Happy 2011!

A repost from New Years 2009, tweaked (I'm feeling lazy) for the most recent year that was.

As 2008 2010 comes to an end, it is hopefully easyier for many of you to curse appreciate the year that was, but I urge you all to remember that the greatest things in life are not your personal finances. For me this includes:

• My family remained healthy and happy
• The birth of my first nephew niece
• Living in one of the greatest city on earth (in my opinion), New York City and getting set to move to another one of the greatest cities on earth (more to come)
• The ability to reach out to thousands (still shocking) of readers via EconomPic Data
• And most important to me... getting engaged being married for the past year and a half to an unbelievably caring (and gorgeous) woman.

Rather then just put this year in the past, I urge you all to look forward to an even brighter 200911. Best wishes to all and a happy New Year.

-Jake

Chicago Outlook: Biggest Jump in 22 Years

Marketwatch details the spectacular report coming out of Chicago:

A barometer of manufacturing conditions in the Chicago region jumped in December to its best level in more than 22 years.

The Chicago PMI rose to 68.6 in December from 62.5 in November, marking the 15th straight month that the gauge was over the 50 level indicating economic expansion and well above the 61 reading that economists polled by MarketWatch expected for December.

To put December’s report into context, the median showing of the Chicago report between 1970 and 2009 was 55.1.

The survey of purchasing managers showed the highest production levels since October 2004, new orders at their highest levels since 2005, the best employment levels in more than five years and the highest prices paid since July 2008.

Source: ISM

Are Earnings Stretched?

The chart below shows the long-term relationship between S&P earnings + dividends and nominal GDP growth. The dotted lines represent the 90 year average and shows earnings + dividends have grown ~2% less than nominal GDP. Not surprising, nominal GDP grows faster on average (otherwise earnings would eventually become larger than GDP, which is not possible).

What this does show is that earnings growth over the past 20 years is above GDP growth, showing how stretched earnings (via record wide margins) are. The risk for equity investors is that this relationship normalizes and earnings growth revert back its historic 1.5% - 2% below nominal GDP trend.

See my previous post Earnings Jump... Cause for a Concern? for some additional thoughts on why current earnings are likely unsustainable.

Source: BEA / Irrational Exuberance

Relationship of the Day

I can't take credit for this (saw it in the background on CNBC), but thought the relationship was interesting (it goes back to at least the beginning part of the decade, but I pulled the data for the ETFs which only go back to 2006).

Source: Yahoo

Housing: Another Leg Down

Biz Journals with the bearish view:

One of the nation’s leading real estate indexes showed home prices are on the decline across the country, raising fears of a double-dip recession in the housing market.

Home prices in the Case-Shiller 20-City Composite fell by .8 percent in October, compared to the 4.6 percent gain it saw in May before the federal housing tax credit expired.

“The double-dip is almost here, as six cities set new lows for the period since the 2006 peaks,” David M. Blitzer, chairman of the Index Committee at Standard & Poor’s, said in a statement. “There is no good news in October’s report. Home prices across the country continue to fall.”

Below is the year over year change by city through October, which appears to show that we are entering another leg down in a large portion of the nation's housing markets.



Source: S&P

The Story of Income and Outlays

Let me walk through the below chart, which I think tells a very broad story of where we were, what happened during the crisis, and how we are back to our old path with regards to consumption, which makes up ~65-70% of the U.S. economy.

First, the details.

The chart below shows the year over change in items that make up personal income (compensation, transfer payments from the gov't, etc...) and items of expenditure we use that income for (consumption, taxes, etc...). A year over year increase in an income item is a positive, while a year over year increase in an expenditure item is a negative. Combined, we get an increase or decrease in savings (a negative savings amount does not mean savings is negative, just that the level of savings has decreased).



A 1000 foot explanation of what I see...

We spent too much relative to our incomes (due to the belief at the time that we could always tap into the "wealth" of our housing stock). This is seen in the chart through 2007 when savings growth turned negative (savings in absolute terms turned negative in this period as well).

The recession started when a slowing economy turned the pace of growth in compensation and receipt on assets to fall. This combined with an uptick in savings, meant consumption slowed and slowing growth (not a downturn in growth) is all it takes for a levered financial system to be strained.

The government attempted to help the shortfall in aggregate demand through a large spike in transfer payments (the $600 tax check in 2008 + unemployment benefits), but individuals chose to save a large portion of this increase, dampening the impact.

In late 2008, individuals dramatically decreased the pace of consumption to rebuild balance sheets and from all the uncertainty in the system. This caused the issues in the system to become magnified.

By mid to late 2009, due in part to transfer payments and reduced taxes (which caused disposable income to spike), and a bottoming in the financial markets, confidence began to slowly come back to individuals. By early 2010, we have once again been on our old spending path through the reduction of the increase in savings (which has topped out at ~5 to 6%, well below a lot of forecasts for savings rates to spike).

What happens now? While the bush tax cuts mean that taxes won't be a drag for at least another few years, transfer payments can no longer be relied on to increase disposable income. What we need now is the job market to bounce back and compensation to allow for spending.

Spending based on compensation? Go figure...

Source: BEA

National Savings Rate Negative

The chart below shows the national savings rate (net savings of individuals, corporations, and the government). What we see is that for the first time since the Great Depression the aggregate savings level turned negative and is still negative.



What does this mean? It means the economy has been reliant on external sources of financing for our current level of consumption, which is sustainable… until it isn’t. Put another way, maintaining our current level of growth isn't completely in our hands at the moment.

This will either reverse at some point in the future with:

• Absolute savings increasing through a higher savings rate, which will cause the economy to slow (all else equal) as we get our balance sheet in check (i.e. what is going on in Europe)
• The growth of the private sector, which will allow the absolute level of savings to increase without a large increase in the savings rate as a percent of GDP; the denominator will grow, rather than the numerator in the savings as a percent of GDP ratio (i.e. the goldilocks scenario)

Source: BEA

If I Were Invited to the Bespoke Roundtable

Bespoke just released their recent roundtable predictions for 2011. Before jumping into everyone's projections and my guesses for the new year, lets take a look at all the predictions from 2010.



Showing that projecting one year out (when the world is filled with so much uncertainty) is so futile, by my calculations a flip of the coin would have done as good a job in projecting the future (i.e. less than 50% of the above predictions are correct as of yesterday). Due to easy money, government intervention, and a recovering global economy, EVERY single asset listed above is up in 2010 (home prices are barely up through September, so that is far from a sure thing through December).



While that proves we should take the 2011 projections in the next chart with a grain of salt, lets take a look.



To summarize the above, the majority believe in a recovering economy that will result in strong performance for risk assets and poor performance for bonds. In other words, the exact same prediction as in 2010.

The most common selection in 2011 (same as 2010) that goes against historical norms is that for a strong equity market, but a weak high yield market (only two went off this specific projection). As EconomPic has shown in the past, the relationship between the spread on high yield and equities is VERY strong, which is turn has historically driven returns.

S&P 500 vs. BarCap High Yield (1984 - 2009)



The way this prediction works is if equities do well and rates rise much more than spreads compress hurting high yield; a definite possibility, but one I view as unlikely.


My Guesses

While I am actually becoming a believer in the recovery over the short-run, who knows what the next 12 months will bring. With Europe's issues, the lack of will to address long-term structural problems in the U.S., emerging markets choosing to accept our easy money policy in their over-heated economies with (outright or pretend-they-don't-exist) currency pegs, and the debt overhang in much of the developed world... I couldn't possibly call my thoughts projections.

BUT, lets play the "if a gun were pointed at my head and I were forced to guess" game:

S&P 500 - Up; a believer (for now) in the short-term recovery and investor confidence
Long Bonds - Down, though I don't see inflation causing a huge sell-off in rates
Corporate Bonds - Up; the spread will make up for the rise in rates
Junk Bonds - Up; same rational as S&P 500 and corporate bonds
Gold - Up; ride the golden bubble / negative real rates will continue to drive capital into the asset
Oil - Down; unlike gold, higher oil prices impact the supply / demand profile which will counter the rise
Dollar - Down; emerging nations will need to loosen pegs to prevent over-heating
Home Prices - Down; higher rates / higher supply is a deadly combination
China - No clue, so lets call it flat with a standard deviation of 50%

We shall see...

EconomPics of the (Past Two) Week(s)

Economic Data

Inflation
Capacity and Inflation
Disinflation Remains

Jobs
Tax Cuts and the Impact (i.e. Cost) per Job
Where's that Job Recovery?
Eventually, Labor Will Be Needed to Meet Output
Companies Increasingly Looking to Hire

Global Recovery
Global Rebound Taking Form
Leading Indicators Strong in November
Personal Income Rebound is Widespread

Other
Nominal Matters: Retail Edition
Inventory Build? Nope...
The Consumer Credit Split
More on Consumer Credit

Assets / Investing

New Home "Pipeline" Lowest Since 1961
When Will the Fed Hike?
The High Yield One Way Ride...
Reach for Yield... Muni Edition
Housing and Inflation

And your song of the past (two) week(s)... The Flaming Lips with 'Do You Realize?'

Do You Realize - that everyone you know someday will die
And instead of saying all of your goodbyes - let them know
You realize that life goes fast
It's hard to make the good things last
You realize the sun doesn't go down
It's just an illusion caused by the world spinning round

Indeed...

Leading Indicators Strong in November

Source: Conference Board

Personal Income Rebound is Widespread

The chart below shows the year over year change in personal income across regions. In my opinion, the key is not to analyze which regions have done better (almost impossible with the below color scheme), but to see that ALL regions are rebounding (though still below old levels).

The issue is of course whether this is sustainable. The rebound was due to the government stepping in. The question is will the private sector bounce back before the goverment's support wanes.

Source: BEA

New Home "Pipeline" Lowest Since 1961

Marketwatch reports:

Construction of new U.S. homes rose 3.9% to a seasonally adjusted annualized rate of 555,000 in November, the Commerce Department reported Thursday. The November rate matched forecasts from analysts polled by MarketWatch. Housing starts for October were revised higher to a rate of 534,000 from a prior estimate of 519,000. Permits for new construction fell 4% to an annualized rate of 530,000 in November, reaching the lowest level since April of 2009. With persistent weakness in the housing market, homebuilders have been cautious.

Not detailed above is the number of permits issued that have not yet been started (i.e. the new starts "pipeline", which is now at the lowest level since December 1961 (i.e. before the New York Mets were a franchise).

While still years away, I think when the market turns and inventory finally falls we may actually see a housing shortage.

Source: Census

Capacity and Inflation

My view yesterday of inflation.

My view? Unless we see a pickup in employment (we may), all the stimulus (fiscal and monetary) will just feed into the rise we are seeing in commodities, not overall price levels. If corporations / individuals don't see a corresponding pickup in profits / income, then all this means is less money for non-core items. The result? A split between headline and core inflation. Just what we have seen thus far...

Capacity utilization strongly (in my opinion) supports this view. While excess capacity has declined (a lot) since the lows, it is still very low relative to historical levels WITH THE EXCEPTION OF MINING (in the U.S. at least - globally levels may be different, though unlikely.



Result? The potential for commodity and core inflation to remain bifurcated going forward.

Source: Federal Reserve

Disinflation Remains

The WSJ details:

So-called core inflation, which excludes energy and food prices and is closely watched by the Federal Reserve, inched ahead by 0.1%, the first move after three flat months.

Economists surveyed by Dow Jones Newswires ahead of the release expected consumer prices to rise by 0.2% and core CPI to gain 0.1%.

The Fed considers core inflation a better measure of price trends because it excludes the most volatile components of the index.

The annual underlying inflation rate was 0.8%, well below the Fed's informal inflation target of between 1.7% and 2%. The Fed's policy-making committee Tuesday signaled that it thinks core inflation remains too low--a key factor in last month's decision to start buying $600 billion in Treasury bonds in an effort to boost investment and consumption.

Year over year changes show INFLATION IS NOT AN ISSUE.

Source: BLS

When Will the Fed Hike?

The chart below shows market forecasts for short-term rates (3 month LIBOR) over the next three years based on EuroDollar futures contracts. As can be seen, the market is projecting a steady increase in short-term rates with an increase in the pace in mid-2012.

Markets have moved from 'Fed on hold for years' to 'Fed on the verge' abruptly since early November. While the chart above shows a snapshot, the chart below shows the trend of what the market is / has priced in for the one year Treasury yield, two years forward (bootstrapped from 3 year and 2 year Treasuries).

Note that current 1 year Treasuries are 0.27%, while the forward rate has jumped ~130 bps to ~2% since the first week of November.

With core inflation negligible, unemployment at 10%, and excess capacity still very... excess, this is definitely way on the optimistic side of my personal forecast.

Source: Federal Reserve

Nominal Matters: Retail Edition

Are there signs of life in the economy? Absolutely! But was this the "monster surprise" to the upside bounce in retail consumption we've been waiting for? Hardly.

First the details per Reuters:

U.S. retail sales were stronger than expected in November as consumers shopped despite high unemployment and producer prices rose, evidence the economic recovery gathered steam in the fourth quarter.

The Commerce Department said on Tuesday total retail sales increased 0.8 percent, advancing for a fifth straight month, as consumers snapped up clothing and other items at the start of the holiday season and receipts at gasoline stations surged.

In addition, sales for October were revised up to 1.7 percent from a 1.2 percent gain. The sturdy rise in sales was a boost for consumer spending, which accounts for more than
two-thirds of U.S. economic activity.

The issue (as I've mentioned before and just last week in the inventory numbers) is this is NOMINAL, not real. Lets take a look at the jump in sales by category to see why this is relevant.



In dollar terms, 46% (yes almost 50% of the jump in nominal dollar terms) of the increase was on gasoline, 16% on clothing, and 13% on food. What we know for certain is that gas and food jumped in price in October and November (clothes jumped 1.2% in October... not sure about November, but we'll know more with the CPI release later this week).

So are things improving? Absolutely, but this is not the "blow out" number it first seemed.

Source: Census

PPI Jumps... Is Core Inflation in our Future?

Sorry for the lack of posts... my life has been a whirlwind; kind of like the latest producer price index release (how's THAT for a transition).

The Atlantic details:

Is the Fed's new asset purchase program already succeeding in raising inflation? Looking at the latest producer price index (PPI) data implies that it could be. The prices for finished goods that producers face increased by 0.8% in November, according to the Bureau of Labor Statistics. That's the biggest increase since March. Is inflation rising, or is this just a blip?

That is the million dollar question.

My view? Unless we see a pickup in employment (we may), all the stimulus (fiscal and monetary) will just feed into the rise we are seeing in commodities, not overall price levels. If corporations / individuals don't see a corresponding pickup in profits / income, then all this means is less money for non-core items. The result? A split between headline and core inflation. Just what we have seen thus far...



Back to the Atlantic:

Since August, there certainly doesn't seem to be much deflationary threat here. The 12-month change in PPI for finished goods is 3.5% as of November.

So what's driving the increase in prices? Food and energy make up a significant influence. Food prices rose by 1.0%, and energy prices were up 2.1%. You have probably noticed the latter driving an increase in prices at the pump. If you exclude those two factors, core PPI for finished goods rose by 0.3%.

Source: BLS

More on Consumer Credit

Karl Denninger details why the jump in non-revolving consumer credit was not necessarily all it was made out to be (hat tip Jim Driscoll):

Except for the idiots borrowing to go to school [who] are going to find that they will never be able to pay it back, having bought into the Kool-Aid (and who will be destroyed by it), the actual non-revolving debt acceptance was down at a 58% annualized rate of change!

That's not a decline -- it's a collapse.

Well then.

Here's the supporting data (assuming Federal owned consumer credit is all student loans).



For those that like ranting... enjoy as I turn it back to Karl:

While the "pumpers" all said that strong auto sales were part of the recovery, that's a lie; "finance companies" (which include GMAC, Ford Motor Credit (FCZ), etc.) declined at a nearly 6% rate for the month, which on an annualized basis is just plain nasty.

"Positive surprise"? Oh hell no. Not only are consumers shunning credit cards, they're shunning credit of all types -- except for young people, who continue to be bamboozled into taking on debt for a so-called "education" into a collapsing credit, salary and employment environment.

Source: Federal Reserve

The High Yield One Way Ride...

Barron's details:

Since the end of August, the i Shares Barclays 20+ Year Treasury Bond exchange-traded fund (TLT), which tracks the long end of the market, has lost 12% in value. Over the same span, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), a popular play on the junk market, is up nearly 3% in price.

Back to Barron's...

Which is the riskier asset isn't apparent from recent experience. As a result of the recent relative moves, Martin Fridson, the long-time high-yield bond observer at BNP Paribas, Wednesday declared the sector as being at "fair value," which is to say, no longer cheap. The spread of the Merrill Lynch U.S. High Yield Master II Index over comparable Treasuries had contracted to 569 basis points (5.69 percentage points) by Tuesday, which is about where it should be based on his model based on default risk, economic conditions and credit availability.

In other words, after an 8 quarter one way ride (with the exception of the sell-off in Q2 '10 due to concerns about European contagion), the drive won't necessarily be as straight going forward.



Source: Yahoo Finance

Tax Cuts and the Impact (i.e. Cost) per Job

American Progress details:

Our analysis of the framework tax agreement that President Barack Obama announced yesterday, including additional tax cuts and an extension of unemployment insurance, finds that 2.2 million jobs will be the end result. In this time of economic distress, millions of new jobs are, of course, very welcome. It is, however, unfortunate that these jobs have to come from an agreement that is a balance between large, unneeded, bonus tax breaks for the wealthiest Americans and the needed continuation of unemployment benefits, middle-class tax relief, and additional help for the economy for the rest of us.

Based on their analysis the "good" components are the unemployment benefits extension, payroll tax cuts, and refundable low income credits forecasted to cost $150k or less per job added; while the bonus tax credit, extension of business tax credits that were set to expire, and bonus expensing provisions (100% for 1 year, 50% for year 2) cost between $400k and $700k per job added.



Source: CBO / Mark Zandi

Inventory Build? Nope...

Bloomberg with some faulty analysis:

Inventories at U.S. wholesalers rose more than twice as much as forecast in October as companies stocked up to meet the biggest sales gain in seven months.

The amount of goods on hand compared with sales in October held at the highest in almost a year, indicating companies may be growing confident about the outlook for demand to spur production. Recent data showed November retail same-store sales rose more than forecast, signs of momentum in the economy before the end of the year.

“The inventory cycle is maintaining its solid momentum,” said Joshua Shapiro, chief U.S. economist at MFR Inc. in New York. “With final demand showing more signs of life, it will build on itself. It means better output but also maybe more imports.”

That would be great... if it were true. The reason for the huge jump in sales and inventories was not due to a surprise pickup in the economy, but rather due to inflation (the sales / inventory levels are nominal, not real).

As an example, the chart below shows the spike in farm products and petroleum inventories. Ignoring these two line items would have resulted in a jump of 0.6%, an improvement (though ALSO largely due to inflation), but much closer to 0.5% estimate.



Source: Census

The Consumer Credit Split

Bloomberg details:

Consumer borrowing in the U.S. unexpectedly rose in October for a second straight month, led by an increase in non-revolving credit, including student loans held by the federal government.

The report showed credit-card debt fell for a 26th consecutive time, showing Americans continue to pay down debt, one reason spending has been slow to recover. Car sales last month climbed to the highest level in a year and holiday purchases have perked up, indicating households may soon start borrowing again.

It looks like non-revolving loans have (for at least the moment) hit bottom, while revolving (i.e. credit card debt) continues to collapse.



Source: Federal Reserve

Companies Increasingly Looking to Hire

Source: BLS

Global Rebound Taking Form

Investment Postcards via The Big Picture shows that the United States is in fact not trailing the rest of the world (at least in November) in terms of pace of an economic rebound.



Source: Investment Postcards

Reach for Yield... Muni Edition

Bloomberg details:

An extension of the U.S. Build America Bond program was left out of a compromise that President Barack Obama struck with congressional leaders to prolong tax cuts enacted in 2001 and 2003, White House officials said.

This wasn't all that unexpected...

Concern that the program would lapse has weighed on the tax-exempt bond market since an end to Build America issuance may boost the amount of money state and local governments borrow with tax-exempt debt. Issuers have also rushed to sell Build America securities before year-end.

And with yields at more attractive levels and supply set to collapse, the opportunity to buy is "apparently" now. CNBC details:

Just weeks before the Build America Bonds program is set to expire, issuance and demand for the government-subsidized notes have reached a fever pitch.

Pricing pressure from a glut in supply, uncertainty over changes in the government’s subsidy levels, and a spike in the Treasury’s 30-Year bond—to which municipal notes are typically pegged—have pushed yields higher, according to investors.

Some investors and analysts say this may be the sweet spot for buying the Build America Bonds, which are now the fastest-growing part of the $3 trillion municipal debt market. “We think we’re at the high for yields,” says one muni bond investor. “If you’re going to buy, now is the time.”

Source: Barclays Capital

Game Day!

Although the J-E-T-S are underdogs in Foxboro this evening (I see a 3.5 point line) and without Jim Leonard (the Jets secondary defensive play caller), I am ready for them to ROLL (or at least significantly BEAT DOWN) the Pats....

Score?

27-17

Nice Uggs Brady...



Best of luck GYSC!

Update: Yikes... That was ugly, but there must be some economic parallel here somewhere.

Source: Refinery 29

Housing and Inflation

Bill Ackman (via Paul at Infectious Greed and pulled from a Beracha and Johnson white paper) shows the following chart comparing the rate of appreciation required for housing to breakeven with an equivalent rental (adjusted in some concocted manner to adjust risk to match the opportunity cost for a homeowner that plans to change the quality of their residence... don't ask).

While not Bill Ackman's only rationale, the claim with the above chart seems to be that with required appreciation only ~4% (down from 9%+ in the early 1980's), the rental equivalent value hasn't been this cheap since the 1970's.

My problem?

Well for one, I am questioning Bill Ackman (not typically the best move).

But ignoring that, my problem is this does not compare the "real" appreciation needed now to "real" appreciation needed in the early 1980's, but only nominal. Nominal appreciation was easy in the early 1980's when inflation was running at 10%+, but not so much with current inflation thus far non-existent.

Want proof that inflation matters to home values? Here you go.



Is housing a good hedge against potential inflation? Sure. But it may not be so cheap should inflation not show itself.

Source: Irrational Exuberance

Eventually, Labor Will Be Needed to Meet Output

As everyone is familiar with, the productivity spike following the economic downturn was initially met with a HUGE drop in hours worked and employment. As detailed previously:

The initial increase in productivity was never due to doing more, with less. It was doing less with (an even larger) less.

The below chart shows that things have evolved (for the good) and that both productivity and hours worked have increased year over year.



Now compare the above year over year figures with the below quarter over quarter (annualized) figures. What we see is that productivity growth (and output) remains strong, but at a decreasing rate.



Shown another way (subtracting the year over year growth in chart 1 from the quarter over quarter growth in chart 2) and we can see clearly that the pace of growth in output has decreased as productivity has decreased and hours worked have not increased enough to offset the decline (again this is in terms of the second derivative of output - there is still outright growth).



What does this all mean to me?

Well, the manufacturing portion of the charts are an interesting study because the collapse in manufacturing was larger and the rebound swifter (though still WAY below the old trend). What initially happened was a huge spike in productivity as jobs were shed by the millions. Later, productivity continued to increase while hours worked eased higher (not necessarily through hiring). When manufacturers got all they could out of this remaining workforce, to meet demand they were forced to... wait for it... actually hire (hence, the jump in labor cost per unit).

This is what is happening, albeit more slowly, in the broader economy. The problem is there is still so much excess capacity in the system that companies are still able to squeeze more out of their existing labor force (i.e. there is still room for additional productivity growth and hours to be increased). I do think we are fast approaching the inflection point as cost cutting has run its course and corporations are now looking to grow the top line to grow profits. Considering the limited investment over the past few years, to meet output (it is my hope) corporations will need to once again rely on labor.

Source: BLS

Where's that Job Recovery?

Two weeks of catching up to do... I'll start with the employment report from Friday and will likely just move forward from here (not even sure where I'd start as there was so much noise from European struggles, to Wikileaks, to North / South Korea, to the J-E-T-S winning another two games).

Household Survey

The household survey showed a continued disconnect (and downturn) from the establishment survey with the number of unemployed AND those not in the labor force jumping. The only "good" news here is that teens are getting hired (likely due to the holiday season?).



Establishment Survey

Unlike the household survey that showed a decline, the establishment survey showed an additional 39k workers (though well below expectations). Worrying (to me) is that private sector growth, which is needed to offset likely job declines from the public sector as states continue austerity measures, appears to be slowing.



Source: BLS