Market indices around the world continue to climb based on forecasts for economic growth in 2011 that are based on historical trends, philosophy, optimism, need – but not an agnostic view of real world date. Simply put, without an upturn in housing in the US, there can be no meaningful upturn in employment and with an upturn in employment there will be no meaningful economic growth. End of story.
First, and Foremost, Housing:
The number of new homes being built is at catastrophically low numbers, an annual run rate of less than 300,000 homes per year. In the gold old days - pre Lehman (LEHMQ.PK) – a run rate of one million residential units was a bottom.
The number of homes in inventory is growing compared to the annual sales rate, which is at historic lows, and this is growing due to foreclosures. Foreclosures will begin to accelerate again late in Q2, as home prices fall, the banks give up on any spring revival, option ARMs begin to reset en masse, and the number of people near or under water on their mortgage tops 30% (that number is now 27.5%).
Foreclosures will bloat inventory, put more pressure on home prices, and the cycle will continue until the foreclosure pipeline – late payments turning into defaults turning into foreclosures turning into more homes in inventory turning into sales – is back to historic norms. A quick look at the data puts this in 2014/2015. Yes, four to five years, if the economy is lucky.
Bloated inventory means radically reduced home building at lower prices and margins. And fewer workers putting up dry wall.
Is Housing That Important to Employment?
Based on my and other calculations, residential construction contributed 40% of all new jobs in the period 2002-2007. This excludes the number of undocumented workers not found in official statistics. While this number may seem high, it makes senses – there was an unprecedented housing boom, China’s massive wipeout of low to medium skill manufacturing around the globe pushed many workers out of this sector and into construction, either residential or commercial.
The indirect impacts of new home construction are enormous. Not just the dry wall and lumber and roofing material suppliers – carpet makers, furniture manufacturers and stores and so on. Housing – new housing – was the driver of a huge expansion of the residential goods supply chain that is now sputtering.
I first noticed the crash in housing as the amount of money being transferred out of the country, a lot of it by undocumented or low skill workers in construction, began to slow. This was more than a year before official statistics began to show slowdowns on construction employment. This means the actual job loss – and loss of spending power in the economy – was greater than most analysts have estimated and will take longer to rebuild.
Unemployment in the real world is north of 22%. This includes out of work, part timers wanting to work full time, the discouraged and not looking right now and work force dropouts who would work if it was easy to find a job, the latter category to included in government stats. That is a big number.
The country needs to add, depending on your favorite economist, roughly 200,000 jobs a month to keep pace with demographic changes. To replace the jobs lost we need to double that rate for 3-4 years – and that would require economic growth 4.5% or better.
What About Recent Increases in Consumer Spending?
What increases? According to a fascinating analysis by Durban Capital, more than 60% of the growth in consumer spending this year went to one company – Apple (AAPL). No kidding, check out the interview on CNBC.
The government is funny about creating numbers and considers healthcare spending as “consumer spending.” Again, no kidding.
Take out Apple and healthcare and you really have no increase in consumer spending – maybe a decrease.
A Jobless Recovery? It Does Not Exist
Recovery – or what some economists are calling a recovery – is a wonderful word for a headline. We all want patients to recover; we wall want to recover the wedding ring we left in the hotel room; we all want to recover the passion of young love. The word is dangerous.
Recovery, in reality, means moderate to strong economic growth. This growth in the US is dependent on national income that in turn drives consumer spending. Consumer spending is dependent on national income and credit – and, a more amorphous metric consumer confidence. Consumer confidence is built on consumer wealth, real and forecast, and consumer attitudes about their economic future.
National income is generated by the number of people working times the average hourly wage times the average work week. The drop in the work force in the past three years has been the sharpest since the end of World War II – the unemployed, the retired, the “disabled,” the “despair” dropouts. The work week is shorter than it was three years ago and average hourly wages after healthcare costs and taxes are lower than three years ago.
Credit continues to contract, down 6% in recent Federal Reserve data, year over year. One fourth of Americans have a credit score low enough to prevent them from borrowing enough money to buy a hot dog. Home equity lines have vanished – and check the data, the entire growth on consumer spending in the period 2004-2007 equals the amount of money drawn down on home equity lines in the same period of time.
Consumers have lost enormous amounts of wealth and continue to do so as their core asset – their home – falls in value. Between one fourth and one third of consumer accumulated wealth in real estate and equities is gone. This has kept consumer confidence low.
We are now in the New Frugal – even well of consumers are being tighter with their purchases. Credit card transactions show revenue growth but not transaction growth.
What About Stimulus?
The Bush tax cut extensions essentially head off a rise in taxes and provide some stimulus – maybe $200 billion. That is it.
The Feds, the states, the localities – they are all broke. No more stimuli until the Republicans panic before the 2012 elections.
The Fed is using QE not to stimulate the economy – that is Bernanke’s excuse – but to continue the process of the healing of the banks. Again, be objective, Apply 2007 accounting standards – market to market accounting for assets, adjustment of underlying collateral values for commercial real estate mortgages – and big banks, are close to insolvency, if not there. At current rates of profit growth, we have another 4-5 years before they have the right capital base to return to 2007 accounting standards.
That means no stimulus from a sudden splurge in bank lending. They are building back their capital base not just to compensate for losses on their balance sheet but to meet new capital standards coming into place in the next few years.
What About Animal Spirits?
They do exist, especially in the US. I was in New York this week and the animals that work on Wall Street are keeping the city humming. I spent two marvelous lunch hours at Eataly, the new all Italian food emporium and there I found both hope and despair. I chatted up the young chef in training at the pasta restaurant and bar – incredible fusilli with a three-meat ragu, served al dente – new job, new restaurant, great business. I was sitting next two a man enjoying his pasta with white truffles and turns out he was a retiree from the MTA, the folks who run the subways and buses in the New York area. He was younger than I am, no longer works, can afford pasta with white truffles, and because of insane pensions such as his a close family member of mine lost his job as a bus mechanic, the MTA is now using operating expense money for maintenance to pay pensions.
Animal spirits also exist in tech land – but tech is not a big employment driver outside of the Bay area.
Animal spirits also exist among the general population but they are getting no support from the baking system. One of my sons is selling rugby T-shirts, some profits to the team, some to him and a partner. He used his savings account to get started. The laid off bus mechanic has a thriving cat sitting and care business. – again, no credit required. Men like Mario Batali can raise money to build Eataly; a mythical Mario Schwartz wanted would not be able to the same for deli food. A friend who has been building Wal-Marts for more than a decade and has a contract to build another one went to his bank of two decades and got turned down for a loan, the contract from Wal-Mart in hand.
What Does This Mean for Traders?
The “recovery” is going to stall in Q2. Look for a double dip in the second half of the year. Maybe a good time to buy puts on the S+P.
Growth in corporate profits will stall at the same time, not just from a slowing economy but even more of a slowdown in the EU - outside of Germany, they can always sell more centrifuges to Iran – and a rising dollar. The play here may be to to buy long term puts on the FXE, the ETF for the euro and long term calls on the UUP, the ETF for the dollar.
Bernanke will continue QE and there is a 50/50 chance we see a QE III. That will put more float in the boat we call the stock market – but not the economy or corporate profits. Once the crazy monetarists reading the headlies and not the textbooks throw in the towel and realize we are suffering from deflation (if you include asset prices) and not inflation, Treausires will fall again and the winners are gold and silver-- the GLD and the SLV.
Stocks dependent on real world valuations based on real world profits will stall and take a hit if they do not raise dividends. If they raise dividends, they will probably be fine, short term.Great, long term shorts are those companies paying out more in dividends than they are generating in profits. They are easy to find, take a look at an otherwise terrific company, Paychex (PAYX) and what they are paying out to shareholders, more than 4%. Another potential villain is Pfixer (PFE) -- Lipitor's patents are expiring, that is a $10 billion dollar plus drug, generics will tourn that into a $2-$3 billion dollar drug in 2012/2013, no way they can pay out the dividend they are using to prop up their share price.
Bottom line: the reality of the world economy will be worse than most forecast, will push Bernanke to expand his balance sheet as much as he can and will make long term trading – something that used to be called investing – problematic in 2011.
Disclosure: No positions