Expectations Alchemy
Max Fraad Wolff is a Doctoral Candidate in Economics at the University of Massachusetts, Amherst and editor of the website GlobalMacroScope. Over the past 6 months the foundation of fundamentals under our Macmansion of equity market hope has started to buckle. One by one the supports show signs of aging. The golden opportunities of the last few years have started to lose some of their shine. The solutions have been to either ignore unpleasant facts or assume they are short lived and of moderate import. All bad news is exciting as it suggests that the Federal Reserve will cut interest rates. All good news is proof of our resilient economy in which stocks, growth, opportunity and optimism spring eternal. Needless to say, risk premiums are small, speculative play massive and triumphalism is the air we breathe. We offer a structural health report, the sort of undertaking that no one has much had time for lately. None of which is to say that much is not well, much is very well. We just happen to believe that admitting all is not perfect provides insight and value. Housing We will keep it brief here, don’t worry. In the one year period between 1Q2006 and 1Q2007 we managed a fall in the US rate of home ownership! How is that for a market entering a rough patch? While you are to be immediately comforted that decline was not statistically significant, we humbly imagine this to be a dramatic indicator of trouble. Housing and associated industries have played the roles of employer, lender and wealth effect sentiment booster to American consumers. It is unclear if, when, what and from where a replacement sector will emerge. New Housing sales and starts have been below their mid-2006 peaks for nearly a year. Total construction expenditure is down. Inventories are rising toward the 1 million unit level. The National Association of Realtors announced a 10.8% decline in existing home sales in April with a 0.8% drop in year over year average price. The US Census Bureau April New Housing Report showed a 10.6% year over year sales decline and a 6.5 month inventory backlog. Using their data we find a 4% year-over-year average house decline and an 11% decline in median home price. A vital sector that loaned citizens hundreds of billions of dollars per year and accounted for 20-35% of employment growth since 2001, is entering a secular bear market. I would tell you not to worry about it, but I know you have already heard that many, many times. Chart 1 The Economy I should have titled this section, “Growth? We don’t need no sticking growth.” Our 1Q 2007 real annualized GDP growth rate is firmly in growth recession territory. Expansion- if you would really call it that- in the 0.6% range is sub-par and begs serious question. Please gaze at the GDP growth chart below and try to spot a pattern. It would seem that we are heading back toward recession territory. A large drag from negative net exports (exports minus imports), inventory declines and housing downturn have created significant headwind. Chart 2 Consumer spending is 70% of the economy and the most recent numbers are not the stuff of frothy good times. The June 01, 2007 Bureau of Economic Analysis Personal Income and Outlays Report starts out with a bang. As the quotation below explains, income—real and disposable—actually fell. You will be comforted—but you should be terrified—to learn that spending rose nonetheless: Personal income (DPI) decreased $9.7 billion, or 0.1 percent, in April, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $52.0 billion, or 0.5 percent. In March, personal income increased $85.9 billion, or 0.8 percent, DPI increased $71.7 billion, or 0.7 percent, and PCE increased $42.4 billion, or 0.4 percent, based on revised estimates. And further down on the same page: Personal outlays -- PCE, personal interest payments, and personal current transfer payments increased $55.2 billion in April, compared with an increase of $44.2 billion in March. PCE increased $52.0 billion, compared with an increase of $42.4 billion. Personal saving -- DPI less personal outlays -- was a negative $132.8 billion in April, compared with a negative $67.8 billion in March. Personal saving as a percentage of disposable personal income was a negative 1.3 percent in April, compared with a negative 0.7 percent in March. The Italics and bold are my additions. These numbers are the stuff of real concern! The housing market is in trouble, retails sales are flat and that is what we get when people dis-save at nearly twice the rate of the pervious month. This is a running on empty story and looks to become a running into the wall story. Why so little concern? Golden expectations seem to produce a kind of alchemy of understanding. These leaden numbers suggest a weighted down public. Through the magical sophistry of expert opinion the lead becomes golden opportunity and impending rebound. When all else fails, we have come to know that credit always saves the day! Credit/Debt The areas of massive and growing strength are those tied to, and dependent upon, credit growth, financial engineering, speculation and expectation. Thus, wave after wave of buy-out and buy-back buoy equity prices. With each repurchase announcement and buy-out deal comes renewed speculation and buying pressure. Easy abundant credit is required. No matter how low you get your wage bill, no matter how inexpensively and innovatively you get your financing, ultimately you still need buyers. Sure, stagnant wages, declining tax bills and regulatory relief seem grand now, but risk greater savings and reduced consumption. For now, debt has filled the gap, and in doing so, opened another grand avenue to profit. So long as this lasts it supports asset prices and economic activity. Already the nimble have begun to realize that the future of lending at high rates with good repayment levels may well be outside the US. Over the past few years we have been consuming 60-70% of the world’s excess savings. We have 4.5% of the world’s population, 20% of global GDP and are now growing more slowly than the EU, India, China much of Latin America. We are also far more indebted. Thus, the growing excitement about micro-credit and booming consumer debt markets in Eastern Europe, Asia and beyond. We suggest that a rethinking of the news flow and less euphoric perspective may now be in order. There is little doubt that such a perspective will cost you some of the remaining upside and dampen spirits. After all, who wants to see lead when where they expect to find gold? [1] US Census Bureau. http://www.census.gov/hhes/www/housing/hvs/hvsgraph.html [2] Federal Reserve Bank of St. Louis. Updated through May 31, 2007. http://research.stlouisfed.org/publications/net/page4.pdf [3] Personal Income and Outlays, BEA. June 01, 2007. http://bea.gov/newsreleases/national/pi/pinewsrelease.htm |
