Inflationary Dreams and Recovery

Through the second half of 2007, to the collapse of Bear Stearns (BSC), US equity indexes were indicating a long hard fall. Selling pressure was relentless. As lagging assistance was offered by The Fed, there were short reversals. Selling became buying for a few weeks to a few days. It never took long for markets to fall after the euphoria and false promise were sniffed out. The Federal Reserve led the world in offering monetary policy accommodation. Rates were slashed, credit was pumped, soothing words were shouted in any and all directions. This failed until late March and again after the 30 April 2008 cuts. Bulls announced buying opportunity after buying opportunity, until Bear Stearns. Quickly tech, de-coupling and commodity plays came to dominate buy side recommendation.

A strange thing has taken shape ever since. We have seen the emergence of several mutually exclusive buying binges. In short, everything is up- if unevenly. Everything except the usual defensive plays that guard capital and return in recession. Shorts, gold, and many defensives have performed as you might expect in a recovery. What we actually have is a recession, no longer a possible recession but, a real one. Inflationary dreaming and valuation scheming have hidden this from view. Agricultural commodities (MOO), the broad commodity index (DJP), emerging markets MSCI (EEM), the S&P 500 (GSCI) and US financials (IYF) are all up since March 17.

click to enlarge

Market leadership has become laggardship. Since late March 2008 we have seen an unbroken series of worsening economic data. February, March and April saw net losses in US employment, stagnant to negative income growth, near zero GDP growth and rising inflation. The most recent 1Q 2008 GDP Advance Estimate from the Bureau of Economic Analysis [BEA] makes clear just how bad things are. Unplanned inventory investment and government spending (military) are the primary providers of “growth.” The inability of businesses to sell as much as planned is pushing up GDP. A rather tame looking 3.7% annualized inflation measure was used to turn nominal GDP into real GDP. If slightly higher inflation had been factored- as many feel it should have been- GDP would have actually fallen. Final estimates are very sensitive to the size of estimated inflation. Any meaningful increase in inflation estimate would create a negative GDP number and likely an official recession call.

Our labor market is defined by shrinkage. The American consumer is squeezed from above and below. Official jobs data offer a useful glimpse into a parallel universe. Here on planet earth, in the area called the United States of America, the following fun facts from the Bureau of Labor Statistics are never reported. 261,000 jobs have been officially lost since New Years Day 2008. There has been an 850,000 person increase in involuntary part-time employment over the last 12 months. There are 1.4 million people “marginally attached to the labor force.” There has been an increase of 800,000 officially unemployed persons in the US over the last year. Thus, we are presiding over a 1.65 million person minimum increase in unemployed and underemployed persons since April 2007. All the while our population grows, even if the labor force does not. The average workweek and average weekly earnings both declined in April.

The economy continues down led by housing, consumer sentiment, employment and earnings. As the market has clawed back up, data has made recession clear. The S&P500 has gone from 1447 on 02 January 2008 to 1413.90 on 02 May 2008. The market is basically flat, off by 2%. If adjusted for inflation, the loss would be greater than 5%. Since 17 March 2008 the markets have trended boldly higher amid rising public woe. The S&P500 is up 11% since the Bear Stearns low. As we entered this downturn we were in the process of breaking many old records. Household debt levels were massive. We have nearly $10.6 trillion in household debt. House price reductions already suggest $2-$3 trillion in paper real estate losses.

The recent recovery broke records for the greatest proportion of earnings for corporations and the lowest for households. It is hard to imagine a way for American firms to grow their earnings here despite household weakness. Folks already can’t afford to be borrowing as much as they have and earning as little as they do. We have spiking food, energy and associated costs. This is a classic scissors crisis for America’s middle class. They are being hit from the cash flow and earnings side. Years of stagnant earnings and now pinched firms mean few wage increases and rising unemployment. Houses can not be borrowed against as prices are falling and debt levels are too high. On the cost side, prices are rising much faster than wages. It is pretty hard to stop buying food, electricity, gas and things made with food or energy inputs!

The market is rising as the news turns worse. Stocks forecast a sharp recession, until one arrived. Now the markets are forecasting a short, shallow downturn. This would be easier to believe if something more serious had not already arrived. There is no slack in the domestic household economy. Private consumption accounts for over 65% of GDP. Deeply indebted, fragile state, federal and family budgets can not absorb the blows already falling. For profits to hold recent record levels, let alone rise, firms would have to get miracle returns in foreign currency and then covert them to declining dollars. This would allow their numbers to grow. Even this unlikely case risks being overwhelmed by falling demand, rising anger and default in the US.

We are left to left to wonder what kind of broad health undifferentiated buying signals. The sector rotation and selection of new leadership is yet to arrive. Commodity inflation and de-coupling schemes rule the roost in the meantime. This has created major sell-offs in defensive plays and short positions. We assume that, however slowly and reluctantly, the markets will re-discover the recession they predicted and the public and politicians are screaming about?

Disclosure: Short

Comments

[iThinkBig]

The politicians are now fine with saying there was no recession. McCain was wise to say there was one going on and was shrewd to go on his bus tour to gather large reams of market research from the street. I see one massive solution and that is declare energy independence and subsidize $200 B in Treasury to build nuke plants, increase biodiesel, solar, coal and hydrogen. How about partnering with our allies and number 2 economic superpower the Japanese oh hydrogen vehicle build-out? What stinks is the attitude of Washington whom is a direct reflection of our multicultural BS society of greed, selfishness and political correctness. So the shame is it is likely we will have to be all the way over the cliff instead of half way over before We the People fix it. In other words, learn through massive pain, not just a little. 911 was a perfect example of how to stay united and win in a very rapidly changing world but failed to unite us because power-hungry politicians want to get elected and hating Bush as a campaign slogan is far easier then actually getting the job done.