CRE: I Think the Shoe Just Dropped

The worry that commercial real estate was the "next shoe to drop" goes back a long time, but after this additional data point, I think we're here. How banks and other financial institutions are hiding this level of damage has me scratching my head. Calculated Risk with the details:

From Dow Jones: Moody's: Commercial Real-Estate Prices Fall 7.6% In May

Commercial real-estate prices fell 7.6% in May ... The indexes are down 29% from a year ago and 35% from their October 2007 peak.

According to Moody's, CRE prices fell in 8.6% in April (about 16% in two months).

Talk about cliff diving!

Source: MIT

Leading Economic Indicators Jump in June

Marketwatch reports:

The U.S. index of leading economic indicators rose 0.7% in June, the Conference Board said Monday. This is the third straight monthly increase. The rise was slightly larger than the consensus forecast of Wall Street economists, who had expected a 0.5% rise. The gain is not as strong as the last two months. The index rose 1.0% in April and 1.3% in May. In the latest month, the coincident index fell 0.2%, while the lagging index fell 0.7%.

A closer look at the monthly (and last six months) breakdown.



Source: Conference Board

Unemployment Across the United States

Completing the recent State Trilogy (More State Woes - Unemployment Insurance, States are Broke - Tax Revenue Crash), we present unemployment across the greater 50 states. BLS (via Calculated Risk):

Michigan again reported the highest jobless rate, 15.2 percent, in June. (The last state to have an unemployment rate of 15.0 percent or higher was West Virginia in March 1984.) The states with the next highest rates were Rhode Island, 12.4 percent; Oregon, 12.2 percent; South Carolina, 12.1 percent; Nevada, 12.0 percent; California, 11.6 percent; Ohio, 11.1 percent; and North Carolina, 11.0 percent. The Nevada, Rhode Island, and South Carolina rates were the highest on record for those states. Florida, at 10.6 percent, Georgia, at 10.1 percent, and Delaware, at 8.4 percent, also posted series highs.

Below is a chart of the highest and lowest 10 unemployment rates among states (and districts - i.e. Washington D.C.).



We can see that Michigan, with its focus on the manufacturing sector, has been negatively impacted to a greater extent than the rest of the United States with unemployment in excess of 15%. Not too far behind in the standings is California, where the issues emanate from the housing bubble, at 6th highest.

Looking deeper into these two states, we see how they have each fared since 1976 against the country as a whole.



A few data points do not make a new trend, but California was the first to see issues with the housing bubble and over the past few months has shown relative strength (or is it that the rest of the country is just catching up), whereas Michigan's problems continue to worsen.

Source: BLS

States are Broke

Bond Tangent reports (note that I've cut out some information - go to Bond Tangent for full post and bold mine):

• Total state tax collections for Q1 fell by more than 11.7% YOY (the largest decline in state since 1963)
• Local taxes, which rely primarily on property taxes that tend to be more stable, rose 3.9%.
• Income tax collections are now worse-off than sales taxes (the effect of a sharp rise in unemployment)
• Total collections declined in 45 states in Q1, versus 35 in Q4 of 2008. Twenty-five of those states experienced double-digit declines.
• Personal income tax declined 17.5% YOY; "preliminary figures for the second quarter of 2009 indicate that the personal income tax declines will be far more severe compared to the last recession when the largest decline was reported at 22.3 percent for the second quarter of 2002."
• Sales tax collections for Q1 represent a 8.3% decline YOY. In fact, the inflation-adjusted decline in state and local sales taxes was the greatest in the 45 years for which quarterly data are available."
• Nominal corporate tax revenues are down 18.8% YOY in Q1, which the authors note is the 7th consecutive decline.

In total, state tax revenues are down ~$20 billion in the first quarter from Q1 '08 levels.

Note the strength of sales tax in the last recession as compared to the current environment.

Source: Rockefeller Institute

EconomPics of the Week (7/17/09)

If you want to keep up with anything interesting I find over the weekend, check out EconomPic at www.twitter.com/EconomPic

Economic Data

Capacity and Inflation
TOTAL Capacity in Economy Shrinking
Capacity Utilization at Record Low
Importing Deflation?
CPI Rises as Gas Prices Jump in June
PPI Jumps in June, Down 4.6% YoY

Jobs
Initial Claims: When a 14% Increase = an 8% Drop
Total Private Hours Worked at 1997 Levels
The Ultimate Head and Shoulders Pattern

Other
Philly Fed Index Disappoints
June Retail Sales in Perspective
Gov't Spending Spike and 15% Less Revenue = Lots of Red
More State Woes...

Asset Classes

Treasury Bull Market Continues
Emerging Markets and Dumb Money
China Still Treasures Treasuries

Global

Japanese Tertiary Index "Unexpectedly" Declines
Eurozone Industrial Production Improves
German Investor Confidence "Unexpectedly" Fell

Random

What Should a Central Bank Do When...
HP Grosses $104 Million on Wednesday... Harry Potter that is

What Should a Central Bank Do When...

There is a global slowdown and the following situation exists?



More here.

Source: ECB

More State Woes...

Urban.org provides a nice background on Unemployment Insurance benefits and the problems certain states faced at the end of 2008:

The states finance UI benefits with payroll taxes paid by employers into state trust funds maintained at the U.S. Treasury. State balances earn interest income. The Treasury also makes loans to states whose trust funds have been exhausted. At the end of 2008, trust fund balances were low in several states, and three (Indiana, Michigan, and South Carolina) had already borrowed to maintain benefit payments to eligible workers.

Those states were just the beginning. Economic Populist with the details:

$10.9 billion. That's the amount of money currently lent by Federal Department of Labor (DOL) to a group of 15 states whose unemployment insurance (UI) trust funds have run dry.

How did we get here? Back to Urban.org (bold mine):

For the aggregate U.S. economy, the highest-ever payout rate was 2.22 percent of payroll experienced during January-December 1982. Before the current recession, reserves across 51 state UI programs totaled $37.6 billion in December 2007 and represented just 0.80 percent of total payroll for the year. The RRM at the end of 2007 was 0.36, that is, the reserve ratio of 0.80 percent divided by the high cost rate of 2.22 percent. Reserves totaled about a third of the recommended actuarial standard and represented roughly four months of benefits at the highest-ever payout rate.

In other words, based on the level of unemployment insurance needed in the 1982 recession, states only had about 4 months worth of unemployment ready to pay out. Thus, the following can't be a surprise. Back to Economic Populist:

And it's about to get a whole hell of a lot worse. By the end of the year that number will likely have have grown to 35 states. Total DOL emergency loans to states at that time? Nearly $50 billion dollars. The situation will be far worse for some states than others. The states appearing in red on the map below are those that will need DOL loans to keep unemployment benefits rolling.

What's $50 billion amongst friends?

Source: DOL

China Still Treasures Treasuries

WSJ reports on the month over month change:

China remained the largest holder of U.S. Treasury securities, having surpassed Japan late last year. China increased its holdings to $801.5 billion in May. Japan, the second-largest holder of U.S. Treasurys, decreased its holdings to $677.2 billion.

Rachel Ziemba (via Brad Setser's Follow the Money) with the broader trend:

While the decrease in the US current account deficit means that the U.S. may be less reliant on foreign finance in 2009, the U.S. has become even more reliant on China as a share of its foreign finance. China has been the largest reported holder of U.S. treasuries for some months now. But as of May China now accounts for 20% of total outstanding foreign holdings and almost equals the combined holdings of Russia and Japan.

Since last fall, China dramatically scaled up its purchases of the shortest term, most liquid U.S. assets. It has purchased $196 billion in treasuries of less than 1 year maturity from July 2008 to May 2009. In part this might reflect a shift last fall within China’s US dollar portfolio. It also vastly decreased its holdings of US agency bonds, while slightly adding long-term treasuries.

Source: TIC

HP Grosses $104 Million on Wednesday... Harry Potter that Is

Reuters reports:

The latest "Harry Potter" movie cast a $104 million spell over worldwide box offices during its first day in theaters, setting a new record for the boy wizard, distributor Warner Bros Pictures said on Thursday.

"Harry Potter and the Half-Blood Prince," the sixth in the film series based on the popular books by J.K. Rowling, grossed $58.18 million in North America and $45.85 million overseas on Wednesday, the Time Warner Inc-owned (TWX.N) studio said.

Source: Box Office Mojo

Philly Fed Index Disappoints

Briefing.com with the details:

The Philadelphia Fed Index didn't live up to expectations. A reading of -7.5 was worse than the consensus estimate of -4.8 and down from the June reading of -2.2. The dividing line for this report between expansion and contraction is zero.

Strikingly, the six-month outlook for general business activity dipped to 51.9 from 60.1 in June. The July reading is still comfortably above the 37.7 six-month average, yet the pullback speaks to the increasing reservations about the pace of recovery in the face of a continued rise in unemployment.

Looking at the changes from June through July, we see longer work weeks (due to less employees), higher prices paid / lower prices received, and an increase in new orders (but less filled and shipped).



Source: Philly Fed

Treasury Bull Market Continues

Volatile? Yes. Upward pressure? Sure. But, David Rosenberg states why we are still well within the secular bull market for ten year treasuries:

To be sure, this has been a brutal year for U.S. Treasuries, with the yield on the 10-year note nearly doubling this year at the June 10th peak of 3.98% (though the Treasury market has generated a +2% return so far in July — the first positive showing since March). From our lens, it cannot be said that the secular bull market in bonds is over until the 10-year breaks above 5.26% because then and only then will we be able to say that for the first time in this 28-year secular bull phase, the prior interim high was “taken out”. Look at the time series below and you will see that ever since bond yields peaked during the inflation bubble of 1981 they kept on hitting lower and lower “highs” during the eight cyclical selloffs, and they continuously made lower “lows” during the intermittent eight cyclical rallies.

Table in chart form below...



Interesting...

Source: Gluskin Sheff

Initial Claims: When a 14% Increase = an 8% Drop

Bloomberg reports:

The number of Americans filing claims for unemployment benefits fell last week to the lowest level since January, depressed by shifts in the timing of auto plant shutdowns.

Initial jobless claims dropped by 47,000 to 522,000, lower than forecast, in the week ended July 11, from a revised 569,000 the prior week, the Labor Department said today in Washington. The number of people collecting unemployment insurance plunged by a record 642,000, also reflecting seasonal issues surrounding the closures at carmakers.

A Labor analyst said the distortions may play havoc with claims data for another couple of weeks. General Motors Co. and Chrysler Group LLC accelerated shutdowns this year heading into bankruptcy, months before the traditional July closings. Through the gyrations, job losses may subside amid signs the housing and manufacturing slumps are easing.

“The trend seems to be toward lessening job losses even if we allow for the fact there may be distortions because in July you typically get layoffs in the auto sector,” said Michael Gregory, a senior economist at BMO Capital Markets in Toronto. “While fewer people are losing their jobs, it is still as hard as it’s been to find a job.”

Source: DOL

TOTAL Capacity in Economy Shrinking

I'll play my own devil's advocate regarding my initial conclusion to capacity utilization. To rewind... in my post about used cars and the inflation / deflation tug of war, I concluded (re: excess capacity):

To me this is deflationary over the longer run, with one HUGE caveat / concern... supply destruction.

This story shows what can happen when there is a significant change in supply (lower supply = higher prices). My fear is that the global economy has another downturn and supply is permanently destroyed when the government finally accepts that they cannot save every GM, Chrysler, etc... At that point I do feel that inflation, even with reduced demand, is a real threat. BUT, until then, deflation is my concern...

The "until then" may be coming sooner than I thought. The following chart shows the annualized monthly change in TOTAL CAPACITY (not capacity utilization) in the economy today.



While of limited concern in an environment with as much excess supply as we currently have, it may be of increasing importance as the economy comes back going forward.

Source: Federal Reserve

Japanese Tertiary Index "Unexpectedly" Declines

First, what is the tertiary index? An explanation via DailyFx:

Evaluates the monthly change in output produced by Japan's service sector. Japan's economy is very export based, because this report excludes manufacturing and only measures service industries catering mainly to domestic needs, the Tertiary Industry Index is a key indicator of domestic activity.

ForexTV with the details:

Tertiary industrial activity in Japan fell a seasonally adjusted 0.1% month-on-month in May, after rising 2.2% in the preceding month, the Ministry of Economy, Trade and Industry said Thursday. Economists expected an increase of 0.4%.

Year-on-year, the tertiary industrial activity was down 6.8% in May,on an unadjusted basis, faster than a 6.1% fall in the preceding month. Moreover, the activity index has been declining continuously since August last year.

On a monthly basis, activity decreased the most in compound services by 4.6%, followed by a 4.1% drop in scientific research, professional and technical services. Activity also declined in finance and insurance, recreational services, medical and healthcare as also in learning support.

Source: METI.GO

Capacity Utilization at Record Low

Another better late than never post as I'm still on the road... this morning's industrial production and capacity utilization release (via RTT News):

The Federal Reserve noted that output in the second quarter as a whole fell at an annual rate of 11.6 percent, a more moderate contraction than in the first quarter, when output fell 19.1 percent.

Decreases in output in both the manufacturing and mining sectors contributed to the continued drop in industrial production in June. While manufacturing output fell by 0.6 percent, mining output fell 0.5 percent.

On the other hand, the output of utilities increased by 0.8 percent in June after decreasing in each of the four previous months.

The report also showed that the capacity utilization rate fell to a record low of 68.0 percent in June from a revised 68.2 percent in May. Capacity utilization had been expected to fall to 67.9 percent compared to the 68.3 percent originally reported for the previous month.

A record low not only in aggregate, but also in manufacturing, mining, AND utilities.



And an updated (shortened) version of my chart with unimpressive fit.



Source: BLS / Federal Reserve

The Ultimate Head and Shoulders Pattern

We recently took a look at total weekly hours worked in the private sector. Now lets look at that figure divided by the civilian noninstitutional population to determine the number of hours worked per "civilian".



Is this not the ultimate head and shoulders pattern?

Source: BLS

CPI Rises as Gas Prices Jump in June

Marketwatch reports:

U.S. consumer prices rose a seasonally adjusted 0.7% in June, matching analysts' expectations, as gasoline prices jumped higher, the Labor Department reported Wednesday.

The core CPI - which excludes often-volatile food and energy prices -- rose a seasonally adjusted 0.2%. Economists surveyed by MarketWatch had expected the core to rise 0.1%.

In June, energy prices rose 7.4%, the largest gain since November 2007, as gasoline prices rose 17.3%, the largest jump since September 2005. Meanwhile, food prices in June showed no change.

The CPI has fallen 1.4% in the past year, the sharpest decline since January 1950. However, the core CPI is up 1.7% over the past year. Some analysts have been concerned about the risk of deflation, with a weak labor market and consumer demand stripping companies' pricing power.

Components of MoM CPI


MoM vs. YoY


Source: BLS

Eurozone Industrial Production Improves

BBC reported:

Eurozone industrial output rose in May compared with April, the first month-on-month increase since August last year, official figures have shown.

Factory production across the 16 nations that share the single currency rose 0.5% last month from April, but was still down 17% from May last year.

The data comes two weeks after official figures showed eurozone retail sales fell in May, while unemployment rose.

Despite this picture, Brussels says the recession is now easing.

The European Commission has predicted that the official figures will show the eurozone economy contracted 0.6% between April and June, a slowdown on the 2.5% rate of decline seen between January and March.

Eurostat, the European Union's statistics office, also revised up its industrial production data for April, saying it contracted by a rate of 1.4%, not the previously reported 1.9% fall.

'Put in perspective'

"May's first rise in industrial production is obviously very welcome news, and reinforces belief that the eurozone economy contracted at a substantially reduced rate," said Howard Archer, chief economist at IHS Global Insight.

"Nevertheless, it needs to be put into perspective - production was still down by 17% year-on-year."

Source: Eurostat

June Retail Sales in Perspective

Traveling all week for the real job, so posting may come late (but better than never right?).

After the early cheerleading following the release of the retails sales data that showed a jump of 0.6% in June (expectations were for 0.5%), a deeper analysis showed while the number was positive, we still have a LONG way to go.

Joshua Shapiro of MFR Inc. ( via WSJ) puts the number in perspective:

That nongasoline retail sales were little changed in aggregate on a month-to-month basis over the latest three months in spite of the tax cut that was implemented starting in April can hardly be described as a good showing. Rather, it is clear that this fiscal boost is mostly being used to help fill the hole left by a decimated labor market and/or to help households whittle down debt burdens.

Digger deeper, we see that of the five areas that showed an increase in sales during June, four of them were in the areas with some of the largest year over year declines (i.e. a bounce off of a massive cliff dive).



And the two biggest areas of growth? Autos and gasoline. After the "massive" jump we are back at Summer of 1998 and Summer of 2005 levels respectively.



Source: Census

PPI Jumps in June, Down 4.6% YoY

WSJ details:

The producer price index for finished goods increased 1.8% in June from May, the Labor Department said Tuesday, nearly double the 1% rise that economists in a Dow Jones Newswires survey had expected. It was the sharpest rise since November 2007. Producer prices were down 4.6% from one year ago.

The core PPI, which excludes food and energy, rose 0.5% from May, the biggest rise since October 2008. Economists had expected no change.

Source: BLS

German Investor Confidence "Unexpectedly" Fell

Bloomberg loves the term "unexpected":

German investor confidence unexpectedly fell in July, suggesting the recovery in Europe’s largest economy may take longer to materialize.

The ZEW Center for European Economic Research in Mannheim said its index of investor and analyst expectations, which aims to predict economic developments six months ahead, declined to 39.5 from 44.8 in June. Economists expected a gain to 47.8, the median of 36 forecasts in a Bloomberg News survey showed.

The government says gross domestic product will plunge 6 percent this year, the most since World War II, even as the economy shows signs of stabilizing after its first-half freefall. Industrial output jumped 3.7 percent in May from April, the biggest gain in almost 16 years, and business confidence increased for a third month in June. The benchmark DAX share index has advanced 30 percent in the past four months.

Source: ZEW.DE

Total Private Hours Worked at 1997 Levels

What do you get when you multiply the total number of private workers and average weekly hours worked (by those private workers)?



Total private weekly hours worked of course... and the largest year over year drop on record... and a level last seen in November 1997 (when the civilian noninstitutional population was 15% smaller).

Source: BLS

Gov't Spending Spike and 15% Less Revenue = Lots of Red

The WSJ details:

The U.S. budget deficit broke past $1 trillion in June, a grim testament to the recession and financial crisis. The federal government spent $94.32 billion more than it made in the ninth month of fiscal 2009, the Treasury Department said Monday in its monthly budget statement.

With that latest spill of red ink, the budget gap, for the first nine months of fiscal 2009, widened to $1.086 trillion. A year earlier, the deficit was $285.85 billion for the same nine months.

In June 2008, the government ran a surplus of $33.55 billion. Fiscal years start Oct. 1. The White House has predicted the deficit will climb to $1.841 trillion this fiscal year. The biggest deficit for any fiscal year on record is $454.8 billion, which was rung up in fiscal 2008.

A survey of economists by Dow Jones Newswires forecast a June deficit of $97.0 billion. June federal government spending totaled $309.68 billion, compared to $226.37 billion in June 2008.

Year-to-date federal government spending totaled $2.67 trillion, compared to $2.22 trillion in the first nine months of fiscal 2008.

The chart below shows the rolling twelve month change in receipt, as well as outlays, and the variance between the two (An inexact formula? Yes, but it puts this all in perspective). What this shows is a massive spike in spending AND a massive cliff dive in receipts.

Source: Treasury

Importing Deflation?

Markets remain volatile, thus while there is concern that a weak dollar will result in commodity prices once again rising, if green shoots continue to shrivel than import prices will likely reverse the recent ascent. Marketwatch reported on Friday:

Prices of imported goods rose 3.2% in June, the largest increase since November 2007 and the fourth consecutive monthly gain, as petroleum prices shot higher, the Labor Department estimated Friday. Analysts polled by MarketWatch had expected the import price index to rise 2.5% in June. Despite the monthly gain, import prices were down a substantial 17.4% in the past year.

In May, the imports index rose a revised 1.4%, compared with a prior estimate of a 1.3% gain. In June, imported petroleum prices increased 20.3%, the largest monthly gain since April 1999 and the fifth consecutive monthly increase. However, the petroleum imports price index is down almost 46% over 12 months.

Since the June 30th date in the above chart, oil has dropped $14 a barrel (~20%), thus expect the recent rise in non-manufactured goods to reverse course in July.

Source: BLS

Emerging Markets and Dumb Money

Fund My Mutual Fund details (hat tip Abnormal Returns):

Stock markets of developing countries like India and Brazil have gone through the roof since early March, reversing some of their declines from last year. The MSCI Emerging Markets Index is up about 34% for the first six months of the year, after losing 54.5% in 2008. Some niche markets have had wilder swings. Russia’s benchmark RTS index is up 56% for the year’s first half, after losing 72.4% in 2008.

The chart below shows the three month rolling performance of the iShares MSCI Emerging Markets Index ETF (EEM). After last Fall's massive free fall, the ETF has performed exceptionally well.



But has it gone too far, too fast?

Fund My Mutual Fund thinks investors should beware. Along with the thought that current valuations may have rebounded ahead of fundamentals, there is another concern. Dumb money.

If you've been around these markets for a while you generally know by the time the retail investor is piling into a group, chasing huge scores - it's generally time to run away (at the least) and for the 5% among us who short, begin to think seriously about betting against the small fry. It sounds cold, but this is just the way it tends to work ... trust me, I used to be one of these people, so I learned the hard (read: expensive) way. As we read the piece below let us trust in the fact that none of these people were buying in early March, but most likely jumped in when it was "safe" a month or so later.

And jumped they have:

In the first five months of this year, investors poured a net $4.9 billion into diversified emerging-market mutual funds, more than reversing the net $2.6 billion they pulled out in all of 2008, according to Morningstar Inc.

There have been numerous studies on "dumb money". One such study by Andrea Frazzini and Owen Lamont Dumb money: Mutual fund flows and the cross-section of stock returns concludes:

That on average, retail investors direct their money to funds which invest in stocks that have low future returns. To achieve high returns, it is best to do the opposite of these investors.

So, the next time you hear from your neighbor about the next big thing, think twice. Or just bet against them...

Update:

Bloomberg ran a story this morning about the valuation of Emerging Market equities and while the analysis is different, the result is the same...

The last time stocks in developing countries got this expensive was in October 2007, just before the MSCI Emerging Markets Index began a 12-month tumble that erased half its value.

The MSCI gauge trades at 15.4 times reported earnings, compared with 14 for the Standard & Poor’s 500 Index, according to weekly data compiled by Bloomberg. When developing nations last commanded a premium, the 22-country benchmark sank 54 percent in the next year.

EconomPics of the Week (7/10/09)

Well, apparently my two week vacation invigorated me as I don't recall posting this many "long" posts (i.e. not just a chart and a link) ever. I hope you all enjoyed, but don't expect it to continue. Especially over the next two weeks as I will be a BUSY traveler for my "day" job.

As a reminder, if you want to keep up with anything interesting I find over the weekend, check out EconomPic on Twitter at www.twitter.com/EconomPic

Investments
Help Jake Invest...
The Ultimate Armageddon Stock
Hedge Funds Continue to Outperform Equities
Hedge Fund Performance Since '02
Q2 Earnings: Front and Center

Inflation
Capacity Utilization vs. Inflation
I'm Impressed with the Fit...
Used Cars and the Inflation / Deflation Tug of War...
ISM Prices Paid Up... End of Deflation Concerns?

Employment
The "Exhaustion Rate" Underestimates the Issue
The "Joys" of the Unemployed Teenager

Other Economic Data
Will the U.S. Become an Export Nation?
Same Stores Sales Suck More Than Anticipated
Consumer Credit (May): Down 4th Straight Month
Wholesale: Sales Up, Inventories Down
Good News Alert! New Orders less Inventory Jumps
The Paradox of Thrift
Contraction is not an Improvement: Services Edition

Global
Aussie Miracle Waning
Japanese Economy "Unexpectedly" Crumbling
German Factory Orders Up 4.4% on the Month... Down 29.4% YoY
British Industrial Production Surprises to Downside
Japanese "Optimism"?

Help Jake Invest...

Back in March, I posted my belief that corporate bonds were a "Screaming Buy". At that time I liked being able to move up in the capital structure, while still being able to receive an 8%+ yield for investment grade and 20%+ for high yield. I detailed I was:

Invested at a ratio of ~70% investment grade / ~30% high yield via an assortment of close-end funds trading at a discount. For the record I do not shy away from risk, so my recommendation would be to tone down the high yield exposure if you are more risk averse.

Since the time of the posting, the investment grade bond ETF (LQD) has rallied 11% and the high yield ETF (JNK) around 20%.

In other words, in just three short months, much of that opportunity has already gone.



WSJ reported on the topic:

Nine months later, investment grade corporate bonds have recovered from the shock of Lehman Brothers’ implosion.

Spreads had taken quite the ride since spiking at the end of 2008. They soared as high as Spreads soared as high as 656 basis points December 5 before returning 100 basis points.

The chart below shows the absolute yield of the Investment Grade Corporate Bond index, as well as the spread to Treasuries. While this is a great sign for corporations that can again finance their operations at levels seen pre-Lehman (i.e. less than 6%), it obviously makes corporate bonds less appealing to investors.



But how much less?

I am still not excited about the prospect of moving down the capital structure (i.e. to equities), especially after the massive rebound in risk assets. So, if I were forced to invest in either equity OR corporate bonds, I would definitely be going the investment grade route. But fortunately, I am not forced to invest.

Thus, the question becomes are investors being compensated enough (via spread) to invest in investment grade corporate bonds over Treasuries (or other higher quality assets). In other words is the spread to Treasuries attractive enough to take on the extra credit risk?

There is nobody better to get answers from than David Rosenberg. And he notes:

Baa corporate yields are between 50bps and 250bps wider than they were at the depths of the last three recessions, suggesting that there is a lot of “bad” news still priced in.

And...

To be sure, corporate spreads have come in a long way from their nearby crisis highs but looking at prior peaks around major events and economic downturns, it does appear as though there is still a lot of very bad news priced into the sector.

But again, after the massive rebound in "anything risk" over the past few months I am not so certain about valuation. After all the economic data I've walked through daily over the past year on EconomPic, I am not so certain that 50-250 bps of additional spread relative to the last three recessions is enough compensation for borderline junk bonds. After the recent rally in Treasuries, I am not so certain that I even like duration like I did just 2 1/2 weeks ago when the yield on a ten year Treasury was 50 bps higher.

And if there is anything I have learned as an investor, if you are uncertain... GET THE HELL OUT.

For that reason (in my trading account - my 401k is another story), I am no longer long anything except for volatility and cash (I'm guessing long time readers have an idea where I'm short), but I am looking for ideas.

And it's Friday, so PLEASE slack off a bit and provide a few.

Source: Barclays

I'm Impressed with the Fit...

I posted the below update directly to yesterday's post on Capacity Utilization vs. CPI, but as it was late in the day, had already moved down the blog, and involved the questioning of the validity of one of my beautiful charts, here it is again with a bit of additional analysis.

Scott Grannis of Calafia Beach Pundit apparently reads my blog, which is cool (for those that missed my earlier post, he is my favorite blogger to disagree with). He posted on the same topic of capacity utilization vs. CPI (bold mine). Here is an excerpt:

As a counterpart to my interpretation of events, I suggest you have a look at a similar post on EconompicData which has a chart that paints a very different picture than my chart. He argues that the change in capacity utilization has always been a good predictor (by 6 months) of inflation. I'm not all that impressed by the fit of the two lines on his chart (sometimes they move together, and sometimes they don't), and I don't think there is a logical reason to expect a strong fit in the first place.

Here is the chart from yesterday which is referring to...


Before I defend the chart, I must defend myself. I never said capacity utilization has ALWAYS been a good predictor of CPI (that would be foolish). The only thing I know that "always" follows something is my interrupting someone after I've had a few beers. I think "generally" would be the term I would have used.

But more important to the credibility of EconomPic is that Scott is "not impressed" by the "two lines" in my chart. To me the relationship seems strong, but let's see what the math shows.

Drum roll please.....

The monthly "lines" in the chart above have a correlation of 0.533 from July 1982 - November 2008 (the last date I have for CPI due to the 6 month lag). Why July 1982? Because I like to make my numbers more impressive (the correlation from June 1982 was "only" 0.504 and from August was "only" 0.522).

And over 1, 5, 10, 20, and 30 years? Well, here's the chart...


Our back and forth reminds me of an article I just read over at Time.com, Yes, I Suck: Self-Help Through Negative Thinking. In the article they detail a study, which I feel is at the heart of our argument and the need for Scott to say that "he isn't impressed by the lines on the chart" and my need to update not only my original post, but add this one as well.

The study's authors, Joanne Wood and John Lee of the University of Waterloo and Elaine Perunovic of the University of New Brunswick, begin with a common-sense proposition: when people hear something they don't believe, they are not only often skeptical but adhere even more strongly to their original position. A great deal of psychological research has shown this, but you need look no further than any late-night bar debate you've had with friends: when someone asserts that Sarah Palin is brilliant, or that the Yankees are the best team in baseball, or that Michael Jackson was not a freak, others not only argue the opposing position, but do so with more conviction than they actually hold. We are an argumentative species.

But, can anyone reasonably argue, whether or not they like the data or analysis, that this isn't at least a semi-strong correlation?

I'm guessing Scott may have something to say.

Source: Federal Reserve, BLS

Will the U.S. Become an Export Nation?

I likely got ahead of myself with the whole export nation thing, but if the dollar does weaken like many anticipate, then along with the reduced consumption by the U.S. consumer, this trade deficit may flip to positive territory sooner than later. Either way, this will definitely be a plus for second quarter GDP. Bloomberg with the details:

The U.S. trade deficit unexpectedly narrowed in May to the lowest level in almost a decade as exports jumped while imports of crude oil and auto parts declined.

The gap between imports and exports decreased 9.8 percent to $26 billion, the smallest deficit since November 1999, from a revised $28.8 billion in April that was lower than previously estimated, the Commerce Department said today in Washington. Imports fell while exports rose the most since July 2008.

A shrinking deficit signals trade will contribute more to U.S. growth as exports to emerging economies such as Brazil increase. Meanwhile, U.S. demand for imported auto parts was held down in May by production cutbacks and factory shutdowns by Detroit-based General Motors Corp. and Chrysler LLC, based in Auburn Hills, Michigan, two of the nation’s three largest automakers.

Source: Census

The "Exhaustion Rate" Underestimates the Issue

There is some confusion out there as to what exactly the "exhaustion rate" is (I had been confused myself). The following definition has been commonly used by many blogs and media pundits alike:

The United States Department of Labor publishes statistics on the "exhaustion rate" - this is a measure of the number of people who have used up their benefits, and will no longer be receiving unemployment checks.

This definition had been correct. And if this were still true, the chart below would show just how large a crisis we were in with those that are no longer able to receive unemployment at almost 50% of their "unemployment" class.



Unfortunately, this equation misses a large change in the U.S. unemployment legislature which results in the figure actually being even worse.

Again, the definition HAD been true. The reason why it is HAD, rather than HAS is that the calculation for the exhaustion rate has not changed, even though benefits have been extended not once, but twice over the past year (first from 6 months to 9 months in July and then to 12 months in November).

Why is this important? Because the Department of Labor never changed their calculation. The calculation is as follows:

• The 12 Month Average of those Receiving their Final Payment divided by...
  
• The 12 Month Average of those Receiving their 1st Payment, with a 6 Month Lag

The 6 month lag was put in to capture the number of those in the "unemployment class" that were now receiving their final payment. Lets go to an example assuming unemployment benefits could only be collected for 6 months:

• 100 people became unemployed 6 months ago
• 50 people six months later were receiving their final payment
• The exhaustion rate equals... 50%

Using that calculation, the number of each is as follow...



But, the length was extended. So, rather than 100 people becoming unemployed 6 months ago, that number is more in the neighborhood of 85 becoming unemployed 12 months ago (the number of those becoming unemployed has grown) AND unfortunately the 50 people receiving their final payment is correct, but it was after 12 months of collections.

And that is exactly what has happened. Swapping in a 9 month delay after July and a 1 year delay after November, we get the following.



So that ugly 49% exhaustion rate figure? It's more likely at 56% and I can only guess where June will come in at.

Source: Department of Labor

The Ultimate Armageddon Stock

Businessweek reports:

Of the 500 stocks in the S&P 500, (according to data from Capital IQ) fewer than 20 have actually risen in value in the economic downturn of the past 18 months. The leader of these recession-defying stocks is, far and away, Family Dollar Stores (FDO). Since the end of 2007, Family Dollar shares are up 67%.

Today, Family Dollar proved again why the downscale retailer is so attractive to investors. In quarterly results released July 8, earnings per share of 62 cents were 35% higher than last year and 3 cents above Wall Street expectations. Family Dollar eased a few investor worries with this report.

Family Dollar Stock Performance vs. Inverse YoY GDP

Source: Yahoo / BEA

Same Stores Sales Suck More Than Anticipated

WSJ reports:

Retailers posted yet another month of dropping same-store sales as June's figures came in below analysts' already dismal expectations amid bad weather and consumers' continued reluctance to spend.

Analysts have already said weather would likely hurt the sales results, since summer seasonal sales were far down because of cool temperatures and rain in the Northeast and mid-Atlantic regions. Several companies have said that was the case. Retailers also suffer from tough comparisons to last year, when consumers were still getting their government stimulus checks.

Where's Walmart you ask?

The industry's results were only the second without Wal-Mart Stores Inc. (WMT) in 30 years. The world's largest retailer said in May it would stop giving monthly sales data, following the lead of other smaller peers in recent years.

Wholesale: Sales Up, Inventories Down

Reuters with the details:

U.S. wholesale inventories shrank for the ninth month in a row in May to $402.24 billion, their lowest level since August 2007, government data showed on Thursday.

The 0.8 percent drop was smaller than the 1.0 percent decline analysts polled by Reuters had expected. The Commerce Department also revised April's fall to 1.3 percent from the 1.4 percent reported last month.

Sales at merchant wholesalers rose 0.2 percent, beating analysts' expectations that they would be unchanged and pushing the inventory-to-sales ratio, a measure of how long it would take to deplete current stocks, down to 1.29 months' worth from April's 1.31 months. That was the lowest since a matching ratio in November.

Wholesale Sales (not all good news, look at the drop in metals)


Wholesale Inventories (Petroleum due to the jump in price)


Change in MoM Sales less Inventories

Source: Census

Good News Alert! New Orders less Inventory Jumps

A data point that I wouldn't have looked into directly, but it does show how an inventory correction plus a jump in new orders may lead to a short term bounce in GDP. First lets go David of the Disciplined Investor with the summary:

Many data points have been cited as green shoots since they are simply "less bad". For example, if earnings continue to decline, but at a lower rate, this has been cited as a positive or green shoot. Well, one data point that is actually positive is the New Orders minus Inventories (NO-I) data point.

Reproduced chart below (original from Argus Research)



Back to David's analysis (bold mine):

Ten industries saw new orders increase with five showing declines. The issue, and you (EconomPic) highlighted this in one of your recent posts,

"Mother of All Inventory Corrections"

is the five declining issues are contracting at a larger rate than the 10 growing industries.

Generally, a new orders index number above 48.8 is consistent with an increase in manufacturing orders. The new orders index for June equaled 49.2 although down from 51.1 in May.

In short, I do think it is a pretty positive print. I would like to see the new orders index find some stability though. Lastly, we need to see jobs created and simply come in at a "less bad" number.

I'll agree that it does point to a possible surprise on the upside in Q3 GDP, but the question remains whether an inventory correction can lead to a prolonged recovery.

Source: ISM / BEA

Capacity Utilization vs. Inflation

Yesterday, we took a look at the recent jump in used car prices and the impact the "drivers" (pardon the pun) of that jump have on inflation. In short, the cause of the jump (people drive their cars longer, thus used car supply is down) has also had a substantial impact on new car sales (they're down). This reasons that factories producing NEW cars will have extra capacity (they do), which will eventually "drive" down their prices.

And this phenomenon can be seen in historical data of capacity utilization for the broader economy and CPI. When capacity utilization has shifted, CPI has followed with a roughly six month lag.



Interesting (to me) is that it hasn't been the absolute level of capacity utilization that has impacted the "going" CPI rate, it has only been the change in that level that has. In other words, if capacity utilization stabilizes or increases in the near term, then inflation is likely to stabilize at this lower rate or come barreling back sooner than I had previously thought.

But before then, expect the negative CPI prints to continue.

Update:

Scott Grannis of Calafia Beach Pundit reads my blog (again, he is my favorite blogger to disagree with). He posts on the same topic and says (bold mine):

As a counterpart to my interpretation of events, I suggest you have a look at a similar post on EconompicData (this post) which has a chart that paints a very different picture than my chart. He argues that the change in capacity utilization has always been a good predictor (by 6 months) of inflation. I'm not all that impressed by the fit of the two lines on his chart (sometimes they move together, and sometimes they don't), and I don't think there is a logical reason to expect a strong fit in the first place.

Here's why: Idle resources and high unemployment may indeed depress the prices of some things, and may cause some workers to accept lower wages. But inflation is a condition in which all prices rise, not just some. So whatever reduction in price pressures we see as a result of rising unemployment and falling capacity utilization are not necessarily going to result in all prices falling. Sometimes a decline in capacity utilization will result in falling inflation, but not always. What's really driving inflation is monetary policy, as I've argued above.

The important thing to focus on today is that while the level of economic activity overall has fallen rather significantly from where it was a year ago, the amount of money circulating in the economy has risen significantly. Money is now abundant, whereas goods and services are relatively scarce. When the public's demand for money declines—something I think may already be underway—then we will have a surplus of money and a reduced supply of goods and services, and that is the classic recipe for rising inflation.

Shocker... I don't agree with Scott. His argument that the amount of money in circulation is what matter runs counter to my belief that credit is what unfortunately matters to prices in the U.S. (for a GREAT read on why I believe 'Credit Money' is what matters rather than 'Fiat Money' see Roving Cavaliers of Credit by Steve Keen).

But more important, Scott is "not impressed" by the "two lines" in my chart. Lets see what the math shows. Drum roll please..... the "lines" in the chart above have a correlation of 0.533 from July 1982 - November 2008 (the last date I have for CPI due to the 6 month lag). Why July 1982? Because I like to make my numbers more impressive (the correlation from June 1982 was "only" 0.504 and from August was "only" 0.522).

0.533 correlation over 27+ years?!?! Pretty darn IMPRESSIVE if you ask me...

Source: Federal Reserve / BLS

Aussie Miracle Waning

The miracle of positive GDP and strong retail sales may be waning as the broader global slowdown continues to impact the Australian labor market (though to a lesser degree than expected).

RTT News reports:

Unemployment in Australia increased in June, but the figures were not as bad as most economists expected.

The Australian Bureau of Statistics reported Thursday that the unemployment rate rose 0.1 percent from the month before to 5.8 percent, the highest level since October 2003.

Most economists had forecast a jobless rate of 5.9 percent.

The number of employed Australians decreased by 21,400 in June, also short of economists' predictions of a loss of 25,000. Full time employment declined 21,900 to 7,61 million, from the May number of 7.63 million.

The number of Australians working part time rose by just 400 to 3.15 million.

Australia's workforce participation rate, which measures the proportion of working age people with jobs or actively seeking work fell a seasonally adjusted 65.3 percent in June from 65.4 percent in May.

Source: ABS.GOV

Consumer Credit (May): Down 4th Straight Month

Marketwatch reports:

U.S. consumers reduced their debt in May for the fourth consecutive month, the Federal Reserve reported Wednesday. Total seasonally adjusted consumer debt fell $3.22 billion, or a 1.5% annual rate, in May to $2.52 trillion. Consumer credit fell in eight of the past ten months. The drop in May is the smallest of the group. This is the longest string of declines in credit since 1991. Credit-card debt had the biggest drop in May, falling $2.86 billion, or 3.7% to $928 billion. Non-revolving credit, such as auto loans, personal loans and student loans. fell $367.1 million or 0.3% to $1.59 trillion.

Source: Federal Reserve