Perhaps There Are Unseen Green Shoots

by: Steven Hansen

Week after week, I continue to pass along the Economic Cycle Research Institute (ECRI) Weekly Leading Index (WLI) which forecasts economic turning points. I want to hear people who have a published track record – whether you agree or not with what they are saying.

Discarding such information is rarely wise. I believe, barring some unforeseen economic event or a second dip, that ECRI’s forecast of the recession ending in the 3Q 2009 is correct.

This week's WLI index fell slightly for the first time in many weeks. The weekly index inched lower largely due to softer housing activity.

But the index's annualized growth rate (which is averaged) surged to a five-year high of 7.0% from 6.2% one week ago, which was revised higher from 5.4%. It was the gauge's highest yearly growth rate reading since the week ended 14 May 2004, when it was 7.1 percent.

This week’s quote from Lakshman Achuthan, the managing director of ECRI:

The recession is already ending. With WLI growth surging to a five-year high, the recession's days are numbered, and the coming recovery is looking more resilient.

There is no way to prove what they are forecasting is correct, or to ask them to expose how their proprietary analysis works. The information they are providing needs to be folded into other data and information you are receiving.

With the WLI beginning to look like a missile’s initial trajectory, you have got to start questioning what is going on while you witness Fed Chairman Bernanke’s green shoots vanish. In a discussion with Lakshman Achuthan earlier last week he offered the following insight:

Perhaps there was a feeling that the “green shoots” have withered, as reflected by the pullback in stock prices [this quote was before the price recovery this week]. But the evidence for this seems to be based largely on backward-looking indicators like payroll jobs (a single month of lower-than-consensus data following a month of higher-than-consensus data). Logically, this should not undermine the strength in the leading indicators, which is why ECRI’s leading indexes remain in decisive cyclical upswings.

Anyone studying ECRI knows they use stock market prices as a component of their leading indicator (a question posed last week by John Lounsbury). I asked Lakshman if the market goes into an extended pullback toward the March lows, how this indicator will be affected.

I assume the reference is to ECRI’s Weekly Leading Index (WLI), because the surge in the U.S. Long Leading Index (USLLI), which does not include stock prices (and in fact leads both the WLI and stock prices) would be unaffected by such a change.

The upswing in the WLI is the result of concerted advances in its components. Thus, even without any increase in stock prices since March, WLI growth would still have been comfortably in positive territory by early July. Hypothetically, if there were to be an extended pullback in stock prices from here, the WLI would decline only if that were to be accompanied by a broad based decline in its other components.

Last week my article focused on a quantum shift caused by aging baby boomers – in other words the effects caused by baby boomers changing from aggregators of assets to sellers of assets. I asked Lakshman if he adjusts his model for changing conditions or demographics.

The short answer is no: such changes are rarely relevant to the timing of business cycle turning points.

I like to compare this Great Recession to the Great Depression as I feel there is a closer resemblance to the Great Depression than any post WWII recession. Lakshman’s position:

A widely held fallacy is that because this is the worst recession since the Great Depression, it is somehow similar to the Great Depression. By and large, this is not true. In fact, if there is any resemblance to past downturns, it is to prewar recessions prior to the Great Depression. Incidentally, some of ECRI’s leading indexes, including the USLLI, cover those earlier recessions and depressions, and are instructive in this context.

Additional Economic Data from This Past Week

The manufacturing survey for New York ended July 2009 basically flat – meaning that conditions were on average not getting worse or better. New orders and shipments rose, inventories fell, and unfilled orders remained unchanged.

This is the first indicator that this region has bottomed – but one month does not make a trend, or is conclusive evidence that a bottom has occurred (click on graph to enlarge).

The Philly Feds July 2009 manufacturing survey is not as rosy as New York’s – and actually declined slightly since June. Their survey continues to show declining conditions, and although less bad than several months ago is not indicating a bottoming is occurring.

We all have our positions in the inflation / deflation debate. I am an inflationist (even though I recognize some very logical and seemingly true portions of deflationary arguments) only because the Federal Reserve said they will not stop easing until there is inflation. The consumer price index (CPI-U) rose “slightly” in June 2009.

Take a gander at the three month annualized increase of 3.3% mostly attributable to energy costs. This is significantly over the Federal Reserve's inflation target. One month’s data does not make a trend. (click on table to enlarge)

Industrial production and utilization was less bad in June 2009. Can things get much worse in this industrial sector (we are at the lowest industrial utilization since records began in1948) as consumer spending has pretty much bottomed? The US has a massive amount of slack capacity which is argumentatively deflationary in normal situations – but I do not assume we are in a normal situation.

I am waiting to see what production returns in the USA, and what will be taken up off shore. This is the important question of this recession (click on table to enlarge).

The Producers Price Index (PPI), an index which analyzes price changes at different manufacturing stages showed slight price increases MoM in June 2009. For me, this index is now showing relatively less volatility which would be indicative of conditions which would allow the markets to stabilize. The majority of the volatility for this index has come from energy prices (spelled oil prices) (click on table to enlarge).

In my last week’s economic wrap, chain stores same store sales were down. This week the Census Bureau is telling us retail sales is up for June 2009. The table below from their report shows sales have indeed stabilized but it requires hocus-pocus seasonal and holiday adjustments to make this true. It should be very obvious things are pretty close to the bottom (click on table to enlarge).

There appears a slight bump up in the new home data for June 2009 for building permits issued. The rest of the data can be spun based on the side of the bed you wake up in the morning. New home starts are important as they are one of the main ingredients in GDP. As the building permit data is so positive, we need to wait a few months to see if these permits actually turn into some construction (click on table to enlarge).

As you would guess, when you get into a nasty, deep unemployment cycle downward pressure would be exerted on wages. June 2009 wage data wiped out the gains made in the last two months. For wages, there is no real trend up – so with the growth of costs (CPI) real buying power is being eroded (click on table to enlarge).

We hear a lot about consumer credit fueling consumer credit spending. Consumer spending is 2/3rds of the economy. Clusterstock distributed this week the graph below showing consumer credit as a percent of GDP. Even though consumer credit remains near its all time high, the percentage has not been growing since 2001, and if anything has been trending down. We are in a long term credit contraction cycle due to the baby boomers' retirements.

New mortgage applications continue their downward trend. The four week moving average of mortgage loan application volume (which includes refinancing) remained unchanged and decreased 2.7% compared with the same week one year earlier. The refinance share of mortgage activity increased slightly to 55% of applications. The average interest rate for 30-year fixed-rate mortgage decreased 29 basis points to 5.05%. Next week the mortgage rate should jump back as 30 year treasuries have climbed 33 basis points this week..

The 4 week moving average of advance initial unemployment claims decreased to 584,500. This should be good news as the rate has dropped below 600,000 for the first time in many months. As an analyst, you want data to trend (trend is slightly down) and not jump around – so you like using averaged seasonally adjusted data which knocks off the sharp edges of inconsistencies and known phenomena which occur.

With seasonally adjusted data falling 8% and non-seasonally adjusted data rising 15% in one week, this is the second week in a row that I believe the data cannot be analyzed. There must be industries which normally shut down in the summer which are either already shut down or did not shut down this year.

Filing for Bankruptcy: RathGibson, Aurora Oil & Gas (AOG), Oscient Pharmaceuticals (OSCI), ISCO International (ISO), Biopure (BPUR) Bank failures this week: Temecula Valley Bank, Temecula, CA, Vineyard Bank, Rancho Cucamonga, CA, BankFirst, Sioux Falls, SD, First Piedmont Bank, Winder, GA.

Economic Forecasts Published This Past Week

Dr. Nouriel Roubini, Chairman of RGE Monitor and Professor, New York University, Stern School of Business is not happy.

Last week I gave excerpts from his RGE Monitors economic forecast. He direct emailed the following statement:

It has been widely reported today [16 July 2009} that I have stated that the recession will be over “this year” and that I have “improved” my economic outlook. Despite those reports - however – my views expressed today are no different than the views I have expressed previously. If anything my views were taken out of context.

I have said on numerous occasions that the recession would last roughly 24 months. Therefore, we are 19 months into that recession. If as I predicted the recession is over by year end, it will have lasted 24 months with a recovery only beginning in 2010. Simply put I am not forecasting economic growth before year’s end.

Indeed, last year I argued that this will be a long and deep and protracted U-shaped recession that would last 24 months. Meanwhile, the consensus argued that this would be a short and shallow V-shaped 8 months long recession (like those in 1990-91 and 2001). That debate is over today as we are in the 19thmonth of a severe recession; so the V is out of the window and we are in a deep U-shaped recession. If that recession were to be over by year end – as I have consistently predicted – it would have lasted 24 months and thus been three times longer than the previous two and five times deeper – in terms of cumulative GDP contraction – than the previous two. So, there is nothing new in my remarks today about the recession being over at the end of this year.

I have also consistently argued – including in my remarks today - that while the consensus predicts that the US economy will go back close to potential growth by next year, I see instead a shallow, below-par and below-trend recovery where growth will average about 1% in the next couple of years when potential is probably closer to 2.75%.

I have also consistently argued that there is a risk of a double-dip W-shaped recession toward the end of 2010, as a tough policy dilemma will emerge next year: on one side, early exit from monetary and fiscal easing would tip the economy into a new recession as the recovery is anemic and deflationary pressures are dominant. On the other side, maintaining large budget deficits and continued monetization of such deficits would eventually increase long term interest rates (because of concerns about medium term fiscal sustainability and because of an increase in expected inflation) and thus would lead to a crowding out of private demand.

While the recession will be over by the end of the year the recovery will be weak given the debt overhang in the household sector, the financial system and the corporate sector; and now there is also a massive re-leveraging of the public sector with unsustainable fiscal deficits and public debt accumulation.

Also, as I fleshed out in detail in recent remarks the labor market is still very weak: I predict a peak unemployment rate of close to 11% in 2010. Such large unemployment rate will have negative effects on labor income and consumption growth; will postpone the bottoming out of the housing sector; will lead to larger defaults and losses on bank loans (residential and commercial mortgages, credit cards, auto loans, leveraged loans); will increase the size of the budget deficit (even before any additional stimulus is implemented); and will increase protectionist pressures.

So, yes there is light at the end of the tunnel for the US and the global economy; but as I have consistently argued the recession will continue through the end of the year, and the recovery will be weak and at risk of a double dip, as the challenge of getting right the timing and size of the exit strategy for monetary and fiscal policy easing will be daunting.

The Federal Reserve Federal Open Market Committee (FOMC) released their detailed minutes of the June 23-24, 2009 meeting.

Here is an excerpt which is noteworthy.

Still, meeting participants judged that market conditions remained fragile, and that concerns about counterparty credit risk and access to liquidity, both of which had ebbed notably in recent months, could increase again. …… The period over year-end was seen as posing heightened risks given the usual pressures in financial markets at that time. In these circumstances, participants agreed that most facilities should be extended into early next year.

Is the FOMC thinking we are going to enter the liquidity tightening phase that began in late 2007 that was the beginning of the tidal wave of the Great Recession? What exactly are they seeing? Is this just a political statement to ensure their liquidity programs stay active?

Investors were waiting for the FOMC economic forecast which is graphed below. Overall, the FOMC revised up their economic outlook and have acquired the rose colored glasses of the IMF. I could find no comment in the narrative which added noteworthy detail to the graphs.

There are simple words and some data which might be pointing to a second leg down economically. If our economy was a game in Las Vegas, it is one table I would be avoiding.

Disclosures: long MMFs, PYEMX, EWZ, TBT, PGJ, EWY, DBC, EWA, EWC, EWT, PIN, Physical Gold