Wilting Green Shoots
By Frank Barbera CMT. June 30, 2009
Today’s announcement from the Conference Board was especially telling as not only did the numbers come in below analyst expectations, but among the key numbers each component declined. In the case of the overall confidence survey, the June figure came in at 49.30, down from 54.80 in May, while the Present Situation component came in at 24.80, down from 29.70. Perhaps the most important gauge at this time is the Forward Expectations survey, which fell to 65.50, down from 71.50 in May. In the aggregate, none of this should really come as any kind of surprise as the same pattern has been seen several times in the past. Usually, as a recession begins to wind down, Forward Expectations take a large leap upward, but the leap is only a leading edge gauge that things are starting to bottom. Invariably, even after Forward Expectations rise, the normal course of events is for the economic data to revert back to a long string of negative values for a period of several months or more. Turning the economy is not like turning a speedboat; it is far more akin to turning an ocean liner and it takes months to accomplish, if it can be accomplished at all.
The chart above shows the prior sharp bounces in Forward Expectations which heralded the earliest signs of a low in 1981 and in 1990, the two worst recessions of the past 20 years (see roman numerals I and II). Notice that in both cases Forward Expectations fell for months on end, even after the initial sharp upward jolt, while Present Situation (top clip) continued down to make new lower lows. As a result, I tend to watch the ratio of Forward Expectations to Present Situation as a better coincidental gauge of perhaps when the economy is really bottoming. Once the Ratio begins to decline, and especially once it begins to fall below its 12 month moving average, that is usually a good indication that some level of economic stability has been achieved.
Importantly, in the 1979-1981 double dip recession, the first “recovery” seen in the second half of 1980 to the first half of 1981 only allowed the Ratio to pull back to the rising moving average line. At no time did the ratio ever break below the moving average line. The ‘second’ relapse into recession pushed the ratio skyward surging to new highs in late 1982 and early 1983. In my view, there remains an excellent chance that the same type of outcome could play out in the months ahead, where Forward Expectations begin to relapse (as happened in June), the Ratio begins to fall as Present Situation numbers stay relatively flat, and then a second contraction creates a situation where both Forward Expectations and Present Situation are falling strongly, surging the Ratio in a second large spike.
While we would love to try and see the ‘silver lining’ in today’s economy, at the moment, it is very hard to see which sectors of the economy are going to lead the US out of the current economic malaise. A close examination of any number of economic reports shows that without the help of government spending, most of the data ex-Uncle Sam is still scraping along the bottom or in decline. While it is true that in the past employment has been a lagging indicator, it is also true that going forward it is hard to see where new employment will come from on a scale needed to turn a global contraction back into global growth. In addition, President Obama’s "Cap and Trade" Bill looms as a giant new energy tax, something that is hard to see will help struggling businesses at the current time.
For the US, the lack of a compelling economic driver could become a very problematic situation as America is now more heavily in debt to the rest of the world than at any time in her past. At the end of 2008, the US international investment position was a negative 3.37 Trillion dollars. Put another way, foreigners now hold just under 50% of the US government’s debt with the scope of new federal debt issuance moving upward in a virtual parabolic curve.In the last few years, total combined outstanding debt for Uncle Sam (totaling up Treasury, GSE and MBS obligations) has gone from an increase of 411 billion in 2005, to an increase of $532 billion in 2006, to an increase of 1.165 Trillion in 2007. Last year in 2008, total combined outstanding debt increased by 1.949 Trillion dollars, and could soar well beyond that in 2009.
The question for the US now becomes -- if growth does not return, will foreign capital continue to flow toward the US markets, or will foreign capital slow its pace of investment? Without even contemplating what would happen if capital starts to withdraw for US markets, even a mere slowing in the flow of foreign capital could easily send US interest rates sharply higher, and if the US economy can not turn the corner now with record low rates, then what will happen once the entire yield curve begins to shift upward across the maturity spectrum? In my view, a funding crisis could well be the next major event, characterized by a weakening Dollar and surging US interest rates, forcing Uncle Sam to issue even more debt as the rate of interest on debt rolling over continues to soar. By comparison to the recent crisis seen in 2008, a funding crisis that questions the quality of U.S. government debt will make everything that came before it look like child’s play with huge additional downside risks to both Real Estate and Equity markets. For now, the sun is still shining on the equity markets, but at these levels the equity markets are fully priced for a reasonable recovery, and if the months ahead show more dismal news and an economic relapse, then the equity markets could come under fire all over again. For now, conservative investors should be in a defensive posture and should only be looking to perhaps trade into the market on a set of major oversold conditions, conditions which at the present time have yet to be seen.
That’s all for now,
© 2009 Frank Barbera