Bring On the Recovery

The data this week has been the best we have seen since last year. Most of the data is for the month of July 2009. Even before this data came out, the Wall Street Journals poll of economists believed the recession was over. The vast majority believed the recession ended in July or earlier.

It is highly likely, short of a black swan event that this recession is over. By definition a recession ends when the economy no longer is declining. The NBER, who decides when recession begins and ends using inexact formulas and smoky rooms, will wait to call the end of the Great Recession.

After all, they waited almost one year after the recession began to tell us we were in one.

Even a year ago, many economists did not believe we were in a recession.

One group of economists who did see the recession coming, and correctly saw its size was ECRI. Their current index is now at a 26 year high, and they are screaming for us to put on our seatbelts as the economic roller coaster is about to take us abruptly skyward. Their analysis for this week is at the end of this article.

Other economic releases this week have been expanded into the following discussions – and are included in this week’s economic wrap:

• Manufacturing Production Decline Stopped
• Show Me the Inventory Depletion
• Employment Trends Not Improving
• The Fed to Slow Treasury Purchases

I am not comfortable with the definition of recession. It does not seem right that in the middle of an economic event you can claim it is over. But maybe that is the point. The consumers cannot perform as expected under a pale of recession – economic doom and gloom.

Consumers will perform better when they hear the word “recovery”. This word implies things are getting better.

This recession is probably over.

Bring on the recovery.

Manufacturing Production Decline Stopped

One month does not make a trend. But for nearly the first time since this Great Recession was declared, industrial production increased in July 2009 (preliminary data). This downward spiral has lasted 19 months. Industrial production was one of the indicators used by the NBER to set the Great Recession starting date of December 2008.

The bulk of the 0.5% industrial production increase was attributed to auto production, but the data shows small production increases were widespread across most manufacturing groups as illustrated in the table below.

Although industrial production data has a history of constant revision, the uptick this month was strong and is expected to hold. The question is will there be an upward trend developing, and how strong it will be.

I expect an upward trend to develop into 4Q 2009. There is always a dead cat bounce after a major contraction. Many economists believe because this recession was so deep, the bounce will be high. I believe it will be a mild uptick which will run into a wall late this year as too many systemic economic issues are restraining recovery for now.

One of the reasons the bounce will be mild is exports will be slow to recover. We are in a global economic downturn. Although data from Europe and Asia (ex China who never entered a recession) shows their recessions may be over, it does not conversely imply real recovery.

The three month moving averages for the period ending June 2009 for exports and imports have flattened demonstrating a bottom in this area of the economy. There was nothing inside of the data which was remarkable.

This weeks headlines announced that we had productivity growth in non-farm business in Q2 2009 of almost 2% YoY. The problem with this headline was that manufacturing productivity declined over 1% YoY. The economists cannot have it both ways – either manufacturing is the cornerstone of economic forecasting, or it is not.

Productivity is a double edge sword – the more productive the fewer people required while the product is more competitive. Combine productivity increases with excess capacity and you have a deflationary pressure.

Overall, non-farm business (which includes manufacturing) has returned to its pre-recession unit costs and productivity implying that this sector has adjusted for the demand levels of the New Normal. Unfortunately, a subset of this is manufacturing which has a way to go to adjust for changes in demand.

It will be interesting to see how the minimum wage increase in July plays out in the 3Q 2009 unit labor costs for non-farm business. Most of manufacturing is above minimum wage, but a lot of retail and service industries would be affected.

Although industrial production levels may have stabilized for now, manufacturing remains in a long term cyclical downtrend. Without major economic policy changes by the government, foreign products, with their lower cost base and ease of import, will continue to displace American production.

Show Me the Inventory Depletion

Manufacturing, retail and wholesale trade data for June 2009 showed sales up approximately 1% MoM and inventories down 1% MoM. On the surface, there was no element within the data which was noteworthy.

However, this data was detailed enough to analyze how close business is to pre-recession inventory levels.

One method of analyzing whether inventories are at the proper level is to compare the value of your inventory to monthly sales. It allows for a historical perspective on inventory levels. This is not a perfect method as it ignores restocking lead times and individual inventory item turnover volumes – but when viewing entire sectors this broad brush approach is reasonably accurate.

The following inventory / sales ratio graphs will bring into question the economists’ optimism about inventory levels bottoming, production filling that gap, and a big boost to the economy anytime soon.

The retail sector which represents 33% of all inventories has been within the normal inventory to sales ratio range since May 2009. This sector should already be restocking.

The wholesalers, who represent 29% of all inventories will have their inventories in a pre-recessionary range sometime between the end of 3Q 2009 through 1Q 2010.

Manufacturing inventories, being the largest group at 38% of all business inventories, will not be within their pre-recessionary range until the first half of 2010. This is more of an educated guess as there are no trends yet on the current inventory/sales ratio depletion rate.

If all inventories were currently within pre-recession ranges, the boost to GDP would be slightly less than 1%. However, based on current trends and analysis, this 1% addition to GDP will kick in gradually over the next 12 months – and not in the next quarter as many believe if demand remains weak.

Another effect inventory has on GDP is an adjustment for changes in inventory levels inside the Gross Private Domestic Investment Account. Since the recession began, GDP has been adjusted downward due to inventory declines (see above table).

It is assumed that once the recession is over and “recovery” begins, this inventory number will again turn positive contributing to GDP growth. Inventory levels are primarily based on sales volumes. No sales volume increases – No inventory increases. And no GDP boosts because inventory is not growing.

In fact, in 3Q & 4Q 2009, the inventory depletion may continue and continue to be a drag on GDP. The only real hope for a big boost to GDP is a rise in demand.

Employment Trends Not Improving

The Conference Boards July 2009 Employment Trends index shows employment trends have been flat for the last three months – meaning overall the jobs situation is not getting better or worse. This index aggregates 8 indicators.

• Percentage of respondents who say they find “Jobs Hard to Get” (The Conference Board Consumer Confidence Survey)
• Initial Claims for Unemployment Insurance (U.S. Department of Labor)
• Percentage of Firms With Positions Not Able to Fill Right Now (© National Federation of Independent Business Research Foundation)
• Number of Employees Hired by the Temporary-Help Industry (U.S. Bureau of Labor Statistics)
• Part-Time Workers for Economic Reasons (BLS)
• Job Openings (BLS)
• Industrial Production (Federal Reserve Board)
• Real Manufacturing and Trade Sales (U.S. Bureau of Economic Analysis)

Three of these aggregated indicators were updated this week after the release of The Conference Boards Index, and it is not clear if advanced data was incorporated. However, 5 of the underlying indexes have bottomed and are improving while 3 are still declining.

The 4 week moving average of advance initial unemployment claims increased slightly to 565,000. This component of The Conference Boards Employment Index has an improving trend line (down is good) despite an upwards data wobble this week.

Based on the economic releases this week, The Conference Board’s Employment Trends Index will show improvement when it is next released on 08Sep2009.

The Fed to Slow Treasury Purchases

The Federal Reserves Federal Open Market Committee (FOMC) met this past week. The abbreviated minutes are dissected by the market to understand shifts in monetary policy sometimes trying to read too much into the statements. The important elements:

• The economy is stabilizing although there is concern about consumer spending which they believe will resolve itself over time due to the good work of the FOMC.
• The FOMC again reaffirmed it was sticking to their low 0% to 0.25% federal funds rate as far into the future that they could see.
• The FOMC did not extend or expand their existing programs. In fact, they discussed winding down programs.

To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

And within seconds of this statement, the New York Fed released one of their own.

The Federal Reserve is in the process of buying $300 billion of Treasury securities. On Wednesday, August 12, 2009, the Federal Open Market Committee announced that it decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. This approach is intended to promote a smooth transition in markets as these purchases of Treasury securities are completed. To implement this decision, the Federal Reserve Bank of New York Open Market Trading Desk will gradually reduce both the size of individual operations and the frequency of operations, beginning with the two-week schedule to be released on Wednesday, August 19, 2009.

If the Fed does not buy Treasuries, who will the buyer be? According the Chinese, they will not be buying. As several auctions recently have been close to failing even with the Fed’s involvement, it does not seem possible the Fed can withdraw.

If market forces operate without the Fed, the market will force higher yields defeating the objective of the Fed’s zero funds rate. This will raise the cost of funding the government, and push the economy back into the toilet.

An old professor told me that when things do not make sense there is something you do not know. There is more to this than what is being disclosed in this FOMC statement.

Additional Economic Data This Week

Preliminary July 2009 retail sales were slightly negative. However, this is preliminary data based on sampling with a stated error possibility larger than the decline. As we are near an economic turning point, I will hold analysis until the advance data is out in September 2009.

The rate of new mortgage applications remains relatively unchanged. It demonstrates that new applications have bottomed as applications have held within a tight range for the last three months. The four week moving average of mortgage loan application volume (which includes refinancing) decreased slightly 0.7% WoW, and increased 16% compared with the same week one year earlier. The refinance share of mortgage activity decreased slightly to 52.3% of applications. The average interest rate for 30-year fixed-rate mortgage increased 21 basis points to 5.38%.

Import and Export prices slightly decreased in July 2009. As the prices had been slightly trending up for the last few months, this slight decrease in the data should be ignored for now.

The consumer price index for July 2009 was unchanged or slightly down (seasonally adjusted or unadjusted). There is no apparent trend in the data. Inflationary and deflationary forces appear to be stalemated – although it seems that the current data released in the last 30 days has a light deflationary bias.

Filing for Bankruptcy: Meridian Automotive Systems (VSTV.PK) Astrata Group (ATTG) Mega Media Group (MMDA) Tetragenex Pharmaceuticals (TTRX). Bank failures this week:

Although I have not expanded on the failed bank list as banking is not my thing, the failure of Colonial Bank may have put the FDIC on the hook for $2.8 billion – essentially bankrupting FDIC. As this is an important economic event, further investigation and reading is recommended.

Economic Forecasts Published this Past Week

The Economic Cycle Research Institute (ECRI) released their Weekly Leading Index has now risen to a 26 year high. Lakshman Achuthan, managing director at ECRI, provided the following statement:

With WLI growth surging, the odds are rising that the early stage of this economic recovery will be stronger than any since the early 1980s.

Next year, looking back you'll see that GDP, industrial production, sales, and even non-manufacturing jobs growth -- where 91 percent of Americans work -- began rising as recovery took hold.

The Fed assembled its team of economists which make forecasts once a quarter. As a group they believe the economy will be stronger, unemployment higher, and inflation lower than they opined three months ago.

Hat tip to Steve at MEMETICS & MARKETING for editing support.

Disclosures: long MMFs, ORCL, GOOG, EWZ, EWY, EWA, EWC, PIN, Physical Gold

Comments

[markfl:]

Reflecting on the comment stream from your article last week seekingalpha.com/artic... , the ATA truck tonnage report www.truckline.com/page...{8E1C7279-ED27-4C03-B1... I think makes the case that inventory growth has not been what some would expect. They put out a new release in a few weeks, but if retail sales and consumer expectations are any indication, it's hard to imagine a real inventory boom, at least in the retail sector.

Aug 16 05:34 AM

[markfl:]

Bad link. They release a preliminary and revised report monthly. The most recent was July 27.
www.truckline.com/News...


On Aug 16 05:34 AM markfl wrote:

> Reflecting on the comment stream from your article last week seekingalpha.com/artic...
> , the ATA truck tonnage report www.truckline.com/page...{8E1C7279-ED27-4C03-B1...
> I think makes the case that inventory growth has not been what some
> would expect. They put out a new release in a few weeks, but if retail
> sales and consumer expectations are any indication, it's hard to
> imagine a real inventory boom, at least in the retail sector.

Aug 16 05:37 AM

[Dave Wrixon:]

"Productivity is a double edge sword – the more productive the fewer people required while the product is more competitive. Combine productivity increases with excess capacity and you have a deflationary pressure."

Well more precisely, if you have increased productivity and reduced demand and you have increased unemployment. The productivity improvements are the direct consequence of sacking workers.

Aug 16 05:40 AM

[Dave Wrixon:]

"If market forces operate without the Fed, the market will force higher yields defeating the objective of the Fed’s zero funds rate. This will raise the cost of funding the government, and push the economy back into the toilet."

This is the real crux of the problem.

Also another observation on productivity. If productivity improves but capacity utilization is low, then despite the productivity improvements operations with high fixed cost with still be in the toilet in terms of profitability.

Aug 16 05:50 AM

[Old Trader:]

As I understand it, the improvement in many numbers is/was the result, in large part, of the C4C program, which was extended. If that is, in fact, the case, we may see some continued improvement in mfg. for a bit longer. Additionally, there has been some tweaking of the program. Initially, it was only to be applied to vehicles in dealer inventory, but because of depleted stocks of the most desired vehicles, the vouchers can now be used for vehicles ordered (Ford's Focus and hybrid Escape are 2 that are in notably high demand).

Offsetting this, from everything I'm hearing/reading, back to school season will be a dud, and nobody's looking for the holiday season to be a barn burner, either. If the recession IS over, I think the second dip of a double dipper is around the corner.

Aug 16 09:29 AM

[Dave Dorgan:]

Yes, C4C has made some dealers happy, but many are now looking at dropping the program, because 80% of the cars sold are Japanese or Korean models. A boost for retail sales, but - not counting where the vehicles are produced - the benefits to the broader economy: manufacturing, labor, etc.. is less significant.


On Aug 16 09:29 AM Old Trader wrote:

> As I understand it, the improvement in many numbers is/was the result,
> in large part, of the C4C program, which was extended. If that is,
> in fact, the case, we may see some continued improvement in mfg.
> for a bit longer. Additionally, there has been some tweaking of the
> program. Initially, it was only to be applied to vehicles in dealer
> inventory, but because of depleted stocks of the most desired vehicles,
> the vouchers can now be used for vehicles ordered (Ford's Focus and
> hybrid Escape are 2 that are in notably high demand).
>
> Offsetting this, from everything I'm hearing/reading, back to school
> season will be a dud, and nobody's looking for the holiday season
> to be a barn burner, either. If the recession IS over, I think the
> second dip of a double dipper is around the corner.

Aug 16 12:22 PM

[Tom E.:]

I wonder if unit labor costs are rising because companies that layoff people have to pay higher premiums for unemployment insurance on their existing labor force. I am not sure exactly how this works, just throwing out an idea I think I read somewhere.

Aug 16 01:15 PM

[Steven Hansen:]

Tom E
the increase in costs for unemployment insurance would definitely create upward pressure on unit labor costs. so will other employment related taxes being imposed by local, state and federal governments.

Aug 16 11:17 PM