Tuesday, August 31, 2010

Housing (Greed - Fear - Bottom) Cycle

Irvine Housing Blog (hat tip The Big Picture) shows the below chart and details that:

It is a sign that people are clinging to the hope of a real estate recovery. We are not yet at the bottom.

While I understand the above chart is meant to make a high level point (rather than show exactly where we are), I thought it would be interesting to overlay the Case Shiller home price index on top.

We are not as early in the process as the chart would indicate (i.e. we've already fallen much further), it appears we still have plenty of risk remaining to the downside.

Another way to view this is Case Shiller 10 vs. inflation (CPI) over this time.

Closer, but still about 20% "too high" and during "despair", it tends to break through.

Source: S&P / BLS

Consumer Confidence Jumps Slightly... Flat Year over Year

The Conference-Board details confidence is just about where it was a year ago (did a recovery actually take place?):

Says Lynn Franco, Director of The Conference Board Consumer Research Center: “Consumer confidence posted a modest gain in August, the result of an improvement in consumers’ short-term outlook. Consumers’ assessment of current conditions, however, was less favorable as employment concerns continue to weigh heavily on consumers’ attitudes. Expectations about future business and labor market conditions have brightened somewhat, but overall, consumers remain apprehensive about the future. All in all, consumers are about as confident today as they were a year ago (Aug. 2009, 54.5).
July vs. August

Month over Month Change

Housing Prices Continue Rebound Due to Tax Credits... Now What?

S&P details:

Data through June 2010, released today by Standard & Poor’s for its S&P/Case-Shiller1 Home Price Indices, the leading measure of U.S. home prices, show that the U.S. National Home Price Index rose 4.4% in the second quarter of 2010, after having fallen 2.8% in the first quarter. Nationally, home prices are 3.6% above their year-earlier levels.

In June, 17 of the 20 MSAs covered by S&P/Case-Shiller Home Price Indices and both monthly composites were up; and the two composites and 15 MSAs showed year-over-year gains. Housing prices have rebounded from crisis lows, but other recent housing indicators point to more ominous signals as tax incentives have ended and foreclosures continue.

Strength was widespread, but note this data is two months old and importantly, during a period before the tax incentive ended.


Calculated Risk with a beautiful chart showing the cumulative change by market here.

Source: S&P

Personal Income Breakdown

Yesterday, EconomPic detailed the slow growth in real personal income over the latest decade. Below we break down the contribution of real per capita disposable personal income over each of the past six decades.

Things to note:

1) Compensation grew by at least $2000 per capita in real terms each decade since 1960 (more than $4000 in the 90's), but only ~$350 in the 00's
2) 95% of real per capita personal income in the 00's were current transfer receipts (unemployment / welfare benefits) and a decline in taxes paid (wonder why our nation's debt has spiked?)

Source: BEA

Monday, August 30, 2010

Personal Income Slow to Rebound

Marketwatch details:

The savings rate for U.S. households fell in July to the lowest level in three months as spending outpaced income, the Commerce Department estimated Monday.

Consumer spending rose 0.4% in July while personal income increased 0.2%.

The report was mixed in terms of market expectations. Incomes rose less than the 0.3% expected, while spending was stronger than the 0.3% gain expected by economists surveyed by MarketWatch.

Real (inflation-adjusted) spending increased a seasonally adjusted 0.2% in July after a 0.1% gain in June, led by a sizable increase in purchases of durable goods.

Real after-tax incomes fell 0.1% in July, compared with a downwardly revised 0.1% gain in disposable incomes in June. This is the biggest decline since January.

The savings rate fell to 5.9% from 6.2% in June, which was the highest level since June 2009.

Source: BEA

Is the Low Quality Rally in Corporates Over?

Bloomberg details:

Returns on U.S. investment-grade corporate bonds are pulling ahead of junk-rated debt as credit investors turn to borrowers likely to weather a slowing economy.

Investment-grade bonds are up 9.7 percent this year, topping the 8.5 percent for speculative-grade, the biggest outperformance since credit markets seized up in 2008.

Yields on investment-grade bonds average about 4.71 percentage points less than junk, compared with 3.76 percentage points in April.
Performance by Rating

Source: Barclays Capital

Friday, August 27, 2010

EconomPics of the Week (8/27/10)

The Importance of Mortgage Rates
Addition by Subtraction
New Homes on the Cheap
BOOM!!! Goes the Treasuries
Are Corporate Earnings Sustainable?

Economic Data
GDP Breakdown by Decade
More Stimulus Needed?
Durable Goods...No Good
Where's the Investment?
US GDP Revised Down... Above Expectations
The Case for Developed Europe
UK Economic Growth Revised Upward

And your video of the week we're going back to the mid-90's with the Toadies' Tyler:

BOOM!!! Goes the Treasuries

Reuters details:

U.S. Treasuries prices fell sharply on Friday after Federal Reserve Chairman Ben Bernanke signaled no new bond buying by the U.S. central bank was imminent, triggering the biggest sell-off in three months.

Although Bernanke did mention such purchases as a possibility, investors found nothing in his comments to indicate the Fed has any immediate plans to stimulate the slowing economy through an expansion of current bond buying.

For a market already at rich levels, this was an important nuance that further fueled a sell-off ignited after data earlier on Friday showed a revised picture of U.S. economic growth was not quite as weak as expected in the second quarter.

Source: Bloomberg

US GDP Revised Down... Above Expectations

Consumption was revised up slightly, net exports and investments were revised down a bit more reducing Q2 GDP -0.8% (from 2.4% to 1.6%) from the advanced figure (better than expected).

Source: BEA

UK Economic Growth Revised Upward

Marketwatch details:
The British economy grew slightly faster than previously estimated in the second quarter, with gross domestic product expanding by 1.2%, the Office for National Statistics reported Friday.

The ONS had previously estimated second-quarter GDP growth of 1.1%. Compared to the second quarter of last year, GDP grew by 1.7% versus a previous estimate of 1.6%. A survey of economists by Dow Jones Newswires had forecast no revisions to the data.

The growth marks the strongest quarter-on-quarter rise for British GDP in nine years.

Construction output was revised to show an 8.5% quarterly rise, up from a previous estimate of 6.6%. Output by production industries rose by an unrevised 1%.

Services output was revised down to show 0.7% growth, but still accelerated from 0.3% growth in the first quarter.

Source: Stats.UK

Thursday, August 26, 2010

New Homes on the Cheap

Unlike the result of existing home sales where the higher end market is holding up well (in terms of sales) relative to the absolute cliff-dive in the low-end market, the new home sales figures show the low-end market is where it is at (though likely because high-end homes are now priced a notch or two down in the price ladder).

Whereas 10% of all new homes sold went for $500k+ as recently as 2008, in 2010 that figure is now less than 4%.

It is important to note that the July 2010 figures are from a base 30% lower than in 2009.

Source: Census

The Case for Developed Europe

Missed this the other day. Reuters details:

Euro zone industrial new orders rose more than expected during the month of June, data showed on Monday, boding well for economic growth in the third quarter of 2010.

Industrial orders in the 16-nation currency zone increased 2.5 percent month-on-month for a 22.6 percent annual gain, European Union statistics office Eurostat said.

"That's good. Shows we can take a lot of the second-quarter momentum into the second half," said Carsten Brzeski, economist at ING.

The data could point to another quarter of economic expansion as the euro zone recovers from its sovereign debt problems and the worst economic crisis in decades. Orders point to trends in activity as they translate into future production.

So the economy seems to be "recovering" (or at least not entering a depression). The importance of this non-depressionary environment? The market is (according to GMO's James Montier - one of my favorite out of the box writers) priced like it is.

To his latest missive (if you are not signed up, I recommend you do - bold mine):

Of course, as with all investments, the price you pay determines the attractiveness of the opportunity. The good news is that European dividends appear to be priced cheaply at the moment.

Exhibit 6 (go to his missive to see) shows the current pricing structure of European dividends (for the Eurostoxx 50, the vertical line marks the point at which we switch from actual dividends to the market’s implied view of dividends), and shows the experience of U.S. dividends during the Great d epression as a comparison. In essence, the market is saying that dividends will have virtually zero growth between now and 2019. This is a worse outcome than the U.S. witnessed in the wake of the Great Depression!

Source: Eurostat

More Stimulus Needed?

Calculated Risk details that according to the CBO, stimulus (i.e. the American Recovery and Reinvestment Act "ARRA") raised GDP in Q2 by an estimated range of 1.7% to 4.5%. If the revision to Q2 GDP growth comes in at the expected 1.4% annualized rate for the quarter, this means that if the impact of stimulus is within range, GDP "would have" been negative in Q2.

The chart below shows actual GDP and a range for GDP ex-stimulus (simply actual GDP less the estimated impact of the stimulus at the low and high-end ranges as detailed by the CBO).

The concern on a going forward basis is that the impact of the stimulus has peaked and the economy still has numerous structural issues. Back to Calculated Risk:

Less stimulus spending in Q3 was one of the reason I expected a slowdown in growth in the 2nd half of 2010. There are other reasons that I've listed before: the end of the inventory correction, more household saving leading to slower growth in personal consumption expenditures, another downturn in housing (lower prices, less residential investment), slowdown in China and Europe and cutbacks at the state and local level.
Source: BEA

Wednesday, August 25, 2010

Durable Goods...No Good

Forbes details:

Orders for big-ticket manufactured goods in July came in weaker than expected, raising the risk that the gross domestic product during the third quarter will not reach 1%, says Michael Feroli, an economist at JPMorgan Chase

On Wednesday the U.S. Commerce Department reported durable goods orders rose by a measly 0.3% in July, well below the 2.5% lift the Street had expected, though still ahead of the 0.1% slip in June.

Shipments of capital goods fell 1.5% on a core basis, which excludes aircraft and defense spending, while orders tumbled 8%.
Transportation (i.e. the only highlight) was distorted by a massive 76% month over month jump in aircraft orders. Without that... not so much.

Source: Census

Where's the Investment?

Traveling again today, so this is all you'll get until later this evening / tomorrow from EconomPic....

In response to my post on the breakdown of GDP by decade, reader DIY Investor comments:

It would be interesting if the investment portion could be broken out between housing and other and be done on an annual basis for the 00s. There may be some pent up demand building on the part of business investment which could bode well for the stock market. My best guess is that the numbers are dominated by the housing crisis.

At least that's my take.
The chart of investment, both nonresidential (structures and equipment / software) and residential below....

Some results that I found interesting:
  • The residential boom doesn't look so large as compared to previous cycles, though the collapse is rather epic (and will only get worse)
  • Investment in structures has been flat going on 20+ years (outsourcing?)
  • After the (telecom) investment bubble in the late 90's / early 00's, equipment and software investment is at a 50 year low (the potential that there is pent up demand for new investment)
The result... a huge lack of investment. As EconomPic has detailed before, this was a partial cause in the jump in profits over the past decade (less investment temporarily increases the bottom line) and now growth is slowing (innovation helps increase the top line / economy).

Source: BEA

Tuesday, August 24, 2010

Addition by Subtraction

As expected, existing homes sales utterly collapsed in July post tax-credit. Barry over at The Big Picture detailed comments from the National Association of Realtors:

Everyone knew that Existing Home Sales were going to stink the joint up today — but I just had to laugh when I read the NAR commentary; The headline along was priceless: July Existing-Home Sales Fall as Expected but Prices Rise. Too bad they don’t cover other events: “Lincoln attends theater opening; leaves early with headache.”

They are the world’s most awesome/awful cheerleaders on the planet.

The real reason for the "rise" in home prices in July? A larger collapse in lower priced homes where the tax credit had a larger impact.

Nothing but "addition by the reduction of subtraction".

Source: Realtor

GDP Breakdown by Decade

On the road today, so I will miss what Calculated Risk (i.e. the expert) believes will be a massive miss in existing home sales (consensus is currently in the range of 4.7 million units... Calculated Risk is calling for a bit above 4 million).

What I do have to offer is an update on the economy over the LONG term. Last week, EconomPic detailed that the economy grew just 1.62% annualized over the past decade in real terms (the lowest level since the 1950's). The below goes back farther and details the components that make up GDP for each decade.

Source: BEA

Monday, August 23, 2010

Are Corporate Earnings Sustainable?

Last week, EconomPic showed the historically relationship between the treasury yield and nominal GDP growth. Below, we compare corporate earnings growth to the treasury yield over that same ten year window.

What we see is that earnings on a cyclically adjusted basis (smoothed per Shiller) have been growing faster than the broader economy for the past ten years.

My thoughts (as shared last month):
The important question is how these earnings have come about. We all know that recent earnings have ratcheted higher due to reduced costs (job cuts, lack of investment, cheap financing) rather than top line growth. In other words, executives for public firms have caught up with the "buy, strip, and flip" nature of private investors.
In addition, simple math proves that earnings cannot grow faster than nominal growth over the long term, as that would imply earnings at some point become larger than the economy as a whole (not possible as earnings are part of the economy).

In summary... expect earnings to be under pressure in the not too distant future unless there is surprise outsized rebound in the economy.

Source: Irrational Exuberance

The Importance of Mortgage Rates

The Washington Post details how low current mortgage rates are:

Mortgage rates fell this week to the latest in a series of record lows amid concerns about the state of the U.S. economy, according to a survey released Thursday by Freddie Mac.

Interest rates on 30-year fixed-rate mortgages, the most widely used loan, averaged 4.42 percent this week, down from last week's 4.44 percent and its year-ago level of 5.12 percent, according to the survey.

Thirty-year mortgage rates have fallen to record lows for nine straight weeks. Freddie Mac started the survey in April 1971.

And the corresponding chart...

In my opinion, rates (and only rates) are the reason why there has been a (temporary?) halt in housing price declines. Housing values were (and I believe are) too high, but low nominal rates have made monthly payments much more affordable.

The chart below shows the monthly mortgage payment for a $200,000 house after a 20% down payment (i.e. a $160,000 mortgage) using the above 30-year mortgage rates.

Current monthly payments on a $160,000 mortgage are only $803, down from more than $1000 in October 2008. In other words, monthly payments are down 20% even if the price of the house didn't drop over that period.

The important question is what can happen from here?

While I am not claiming that prices will fall off another cliff soon, there is a significant risk of a further decline... especially if rates don't stay this low (for this reason I do expect rates to stay this low). The below chart keeps the current $803 monthly payment constant, but backs into what the value of a home using historical mortgage rates would have been for monthly payments to stay at that $803 level.

What does this mean for anyone looking to buy a house?

Since the key contributor to housing affordability is not the current list price, but rather the mortgage rate, anyone looking to buy should seriously consider the alternative (i.e. renting) if they don't plan to use that contributing factor (again... the mortgage rate) for the life of the loan (i.e. to keep their house for 15-30 years).

If you do plan to buy a house for a smaller window of time (i.e. 1-10 years) with the idea of flipping it into a larger house, be careful. That $803 per month clearing price may mean a much lower home value when you are trying to sell...


An anonymous reader makes a common mistake in questioning the details of the post:

If you're planning to swap out your house after a couple of years for a bigger house, wouldn't you want house prices to come down? Yes, you'd lose money when you sell your old house, but you'd save even more money on the larger house, whose price also went down.

This would be true is there was no leverage (i.e. financing) involved or if the decline occurred in combination with a further decline in rates. My concern is that a rise in rates will coincide with or even trigger the next price decline. As a result, a decline in the value of homes could be disastrous (remember, investments in housing typically involve a ton of leverage).

My response (slightly edited):

Not if housing prices decline due to a rise in mortgage rates, which would result in a unchanged monthly payment on the new property (i.e. home price drop is exactly offset by mortgage rate rise = no impact on the mortgage payment).

The reader used an 'extreme' example of a $100k house flipped into a $1mm house, which I will replicate:

  • $100k mortgage = $500 / month mortgage payment at current rates
  • $1mm mortgage = $5000 / month mortgage payment at current rates

Now, assume home values drop 10% due to a rise in rates, which would happen all else equal if homes were strictly based on monthly payments individuals could afford and rates rose to 5.32% (monthly payments on a $90k loan at 5.32% = ~$500, which is the same as a $100k loan at 4.4% = ~$500)


  1. $100k home is now worth $90k (you lose $10k)
  2. your monthly payment on the new $900k mortgage is the same as it would have been previously on a $1mm mortgage (~$5000 per month)

As you can see, the owner doesn't get the benefit of the price decline if they need financing to own. The situation becomes dire in a move to a similarly priced home. Assuming a move from a $1mm house to an identical house now worth $900k.

  1. you lose $100k in equity
  2. your monthly payments are the same

If there is a larger price decline (one larger than the level of equity in a home), one can see how ugly this can get. Again, the reason being leverage and my concern that the only thing propping up the housing market is subsidized financing. My concern is that borrowers are buying what they can (barely) afford in terms of a monthly mortgage payment and not in terms of what they can afford in terms of price of a home relative to wealth.

Friday, August 20, 2010

EconomPics of the Week (8/20/10)

Asset Class Performance
Bond Bubble Blasphemy
Treasuries: Bubble or Accurate Reflection of Slow Growth?
More on the 16/18/20
The Case for Emerging Markets
Swap Curve Whacked
More on Equity Earnings Yield
How Well Have Treasuries Perfomed?

Economic Data
The Household Sector is Deleveraging
Philthy Fed Index
PPI Jumps Due to Energy in July
Capacity Utilization Jumps in July
Tame Leading Economic Indicators in July
Empire Manufacturing "Modest" Gain... Orders Fall
China Passes Japan as 2nd Largest Economy

And your video of the week... The Strokes with Reptilia:

Treasuries: Bubble or Accurate Reflection of Slow Growth?

Sean over at Dead Cats Bouncing details:

While another economic crash landing remains unlikely given the inventory and corporate funding backdrop, there won't be much room for policy error either politically or at the Fed in coming months. Monthly headline US CPI has now fallen for three consecutive months, which has only happened a handful of times since the data series began in 1947. If you take the rough and ready rule that a 10 year government bond yield should equal the long term growth rate plus the long term inflation rate, then it's clear that a near 2.5% 10 year Treasury yield is pricing in a grim growth scenario.
Well, I for one was surprised just how strong the relationship has been.

Update: An anonymous reader commented:
I suspect both nominal GDP growth and treasury yields are mostly driven by inflation, since both real yields and real GDP growth vary less than inflation did.Which means all this graph is telling you is that inflation plus some noise is correlated with inflation plus some different noise
While inflation has indeed dominated the change in nominal GDP over the long run, real GDP has actually been more volatile than CPI over the course of the past ten years. Also of note; ten year annualized real GDP has dipped to 1.62%... the lowest level since the early 1950's.

More on the 16/18/20

The 16/18/20 method was detailed previously (go here) at EconomPic. At the time, we showed the performance of those periods that were to be avoided (they underperformed historically).

Below, we show the performance in terms of real change of the S&P 500 index during periods deemed "attractive" based on the 16/18/20 method.

How'd they do?

Quite well.

Source: Irrational Exuberance

Thursday, August 19, 2010

Philthy Fed Index

Bloomberg details:

Manufacturing in the Philadelphia region unexpectedly shrank in August for the first time in a year as orders and sales slumped, a sign factories are being hurt by the U.S. economic slowdown.

The Federal Reserve Bank of Philadelphia’s general economic index fell to minus 7.7 this month, the lowest reading since July 2009, from 5.1 in July. Readings less than zero signal contraction in the area covering eastern Pennsylvania, southern New Jersey and Delaware.

Manufacturing is slowing after leading the economy out of the worst recession in seven decades as consumers rein in spending. With factory growth waning and companies slow to add employees, the economic expansion will slow in the second half of the year.

“It’s not a pretty picture,” said Raymond Stone, chief economist at Stone & McCarthy Research Associates in Skillman, New Jersey, who forecast a reading of minus 6. “We’ll see continued gains in manufacturing output, but it might be very small.”

Source: Philly Fed

Tame Leading Economic Indicators in July

Bloomberg details:

The index of U.S. leading indicators rose in July for the second time in four months, extending a see-saw pattern that indicates slower growth through the end of the year.

The 0.1 percent gain in the New York-based Conference Board’s gauge of the prospects for the economy in the next three to six months followed a 0.3 percent decline in June that was larger than initially estimated. The June decrease was the biggest since February 2009.

Manufacturing, which led the economy out of the worst recession since the 1930s, will probably moderate in coming months as a slowdown in consumer spending depresses orders. Federal Reserve policy makers last week said the recovery was “more modest” than they had projected, prompting them to take additional steps to revive growth.

“Economic growth is going to slow in the second half and we might face something a little more ominous than that,” said Mark Vitner, a senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina, who accurately forecast the gain in the leading index. Recent economic data “have shown marked deceleration in economic activity or even some pull-back.”


The Big Picture has an old postcard posted that shows a pattern of 'Periods When to Make Money' based on a simply 16/18/20 year pattern:

Today, lets have a look at periodicity dating back to 1763. The cycle the (unknown) author poses is a repeating 16/18/20 year

Across the top is the legend “Years in which panics have occurred and will occur again.” The past panic century of dates are 1911, 1927, 1945, 1965, 1981, 1999, 2019. Except for 1981, these were all pretty good years to sell (or short) stocks.
The "antique" postcard...

One of TBP's readers (dasht) found some additional background:
“The diagram which we give above was published on a business card by George Tritch, in Denver, Col., in 1872. We reproduce it from the card, with the explanations given with it. The diagram is not altogether accurate; for example, the panic Tritch predicted for 1891 actually occurred in 1893; still, the year 1891 witnessed the beginnings of the depression and the shrinkage in values which culminated in the crisis of 1893. It will be noted that the diagram gives the year 1897 as the time when an upward movement is to begin, and when it will be wise to buy stocks and real estate.

Here Tritch has predicted like an inspired prophet. Everything in the grain, stock, and real estate markets are booming skyward, while the gold discoveries in various quarters, the financial legislation in foreign countries, and the opening up of factories and mills throughout this country indicate that good times have come again, to stay, let us hope, many years beyond the period Tritch sets down for another relapse, viz., 1899-1904.”
So... how well has Mr. Trich predicted? Using available data from Irrational Exuberance (since 1873) and judging performance of when to avoid the market via the real (i.e. inflation adjusted) change in the equity index over a five year period... quite well.

Since 1873, in "down years" the index has decreased 4.7% over five years in real terms, while the index has increased 18.9% on average over a five year period over that same time.

And now? We are still in the middle of a down period... but make sure you're ready for the next bull market in 2012.

Source: Irrational Exuberance

Wednesday, August 18, 2010

The Case for Emerging Markets

Fascinating chart over at The Big Picture showing the history of GDP. Below is my version showing GDP per capita for an assortment of countries going back 100 years.

What does this show?

Well, just playing catch up, China and Brazil can each grow 500% before they catch the United States (i.e. before current technological limitations impede growth) in GDP per capita terms while India has 1000% growth before catching up.

While catching up is not inevitable (just ask Japan), outsized growth over the next 20, 30, 50, 100 years likely is.

Source: GGDC

The Household Sector is Deleveraging

Calculated Risk (via the NY Fed) details household debt is now down more than 6% from its peak:

The Federal Reserve Bank of New York today announced the release of a new quarterly Report on Household Debt and Credit and an accompanying web page. The report shows that households steadily reduced aggregate consumer indebtedness over the past seven quarters. In the second quarter of 2010, they owed 6.4 percent less than they did in 2008, the peak year for indebtedness.

Additionally, for the first time since early 2006, the share of total household debt in some stage of delinquency declined, from 11.9 percent to 11.2 percent. However, the number of people with a new bankruptcy noted on their credit reports rose 34 percent during the second quarter, considerably higher than the 20 percent increase typical of the second quarter in recent years.

Source: NY Fed / BEA

Tuesday, August 17, 2010

PPI Jumps Due to Energy in July

Looking at the details we see the cause of the increase in the PPI... energy.

And this will likely reverse in August as commodities have reverted following the July spike.

Source: BLS

Capacity Utilization Jumps in July

Daily Finance details:

Don't write-off the U.S. economic recovery just yet. The nation's industrial sector, which has led the expansion but cooled recently, showed signs of renewed life in July, with industrial production climbing a better-than-expected 1%, the U.S. Federal Reserve announced Tuesday.

Capacity utilization jumped to 74.8% in July from 74.1% in June. The 74.8% utilization rate is 5.7% higher than a year ago, but is still 5.7 percentage points below its 1972 to 2009 average of 80.5%.

A Bloomberg survey had expected industrial production to rise 0.6% in July and the capacity utilization rate to rise to 74.5%. Industrial production fell 0.1% in June and rose 1.3% in May.

Source: Federal Reserve

Swap Curve Whacked

At a very basic level, interest rate swaps allow the exchange of a fixed rate for a floating rate across maturities. When viewed in the form of a swap curve (below), we can see what the market is pricing in for this fixed for floating across maturities, similar to a Treasury curve (i.e. the level in which you can get paid over various maturities on one side, while paying 3-month LIBOR on the other).

Below we see the swap curve at spot (i.e. current levels) and what the market is pricing in one, three, five, and ten years into the future.

What is the below chart showing?

1) The swap curve is currently steep, though not as steep as the Treasury curve (as long swaps are currently trading well through Treasuries)
2) The market is pricing in rates to rise rather dramatically at the front-end of the yield curve over the next five to ten years (though not much at all over the next 12 months)
3) The yield curve is actually inverted at the very long-end as early as three years out

Why? For one, investors that were underweight (or short) duration got themselves caught majorly off-guard over the course of the past few weeks as the long-end has taken a cliff-dive and now need duration at any cost.

Source: Bloomberg

Monday, August 16, 2010

Empire Manufacturing "Modest" Gain... Orders Fall

NY Fed details:
The Empire State Manufacturing Survey indicates that conditions improved modestly in August for New York manufacturers. The general business conditions index rose 2 points from its July level, to 7.1. The new orders and shipments indexes both dipped below zero for the first time in more than a year, indicating that orders and shipments declined on balance; the unfilled orders index was also negative.

Source: NY Fed

More on Equity Earnings Yield

EconomPic has detailed the (what appears to be) relative attractiveness of the earnings yield of the S&P 500 on multiple occasions the past few months (here, here, and here are a few examples). Below we make another comparison... the earnings yield of the S&P 500 (in this case using Shiller's cyclical adjusted earnings) to the BBB corporate bond yield going back 35 years.

What the chart below shows is that the yield of S&P 500 has now surpassed that of the BBB rated corporate bond market (i.e. the lowest rated investment grade bonds) for the first time since the early 1980's.

Bull Scenario

Forecasts are for earnings to continue to grow.

Bear Scenario

Forecasts are just forecasts; a likely scenario is that forecasts are too rosy and earnings will reverse course (though this was accounted for in part within the first chart through the use of the CAPE [cyclically adjusted earnings], which uses a 10 year average of earnings). But it is possible that earnings over this entire 10 year period have been amplified by leverage, low interest rates, and a lack of reinvestment as production was pushed offshore. John Hussman (hat tip Credit Writedowns) provided the background for this a month back:

Current forward operating earnings estimates assume profit margins for the S&P 500 companies that are nearly 50% above their long-term historical norms. While we did observe such profit margins for a brief shining moment in 2007, profit margins are extraordinarily cyclical. Investors will walk themselves over a cliff if they price stocks as if profit margins, going forward, will be dramatically and sustainably higher than U.S. companies achieved in all of market history.
And this all may just prove that BBB corporate bonds are simply rich. According the Barclays Capital BBB corporate index, BBB corporate bond yield are just 4.4%... an all-time (since the index was tracked in 1988) low.

Source: S&P / Irrational Exuberance

How Well Have Treasuries Perfomed?

Despite starting the year yielding little (3.84% for the 10 year and 4.66% for the 30 year), the chart below shows how well Treasuries have performed year to date. More specifically, what is shown is the current yield curve (in blue) and year to date returns of the various points of the yield curve (in red).

Going forward? As we know, yield wins in the long run.

Source: Barclays Capital

Sunday, August 15, 2010

China Passes Japan as 2nd Largest Economy

Bloomberg reports:

Japan’s economy grew at less than a fifth of the pace economists estimated last quarter, pushing it into third place behind the U.S. and China and adding to evidence the global recovery is faltering.

Gross domestic product rose an annualized 0.4 percent in the three months ended June 30, slowing from a revised 4.4 percent expansion in the first quarter, the Cabinet Office said today in Tokyo. The median estimate of 19 economists surveyed by Bloomberg News was for annual growth of 2.3 percent.

Saturday, August 14, 2010

Indie Fix of the Week

Extremely slow week at EconomPic, so I can't even call this EconomPics of the week (on the road all week).

V-Shape in Job Openings?
Productivity was about Doing Less.... With Even Less
Deflation Trade... On
Not Sustainable... Trade Edition

But, since one of my favorite readers asked for an Indie fix, here goes.

Grizzly Bear with Two Weeks...

Wednesday, August 11, 2010

Deflation Trade... On

Just beginning the process of catching up on one ugly day...

Source: Yahoo

Not Sustainable... Trade Edition

What happens when the U.S. stimulates consumer demand when the rest of the developed world pushes austerity measures.... the below.

Source: Census

Tuesday, August 10, 2010

V-Shape in Job Openings?

Vincent Fernando (hat tip Abnormal Returns) claims there is a v-shaped recovery after all in employment... in job openings. The reason this is not translating to job growth? People don't want those jobs:

Many Americans are choosing unemployment benefits over available jobs on offer. Earlier today we highlighted how unfilled job positions were rising at a much faster rate than new hires. We described how some Americans were forgoing job offers due to the fact that they calculated (correctly, from an individual perspective) that it was a better deal to continue receiving unemployment benefits rather than accept many jobs currently on offer.
While EconomPic detailed the rise in openings last week, it is (in in my opinion) not in fact due to the unemployed being choosy (this actually seems quite ridiculous to me), but rather because corporations are taking more time to hire due to all the uncertainty.

Lets look at the details that may (or may not) back that opinion. The below chart includes the number of job openings at month-end (as was in Vincent's post) going back to 2002, but also the number of hires within each month and ratio between the two to give the job openings figure some context.

What does this chart show?
  1. the rate that individuals are hired per opening (i.e. the ratio) is still elevated from pre-crisis levels
  2. this indicates that more people are actually being hired per opening (not less) than pre-crisis
  3. this ratio is indeed below the ratio from last summer (i.e. hiring has slowed relative to job openings since the peak of the crisis - Vincent's point)
  4. the recent decline (and jump in openings relative to hires) is only a decline relative to a period when the number of hires per opening spiked 50% from pre-crisis levels (likely because employers had existing offers out and/or workers took any job they could get their hands on at that point in time)

As for the recent rise in openings relative to hiring?

It is important to note that the level of job openings is the amount at month end, not net new job openings. Thus, my best guess is that this has more to do with businesses taking their time to hire. Why rush when the economic outlook is still so uncertain / there are so many qualified candidates out there? Why not post a job opening even if there aren't plans to fill it just in case a strong candidate appears. I know if I was a small business owner (or corporation), I would want to use this opportunity to interview a slew of candidates. It is only when the market is tight that businesses need to hire quickly and the market is not exactly tight right now.

To conclude... I find the increase in job openings a positive at the margin. But, this is FAR from v-shaped...

Source: BLS

Productivity was about Doing Less.... With Even Less

The WSJ reports:

U.S. productivity unexpectedly fell in the second quarter, the first drop in 18 months, amid slower output growth and an increase in labor costs. Nonfarm business productivity dropped at a 0.9% annual rate in the April to June period, the Labor Department said Tuesday. It was the first decline since the fourth quarter of 2008, when productivity fell by 0.1%.

The strong gains in productivity growth, which ranged from 3% to 8% in 2009, are likely over. Productivity usually picks up sharply at the end of recessions. The recovery has been in place for more than a year now, and the economy slowed in the second quarter compared to the previous two quarters.

The chart below shows it all. The increase in productivity was never due to doing more, with less. It was doing less with (an even larger) less.

The recent drop in productivity is (to me) not a bad sign. It is simply the decrease in marginal returns from bringing workers and capacity back into the system. In other words... the jump in productivity wasn't as great a thing as some thought, while the decline is not as bad as many now think.

Source: BLS

Friday, August 6, 2010

EconomPics of the Week (8/6/10)

Busy week here at EconomPic...

Asset Classes

The Power of Mean Reversion
More on Mean Reversion
Yield Wins in the Long Run
Hedge Funds Snap Back in July
IBM Borrows on the Cheap

Economic Data

From Unemployed to Out of the Workforce
Leaving the Workforce in Droves
Job Postings on the Up and Up
Private Employment Rebound Stalling
ADP Report: Employment Rebound Remains Tepid

U.S. Consumer
The Changing Auto Sector
Personal Savings on the Rise
Personal Income... A Matter of Wages
Consumer Credit Continues Decline, Though Past Months Revised Up

Other U.S.
ISM Manufacturing Growth Slows
Services Industry Expands in July
Real GDP per Capita at September 2005 Level

Brakes Put on the Chinese Economy
Is the German Economy Booming? No...
European Consumption Stagnant

And your video of the week... Arcade Fire with 'Sprawl II' from Thursday's MSG show (the new album is insanely good IMO).

And as an encore, Arcade Fire with 'Wake Up' because it might just be the best song ever...

Consumer Credit Continues Decline, Though Past Months Revised Up

Marketwatch details:

U.S. consumers shed some of their debt in June for the fifth month in a row, the Federal Reserve reported Friday. Total seasonally adjusted consumer debt fell $1.34 billion, or a 0.7% annualized rate, in June to $2.418 trillion. Economists expected a decline. The series is very volatile. May consumer credit was revised sharply higher to a decline of $5.28 billion compared with the initial estimate of a drop of $9.15 billion. The decline in June was led by revolving credit-card debt, which fell $4.48 billion or 6.7%.

More on Mean Reversion

Data from a previous post The Power of Mean Reversion shown in a different format below.

Source: Irrational Exuberance

Private Employment Rebound Stalling

Last employment chart of the day. Below is the monthly change in the nonfarm private sector since the financial crisis began (i.e. without census hiring).

Source: BLS

From Unemployed to Out of the Workforce

WSJ reports:

The U.S. economy shed more jobs than expected in July while the unemployment rate held steady at 9.5%, a further sign the economic recovery may be losing momentum.

Nonfarm payrolls fell by 131,000 last month as the rise in private-sector employment was not enough to make up for the government jobs lost, the U.S. Labor Department said Friday. Only 71,000 private-sector jobs were added last month while 143,000 temporary workers on the 2010 census were let go.

As EconomPic has detailed many times before, employment can fall while the unemployment rate stays flat (or in cases drop) because the denominator (i.e. the workforce) has been dropping. As the chart below shows, the duration of unemployment has increased dramatically over the past year and a half AND at a certain point these individuals simply drop out of the workforce.

Note the dip earlier this year and the "rebound" from temporary census hiring. Perhaps we need some new temporary hiring efforts before more yellow rolls to blue.

Source: BLS

Leaving the Workforce in Droves

Check out the number of people leaving the workforce (green) and the spike in the overall number of working age individuals not in the workforce (blue).

Source: BLS

Thursday, August 5, 2010

The Power of Mean Reversion

Index Universe (hat tip Abnormnal Returns) details why now may be the time to allocate to U.S. equities... reversion to the mean.

There have only been four decade-long periods where U.S. equities have delivered negative returns, which were the 10 years ending in 1937, 1938, 1939 and 2008 (2009 was not included in the study). In each case, the subsequent 10-year period was strongly positive, with equities delivering (on average) an 11 percent compound annual return. Reversion to the mean. It’s simple, but it works.
Rather than look at nominal returns, I took at look at rolling ten year total returns of the S&P 500 index in real terms and then took a look at what the relationship was to ten year forward total real returns (using year end levels).

While the past is not a perfect predictor of the future, there has not been one period in which the ten year real return of the S&P 500 was negative, then followed by another decade of negative ten year real returns going back to data from the 1880's (i.e. no marker in the bottom left quadrant).

Source: Irrational Exuberance