Calculated Risk

 

Calculated Risk

Key Question: Is the slowdown temporary?
Retail Sales declined 0.2% in May
NFIB: Small Business Optimism Index decreases in May
Q1 2011: Mortgage Equity Withdrawal strongly negative
DataQuick: SoCal Home Sales Slow in May, Record Low New Home Sales
Greece Downgraded Again

Key Question: Is the slowdown temporary?
Posted: 14 Jun 2011 09:18 AM PDT

The recent economic data indicated a slowdown in May: only 54,000 payroll jobs were added, auto sales declined significantly, retail sales were sluggish even excluding autos, growth in manufacturing slowed sharply, house prices continued to decline to new post-bubble lows (as of March), and home sales slowed.

This raises a key question: Is the recent economic slowdown temporary or is the U.S. heading into a "double dip" recession?

Some of the recent slowdown was related to the tragic events in Japan that started with the earthquake on March 11th. These events impacted the supply chain, especially for the automakers, and these disruptions negatively impacted manufacturing output in the U.S.

Also the sharp increase in oil and gasoline prices - partially attributable to events in the Middle East and North
Africa - has impacted consumer sentiment and retail spending. Oil and gasoline prices have fallen in recent weeks, but are still up sharply from the end of 2010. (WTI futures averaged $85 per barrel in Q4 2010 and are now at $98 per barrel).

A third possible temporary impact has been the severe weather this year. Although there is always severe weather somewhere, the weather has been especially extreme this year from the massive snowstorms in the east, to the recent flooding along the Mississippi river.

But are these impacts temporary?

The supply chain disruptions are clearly temporary, and the good news is the supply issues are being resolved ahead of schedule. From Edmunds.com:
“Manufacturing disruptions appear to have peaked in April and May, and recent news points to steady improvements moving forward,” said Lacey Plache, chief economist at Edmunds.com. “Toyota said it expects North American production of its top-selling Camry and Corolla models to be back at 100 percent [in June], and Nissan’s key engine plant in Japan is returning to full production [in May]. Even Honda, which was the hardest hit of the big three Japanese automakers, is making optimistic statements about its recovery."Also the recent decline in oil and gasoline prices will help, although $100 oil is still a drag on the economy. The weather is unpredictable, but hopefully it will be less severe.

There are also several other ongoing drags on the economy. These include:

• Less Federal stimulus spending in 2011. The American Recovery and Reinvestment Act of 2009 (ARRA) is winding down, and will be a drag on GDP
growth.

• The ongoing cuts in state and local spending.

• The festering financial crisis in Europe. Although the direct impact on U.S. trade would be minimal, there could be a significant financial impact on the U.S. if Greece (and other countries) default.

• The slowdown in China impacting U.S. exports.

• Another downturn in house prices.

Note: Since it appears that most of the impact from QE2 is due to the stock effect (as opposed to flow), the end of the buying program will probably have little impact on the economy.

And of course this is all on top of the generally fragile economy. My general outlook since mid-2009 has been for a sluggish and choppy recovery. Usually the deeper the recession, the steeper the recovery - however recoveries following a credit bubble-financial crisis tend to be
sluggish.

There is still too much excess capacity in most of the economy for a large contribution from new investment (except in equipment and software). We see this excess capacity in housing, and in overall industrial production. As an example, domestic auto production is still only about 2/3 the level of 2006 - so there is no need to expand production. There is also excess capacity in office space, retail space, and other categories of commercial real estate. In addition, household debt, as a percent of income, remains very high and household deleveraging is ongoing.

Of course a sluggish recovery following a financial crisis is not unusual. From "The Aftermath of Financial Crises", Reinhart and Rogoff, 2009:
"An examination of the aftermath of severe financial crises shows deep and lasting effects on asset prices, output and employment. ... Even recessions sparked by financial crises do eventually end, albeit almost invariably accompanied by massive increases in government debt."To answer the key question we need to distinguish between the impact of these short terms issues (supply chain disruption, oil prices, weather), and the ongoing drags.

Although we can try to model the impact, it is hard to separate out the various factors. Note: Cleveland Fed economist Kenneth Beauchemin argues that "the shocks we experienced in the first quarter of 2011 have had measurable effects on both economic activity and consumer price inflation. However, as long as energy and other commodity prices do not continue to rise sharply, these effects are likely to be temporary and modest." See: Shocks and the Economic Outlook

I think the data will help us over the next month or two. If the impact was temporary, auto sales and manufacturing should rebound by July. If there are more severe issues, the weakness will persist.

We have to also remember that Residential Investment (RI) will probably make a positive contribution to the economy this year, for the first time since 2005. The five years of drag on GDP from RI (2006 through 2010) is the longest period on record, breaking the previous record of four years from 1930 to 1933. The positive contribution this year will mostly be due to a pickup in multifamily construction (apartments) and in home improvement. Of course single family housing starts will
continue to struggle.

Since RI is the best leading indicator for the economy, I think a pickup in RI suggests the recovery will continue. This isn't perfect - nothing is - but RI is usually a strong leading indicator for the business cycle.

So for now I'll stick with my general forecast for 2011: growth will remain sluggish, but I expect 2011 to be better than 2010 for both employment and GDP growth.

Retail Sales declined 0.2% in May
Posted: 14 Jun 2011 07:18 AM PDT

On a monthly basis, retail sales decreased 0.2% from April to May (seasonally adjusted, after revisions), and sales were up 7.7% from May 2010. From the Census Bureau report:
The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for May, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $387.1 billion, a decrease of 0.2 percent (±0.5%) from the previous month, but 7.7 percent (±0.7%) above May 2010. Click on graph for larger image in graph gallery.

This graph shows retail sales since 1992. This is
monthly retail sales and food service, seasonally adjusted (total and ex-gasoline).

Retail sales are up 16.4% from the bottom, and now 2.3% above the pre-recession peak.

The second graph shows the year-over-year change in retail sales and food service (ex-gasoline) since 1993.

Retail sales ex-gasoline increased by 6.1% on a YoY basis (7.7% for all retail sales).

This was above expectations for a 0.5% decrease. Retail sales ex-autos were up 0.3%; at
expectations of a 0.3% increase. As expected, auto sales impacted retail sales (due to supply disruptions).

NFIB: Small Business Optimism Index decreases in May
Posted: 14 Jun 2011 04:45 AM PDT

From National Federation of Independent Business (NFIB): Consumer Spending Remains Weak: Small Business Optimism Dips Lower in May
The Index of Small Business Optimism fell 0.3 points in May to 90.9. This month marks the third monthly decline in a row. The proximate cause is the fact that 1 in 4 owners still report weak sales as their top business problem. Consumer spending is weak, especially for “services,” a sector dominated by small businesses.
...
Twenty-five (25) percent of the owners reported that weak sales continued to be their top business problem Note: Small businesses have a larger percentage of real estate and retail related companies than the overall economy.

Click on graph for larger image in graph gallery.

The first graph shows the small business optimism index since 1986. The index decreased to 90.9 in May from 91.2 in April.

This has been trending up, although optimism has declined for three consecutive months now.

The second graph shows the net hiring plans for the next three months.

Hiring plans declined in May and are slightly negative.

According to NFIB: “[I]ndications of minimal future growth include the fact that in the next three months, 13 percent plan to increase employment (down 3 points), and 8 percent plan to reduce their workforce (up 2 points). That yields a seasonally adjusted net negative 1 percent of owners planning to create new jobs, a 3 point loss from April."

Weak sales is still the top business problem with 25 percent of the owners reporting that weak sales continued to be their top business problem in May. In good times, owners usually report taxes and regulation as their biggest problems.

The recovery continues to be sluggish for this index, probably somewhat due to the high concentration of real estate related companies.

Q1 2011: Mortgage Equity Withdrawal strongly negative
Posted: 13 Jun 2011 04:04 PM PDT

Special Note: Dr. James Kennedy has a new method for calculating equity extraction: "A Simple Method for Estimating Gross Equity Extracted from Housing Wealth". I haven't evaluated his method yet (here is a companion spread sheet), so the following is using my old "simple" method.

Note 2: This is not Mortgage Equity Withdrawal (MEW) data from the Fed. The last MEW data from Fed economist Dr. Kennedy was for Q4 2008.

The following data is calculated from the Fed's Flow of Funds data and the BEA supplement data on single family structure investment. This is an aggregate number, and is a combination of
homeowners extracting equity (hence the name "MEW", but there is little MEW right now!), normal principal payments and debt cancellation.

Click on graph for larger image in new window.

For Q1 2011, the Net Equity Extraction was minus $107 billion, or a negative 3.7% of Disposable Personal Income (DPI). This is not seasonally adjusted.

This graph shows the net equity extraction, or mortgage equity withdrawal (MEW), results,
using the Flow of Funds (and BEA data) compared to the Kennedy-Greenspan method.

The Fed's Flow of Funds report showed that the amount of mortgage debt outstanding declined sharply in Q1. Mortgage debt has declined by $634 billion over the last twelve quarters. This decline is mostly because of debt cancellation per foreclosures and short sales, and some from modifications. There has also been some reduction in mortgage debt as homeowners paid down their mortgages so they could refinance. Note: most homeowners pay down their principal a little each month unless they have an IO or Neg AM loan, so with no new borrowing, equity extraction would always be slightly negative.

DataQuick: SoCal Home Sales Slow in May, Record Low New Home Sales
Posted: 13 Jun 2011 11:46 AM PDT

From DataQuick: Southland Home Sales, Median Price Post Steeper Declines From 2010
Southern California home sales held at a three-year low last month amid a sluggish move-up market and record-low sales of newly built homes. ...

A total of 18,394 new and resale houses and condos sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties in May. That was up insignificantly – 0.3 percent – from 18,344 in April, and down 17.4 percent from 22,270 in May 2010, according to San Diego-based DataQuick. ... On average, sales between April and May have increased 5.7 percent since 1988, when DataQuick's statistics begin.

The 1,152 newly built homes that sold across the Southland last month marked the lowest new-home total for the month of May since at least 1988.
...
Distressed property sales continued to account for more than half of the Southland resale market last month, with little change from April. Roughly one out of three homes resold was a foreclosure, while about one
in five was a “short sale,” where the sale price fell short of what was owed on the property.May was another month of sluggish home sales in SoCal, especially for new home sales. National existing home sales will be reported next week on Tuesday, June 21st, and new home sales will reported on June 23rd - and I expect weak reports.

Greece Downgraded Again
Posted: 13 Jun 2011 10:02 AM PDT

From the WSJ: Greece Gets Yet Another Downgrade (ht Kevin)
Standard & Poor’s just cut Greece’s debt rating to CCC from B, meaning Greek debt is “extremely speculative.” The outlook for Greek debt is “negative.”
The downgrade reflects our view that there is a significantly higher likelihood of one or more defaults, as defined by our criteria relating to full and timely payment, linked to efforts by official creditors to close an emerging financing gap in Greece. This financing gap has emerged in part because Greece’s access to market financing in 2012 and possibly beyond, as envisaged in the current official EU/IMF program, is unlikely to materialize.

This lack of access, in our view, creates a gap between committed official financing and Greece’s projected financing requirements. Greece has heavy near-term financing requirements, with approximately EUR95 billion of Greek government debt maturing between now and the end of 2013 along with an additional EUR58 billion maturing in 2014.

Moreover, the downgrade reflects our view that implementation risks associated with the EU/IMF program are rising, given the increasingly complicated
political environment in Greece coupled with its current difficult economic climate.And from Reuters: LCH.Clearnet ups Irish, Portuguese bond repo margin

It raised the additional margin required to 65 percent from 45 percent for long positions on Portuguese government bonds when clearing transactions through its Repoclear service.

The equivalent Irish rate increased to 75 percent from 65 percent, LCH.Clearnet said in a statement on its website.The yield on the Portugal 10 year is at a new high (10.7%) and Ireland 10 year too (11.35%).

Here are the links for bond yields for several countries (source: Bloomberg):

Greece
2 Year
5 Year
10 Year

Portugal
2 Year
5 Year
10 Year

Ireland
2 Year
5 Year
10 Year

Spain
2 Year
5 Year
10 Year

Italy
2 Year
5 Year
10 Year

Belgium
2 Year
5 Year
10 Year

France
2 Year
5 Year
10 Year

Germany
2 Year
5 Year
10 Year

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