Stagflationary Recession Deepening
Retailers lining up in the crosshairs
By Frank Barbera CMT. May 27, 2008
Amid the endless gasoline headlines crossing the news this past weekend came the headline from Germany that billionaire investment guru Warren Buffett sees the USA already in recession. According to Buffett, "the US is already in a recession, which he believes will be deeper and longer than what many think".
BERLIN (AP) "Warren Buffett, whose business and investment acumen has made him one of the world's wealthiest men, said in an interview published Sunday he believes the U.S. economy is already in a recession. Asked by Germany's Der Spiegel weekly whether he thinks the U.S. could still avoid a recession, he said that as far as the average person is concerned, it's already here. "I believe that we are already in a recession," Buffett was quoted by Spiegel as saying. "Perhaps not in the sense as defined by economists. ... But people are already feeling the effects of a recession." "It will be deeper and longer than what many think," he added.
Of course, the good folks at the BLS have managed to make sure that the "official data" have been massaged enough to the upside in this election year so that, despite two consecutive quarters of negative real GDP growth, have been postponing the "official" recession signal so far. In today's update, we review some of the economic data released today from a bigger picture point of view to illustrate just how "spot on" Mr. Buffett's comments in fact are. The primary focus of the last 12 months has been, and remains, the sinking housing market, where this month's action produced a technical bounce. Earlier today, the Commerce Department reported that New Homes sales rose by 3.3% in April to a seasonally adjusted annual rate of 526,000 units. At the same time, the government also revised March activity lower to show an even bigger drop of 11 percent to an annual rate of 509,000, which was the weakest pace for sales since April 1991, a 17 year low. Viewed through the lens of a smoothed Rate of Change, we see that New Home Sales are still very close to the lowest levels of the last 40 years, sinking to the depths of the 1980 Carter "Stagflationary Recession." Appropriate, since today's unreported inflation rate is running close to 12%.
Above: Annual Rate of Change on New Home Sales in Deep Recession territory
In addition to the data on Housing Sales, today's report also reported that inventories of unsold new homes edged down slightly to 10.6 months' supply at the April sales pace, compared with 11.1 months in March. According to CBS Marketwatch and AP, the April level was still about double the inventory level that was normal during the five-year housing boom. In our work, we follow the Ratio of Houses For Sale versus Houses Sold, which remains well above the 8 month upper benchmark that in the past has defined US recessions.
Above: the Ratio of Houses FOR SALE versus Houses Sold - still in deep recession territory
With inventories still at near record levels of supply, it was also no big surprise that Housing prices remained under heavy downside pressure. According to CBS Marketwatch, the pace of home price declines accelerated in March with home prices in 20 major U.S. cities now down 14.40% over the past 12 months, a record breaking decline. According to the 20 City Case-Shiller Home Price Index, prices fell 2.2% from February to March marking the 16th consecutive monthly decline. Within the 10 largest US cities, prices fell by 2.4% in March, and by 15.3% over the last 12 months. The combination of falling home prices and rising food and energy prices, stagflation (no growth and rising prices) continued to put a major damper on Consumer Confidence with the Conference Board Index plunging to 57.20 in May, down from 62.80 in April. At this point, there is simply no longer any argument remaining about whether or not the US is in recession, as the Conference Board Index has only declined below the lower +70 benchmark during recessions and is now closing in on some of the worst readings seen in prior recessions.
Above: Consumer Confidence Survey fell to a 16 year low in May, now well below the +70.00 recession benchmark with a reading of 5.720 in May, down from 62.80 in April.
In fact, if one looks closely at the components which comprise the Conference Board Composite Index, the outlook going forward is bleak. To begin with, we note that the Forward Expectations Index which looks out six months from today, plunged this month to a reading of 50.00 to a value of 45.70. For proper context, that is an ALL TIME LOW since record keeping was started in the 1970's. Talk about huge, this makes a strong case that the current economy is nowhere close to an important bottom as the Expectations component tends to usually lead bottoms by a year or more. What's more, the overall Consumer Confidence Composite has actually been benefiting to this point by the Present Situation Component, which has been trending down in consistent fashion, but not falling out of bed.
Above: Conference Board Index of Forward Expectations (6 months out)
If we look at the Present Situation Component in May the indicator fell to a reading of 74.4, down from 81.90 in April. Historically, this gauge is very likely to dip under the +50 mark, and could even � given today's circumstances - be expected to fall into the +40 to +30 range. From where it stands at the current time near +75, we are still a long way from the zone where an important bottom could be seen. In our view, this implies that the current recession is simply just beginning to pick up downside momentum, and that the current bout of economic weakness will remain right through 2009.
Above: Conference Board - Present Situation, still a long, long way from a low
Above: Ratio of Leading to Lagging Indicators - 12 Month Rate of Change
Paralleling the steep declines in all of these gauges in the last 12 months are a number of other gauges, including the Ratio of Leading to Lagging Economic Indicators, which for the balance of the last two years has been drifting its way steadily lower toward the full recession levels of -5%.
Again, in very deep recessions this gauge has fallen to readings well below -10 to -12%, and thus, for anyone concluding that a bottom has been seen, we would argue that historically what is showing up right now in terms of falling Home Sales, Home prices, and diminished Forward Expectations makes a compelling case that the Ratio of Leading to Lagging Indicators has potentially a long way to go on the downside. To bring things full circle and close the loop, in the chart below we plot the annual rate of change on Home Sales (thin line) and overlay it against the Ratio of Leading to Lagging Indicators (thick line). What we find is that over a long stretch of time, the directional change of Home Sales has led the Ratio of Leading to Lagging gauges by about 5 to 6 months. That means that from where things stand right now, we could be staring down the barrel of new record lows in the Leading to Lagging Gauge Ratio which would imply a very deep recession, possibly even a depression getting underway. The same time of implication is seen with an overlay of the Conference Board Confidence data versus the Leading to Lagging Indicators. The clear implication from the way some of these ultra leading indicators are pointing is that the downside risk in the US, and likely the global economy, is still very substantial and that at present, we are a long way from the bottom of this downside contractionary cycle.
Above: Housing sales at Annual Rate of Change lead even the Leading Indicators (Thick line is Leading to Lagging Ratio at Annual Rate of Change)
Above: Ratio of Leading to Lagging Indicators versus Conference Board Composite
Above: top clip: S&P rate of change, middle clip: Payrolls rate of change, and bottom: Home Prices - rate of change.
Finally, we view the current decelerating economy through the lens of the stock market as a leading indicator for broader economic conditions. In the chart above, we plot a two year rate of change for the S&P in the top clip. Immediately below the S&P we show the 12 months rate of change on Non-Farm Payrolls, and below that, the 12 months Rate of Change for Real (Inflation Adjusted Home Prices). In both cases, we have lagged Employment and Home Prices by 12 months as the stock market has historically turned down in advance of economic weakness. In all three cases, the rate of change data is now negative with Housing leading the way on the downside over the last few months as the Credit Crisis has had a powerful negative impact on Housing Affordability. In our view, given what is happening in Housing, it is a very logical outcome to suggest that the Employment Rate of Change will revisit prior lows and that the stock market rate of change may also have another big excursion below zero dead ahead. Again, the implications are powerful that this down cycle still could have a long way to go as neither the stock market rate of change or the Non-Farm Payroll Rate of Change has seen the kind of figures which typically mark major lows; we suspect before this is over, those readings will be seen.
Above: the S&P 500 (top clip) and lower clip Relative Strength Ratio of Recession Retailers versus Discretionary Retailers
As far as the stock market is concerned, we believe that an extended recession from here will place more downside pressure on both cyclical stocks, and on retailers. In the chart above, we plot the relative strength ratio of defensive retailers, what I call "recession retailers" versus 'discretionary retailers." On the defensive side, we have names like Wal-Mart, Costco, Ross Stores, Big Lots, TJX Corp, and CVS all in rising configuration, while on the downside names like Radio Shack, Pacific Sunwear, Guess, Starbucks, Whole Foods, Urban Outfitters, and Nordstrom all look overbought and vulnerable. In the chart above, we plot the R/S Ratio of the recession retailers versus discretionary retailers, which is just now breaking out of a multi-week consolidation phase. The vertical dashed line on the chart shows that this ratio bottomed the same week that Sub-Prime Mortgages became headline news in February 2007. Clearly, the defensive tone remains intact within the stock market, a trend which should continue to favor the most basic industries with a special emphasis on commodities, sectors such as Energy and Precious Metals. We end with the most discretionary of all items, New Cars, where last week Ford Motor guided lower, reversing its prior upbeat forecasts. We continue to maintain that neither GM nor Ford are likely to survive this downturn (in present form) as both companies have severe financial problems unlikely to withstand a Category 4 or 5 storm which is just now making landfall. On Friday, GM (which owns Rescap/Green Light Financial), Ambac, MBIA, Lehman Brothers, Indymac Bank and Bank America all closed near historic lows, and all are on the high alert watch list for potentially major pieces of bad news.
From CBS Marketwatch - May 22nd
Ford cuts truck production, scales back profit view
Automaker's coming to grip SAN FRANCISCO (MarketWatch) -- Ford Motor Co.'s grand plans for profits in 2009 came to an end Thursday, sending the automaker's shares down more than 8% as plunging demand for trucks and SUVs have combined with rising fuel and steel costs to weigh on the bottom line. Ford Motor Company also cut its outlook for full-year car and truck sales to a range of 15 million to 15.4 million units, down from 15.3 million to 15.6 million previously. And in an effort to align production with the sliding demand, the company now plans to build fewer vehicles. "Unless there is a fairly rapid turnaround in U.S. business conditions, which we are not anticipating, it now looks like it will take longer than expected to achieve our North American Automotive profitability goal," Ford CEO Alan Mulally said.
At the close, the S&P 500 ended on a positive note rising 9.42 points to finish at 1385.35, with the DJIA ending higher by 68.72 to close at 12,548.35. On the NASDAQ, prices also moved higher for a gain of 36.57 points finishing at 2481.24, with the 10 Year Bond yield also rising, with yields edging up by 9 basis points to finish at 3.921%.
That's all for now,
© 2008 Frank Barbera