At the end of last week, Christina Romer, Chairperson of the White House Council of Economic Advisors, stated that she saw nothing in the data that would suggest the US economy is headed for recession. We have to wonder whether this comment should be filed in the “bigger lie” category, a propaganda technique made popular by Hitler, who opined that big lies, especially when in cahoots with the media, are easier to sell to the public because no one would believe anyone could distort the truth so badly. Alternatively, the statement could simply constitute just another mistake on the part of the federal government policymakers as they struggle to provide Americans with the environment necessary for the economy to thrive.
For last week, we noted one data point in particular, the weekly ECRI leading indicators index, strongly suggested that the US economy is headed for another recession. Last week, that leading indicator had dropped 6.9% on a smoothed annualized basis, and we observed that the last six times the index fell this hard, the economy had either already dropped into recession or was heading in that direction. This past week, the index fell yet more: 7.7%. The easiest to observe of the leading indicators is stock prices, and these have traded horribly since April, with technical analysis suggesting the potential that we’re only just over half way through the decline that started in April. Below, we’ll discuss some other dubious data. However, the key takeaway is that one does not have to look very hard at all to be significantly worried about the prospects for an imminent recession.
Good slowing versus bad slowing
The markets were rocked last week by a plethora of data showing the economic growth in various countries was moderating. We were struck by the universal negativism when economic slowing meant different things to different countries. For brevity’s sake we distinguish between the “good” moderation in China versus the “bad” slowing in the US.
Slowing in China is a “good thing”
Last week, China’s PMI for June fell more than expected, from 53.9 to 52.1 (consensus 53.2), indicating that economic activity had peaked in Dec’09 and was continuing to moderate. The leading index for April was unexpectedly revised lower, from 1.7% to 0.3%, after the Conference Board found an error in its calculations. The 0.3% rate represents the slowest pace in five months and suggests yet further moderation in Chinese growth. These developments are positive for China in that the Chinese economy has been in danger of overheating, as evidenced by skyrocketing property values and rising inflation pressures (May CPI inflation at 3.1%y/y, a high since Oct’08.
The stall in the US recovery is a “bad thing”
The US data also show a moderation in growth. Unfortunately for the US, the loss of momentum is not a good thing, as the US economy is still trying to dig out from the massive losses during 2008 and 2009 and is nowhere near overheating. Two key indicators last week spooked markets that the US economy might stall on “take off”: the manufacturing ISM and the labor report.
The manufacturing ISM for Jun was expected to have moderated slightly, from 59.7 to 59.0, but instead it fell significantly to 56.2, suggesting that the surge in manufacturing deriving from government stimuli, inventory rebuilding and global economic strength is stalling, which is particularly troubling given that it comports with the turn already observed in the leading indicators index.
The labor data represents a lagging indicator for the economy, and unfortunately, it continues to show that the massive surge in economic activity has never taken hold enough for private companies to make the long-term investment in putting America’s human capital to work. Non-farm payrolls fell about as expected (-125K, consensus 130K), but that decline stemmed from the laying off of temporary census workers, and private industry hiring did take place. Unfortunately, the private hiring proved much less than expected (83K versus 110K). Only twice since early-2007 has the private sector hired more than the 150+K people generally thought required simply to absorb new entrants into the work force. Not only are the structurally unemployed piling up, but so, too, are the new entrants (i.e. graduates and immigrants), making for ever increasing slack in US human capital. The unemployment did fall from 9.7% to 9.5%. However, this shift actually makes for bad news, as it results from over 600K Americans dropping out of the work force – they simply stopped looking for work.
But wait! It gets worse! John Mauldin performed one of his periodic, insightful dissections of the birth-death model that is used to smooth the non-farms payroll data over the course of business cycles. The model provides estimates of jobs that should be added to (or subtracted from) the results based on where we are in the business cycle. He notes with a fair degree of disbelief that the model told economists to add 65K construction jobs in the past two months, despite the slowdowns in both home and commercial real estate construction. He also notes that the model told economists to add 158K new hospitality and leisure industry jobs, this at a time when the percentage of US families planning vacations has collapsed to the 2nd lowest reading on record.
Temporary government inducements don’t work! Part II
Last week we argued that temporary government programs intended to stimulate the economy do little more than distort economic activity data, at best, and potentially provide false signals for real participants in the economy, at worst. This week provided yet more evidence of the futility of the government meddling in the private economy. Pending home sales plummeted 30.0%m/m in May as the homeowners’ rebate scheme expired. There simply is not enough demand for homes at the current combination of real estate prices, real estate supply and cost of debt. The homeowners’ rebate program merely brought forward sales in time – thereby delaying the day of reckoning for the massive overbuilding that took place in the bubble years. Separately, auto sales for Jun disappointed, falling more than expected for both domestic and overall sales. Domestic sales registered an annualized pace of 8.57m cars, while overall sales fell to an annualized pace of 11.08m. The time series for both categories of sales suggest that the tepid recovery from the 2008 collapse achieved in 2009 and so far in 2010 is in danger of stalling and retracing.
European funding is ok for now – jury still out on European banks
The week started with tremendous concerns about the expiration of the ECB’s emergency 1-yr loan facility. Separately, Moody’s put Spain on review for a downgrade of its credit rating. Despite these rumblings, the worries seemed to dissolve. The 3-month and 6-day ECB loans that replaced the 1yr loan went smoothly, and Spain was still able to successfully auction EUR3.5bn of 5yr bonds. However, before we assume that the European funding crisis has passed altogether, note that ECB Governing Council member Axel Weber warned sixteen bank executives to be ready to increase capital reserves in the wake of upcoming stress tests.
Not-so-happy new (fiscal) year for US states
July 1 marked the start of a new fiscal year for the vast majority of US states, and it started with some pretty hard feelings in two of the bigger states: New York and California. In New York, Governor Paterson commenced hand vetoing 6,900 legislative bills that made up the new year’s budget. His reason was quite simple. He had asked for a balanced budget and such had not been delivered. In California, Governor Schwarzenegger put the state’s workforce on minimum wage because a budget has not been passed. The state controller stated he would refuse such a draconian measure, but the law appears to be on Schwarzenegger’s side; the Supreme Court of California has ruled that the state controller has no authority at all to issue employee pay in the absence of a budget – so Schwarzenegger is actually being kind in providing a minimum wage.
Disclosure: No positions