When Fed Chairman Ben Bernanke speaks, I listen. The Federal Reserve oversees the American economy, and it is insightful on how the Fed views our economic conditions.
In an address this week, not only did Chairman Bernanke provide little new insight – this is the first time I have felt he was misleading in some of his points.
Excerpts from Bernanke's speech this week at the New York Economic Club:
On reluctance of banks to lend - First, bank funding markets were badly impaired for a time, and some banks have accordingly decided (or have been urged by regulators) to hold larger buffers of liquid assets than before. Second, with loan losses still high and difficult to predict in the current environment, and with further uncertainty attending how regulatory capital standards may change, banks are being especially conservative in taking on more risk. Third, many securitization markets remain impaired, reducing an important source of funding for bank loans. In addition, changes to accounting rules at the beginning of next year will require banks to move a large volume of securitized assets back onto their balance sheets. Unfortunately, reduced bank lending may well slow the recovery by damping consumer spending, especially on durable goods, and by restricting the ability of some firms to finance their operations.
On commercial real estate - Demand for commercial property has dropped as the economy has weakened, leading to significant declines in property values, increased vacancy rates, and falling rents. These poor fundamentals have caused a sharp deterioration in the credit quality of CRE loans on banks' books and of the loans that back commercial mortgage-backed securities (CMBS). Pressures may be particularly acute at smaller regional and community banks that entered the crisis with high concentrations of CRE loans. In response, banks have been reducing their exposure to these loans quite rapidly in recent months. Meanwhile, the market for securitizations backed by these loans remains all but closed. With nearly $500 billion of CRE loans scheduled to mature annually over the next few years, the performance of this sector depends critically on the ability of borrowers to refinance many of those loans. Especially if CMBS financing remains unavailable, banks will face the tough decision of whether to roll over maturing debt or to foreclose. Recognizing the importance of this sector for the economic recovery, the Federal Reserve has extended the TALF programs for existing CMBS through March 2010 and newly structured CMBS through June. Moreover, the banking agencies recently encouraged banks to work with their creditworthy borrowers to restructure troubled CRE loans in a prudent manner, and reminded examiners that--absent other adverse factors--a loan should not be classified as impaired based solely on a decline in collateral value.
On Jobs - …..the excess supply of labor is even greater than indicated by the unemployment rate alone.:... Given this weakness in the labor market, a natural question is whether we might be in for a so-called jobless recovery, in which output is growing but employment fails to increase..... Thus, essentially by definition, a jobless recovery--in which output is growing but hours of work are not...... In fact, productivity growth has recently been quite high, even when the economy was contracting. ….Will the increases in productivity persist? It is likely that, in some cases, firms achieved their productivity gains by asking their remaining workers to provide extra effort.…... Although continuing uncertainty and financial constraints might make such firms hesitant to hire, if demand, production, and confidence pick up, they will find their labor forces stretched thin and will begin to add workers. ….. Because smaller businesses account for a significant portion of net employment gains during recoveries, limited credit could hinder job growth. Overall, a number of factors suggest that employment gains may be modest during the early stages of the expansion.
On the overall economic outlook - …..I expect moderate economic growth to continue next year. Final demand shows signs of strengthening, supported by the broad improvement in financial conditions. Additionally, the beneficial influence of the inventory cycle on production should continue for somewhat longer. Housing faces important problems, including continuing high foreclosure rates, but residential investment should become a small positive for growth next year rather than a significant drag, as has been the case for the past several years. Prospects for nonresidential construction are poor, however, given weak fundamentals and tight financing conditions. In the business sector, manufacturing activity has been expanding and should be helped by the continuing strength of the recovery in the emerging market economies, especially in Asia. As the recovery takes hold, enhanced business confidence, together with the low cost of capital for firms with access to public capital markets, should lead to a pickup in business spending on equipment and software, which has already shown signs of stabilizing.
On inflation - On net, notwithstanding significant crosscurrents, inflation seems likely to remain subdued for some time.
On the dollar - We are attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability. Our commitment to our dual objectives, together with the underlying strengths of the U.S. economy, will help ensure that the dollar is strong and a source of global financial stability.
Overall, Fed Chairman Bernanke was talking more as a cheerleader than providing an honest assessment of the economy. His comments:
- on jobs were naive like a book keeper explaining manufacturing processes.
- on the dollar's value lacked definition on what he considered a strong dollar as the dollar has fallen 91% since 1920, and over 8% since he was appointed the Fed Chairman.
- on buying securitized commercial real estate debt ignored how the Fed could purchase these CMBS when the majority of underlying assets were underwater. I can only conclude the Fed has decided to leave the toxic commercial assets in the banks. This is one more nail in following Japan's 1990's formula for economic quicksand.
To be clear, I am not a doomsayer. I see no data which would give me concern of another leg down - a "W" recovery. Using coincident data to forecast any distance into the future is problematic. In fact using any tool to forecast the future economic direction provides questionable results. But using coincident data did provide a very short warning that the economy was stalling last year The clearest warning came from shipping counts.
The economic cheerleaders have mislead you that an expansion has been underway.
The economy had sections of expansion in the 3Q 2009. The reasons are many – from pent up demand to stimulus. GDP did rise above zero - but GDP has become an artificial metric for real economic activity.
But the signs of economic expansion over the last few months have proven to be illusive, and now most of these green shoots of recovery are not being confirmed by subsequent hard data.
I review coincident data. The data plainly is showing no signs of overall economic expansion. The Conference Board’s Coincident Economic Index (CEI) released this week concurs with my assessment. Overall economic growth has not begun yet (see discussion at the end of this article).
The Chicago Fed National Activity Index (CFNAI) is not yet showing economic growth.
Even the coincident indicators of ECRI (USCI) are not showing growth yet.
There are patches of economic expansion but they are being counterbalanced by areas of economic contraction.
We seem to be so determined to be out of this Great Recession that we are accepting an illusion of recovery. There are weak signs of real expansion coming in the coincident data.
The data is currently suggesting that our economic expansion - WHEN it comes - will be weak.
Manufacturing Not Yet Showing Moderate Growth
Chairman Bernanke says manufacturing is expanding.
The Empire State Manufacturing Survey indicates that conditions for New York manufacturers improved in November 2009, but at a somewhat slower pace than in October.
Looking below the headlines, it is observed the upward tick in worsening conditions (blue line in below graph) in new orders, shipments and unfilled orders – however, the overall trends still show improving conditions but at a slower rate.
Please note that although this is a well executed survey – it is a survey and not based on hard data.
And the Philly Fed’s manufacturing survey for November 2009 was also released this week. It is the opposite of the Empire State Manufacturer’s survey – future outlook down and present outlook up.
The Philly survey summarized conditions:
Indexes for general activity, new orders, and shipments all improved this month. The overall level of employment was mostly steady this month, and the average work hours index was positive for the first time in more than two years.
Employment was steady???? Excuse me but employment is still contracting – things are less bad only, not steady. We lost around 200,000 jobs last month (47,000 in manufacturing), and the weekly initial unemployment claims are stubbornly holding over 500,000 new victims each week.
But the disturbing part of both the Philly and New York surveys are the worsening unfilled orders. Unfilled orders are future shipments. Basically the manufacturers have enough spare capacity to ship quicker – this means industry has not completed with its rationalization process and further layoffs may be coming.
The September 2009 manufacturing sales (US Census) does support that an increase in manufacturing sales was occurring in September at least.
The take from this data is the odd situation that retail sales are still contracting while manufacturing is starting to gain traction. Manufacturing inventory levels are still contracting; while retail inventory is expanding (which I have been advised is the beginning of the Christmas season buildup).
On the other hand, industrial production data paints a far less clear picture of growth.
The October 2009 industrial production G.17 data from the Fed shows a flat month with an overall 0.1% increase (seasonally adjusted - which is within the potential reporting error). Repeating – seasonally adjusted data in a trough of a recession is suspect.
But the sad truth is that the October 2009 industrial production increase is a simple illusion caused by an increase in energy (electricity) production. If energy production is backed out, there was no measurable increase.
However, there is no question the economy has stabilized from a manufacturing point of view. But a bump up in production at the end of a recession happens simply because inventories begin to stabilize. And the disconnect between the Fed’s G.17 hard data and the New York / Philly Fed’s survey data brings into question again the accuracy of survey data.
Simply on the basis of the G.17 report, there is no real expansion in the manufacturing sector occurring yet.
What is the expansion Bernanke is seeing in industrial production?
No Inflation Worries in Producer or Consumer Prices
The Producer Price Index for October 2009 shows negative or flat price growth when oil prices are backed out.
Consumer prices rose in October 2009 0.3% MoM. If you back out food and energy, the gain remains within the Great Recession norms. The big increases this month were fuel oil (6.3%) and used cars (3.4%). Apparel declined 0.4%.
Bernanke is right – if you consider prices as a sign of inflation, then inflation should not be one of our current worries.
Bad Christmas Stock Levels
Looking at industrial production discussed above, production levels YoY have declined. Retail inventories (also discussed above) are down YoY. Just to put icing on the cake, import container counts – twenty foot container equivalent unit (TEU) – are down YoY.
Shipping is the validator of the government and industry data. As the economy is driven by the consumer, each item purchased must be shipped several times as it evolves from a raw product to a finished good.
The door to America from Asia are the Ports of Los Angeles and Long Beach - combined they handle the majority of containers in America. Literally all imported consumer goods travel in sea containers (except autos).
For most retailers in the USA, the Christmas products must be in their possession at their main warehouses two months prior to the main sales period after Thanksgiving (Wal-Mart is one month). This means that October would be the last month for imported items destined for Christmas showroom sales.
There is less product available to sell this Christmas season based on inventory and shipping data. If this data is correct, then the only way Christmas could be better than 2009 is if there is a general price increase.
But in the midst of this pessimistic outlook, American exports are gaining strength. Using the same data source, American exporters are going strong.
It would be wonderful if we could validate truck transport in America. However, the trucking industry does not release timely data. As most diesel used in America is used for transport, this could be another source to validate shipping – but alas, the government combines fuel oil and diesel use into a single account (fuel oil is used for heating).
But at least the railroads release timely data through ASI/Transmatch. And their data just adds more mystery to the shipping puzzle as the traffic counts have flattened in 4Q 2009.
No, Chairman Bernanke, transport is not validating we are currently seeing an economic expansion except in exports – and this is most likely being counterbalanced by weak consumer demand. Shipping is validating that the economy is no longer contracting, but also questioning the notion of robust holiday sales.
Housing Does Have Issues
New home construction October 2009 data was down even from the low recessionary levels. First time buyer credits stimulus program was extended last week, but the uncertainty over whether it was going to be extended could have depressed housing starts. On the other hand, it was more likely this stimulus program was not effective in raising new housing starts.
The weekly Mortgage Bankers Association mortgage application data continues to show a downward trend in new mortgage applications and again further declined from last week's lowest level since April 2009. The 30 year fixed mortgage rate decreased to 4.83%. This decline in new mortgage originations is significant and will reflect in home sales volumes (both new and existing) in 4Q2009.
In any event, the demand for new houses appears to be down.
Chairman Bernanke thinks real estate investment may grow next year (in this he means new houses will be built and sold – he is not talking about existing home sales). With the current issues with foreclosures and excess property, I hope he is wrong.
Every public figure seems to be focused on GDP as their report card for performance. Real estate investment (new homes) is in GDP. I cannot see how building more homes will improve the real economic conditions in America - but it does improve GDP.
Additional Economic Data This Week
Bankruptcies this week: Champion Enterprises, deCODE genetics, Simmons, Penn Traffic Company
Economic Forecasts Published This Past Week
The Economic Cycle Research Institute (ECRI) released their Weekly Leading Index which slipped to a nine week low. Lakshman Achuthan, Managing Director at ECRI added:
While WLI growth has eased from the record high set five weeks earlier, it is still pointing unambiguously to a continued economic recovery. The weekly index fell due to slower housing activity.
The Conference Board released their Leading Economic Index (LEI) and Coincident Economic Index (CEI) for October 2009. Says Ken Goldstein, Economist at The Conference Board:
The data indicate that economic recovery is finally setting in. We can expect slow growth through the first half of 2010. The pace of growth, however, will depend critically on how much demand picks up, and how soon.
It has now been seven months since the LEI went ballistic, and the CEI remains flat. I am confused by The Conference Board’s statement as I do not see in their data that “economic recovery is finally setting in”. My assertion remains the leading index is broken, and the coincident index shows the real picture.There is no evidence of real economic growth occurring yet.
Hat tip to Steve at MEMETICS & MARKETING™ for editing support.
Disclosures: long MMFs, GLD, IOO, PIN, UUP, Physical Gold - as well as numerous puts and calls which comprise less than 3% of my portfolio.