De-Industrialization and the 'Nordstrom's -- Wal-Mart' Economy
By Frank Barbera CMT. September 25, 2007
For the last few years, there has been an ill wind blowing for anyone who would care to notice. Yes, we know that the combination of rising asset prices and a lower cost of money has at times produced the illusion of an economic nirvana, as the aggregate level of wealth within our society has continued to increase. With that rise in wealth cast against relatively stable consumer prices and the outreach of capitalism to a global economy, we have benefited from the excess capacity in the means of production, as cheap foreign labor has been a boon to the industrialized economies. It has allowed many of us to devote an increased portion of our incomes to the purchase of luxury items and personal services, leading to an ever-expanding array of such services. Yet, through this process, what we could term the ‘de-industrialization’ of the west, the economies of many nations have been transformed. First came the collapse in manufacturing jobs, as capitalism outsourced its productive needs to the emerging economies of the third world. The capacity to produce and create widgets was deemed less worthy of capital investment, and so, yielded the rise of the Services economy.
Above: Manufacturing Employment in the United States 1939 to Present.
Yet over the years, as more and more jobs have been outsourced and eliminated through advances in Technology, even the service sector has matured, tracing out a series of steadily lower peaks with each cycle over the course of the 1990's and the new millennium. As wealth became more concentrated in the hands of a smaller and smaller percentage of the upper echelon income strata, services catering to that niche meant intensified competition for the best class of customers. Along the way, wealth creation became tied and inextricably connected to the function of ‘lending’ as opposed to ‘investment.’ Finance became the driving force for the new economy and within finance, the principle agent of growth became asset inflation. It has been a long evolution, with the finance economy beginning in the realm of traditional lending and morphing into the gross excesses of speculative structured finance.
Above: Annual Rate of Change on Service Sector Employment
As the years have past, and the appetite for risk taking has expanded, the financial economy has become increasingly decoupled from the plight of the mainstream. A multi-decade morphing act, the US began as the supreme manufacturing economy, morphed into a giant service economy, and in recent years with corporate outsourcing unleashed, became the leading financial economy, and with that, the ultimate consumer economy. And therein lies the rub, as over the last few years, the dis-equilibrium between ‘the have's’ and the ‘have not's,’ between the Wal-Mart shopper and the Nordstrom shopper has done nothing but widen out. Want proof? Have a look at the chart below which rebases Wal-Mart and Nordstrom shares to the beginning of the last bull market in March 2003. Quite the striking dichotomy now, isn't there?
Above: Wal-Mart and Nordstrom’s rebased.
For the US, never before has the country seen its Labor Force contract during the course of an economic expansion. Never before has an economic expansion failed to generate any gains in real wages, and never before has the US Economy been so dependent on a single driver named Housing. Today, and over the last few years, Housing has taken center stage, not only as the object of speculative fever during the boom, spawning shows like ‘Flip that House,’ ‘Design to Sell’ and ‘Curb Appeal,’ but also as the key underlying driver for growth in the US.
Unlike the past, when increases in investment in capital production would drive job creation, which would in turn raise incomes, and put upward pressure on housing prices, this economy of the last few years has been the ‘Backwards Economy,’ where ‘cheap money’ led to speculative investment and rising prices, with rising prices begetting more speculative investment, triggering the hiring of armies of contractors, designers, and then ultimately selling agents and mortgage finance people.
All of these jobs were created in response to higher prices, which were fundamentally disconnected to any discernable change in the enhanced productive capacity for the overall economy. We have lived through the age of asset inflation led ‘growth,’ which as we are finding out now is really just ‘Asset Inflation’ and very little lasting growth at all. So it is today, as layoffs mount and payroll numbers are revised down, that confidence is on the wane.
On Wall Street, the excess greed which led to the rise of Asset Backed ‘sliced and diced’ securities, has encountered the Von Mises ‘Crack Up’ boom, and blown up like an atom bomb during the summer of 2007. Of course, the Fed has attempted to rally stock prices and restore confidence by infusing money. Yet, despite the Fed's aggressive actions of the last few weeks, confidence in the financial economy remains severely undermined while the fundamental lock up in the credit markets remains an ongoing problem. When we look around to survey the situation in light of last week's aggressive Fed cut, we see the obvious signs of resurgent confidence embodied by the sharp stock market rally, but we also see a whole subset of indicators which argue that things are a long way from being ‘back to normal.’ Take for example the Bank Stocks, where the credit crunch has likely impaired a large number of SIV's, Conduits and other vehicles about which we have been told very little. According to BusinessWeek, Citicorp alone owns 25% of the market for Structured Investment Vehicles, or SIV's. That is about $100 Billion dollars of which some part of that total may be at risk. Is the market really confident in the outlook for the banks and Citicorp in particular, in the wake of the Fed's aggressive rate cut?
As can be seen in the hourly chart below, one week ‘post’ the Fed announcement, we see that Citicorp stock is not holding onto its gains. Strange, that confidence in a major bank should be so underwhelming in light of the Bernanke Fed riding to the rescue.
Above: Citicorp Hourly - no staying power post the Fed announcement. What's up with that?
Worse, we see that on the daily chart of Citicorp, the trading pattern of the last few weeks has produced a classic symmetrical triangle which is traditionally a downside continuation pattern. To date, despite the Fed's aggressive action, Citi stock remains below its 50 day average and in an accelerating down trend versus the S&P 500 on its relative strength ratio. Can this be a good sign? Sure doesn't inspire confidence on our end. Nor does the abysmal action in other big name financials like JP Morgan (JPM), Wachovia, Washington Mutual, Suntrust or any of a handful of other major European Banks.
Above: Citicorp Daily chart with Relative Strength Ratio in lower clip, serious downside acceleration in the relative strength says big money is selling this issue.
Above: JP Morgan with Relative Strength Ratio versus S&P 500 - the King of all Derivatives - leveraged how to the hilt to such a degree, no one really knows, JPM slides back odd?
Above: Wachovia - which acquired Golden West Financial at the top of the Housing market in 2006, is also not acting well post the Fed's confidence building action. Could it be there are more problems ahead for the Golden West portfolio of Sub-Prime Adjustable Rate Mortgages?
Above: Not much of a sustained bounce for the good folks at UBS, still below key resistance at the underside of a massive Double Top; both moving averages still pointing lower, we still see a downtrend in effect. Same thing is present at Euro-partners Barclays (BCS), Lloyds (LYG), Deutsche Bank (DB), and Credit Suisse (CS)? What could be the problem here?
Above: Suntrust Bank (STI) has also reversed lower rather rapidly - funny how the Fed announcement didn't work miracles for this Sunshine State goliath.
Above: the long term chart of Sovereign Bancorp (SOV), an S&L, has had almost no bounce and resides below prior long term support. This looks sick, very sick.
Above: Banco Privanza International Gibraltar Ltd (BBV) - with its 83 BILLION dollar market cap, the Head and Shoulder Top on this stock sounds like there could be some ‘issues’ at hand.
Above: the GST Banking Index (30 stocks) and the Daily A/D Line for the Bank Index, daily A/D Line remains locked in a downtrend below 50 day average despite near term Fed bounce in the individual shares.
Above: the GST Banking Index and Cumulative Volume; so far, not much of a bounce, still very weak.
So just what could be this bout of relative strength weakness by the banks trying to communicate? In our view, the answer comes back to Housing, the core of the Backwards Economy. At the heart of any Housing boom is a Lending Boom, and to that end, Housing Industry problems can all too often become Banking Industry problems. Just how serious the current set of problems are, we have no way of knowing for sure, but gauging from the headlines which scream ‘recession,’ we are probably going to find out in the months just ahead.
Speaking of Confidence, or the lack thereof, earlier today the Conference Board announced the latest data for Consumer Confidence for the month ended September 2007. In the report, the headline figure fell 6 points from 105.6 in August to 99.80 in September. Within the other components, the Present Situation Gauge fell from 130.1 in August to 121.70 in September, with the Forward Expectations gauge falling from 89.20 to 85.20. As can be seen in the top chart, Expectations have been diverging bearishly against the Present Situation for the better part of two years, which is reminiscent of prior downturns just ahead of recessions. At the same time with this month's sharp decline, the Present Situation Gauge has now moved below its 2 year moving average for the first time since 2003, when this ‘so-called’ recovery began. Always a good coincidental gauge, with this month's decline in both indices, the Ratio of Forward Expectations to Present Situation surged and is now cleanly above its 20 month moving average. While it may take a few more months for the signal to become ‘really clear,’ the cross-over has been made and for those of you wondering whether the US is headed for recession, wonder no more; the data is now confirming the turn.
In addition to the Consumer Confidence gauges, we also note the continued deterioration in the headlines and in the Housing market indicators where a deep recession is presently underway. Over the last few months, the Ratio of Houses Sold to Houses For Sale has continued a steady march, and still has a long way to go before we can even begin to contemplate that the worst is over for Housing.
A casual look through the charts of the HomeBuilding Industry also makes the point, as company after company runs ashore like a ship on the rocks in a violent storm. Most of these charts have no bottom of any kind and in fact, most of these charts look like they are only about half way down out of major tops. With downside momentum still building in this sector, the implication is that years of capital gains, years of value is now in the process of being erased.
Above: Centex Corp.
Above: DR Horton
Above: KB Homes
Above: Ryland Homes
Above: Lennar Corp.
Above: Beazer Homes (BZH)
Above: Dominion Homes
Above: Hovnanian Ltd
In summary, these are not ‘normal’ times, and we are in uncharted and untested waters with respect to how this new millennium Financial Economy will weather its first serious recession. Will monetary easing be the tonic that heals all, or like 2000-2002 will monetary easing simply slow down the inevitable contraction? For investors, this means trying to get a tighter grasp of the larger problems, especially in the area of bad debts as unfortunately, problems of this type tend to seep from one industry to another, and what is a major headache one month for Homebuilders quickly becomes a major migraine for the Banks.
Perhaps the Fed is trying to ‘get out in front of the situation’ by being proactive as they said in their last press release, or perhaps the Fed is panicked at the sight of a problem whose size and scope is far more serious than they would have anyone believe. When you think about it, aggressive Fed easing usually takes place with the stock market down 15 to 20% (or more) off the absolute highs. Here we are in late 2007, the S&P is down less then 5% from the all time high, and the Fed has unleashed its full array of monetary elixir. One can only wonder what they know, that we don't know. As an investment prescription, caution would seem to be the best approach with a careful eye fixed upon the price action in leading lending institutions.
Stocks closed mixed on the session with the NASDAQ Composite gaining 15.97 index points to close at 2683.92, the DJIA closing higher by 19.59 at 13,778.65, with the S&P 500 ending lower by .52 at 1517.21. The 10 year Bond Yield ended slightly lower at 4.61, down .01 basis points, while December Gold closed lower as well, finishing down .30 at $739.00.
That's all for now,
© 2007 Frank Barbera