, BUT more amazing, how much lower they can potentially go (think 2002).



This almost makes that 3.2% yield on 10 year Treasuries seem attractive huh?

Source: Barclays

Chicago PMI: Strength, but No Jobs

Details of this morning's Chicago PMI release per Briefing.com:

  • At 56.1, the index is at its highest point since August 2008 and showed an expansion in manufacturing for the second consecutive month.
  • The production rating, while still expanding at a strong rate, slowed as the index dropped from 63.9 to 57.6.
  • Beyond production, employment is still under heavy contraction but the rate slowed slightly as the index rose from 38.3 to 41.9.
  • Firms will also have to settle for lower profits as prices paid for supplies entered an expansion phase as the index rose from 48.6 to 52.6. Due to extreme slack in the labor market, firms will have a tough time passing the higher prices to the consumer.


Source: Briefing

Durable Goods Down, But Out?

Catching up on some Thanksgiving week releases and saw that durable goods "surprised" to the downside following the upside spike in September. Per MarketWatch:

Orders for U.S.-made durable goods fell in October, declining 0.6% on weaker demand for machinery and defense goods, the Commerce Department reported Wednesday.

Excluding transportation goods, orders fell 1.3%. Economists surveyed by MarketWatch had expected a gain of 0.5% for durable-goods orders, and a gain of 0.4% for orders excluding transportation.

Overall, the report was "disappointing," wrote Millan Mulraine, an economics strategist with TD Securities, in a research note.

However, better times could be coming, according to Mulraine: "Despite the disappointing October print, we continue to maintain our bias for U.S. capital-goods orders to be fairly robust in the coming months as the combination of the U.S. economic recovery and weak dollar bolsters orders."
The reason why this (and other non-spiking economic indicators) are disappointing is that overall levels are still SIGNIFICANTLY below longer term trends (thus STRONG growth is needed just to make up lost ground). The chart below shows just that; while October durable goods new orders were weak, we see the massive drop YTD October vs. a similar period in 2008, thus plenty of room for a strong rebound if / when the economic recovery truly takes hold.



Not a surprise then that those areas showing relative strength were broadly the same areas that have fallen the furthest.

Source: Census

The Scale of Hedge Fund Gold Purchases

In case you missed it... early last week The Reformed Broker detailed the incredible amount of gold that hedge funds (in this case Paulson & Co.) have accumulated in a very short period of time:

John Paulson of Paulson & Co, the legendary hedge fund manager who made tens of billions betting on the mortgage crisis between 2007 to 2009, likes gold. He really likes it. He likes gold more than a friend.

To most market participants, this is not news, but here’s something you probably didn’t know: Paulson owns more gold than several major countries! Combined!


Retail investor (and more recently this hedge fund) support has made gold a one way bet for much of the past 6+ years. Thanksgiving's Dubai debacle however provided a glimpse into how quickly this may potentially all come to an end. Per the FT Alphaville:
Gold had at one stage dropped as much as 5 per cent as it responded to safe haven flows into the dollar. The precious metal has since recovered to trade about 3 per cent lower at $1,155.80.

Commenting on the sell-off, Davies — who had moved his fund to its maximum 50 per cent under weight gold position:
“It happened so quickly, I’ve never seen a quicker paper liquidation in gold ever.”
Don't fret... gold has snapped back / stabilized and now is once again within striking distance of new highs (chart below per Kitco).



Regardless of what is or is not a justified price for gold, the only thing that matters is the next price that a buyer or seller is willing to transact. And while I continue to expect to see a one-sided trade, when that one sided trade ends, it has the potential to get real ugly, real fast (though I think we are still a long ways away) as this "tonnage" hits the market.

Sunday, November 29, 2009

Japanese Industrial Production Up, but Disappoints

Bloomberg reports:

Japan’s industrial production rose less than economists estimated in October, undermining the nation’s recovery from its deepest postwar recession.

Factory output increased 0.5 percent last month from September, the slowest pace in eight months, the Trade Ministry said today in Tokyo. The median estimate of 27 economists surveyed by Bloomberg News was for a 2.5 percent gain.

The decline, led by automakers and electronics parts companies, adds to concern that the economy may slow once global stimulus spending wanes. Bank of Japan Governor Masaaki Shirakawa and Prime Minister Yukio Hatoyama will meet “soon” to discuss how to address a surging yen and slumping stock market, Chief Cabinet Secretary Hirofumi Hirano said today.

“These are weak numbers,” said Junko Nishioka, chief economist at RBS Securities Japan Ltd. in Tokyo. “We’ve been seeing a V-shaped recovery so far, but the pace is starting to moderate.”
Below we see the speed and size of the recovery. While the six month change is still up ~15%, the size of this change has begun to reverse course. While not only indicating that we should not be looking for a "V" shaped recovery, it also puts how large the decline in output really was last Fall.



Source: METI

Friday, November 27, 2009

EconomPics in Brief (Tryptophan Edition)

Can't really call this EconomPics of the Week as there were only 6 posts and I'm too Turkey hungover to post anything today... I'll be back in force Monday.

Why the U.S. is Broke... Personal Current Tax Edition
Recovery in Perspective: Nominal GDP Edition
Q3 GDP Revised Down to 2.8%
Existing Home Sales Jump
Agency Mortgage Bonds are RICH
The New Moon... The Power of the Women Filmgoer

And your video of the week from Deadspin:

There's always one football player who's bigger and faster than everyone else. In preps, it's infuriating. In college, it's awe-inspiring. But in Pop Warner football, it's hilarious and makes you revel in tiny children getting wrecked.

Wednesday, November 25, 2009

Why the U.S. is Broke... Personal Current Tax Edition

Always lots of interesting information within the Personal Income and Outlays release. Here is one such area... personal current taxes, which:

Includes taxes paid by persons on income, including realized net capital gains, and on personal property.
For all we complain about taxes, our current rate as a percent of personal income is a measly 8.8% down a whopping 60% from 2000 levels.



In real per capita space, while our economy has grown 62% per capita since 1979, personal current taxes paid (again in real per capita terms) is only up 13%.

And we wonder why our country is so indebted?

Source: BEA

Tuesday, November 24, 2009

Recovery in Perspective: Nominal GDP Edition

Remember that "recovery" we experienced in the third quarter? Turns out nominal GDP bounced a "whopping" 3.2% (down 1% from the initial release). Or to put this figure in perspective, the 42nd highest quarter out of the last 251 (i.e. one of the lowest 17% quarters over the last 50+ years).


And while real GDP is the real production of the economy, nominal GDP is important for a debt burdened economy as debt is in nominal terms. Since the recession started in December 2007 nominal GDP is cumulatively negative (over 7 quarters), something that has not happened since WWII.



Some recovery.

Source: BEA

Q3 GDP Revised Down to 2.8%

WSJ reports:

The U.S. economy's recovery wasn't as strong as earlier believed, the government said Tuesday, revising its third-quarter numbers to show a wider trade deficit and lower consumer spending than previously estimated.

Gross domestic product rose at a 2.8% annual rate July through September after falling by 0.7% in the second quarter, the Commerce Department reported. A month ago, the department first estimated that GDP rose by an annual 3.5% in the third quarter.

Although the data confirmed that the economy expanded for the first time in more than a year as the government's stimulus boosted consumer spending, the latest report showed that motor vehicles spending in September was lower than had been estimated.

Overall consumer spending rose a quarterly 2.9% in the third quarter and contributed 2.1 percentage points to GDP at annual rates, the new figures show. That compares to earlier estimates that spending had risen a quarterly 3.4% and contributed 2.4 percentage points to GDP.



Source: BEA

Monday, November 23, 2009

Existing Home Sales Jump

Washington Post details:

The National Association of Realtors reported that sales of existing single-family homes, townhomes and condominiums in October surged to a seasonally adjusted annual rate of 6.1 million units from 5.54 million in September -- making last month the strongest since February 2007. Sales were up 23.5 percent from last October.

Every piece of housing data is scrutinized these days because it was primarily the housing market that derailed the U.S. economy, and its recovery is key to restoring economic vitality.

Low home prices, federal programs that helped push down interest rates and a temporary $8,000 federal tax credit mostly for first-time buyers have all played a role in boosting home sales in recent months. As sales picked up, the excess supply of homes started shrinking and prices began stabilizing.
Below is the non-seasonally adjusted October '09 figures vs those from October '08 (for some reason the seasonal adjustment multiplier was higher this October than last, resulted in an out-sized gain in the seasonally adjusted figure of 23.5% vs. 20.8% for the non-adjusted data). In looking deeper, we see the struggle the west coast continues to live through as the housing bubble continues to unwind.



The issue is the question of sustainability. Back to the Washington Post:
But real doubts linger about whether these gains can be maintained, especially if unemployment continues to rise and government intervention is curtailed. The federal "cash for clunkers" program boosted auto sales, for instance, but only temporarily. And many economists forecast weak growth once the government's broader economic stimulus spending winds down.
Source: Realtor.org

Agency Mortgage Bonds are RICH

Bloomberg (via Calculated Risk) details Meredith Whitney's latest concern:

The Federal Reserve has begun slowing purchases in the $5 trillion market for so-called agency mortgage-backed securities after announcing in September that it would extend the timeline for its $1.25 trillion program to March 31 from year-end. Whitney said that banks are only originating home loans that they can sell to Fannie Mae and Freddie Mac.

“If Fannie and Freddie can’t sell to an end buyer, i.e. the U.S. government steps back, the mortgage market at minimum contracts, rates go higher, and banks are poised with more writedowns,” said Whitney, founder of Meredith Whitney Advisory Group. “This is probably the issue that scares me most across the board.”

The chart below shows the option adjust spread "OAS" of Agency Mortgages to Treasuries. This is model driven (the below utilizes Barclays model) to estimate for pre-payments by borrowers and a number of alternative models suggest the OAS is now NEGATIVE to Treasuries (the power of subsidies!).



The question is who is buying mortgages at these levels besides the Fed? Easy... any investor in the Barclays Aggregate index (think pension plans, 401k participants, etc...) .

Source: Barclays Capital

Sunday, November 22, 2009

The New Moon... The Power of the Women Filmgoer

"Monster" weekend for The Twilight Saga: New Moon. Per the AP:

The vampire romance "The Twilight Saga: New Moon" sucked up $140.7 million in its first three days and pulled in a total of $258.8 million worldwide, according to studio estimates Sunday.

The No. 1 domestic debut for Summit Entertainment's "New Moon" was more than twice the $69.6 million haul over the same weekend last year for "Twilight," the first in the franchise based on Stephenie Meyer's novels.

"New Moon" placed third on the all-time domestic chart behind last year's $158.4 million opening weekend for the Batman blockbuster "The Dark Knight" and 2007's $151.1 million haul for "Spider-Man 3."

Among the top-10 all-time openings, "New Moon" is the only one that came outside of Hollywood's busiest time, the summer season. The movie adaptation of Meyer's next "Twilight" chapter, "Eclipse," arrives in the heart of summer, next June 30.

On Friday, "New Moon" set an all-time domestic high for opening day with $72.7 million, topping the previous record of $67.2 million by last year's "The Dark Knight.
And the devoted (teen / tween / female skewed?) fans could not wait until Saturday to see the film. As detailed above, the film broke the record for the largest grossing Friday of all time and while Saturday was nothing to sneeze at, the drop from Friday was the 6th largest of all time (in percent... in $$ it was by far and away the largest).



So what kind of business can we expect from the New Moon going forward? Well, the next stage is typically driven by word of mouth based on the quality of review. And the viewers were split by just about as much as I've ever seen. Well, not viewers... just the sexes. Females LOVED the film for its Abercrombie'ish models acting. Men... not so much.



So my guess... females will continue to come out in droves. Men... not so much.

Source: Box Office Mojo / IMDB

Friday, November 20, 2009

EconomPics of the Week (11/20/09)

Short week...

Breakin’ Down the Growth
Leading Economic Indicators Losing Strength
No Inventory Correction in September
Retail Sales Upside Suprise... Still Weak Longer Term
Japanese GDP... 4.8% Growth, but Ugly?

Assets
Selecting a Domestic Fixed Income Benchmark
Housing Starts and Permits Down.... GOOD

Inflation / Deflation
Auto Prices and CFC; CPI and Capacity
Has Euro CPI Seen Its Lows?
What Stinkin' Inflation? PPI Edition

Struggles
1 in 7 Americans Affected by Food Insecurity

And your video of the week... rookie Brandon Jennings drops a double-nickel (and yes, the Knicks passed on him in the draft):

Selecting a Domestic Fixed Income Benchmark

Barclays Aggregate is Yielding Just 3.35%

Last month I detailed that the yield to worst of the Barclays Capital Aggregate Bond Index (i.e. the most popular US dollar fixed income benchmark) was minuscule at just around 3.5%. Well it is now yielding just 3.35% and as a reminder, that is really all you can expect to receive (details here).

As a background, this benchmark is around 40% Government Related bonds, 40% securitized bonds (mainly Agency MBS - i.e. mortgages guaranteed by the government / agencies), and 20% Investment Grade Corporates. With low Treasury yields, rich Agency MBS after $1.25 Trillion in Fed purchases through Q1 '10, and much reduced credit spreads, that 3.35% yield is not necessarily a surprise.

How to Pick up Incremental Yield

There are two main ways for an investor to pick up incremental yield above and beyond that level in this market from their fixed income allocation... move down in quality (i.e. away from Government or Agency MBS to credit) and/or to move out along the yield curve (i.e. the yield curve is STEEP). For this reason, a popular benchmark some investors have moved to is the Long Duration (i.e. out further along the steep yield curve) Government / Credit Index (~50% government related / 50% credit blend).

Risk-Reward

The Long Government / Credit benchmark has a duration of almost 12 years vs. the Aggregate's ~4 years, thus an investor is not only taking more credit risk (i.e. 50% vs. 20%), but significant duration risk (i.e. exposed to interest rate movements by almost 3x more than the Aggregate index - if interest rates move up 1%, the Aggregate underperforms ~4%, whereas the Long Government / Credit underperforms by ~12% all else equal).

But, How Much Incremental Yield will this Add?

A record amount.



In other words, investors are being compensated 1.8% to take on the incremental credit and duration risk.

Breakdown of Incremental Yield

Below is a quick and dirty breakdown of what makes up that 1.8%. The quick and dirty methodology is as follows; the credit portion [red bars] is taken purely as the spread of the Long Government / Credit Index over the Long Treasury Index (i.e. "risk-free" government bonds), whereas what I label 'Yield Curve Positioning' [blue bars] is everything else being compensated for the move from the Aggregate to the Long Gov't Credit (assume for this Q&D that it is only yield curve positioning).



My Thoughts

In my opinion, duration is relatively attractive on a stand-alone basis, but with the incremental yield that compensates one to take that risk, it becomes very attractive in relative terms. However, that is based on my (non-consensus? see here) view that deflation and another downturn is a higher risk over the next 12 months than the risk of increased rates and/or inflation.

On the other hand I am a bit more cautious with regards to the credit risk associated with the 50% allocation to credit. As a substitute for equities? Definitely. But, I wouldn't be too shocked if spreads widen after the record rally we've seen over the past 7-8 months.

Source: Barclays Capital

Thursday, November 19, 2009

Leading Economic Indicators Losing Strength

The AP details the "best in 25+ year" run of the leading economic indicators that still somehow managed to disappoint:

A private forecast of economic activity over the next six months edged up less than expected in October, signaling slow, bumpy growth next year.

The Conference Board said Thursday that its index of leading economic indicators rose 0.3 percent last month. Economists polled by Thomson Reuters had expected an 0.5 percent gain.

The index climbed 1 percent in September.

"We're still getting some positive momentum, but it looks like things are slowing down again," said Jennifer Lee, economist at BMO Capital Markets. "A lot of the economic growth has largely been driven by the government stimulus packages."

The government's Cash for Clunkers program boosted the auto sector and consumer spending, while tax credits for homebuyers have propped up the housing market.

Still, the indicators have risen for seven straight months. The Conference Board said last month that the 5.7 growth rate in the six months through September was the strongest since 1983. That ticked down to 5 percent growth in the six months through October.
Taking a look at the details of that 7 month run, we see that October was a downside outlier in terms of performance (less "upside" in aggregate and consumer expectations / building permits causing a drag).



Another disappointment is the performance of the indicators less the HUGE contribution of the interest rate spread (i.e. the steepness of the yield curve), which actually printed a negative number in October.



Why exclude interest rate spread? While the spread still relays the current monetary policy (i.e. when the yield curve is steep, the Fed is typically adding liquidity to the system which drives growth), this becomes less relevant when individuals and business aren't utilizing that liquidity (i.e. borrowing) to invest in "actual" economic activity. Instead we see that the liquidity is just being used to drive up prices of already rich, but not yielding 0% assets and/or to recapitalize a beaten down, but not yet out banking system.

Source: Conference Board

Gone Fishing

Posting to resume tomorrow...

Wednesday, November 18, 2009

Auto Prices and CFC; CPI and Capacity

Marketwatch details the latest CPI release:

The consumer price index increased a seasonally adjusted 0.3% in October as energy prices increased for the fifth time in six months to offset another rare decline in rents, the Labor Department said.

The core CPI rate, which excludes food and energy prices in order to get a better look at underlying inflation in the economy, rose 0.2% last month, led by higher prices for cars and trucks, due in part to the unwinding of the government's "cash-for-clunkers" incentives program.

Prices for new cars rose 1.6%, the most in 28 years. Used-car prices also increased, up 3.4%, the most in 29 years.

The consumer price index has fallen 0.2% in the past year. The core CPI is up 1.7% in the past year. In September, the CPI and the core CPI were up 0.2%.
Autos and Cash for Clunkers

For the relationship between used car prices (legitimately higher) and cash for clunkers go here. And while cash for clunkers also plays the role in why prices of new cars increased, it is not permanent (i.e. not legitimately higher), but what I would classify as a reporting blip. Broadly it goes like this... no cash for clunkers + no change in methodology to account for no cash for clunkers = higher prices feeding into CPI. Per the BLS:
The BLS did not change its estimation method to incorporate the cash for clunkers program. The standard method for estimating the transaction price on sampled new vehicles calls for collecting the retail price of the vehicle and its selected options, and asking the dealer for the average discount on that sampled model over the previous 30 days. The 30 day average is used because sales volumes per specific model per month are typically low at individual dealerships.

To the degree that the total dealer discount to the consumer is influenced by discounts or incentives to the dealer from any source, including the cash for clunkers program, it would be reflected in the CPI. The average discount for sampled vehicles would reflect both cash for clunker transactions as well as transactions not eligible for the program.
As mentioned yesterday, the opposite was true for PPI (autos were a drag on PPI as producer pricing of autos were impacted less directly than prices to the consumer). In other words, expect CPI to bounce back (at least the auto portion) in November.

CPI and Capacity Utilization

As for relationships to keep an eye on regarding future CPI prints; think capacity utilization. As I detailed back in July, the relationship between capacity utilization and CPI (lagged six months) has been very strong for more than 30 years.



So, if you think capacity will come back (good) or be eliminated from the system (bad) [i.e. numerator vs. denominator] eliminating excess capacity, then you probably should gear towards higher inflation (sell fixed rate bonds, buy who knows... depends on if the "good" or the "bad"). If you think capacity will remain low due to continued production capacity staying off-line (very possible) or new capacity being added (not likely), then inflation will likely be in check (fixed rate bonds = opportunity).

Source: BLS / Federal Reserve

Housing Starts and Permits Down.... GOOD

Marketwatch reports:

New construction of U.S. houses fell sharply in October to the lowest level in six months, the Commerce Department estimated Wednesday. Starts fell 10.6% in October to a seasonally adjusted 529,000 annualized units weaker than the 590,000 pace expected by economists surveyed by MarketWatch.

This is the lowest level since April. Starts of new single-family homes fell by 6.8% to 476,000 in October, while starts of large apartment units fell 34.6% to 53,000. Building permits, a leading indicator of housing construction, fell 4% to a seasonally adjusted annual rate of 552,000. This is the lowest level of permits since May.


While this is not good for Q4 GDP expectations (or housing companies), this IS good for the long term re-balancing between supply and demand that needs to take place.

Source: Census

Tuesday, November 17, 2009

What Stinkin' Inflation? PPI Edition

Briefing detailed the latest PPI release:

The producer price index rose 0.3% in October, well below the consensus expectation of an increase of 0.5%.

Excluding food and energy prices, core PPI fell an astounding 0.6% over the month. For the year, core PPI has only increased 0.7% after posting a 1.4% year-over-year increase in September.

On the surface, the numbers would suggest an increasingly deflationary environment. However, the data for October was skewed.

The decline in core prices was due to large drops in vehicle prices. Passenger car prices declined 0.5% month-over-month after increasing 1.0%. Light truck prices fell 5.2% and heavy trucks prices declined 0.1%.



Briefing then poorly explains the drop in auto prices:
The information on the decline in motor vehicle prices is sketchy. New 2010 model year vehicle prices were introduced in this month's PPI report. The drop in price would suggest that car manufacturers are planning on introducing new model vehicles at lower price points. If this hold true, prices should hold at these levels through next summer.
But Market News quickly disproves this theory:
Core was cut by -5.2% in light trucks and -0.5% in cars where quality changes/model year changes and slack demand cut prices. The Bureau of Labor Statistics said the value of quality changes for 2010 model cars was $250 and for light trucks $793, less than usual, and that this pricing was adjusted out.
My thought of why there was an increase (and this could be wrong). Cash for clunkers. When the government was throwing cash at the end-user, this artificially increased demand for autos (by dealers) from producers. As the program ran out, the demand ran out, thus the pricing power ran out.

Too logical?

Source: BLS

1 in 7 Americans Affected by Food Insecurity

Ed Harrison of Credit Writedowns (via The Guardian) details a disturbing trend:

The US Department of Agriculture highlights how the United States in the last decade, despite increased aggregate wealth, slid back significantly in terms of food insecurity as measure of poverty. With everyone now focused on the unemployment situation, it bears noting that even before the downturn in the economy there had been a large surge in food insecurity nationwide.
What is food insecurity?
Food insecurity - defined by the USDA as when "food intake … was reduced and their eating patterns were disrupted at times during the year because the household lacked money and other resources for food" - afflicted 14.6% of Americans in 2008. i.e., some 50 million people were too poor to guarantee being able to put food on the table.
Only three of the worst 17 states in terms of food insecurity showed an improvement over the past decade and my guess is things have gotten a whole lot worse.



Lets realize what has changed since 2008. Back then, the percent of TOTAL people under or unemployed (i.e. U-6) was 5.5% LESS than it is now. Even then, 14.6% Americans were affected by food insecurity (that is one in less than 7 people THEN).

Back to Ed:
My interpretation of the data goes to income inequality. I see this as evidence that the last decade of growth in the U.S. has not been beneficial for poorer Americans. However, I would go further in saying that the downturn in the U.S. and rising unemployment, bankruptcy and foreclosure in the middle class has made plain that the middle class has also been left behind.
I'd go further. It hasn't only been the middle class that hasn't shared in the wealth creation... HARDLY ANYONE outside of the uber-rich have.

Source: The Guardian

No Inventory Correction in September

Forbes reported yesterday (traveling again all week so expects delays):

Total business inventories continued to fall in September by 0.4%, less than the 0.7% decline economists were expecting, the Commerce Department reported today. September now marks the thirteenth consecutive month of inventory declines, the longest streak since the 15 months ending April 2002. Total business inventories are 13.4% lower compared to August 2008.

Total business sales fell 0.3% in the month, breaking the three-month streak of growth. The decline can be attributed to a 2.6% decrease in retail sales, reflecting a 14.3% decline in auto sales. All other major types of retail stores experienced sales gains of less than 1% except for building material stores whose sales decreased by 0.6%. Manufacturing sales and wholesale sale rose 0.85 and 0.6% respectively.
Marketwatch explains how inventory correction works its way through to final output figures:
Once businesses reduce their inventories to desired levels, any increase in sales will have to come from new production, which would boost both U.S. jobs growth and imports.

The inventories report typically receives little attention from investors, but the pace of inventory reduction will be at the heart of any economic recovery this year. Most economists believe inventories will continue to be cut for several quarters before general restocking is needed.
But unfortunately, the trend of a continued declining inventory to sales ratio was not in the cards for September.



While this is only one data point, without sales growing faster than inventories, we won't get the mother of all inventory corrections many (I included) expect.

Source: Census

Monday, November 16, 2009

Retail Sales Upside Suprise... Still Weak Longer Term

Marketwatch reports:

U.S. retail sales increased a seasonally adjusted 1.4% in October, led by a rebound in auto sales, the Commerce Department estimated Monday. Excluding the 7.4% increase in auto sales, retail sales rose 0.2% in October. Auto sales had plunged 14.3% in September after the expiration of the government's cash-for-clunkers program.

The 1.4% gain in October was higher than the 1% gain forecast by economists, but a large downward revision to September's sales offset the upside surprise. Economists were expecting sales excluding autos to rise 0.3%. October sales were mixed. Sales of durable goods, other than autos, were weak. Sales at the mall stores were generally healthier.


Source: Census

Has Euro CPI Seen Its Lows?

The AP details:

Consumer prices in the 16 countries that use the euro fell by 0.1 percent in the year to October, official figures confirmed Monday. Eurostat, the EU's statistics office, kept the rate unchanged from its preliminary estimate, in line with market expectations.

October's decline was the fifth in a row. In the year to September, prices fell by 0.3 percent. Though falling prices may be good for hard-pressed consumers, it is a sign of just how shaky demand remains.

Inflation is expected to turn positive in the months ahead as last year's sharp falls in energy prices fall out of the annual comparison and growth returns — figures last Friday confirmed that the eurozone returned to growth in the third quarter of 2009, albeit at a fairly anemic level of 0.4 percent.


Source: Eurostat

Sunday, November 15, 2009

Japanese GDP... 4.8% Growth, but Ugly?

EconomPic detailed Japan's odd Q2 GDP print in which real GDP rebounded to positive territory for the first time since Q4 2007, even as nominal GDP continued to contract:

This has happened before (but real GDP has never been higher, while nominal GDP was negative).
That is... until this release.



The issue with any recovery in real only terms is that the country's debt (and there is a ton in Japan) remains in nominal terms. Thus, the fact that Japan produced more (4.8% quarter over quarter annualized more in real terms), but the overall value of that production is still less in Yen terms (-0.3% in nominal space) makes it difficult to service that debt. It is not a surprise then that the cost of credit insurance on Japanese sovereign debt has risen during this "recovery". Per the WSJ:
Canary in the coal mine? The cost of insuring Japanese government bonds against default has doubled to 0.75 percentage point in the past three months, as markets fret about debt issuance. Credit risk is assuming ever-greater stature in government-bond markets previously blithely assumed to be risk-free.

Its debt-to-gross-domestic-product ratio is set to rise to a staggering 227% in 2010, the International Monetary Fund forecasts, making it particularly exposed to any rise in market interest rates. Japan's aging population is a crucial concern, driving a change from saving, much of which went into JGBs, to consuming.
Japanese government officials seem to share the concern that the "strong" print may not be all it initially seems. Per Bloomberg:
The acceleration in the world’s second largest economy is projected to fade in coming quarters as the impact of stimulus spending wanes and job losses restrain consumer spending. Prime Minister Yukio Hatoyama said the economy remains “worrisome” and that another supplementary budget is “probably” warranted.
I second that and will repeat the question I posed last quarter; how strong is end-user demand really if the price deflator increases GDP a full 5% quarter over quarter (annualized)?

Source: ESRI

Friday, November 13, 2009

EconomPics of the Weeks (11/13/09)

Economic Data

United States
The "Paradox of Deleveraging"
Civilian Hours vs. Real GDP
Consumers Don't Enjoy Unemployment
Trade Deficit Jumps in September
The State of States: They're Broke
Spending Down + Deficit Up = Not Good

Foreign
Eurozone GDP Breaks Through Zero... Concerns Still There
Aussie Miracle Continues
China is Ripping... Bears are Smoking Dope
Germany: Improving Economy

Long Bonds
Where are Long Bond Yields Going?
Where are Long Bond Yields Going: Late 70's / Early 90’s Edition
Just One Super-Secular Mean Reversion?

Other
Will There be Appetite for Another Stimulus Plan?
The Job Market and Equities

Consumers Don't Enjoy Unemployment

Bloomberg details:

Confidence among U.S. consumers unexpectedly fell in November for the second consecutive month as surging unemployment shook households.

The Reuters/University of Michigan preliminary index of consumer sentiment decreased to 66 from 70.6 in October. The gauge was projected to rise, according to the median forecast in a Bloomberg News survey of economists.

A jobless rate that jumped to a 26-year high last month and is projected to remain above 10 percent through the first half of next year is weighing on Americans as they head into the holiday shopping season. Macy’s Inc. is among retailers showing a decline in sales as consumers spend only on essentials such as food and clothing.

Trade Deficit Jumps in September

Bloomberg details:

The trade deficit in the U.S. widened in September by the most in a decade, reflecting rising demand for imported oil and automobiles as the economy rebounded from the worst recession since the 1930s.

The gap grew a larger-than-anticipated 18 percent to $36.5 billion, the highest level since January, from a revised $30.8 billion in August, the Commerce Department said today in Washington. Imports surged by the most in 16 years, swamping a gain in exports.


As detailed above, a large component of that net trade deficit was autos. This isn't a huge surprise. When we took a look at September Auto sales, foreign cars performed much better on a relative basis.


So glass half full... The global economy is rebounding. Glass half empty... We (the global economy) are back to relying too much of an indebted US consumer (see Eurozone GDP).

Source: Census

Eurozone GDP Breaks Through Zero... Concerns Still There

Bloomberg reports:

Gross domestic product in the economy of the 16 nations using the euro rose 0.4 percent from the second quarter, when it fell 0.2 percent, the European Union’s statistics office in Luxembourg said today. Economists had forecast the economy to grow 0.5 percent, according to the median of 34 estimates in a Bloomberg survey.

Europe’s economy is gathering strength after governments stepped up stimulus measures and the European Central Bank injected billions of euros into markets to encourage lending. While confidence in the economic outlook is at a 13-month high, rising unemployment, the expiration of stimulus plans and a surging euro are threatening to undermine a recovery.

“The euro-zone economy has officially turned the corner and that is cause for relief, but not celebration,” said Martin van Vliet, a senior economist at ING Bank in Amsterdam. “The economy remains in a fragile state and is recovering mainly because of government stimulus and temporary inventory effects.”
JP Morgan analyst David Mackie was similarly unimpressed (via FT Alphaville):
The third quarter GDP data suggest that the region has exited recession, but the move was hardly a decisive one. Despite a 12%ar gain in industrial production across the region, GDP managed to increase by only 1.5%ar. Clearly, there was a lot of weakness in construction and services. These data will reinforce the perceptions of the consensus: that the upswing will be lackluster and bumpy. And, they present a major challenge to our more upbeat forecast of growth over the coming year. Indeed, if GDP can only increase by 1.5%ar when IP grows at a double digit pace, the largest gain since 1984, one can only worry about the future.


As for the monster quarter from Lithuania... call it a massive dead cat bounce as year over year GDP is still down 14.3%.

Source: GDP

Just One Super-Secular Mean Reversion?

In response to my post Where are Long Bonds Going? Late 1970's / Early 80's Edition, reader Henry Bee responds:

I'm going to replicate the study using 20-year bond in place of 30-year to see if that makes a difference because 20-year bond data goes all the way back to the 30's.
While I am definitely interested to see what Henry comes up with for the late 1950's-1970's, he'll likely run into a problem if he simply tries to replicate what I have shown going back any further. The problem? Rates were never high enough in the first place (outright), let alone on a relative basis to shorter yields.

Below we see just that, but with the 10 year Treasury bond (data goes back to the late 1800's). Interesting to see the yield bumps against the 10 year average on the way up without really penetrating the average AND then again on the way down, but in reverse.



Well, they always say it's dangerous to bet against a strong trend. From the looks of it, the decline in interest rates is more than a long trend. It is a reversion to a 100+ year mean.

Source: Irrational Exuberance

Thursday, November 12, 2009

Spending Down + Deficit Up = Not Good

Bloomberg reports:

The U.S. budget deficit widened in October from a year earlier, reaching a record for that month, as rising unemployment cut revenue at the start of the first full fiscal year under President Barack Obama.

The excess of spending over revenue widened to $176.4 billion last month, compared with a deficit of $155.5 billion in the same month a year earlier, the Treasury Department announced today in Washington in its monthly budget statement. It was a record 13th consecutive shortfall and the fifth-largest monthly gap on record, the department said.



The issue may be that outlays are reduced (non-stimulating) and the deficit still grows due to the collapse in revenues. That my friends, would be a lose-lose for the economy.

Source: Treasury

Where are Long Bond Yields Going: Late 70's / Early 80's Edition

My comment in my post Where are Long Bond Yields Going?:

But the money shot is that when the yield curve has been VERY steep (i.e. more than 4%) the Long Bond has rallied in all cases (19 out of 19 times) over the next year.
Received the following response by reader Henry Bee (bold mine):
This is a great observation! One caveat though: the data is taken during a period of time where the 30-year bond yield DECLINED consistently (the data was from 1986-2009). This observation would be more reliable if it includes 1960-1980 where the 30-year bond yield ROSE.

If we're experiencing a regime change today, then the relationship likely won't hold.

And he is correct that rates rose DRAMATICALLY from the late 1970's through the early 1980's (the Long Bond only started trading in 1977). Looking at the data from 1977-1985 (i.e. the time frame that took place before my post), we have the following:

Note that the yield curve was only as steep as it is now (i.e. more than 4%) for a brief period in 1982 and the steepness (i.e. spread between 30 Year Treasuries and 3-Month T-Bills) was much more volatile during the above time frame than since. We can also see the spike in this steepness from April - October 1980 when 3-Month T-Bill rates dropped dramatically (the data is from the Federal Reserve), only to rise within 6 months. As an anonymous reader explained:

In 1980 there was a mini credit crunch following, I believe, a speech by Pres. Carter about not using your credit card. The Fed eased in the spring, pushing rates down from the high teens to the high single digits. They reversed course by the end of that summer. You can see it in both the consumer credit data and in the effective Fed funds rate.

And below we show an updated chart showing the steepness of the yield curve on the x-axis and the change in the 30 year yield, one year forward, on the y-axis for the 1977-1985 time frame (each point represents an end of month figure) with that 6 month window broken out in red.

What do we see? I would say the overall theme is unchanged. When the yield curve is VERY STEEP rates move down in more cases than up. When Long Bond rates were rising dramatically, it was in a number of cases led by a rise in the short rates (in response to inflation and/or an attempt to stomp out inflation), which resulted in the yield curve to be inverted. The outlier was that odd period from April 1980 - October 1980.

In summary, when the market historical priced-in inflation into long yields, it typically also priced-in inflation in short yields. The idea that short-term deflation is a potential outcome, while at the same time long-term inflation is a potential outcome is an outlier event.

In other words, history can not necessarily help us with what to expect.

Will There be Appetite for Another Stimulus Plan?

Calculated Risk has a nice post detailing the Possible Upside Surprises, Downside Risks going forward. One area [frequently] mentioned is that only 1/3 of the fiscal stimulus has been spent to date. Below are the details how the ~$180 billion fiscal stimulus has been spent.



But while the impact of the stimulus has been HUGE (Mark Zandi, Chief Economist of Moody's Economy.com estimates the stimulus contributed ~3% to Q2 '09 GDP and 3.5% to Q3 '09 GDP before the Joint Economic Committee), much of the impact is now fading (a vast amount of the impact was due to pulling demand forward). Calculated Risk details the potential drag and the why there may be appetite for an additional stimulus plan in 2010:

This suggests that all the growth in Q3 was due to the stimulus package, and the impact will now wane - only 2% in Q4, and 1.5% in Q1 2010 - and then the package will be a drag on the economy in the 2nd half of 2010.

With unemployment above 10%, there will be significant political pressure for another stimulus package - especially if the economy starts to slow in the first half of 2010. This next package could be several hundred billion (maybe $500 billion) and could increase GDP growth in 2010 above my forecast.
Source: Mark Zandi

Wednesday, November 11, 2009

Aussie Miracle Continues

Bloomberg details what happens when a workforce of around 11 million (~1/13th that of the United States) that focuses on commodities is located near a BOOMING China that happens to be in need of those commodities:

Australian employers unexpectedly added workers in October, pushing the nation’s currency to its highest level this year on speculation the central bank will raise interest rates for a record third straight month.

The number of people employed rose 24,500 from September, the statistics bureau said in Sydney today. The median estimate of 20 economists surveyed by Bloomberg was for a decline of 10,000. The jobless rose to 5.8 percent from 5.7 percent.

Australia’s economy is expanding with “less spare capacity than earlier thought likely,” according to the central bank, as Chinese-led demand for resources spurs companies such as Chevron Corp. to hire workers.


Total employed persons flat year over year during one of the worst global economic downturns in modern times... pretty, pretty, pretty good.

Source: ABS

China is Ripping... Bears are Smoking Dope

The equity markets opened up huge this morning with strong news coming out of China. Bloomberg details:

Production in China rose 16.1 percent from a year before, the most since March 2008, the statistics bureau said today. The trade surplus almost doubled from September, to $24 billion, as a drop in exports eased.

Separately, Japanese machinery orders, an indicator of business investment in three to six months, climbed 10.5 percent from a month earlier, according to the Cabinet Office in Tokyo. The median estimate of 25 economists surveyed by Bloomberg was for a 4.1 percent increase.



And the analysis of the day goes to Jeffrey Saught, chief investment strategist of Raymond James.
You got people out there saying the bear market rally’s over, I think they’re smoking dope.
Source: Haver

The Job Market and Equities

WSJ details the "hopeful" job opening data:

The Labor Department's Job Openings and Labor Turnover Survey found that the number of job openings in the U.S. increased slightly in both August and September, the first two-month rise since early 2007. Hotels, restaurants, education and health care made the largest contributions; even such hard-hit sectors as manufacturing saw a rise.
The number of job openings per unemployed persons has "slid" to 6.11 in September from 6.17 in August. Unfortunately, we already know the numerator in this equation jumps 558,000 jobs in October, so we need an increase of at least ~90,000 job openings to keep that ratio steady (unlikely). More "broadly", the broad unemployment measure points to almost 10.6 unemployed / underemployed persons per job opening (down slightly from 10.67).



The report also details the number of individuals separated from their jobs that were in the form of a "quit" (i.e. power of the people!) vs "layoff" (damn corporations!). Not surprising, when the going gets tough, the layoffs win.



Taking the ratio of quits to layoffs, we get the 'quits to layoff ratio' (anyone have a better name?), which has a very strong correlation (0.69 monthly correlation going back to December 2000) to the S&P 500 index.



Based on history it does appear that the equity market has been a leading indicator of 'quits to layoffs', but does anyone think the "power of the people" outweighs the power of the "damn corporations" right now?

Source: BLS

Tuesday, November 10, 2009

Where are Long Bond Yields Going?

The Case for Higher Rates

  • Massive debt issuance (over supply)
  • Central bank diversification (less demand)
  • Rebounding economy will bring inflation (decrease value of nominal debt)
  • Near historical (recent history at least) low yields
The Case for Lower Rates
  • Pension (liability driven investing) demand
  • Flight to safety
  • Excess capacity and labor supply will bring deflation
  • When the yield curve has been this steep, rates have rallied (in recent history)
Lets take a deeper look into the last bullet points for each case (i.e. the low yields vs. the steepness of the yield curve). The blue line in the chart below shows the one way direction of the Long Bond's yield since the early 1980's, which on a stand alone basis points to much more "downside risk" than "upside potential", while the red line shows how cyclical the spread between the yield of the 3 month T-Bill and 30 year Treasury bond has been.



In the second case, if one were to believe in mean reversion, history would indicate the yield curve will flatten in coming months / years. A yield curve can flatten (i.e. the spread becomes smaller) due to a fall in the long-end or due to a rise in the front-end (there are two camps on whether the Fed will hike rates anytime soon... I personally don't see that happening).

So what does history show has been the cause of flattening... the long bond rallying or the short-end rising? To see, below is a colorful chart showing the steepness of the yield curve on the x-axis and the change in the 30 year yield, one year forward, on the y-axis. The various colors show different time frames to show that each "lumping" isn't all from one period (each point represent the end of month figure going back to January 1986).

Notice any patterns?



The first pattern I notice is that the change in the Long Bond's yield becomes much more unpredictable when the yield curve is mildly steep (the first chart shows it doesn't stay 'mildly steep' long) and tends to be more stable in periods when the yield curve is either very flat or very steep.

But the money shot is that when the yield curve has been VERY steep (i.e. more than 4%) the Long Bond's yield has rallied in all cases (19 out of 19 times) over the next year.



Why? The only thing I can think of is that the yield curve becomes this steep due to massive easing by the Fed. And why would the Fed cut rates so dramatically? A slow deteriorating economy, which has historically been the opportune time to own long dated Treasuries.

Germany: Improving Economy, Idea of Fast Turnaround Fading

Some insight into Germany, European's largest economy. Similar to the U.S. the current situation is rather ugly, but improving, while optimism for the future is stronger, but expectations for a fast rebound are fading.

Bloomberg details:

German investor confidence declined more than economists forecast in November as the prospect of expiring government stimulus programs and rising unemployment tempered expectations for economic growth.

The ZEW Center for European Economic Research in Mannheim said its index of investor and analyst expectations, which aims to predict developments six months ahead, dropped to 51.1 from 56 in October. The median forecast in a Bloomberg News survey of 39 economists was for a decline to 55.

ZEW’s gauge of the current economic situation rose to minus 65.6 from minus 72.2 in October. The DAX index and the euro fell after the report and the yield on German 10-year government bonds slipped 3 basis to 3.27 percent.


Source: ZEW

The State of States: They're Broke

Loads of good data and charts in the Rockefeller Institute's latest State Revenue report (hat tip Calculated Risk), but unfortunately it is all depressing.

Here's one such depressing nugget.



Source: Rockefeller Institute

Monday, November 9, 2009

The "Paradox of Deleveraging"

CNN Money with the details of Friday's continued decline in consumer credit outstanding:

Consumer credit fell in September for the eighth straight month, the longest streak of declines since the Federal Reserve started keeping records in 1943.

Total consumer borrowing fell a seasonally adjusted $14.8 billion, or 7.2%, to $2.456 trillion in September, according to the Federal Reserve.


Ed over at Credit Writedowns asks whether this decline in consumer credit shows actual deleveraging.
My baseline for deleveraging is Debt to Nominal GDP – when debt to GDP goes down, that shows deleveraging. For example, for the latest data released in September for Q2 2009, Private sector total debt to GDP (incl. financial services) in the U.S. was 292.2% of GDP. Because of the huge drop in nominal GDP, this was actually up from 283.0% when the recession began in Q4 2007. For households, the number was 96.8% in Q2 2009, up slightly from 95.9% at the end of Q4 2007. What this shows is that deleveraging has yet to begin in earnest as debt levels have remained relatively high even while GDP had collapsed.
Ed makes an important observation that debt to GDP levels are not improving, but I don't agree with his definition of deleveraging. Lets call our disagreement a 'chicken or the egg' problem:
  • Did deleveraging NOT occur because GDP declined more than the level of debt outstanding?
  • Or... Did deleveraging occur, which caused GDP to decline more than the debt outstanding?
There are many examples of this paradox in economics (I detailed Paul Krugman's Paradox of Thrift back in the summer... i.e. the more people save, the less overall savings is in the short run as the whole savings pie shrinks). As it relates to deleveraging, lets go back to Paul McCulley:
At the collective level, however, it has given us the paradox of deleveraging: when we all try to do it at the same time, we actually do less of it, because we collectively create deflation in the assets from which leverage is being removed. Put differently, not all levered lenders can shed assets and the associated debt at the same time without driving down asset prices, which has the paradoxical impact of increasing leverage by driving down lenders’ net worth.
Deleveraging has the ability to drive down GDP as well as asset prices. Our economy is heavily dependent on consumption, which in itself is dependent on debt financing, which in itself is dependent on asset prices that serve as collateral for the financing (or in the case of banks, improve their capital requirement ratios so they can put more capital to work). This is the reason why the Fed has intervened in an attempt to re-inflate asset prices with a wide assortment of initiatives.

Will it work? If the goal was to reinflate these assets back to 'fair value' following the deleveraging of 2008 than these new prices may be sustainable. The issue (in my opinion) is that the goal seems to be to reinflate asset prices (i.e. homes, financial assets, etc...) to pre-crisis "bubble" valuation levels. So far we've seen subsidized financing, tax incentives, private/public partnerships (i.e. TALF and PPIP), purchases by the Fed, etc... to make this happen. I am of the opinion that whenever these initiatives roll off, prices will once again (absent inflation), fall.

Is this bad? For GDP in the short run... absolutely. But in the long run we need debt levels as a percent of GDP to rebalance. There are only two ways to do this... decrease the numerator (i.e. delever) or increase the denominator (through growth or inflation). Thus, absent atrong growth and/or perfectly timed and scaled inflation, we need to accept the inevitable pain before we pump up prices to even more unsustainable levels.

Civilian Hours vs. Real GDP

In response to my post detailing the decline in the per capita civilian hours worked per week by a member of the population (we need a better name for this), an anonymous reader points out that:

the graphs have basically been declining since 1999
He/she is right. Comparing that ten year period over the historical data series, we do see an unprecedented (going back to available data from 1964) decline. Below is the chart of the rolling ten year change in hours, along with corresponding annualized change in real GDP over the same 10 year time frame.



And we see the hours worked isn't alone... in looking at the data, ten year rolling real GDP growth is at an end of WWII low.

Source: BLS / BEA

Share via Twitter

Facebook Share