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July 19, 2010 Economic Commentary
MARKET MUSINGS & DATA DECIPHERING
Breakfast with Dave
WHILE YOU WERE SLEEPING It really is a mixed bag to start off the week. Global investors are clearly taking a punt on the upcoming European stress tests as the region’s equity market is up fractionally thus far; as is the euro, which has rebounded 10% from the four-year lows posted in May (have a look at Currency Investors Reassess Assumptions on page C2 of the WSJ). Following Portugal’s downgrade last week, Ireland was cut by Moody’s today to Aa2 from Aa1. Moreover, Hungary’s failure to come to fiscal terms with the IMF and EU should start to renew concerns over Eurozone exposure to the struggling eastern European countries. Alas, the markets are managing to shrug off this news, apparently taking comfort in the recent successful debt auction in Spain. Meanwhile, Asian equity markets, which are far more cyclical, remain under selling pressure (down 0.9% today — worst drubbing in two weeks), as are commodities with oil riding a four-day losing streak. The resource-based currencies are softer as well. On the economic data front, it’s pretty sparse with only the Rightmove data confirming that U.K. home prices are rolling over yet again (down 0.6% in July — first decline this year). We also see that in the U.S.A., the FDIC had a busy weekend, shuttering six banks — bringing the year-to-date tally to 96 (on track for the most in 18 years). And, if there is one area of the U.S. economy that is sure to keep the recovery under wraps, it is the state and local government sphere (see A3 of the WSJ — Strapped Cities Rent Police, Janitors). We can’t help but think of last week’s front cover of Barron’s when we see this article — Fall in Treasury Yields Poised to Continue. That Barron’s cover read “Beware Bond Funds”, which really was the kiss of death for the litany of bond bears out there. Recall that Barron’s also ran with Double Dip, Hell No! on March 22nd, The Economy May Be Better Than You Think on October 20, 2008, Buy Banks—Selectively on July 21, 2008, and of course, Buy GM on the June 2, 2008 front cover — about why GM's share price could nearly triple — it was a great contrarian signal to actually run for cover! There’s quite a bit for investors to chew on this week. Over and beyond the heat of the earnings reporting season (Big Blue today), we have a few housing reports (National Association of Home Builders house price index today, housing starts tomorrow, and existing home sales on Thursday), the BoC’s policy meeting on Tuesday, Bernanke’s semiannual Congressional testimony on Wednesday and the ballyhooed made-to-pass European bank stress tests on Friday (the release may be after the market closes). The German Ifo report on Friday will serve as a critical test for just how well the Eurozone economy is holding up (some of the recent production data have been surprisingly firm). IN THIS ISSUE • While you were sleeping: a mixed bag to start off the week — markets in Europe are rallying ahead of the bank stress tests results; Asian markets remain under selling pressure • What a roller coaster! In June, the U.S. equity markets fell to 10-month lows, then it powers ahead for a week, closing gaps along the way, and then, ends up diving once more • Technology now a value sector? • Frugality hits the big-wigs • Deflation pressures intact: shipping rates have collapsed nearly 60% since May • Disinflation momentum intact: in another rare development, CPI down three months in a row • Pricing power in the retail segments of the CPI report — the good and the bad • UofM consumer sentiment index: Sediment or Sentiment? • Double-dip … What flavour? • Main street already seen the double-dip • U.S. housing sector remain in a deep funk • The economy hits a major speed bump • Canadian leading indicators — not as great as the headline imply
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then why is the IMF seeing another $250bln in additional commitments? Page 2 of 12 . the country’s numero uno newspaper. • And. Mattel. bank earnings improvement on the back of lower loan loss provisioning was being treated with glee. closing gaps along the way.) All the more so when a proxy for nominal GDP — G. after failing to break out. But this has certainly become a more discerning market — just having headlines that three in four S&P 500 companies have beaten their estimates are not good enough. the world's largest toymaker. why is the IMF seeking another $250 billion in additional commitments? More bad debts seem to be coming down the pike.3% from year-ago levels.S. the yield on the U. but now investors are demanding that they see signs of top-line growth.’s revenues — was off target and down 4. hardly music to the ears of anyone still long the sector.0% mark and the 5-year note under the 1.. 2-year note sliced to a new all-time low of 57 basis points (this isn't Japan?). with regards to the earnings backdrop. missed on its bottom line and issued cautious guidance over the sales outlook. the 10-year is back well below the 3. and the Basel Committee on Friday also issued a report stating that global banks need a further capital raise . In a sign that a lot of good news is priced in — in sharp contrast to views out there that the market had discounted a double-dip recession – Friday’s negative action (all the 30 Dow stocks closed in the red column!) occurred against a backdrop of “positive spin”. … But we still have to ask the question: if things are as bright as the bulls would have us believe. the National Association of Business Economists continues to forecast There have actually been some positive developments for the markets in recent days… sunny times ahead. Little wonder that even in a week that saw a mountain of supply. WHAT A ROLLER COASTER! After a sharp slide to 10-month lows in June. and then. ends up diving once more. Sanford Bernstein cut Wal-Mart’s sales and profit outlook. also posted a 6% slide in print ad revenue.. Gannett. In a classic reminder that we are in a deflationary environment. (A year ago.July 19. • The earnings season is going as planned thus far • There has been some success in capping the oil spill • Some calm in Europe after the springtime instability • The shift in the public opinion polls towards the right • China’s flexibility on the currency (though the yuan has barely risen) • Obama’s overtures and shift in tone in the mid-East.E. Mr Bond is sending Mr Dow and Mrs Jones a somber message over the odds of double-dip in double-day.7% line for the first time since the recession’s depths 15 months ago. But we still have to ask the question — if things are as bright as the bulls would have us believe. Citi's top-line was crushed 33% and also missed analyst views (BoA's revenues also fell 11% YoY). the stock market then powers ahead for a week. 2010 – BREAKFAST WITH DAVE There have actually been some positives for the markets in recent days and weeks.
and what Mr. The sector has not been this “cheap” in an expanding economy since 1992. to a 15x P/E and 13x on forward earnings (see page 47 of BusinessWeek). For the record.7% during the first half of the month. those once infinite multiples during the dotcom boom have been sharply compressed. But yet. What little we know this far about the third quarter from much of the weekly indicators and regional manufacturing surveys strongly suggests that a further slowing in the pace of economic activity is in motion. On the consumer side. for all the talk of an eventual foreign buyers’ strike. has not been this “cheap” in an expanding economy since 1992 Page 3 of 12 .July 19. The pain trade remains the ongoing rally in the Treasury market. The paper wealth gains in the equity market was the primary cause of this. Market giveth.S. Friday’s slide in the major equity indices in the U. It may well be worth a look. DEFLATION PRESSURES INTACT The Baltic Dry Index has been maligned by the bulls lately — some claim its decline is more a reflection of excess supplies of shipping vessels as opposed to a signal of slowing global growth. See Wealthy Sector of Buying Public is Cutting Back on the front page of the Saturday NYT for an insightful take on the issue. which never really even sold off that much during that short-lived bounce in equity prices. which is a sign that institutional investors are bailing. Indeed. the 10-year yield still managed to rally 43bps on the month. we did in fact see China dump $33 billion of Treasuries in May and even Japan cut its holdings by 1%. the University of Michigan sentiment survey hit an 11-month low in July. confirmed by the 17-month low posted in the IBD/TIPP economic optimism index. FRUGALITY HITS THE BIG WIGS Beyond the sporadic bouts of policy-induced spending growth in the past year. It is abundantly clear that the whippy rally coming off the July 4th holiday was nothing more than a short squeeze — short interest on the NYSE dropped 2.S. 2010 – BREAKFAST WITH DAVE Friday’s slide in the major indexes took them back below their 50-day moving averages and occurred on higher volume — a classic distribution day to close out the week. The reason why the earnings season isn’t generating sustained optimism is because these are backward-looking numbers and the incoming economic data are flashing a serious loss of momentum as the second quarter drew to a close. Go figure — the locals must have been buying at a faster rate than the Asia region was selling! TECHNOLOGY NOW A VALUE SECTOR? From growth to value in a decade. took them back below their 50-day moving averages … and it occurred on higher volume The Technology sector in the U. he is now taking away as confidence among the high-end shopper cohort is beginning to fade. we don't care. what really fuelled whatever consumer recovery we had was due largely to a pickup in outlays by the upper ends of the income strata. Shipping rates have collapses nearly 60% since the peak set back at the end of May and this is a deflationary stand-alone event. Back to the bond market.
• Toy stores are getting killed. This was the steepest decline in a year-and-a-half. to have both of the price measures decline in tandem for three months straight is a 1-in-85 event! in June. Page 4 of 12 .155% and outside of the 1. U. Prices are now down four months in a row.1% dip in June — this sector have not been able to raise prices since April. spot benchmark iron ore prices have plunged 18% in the past three weeks and by 36% since the nearby peak in April.S. the first decline since May 2009. We mentioned above that a three-in-a-row decline in the CPI is a 1-in-40 event. ending a streak of eight monthly increases. To have both of the price measures decline in tandem for three months in a row is a 1-in-85 event! The new normal — a recovery gripped with deflationary impulses. CPI REPORT — THE GOOD AND THE BAD • Grocery stores saw a 0.7% at the turn of the year.4% in June.July 19. And. the headline inflation rate was sliced from 2. -0. • This is NOT good news for FedEx. Construction steel prices are down 17% in China over the past three months too (see page 79 of the Economist). and from 2. and the core crude PPI tumbled 4.2% but this was really +0.1%) — roughly a 1-in-40 event. Moreover. the PPI has done the same.6% falloff in May.S.0% to 1.A. the PPI has done the same and this is a 1-in-25 event. the first decline since February.9% U. delivery service pieces tanked 0. Well. this week). So while the core service sector CPI is no longer trending down — it has stabilized at a record low 0. The core intermediate PPI (which removes the effects of food and energy) fell 0. the core rose 0. On a year-over-year basis.1%.9% — it is the same pace as core CPI right now and if that trend ever reverts to where it was in 2002-03.1%) — roughly a 1-in-40 event… … And. was fully booked • Restaurants have very little pricing power — up 0. See Chinese Economy Shows Signs of Cooling on page 4 of the weekend FT.5%. something is clearly going on here beyond just the supply of freight ships. the long bond yield should drop towards 2. This occurred in the same month that average hourly earnings fell 0. look for further disinflation momentum going forward in the U.1% — itself a 1-in-50 event. consumer prices dropped for a third month in a row in June (-0.S.2% in June.9% in June. PRICING POWER IN RETAIL SEGMENTS OF THE U. 2010 – BREAKFAST WITH DAVE We know that Chinese imports of iron ore and coal fell sharply in June (by 8% and 9% respectively).6%). The year-over-year core CPI rate stayed at 0. The core CPI (which excludes food and energy) did rise 0. nothing exciting • Jewellery prices dipped 0.1% in June. then the core CPI inflation rate will drop to zero and along with that. air fares dropped for the first time since February (-0. • While hotels successfully raised rates (the Montage in L.S.0% jump in tobacco prices.8% — the largest decline since November 2008 — after a 1. here. So. consumer prices dropped for a third month in a row in June (-0.1% in June. DISINFLATION MOMENTUM INTACT In another very rare development.9% — half the pace at the end of 2009.
3% MoM and the fifth month of successful • Clothing stores are passing along price increases too — up 0. the volatility is crushing confidence — along with increasing signs of slowing economic growth. 2010 – BREAKFAST WITH DAVE • Anything in the retail sector that touches the housing market is losing pricing power in a big way: appliances down 0. which was the fifth slippage in a row. • Bookstores posted a nice 0.7% (negative for the fourth month in a row). But several other sectors are successfully raising prices of late: • New car prices edged up 0. Same for auto parts. • Video/audio stores typically see flat to negative pricing. Then. troops began to amass in the mid-East for the eventual war with Iraq (operation Desert Storm). then prior to that. it posted a 0.9% and off in five of the past six months.9% in June and 0. months. but in June. price increases. A 9. the used auto market is booming — up 0. guess what? We endured such a decline in December 1980 when double dip concerns were morphing into reality. hardware/home improvement stores saw a 0.5 in the University of Michigan consumer sentiment for July takes the index back to August 2009 levels.9% in June) • Hospital services — pricing starting to re-accelerate (up 0.July 19.0% annual rate in the fourth quarter of that year.3% price decline.S. up 0. believe it or not. which is the best month since September 2007. best in three months).8% in June on top of the 0. The decline we saw. Even with the bounce-back in the equity market.4% print. And.4% MoM in June.01% to second The dive to 66. SEDIMENT OR SENTIMENT? The dive to 66. now rising for three consecutive months and the 0. when U. at least there is no deflation here. To put this latest dive into perspective it was twice as severe as the decline after the October ‘87 crash — then again.5 point plunge in this indicator does not happen too often — you have to go back to the aftermath of the Lehman collapse in October 2008 and before that in September 2005 after Katrina. you have to go back to August 1990.6% in June. the economy was booming at a 7.2% increase in May. Just awful. was nearly as big as the plunge we saw right after 9/11.1% for the second month in a row. Page 5 of 12 .3% gain in June — now up three of the past four • Admission to movie theatres are now up three months in a row (+0. furniture down 0.5 in the University of Michigan consumer sentiment for July takes the index back to August 2009 levels decimal place). • Hotels are raising rates — up 1.6% in May. • Drug prices at the retail level posted a rare decline in June (-0.4% reading is the best print for the year. And. Even by November 2002 (12months after the recession ended in 2001) consumer sentiment was at 84.
down from -9. which is the part of the report that tends to lead consumer spending.July 19. 2010 – BREAKFAST WITH DAVE As an aside.S. and in expansions.3. This was the tenth deterioration in a row and the growth index is now negative for six straight weeks. Let’s talk about what is normal and what is not. We have never failed to have a recession with the ECRI at current levels but there is also inherent volatility in the index that requires acknowledgment. the index averages out to be 73.8% during the week ending July 9.75% at an annual rate in the second half of the year on spending. the “expectations” component.. is now pointing to a visible slowing of 0.6. What is it that these economists and strategists don’t see? Page 6 of 12 . now at -9. What is normal is that at this stage of the cycle.1% the prior week 1 0 0 -10 -20 -30 7 0 75 80 85 90 9 5 00 05 10 Shaded region represent periods of U.50.1% the prior week. now at -9. and has undercut the “recovery low” of 63. down from -9. to 60. Buying conditions (for large household goods) sank to an eightmonth low of 120 from 139. In recessions.2 points. Our reckoning is that in the past few weeks.8% during the week ending July 9.9. Gluskin Sheff All we hear from in the mainstream economics community is that double-dip recessions are out of the question because they are “extremely rare” events. This metric dropped 9. It may take a while. recession Source: Haver Analytics. Could it be that we are still in a recession? DOUBLE DIP . WHAT FLAVOUR? The growth rate on the ECRI leading index did it again! It sank further into negative terrain. Today we sit at 66.8..2 and down to levels last seen in March 2009 when the economy was knee-deep in recession. the UofM sentiment index is sitting at 89.5. Market will figure it out before long. The double-dip deniers say that this only happened in 1982 because of the renewed sharp tightening by the Fed (as if we aren’t going to see a sharp fiscal withdrawal this time around to take its place). on average. a year into a supposed recovery. CHART 1: ECRI POINTING TO CLEAR HARD LANDING United States: ECRI Weekly Leading Index Growth Rate (percent) 3 0 2 0 The growth rate on the ECRI leading index did it again! It sank further into negative terrain. it is usually already sitting at 90. but Mr. Auto buying plans dropped to 129 from 139 — the lowest since last February. the index has gone from pricing in even-odds of a double-dip to two-in-three odds.
The growth rate on the ECRI weekly leading index is currently at -9.July 19. Relying on indicators that have been useful in previous post-WW2 recessions is like comparing the statistics of U.. Industrials Bottom S&P 500 Sectors: Materials. Cons. Utilities Canada S&P/TSX: 4.4% Top S&P 500 Sectors: Energy.9% CAD: 0.4% VIX index: -1. Cons. The past 24 months have given us a lifetime of “extremely rare” events. expansion of private credit. Health Care Canada S&P/TSX: 8. but they did this time!). Discretionary. Discretionary. football teams versus the statistics of Australian football teams. Utilities. a record-high duration of unemployment. so the “extremely rare” would be things like.7% CAD: -3. these are only “rare” from the perspective of an analyst that sees the past 24 months as a typical post-WW2 recession. but as we suggested last week.2% Credit Baa spreads narrows by 34bps.3% VIX index: 17.8% Top S&P 500 Sectors: Financials.S. negative operating earnings. The economy is one sick puppy and we are seeing first hand now what it looks like once the crutch of government support is taken away. Cons. Materials. Tech.2% VIX index: -12. Materials Bottom S&P 500 Sectors: Telecom. Health Care Bottom S&P 500 Sectors: Cons.. Industrials.3% Phase III — Slowdown VIX index: 25. Industrials Bottom S&P 500 Sectors: Telecom.7% Credit Baa spreads widen by 60bps.1% Top S&P 500 Sectors: Tech.0% CAD: 3. Tech Canada S&P/TSX: -2. these extreme events are the norm. High-yield spreads widen by nearly 100bps Phase I — Post-Recession (trough to zero) Credit Baa spreads narrows by 37bps. High-yield spreads widen by 13bps United States S&P 500: -6.8% (peak back to zero) Top S&P 500 Sectors: Telecom. Discretionary. Utilities.8% CAD: 1. They may be called the same thing but they are different sports. In a balance sheet recession.8% United States S&P 500: +1. 2010 – BREAKFAST WITH DAVE These “extremely rare” events have been the norm for the past 24 months: negative nominal GDP growth. Energy Canada S&P/TSX: 14.8% Source: Haver Analytics.9% Credit Baa spreads tighten 11bps. Staples. strong inflationary pressures. a massive contraction in credit. High-yield spreads narrows by over 200bps Phase IV — Recession (zero to trough) Bolded quadrant represent the phase we are currently in. Gluskin Sheff Page 7 of 12 . rapidly declining unemployment and rising interest rates. High-yield spreads narrows by over 150bps United States S&P 500: 12. CHART 2: THE ECRI LEADING INDEX AS AN INVESTMENT TOOL United States: ECRI Weekly Leading Indicator: Growth Rate Phase II — Boom (zero to the peak) United States S&P 500: 22. a 30% slide in home prices (these same economists — Bernanke too — were telling everyone that home prices never deflate over a 12month time span .
0% -10.3 0. but it would be far. Only 43% see things getting “better” in the next year (ostensibly Wall Street economists weren't counted in the poll).July 19. HOUSING SECTOR REMAINS IN A DEEP FUNK Banks repossessed a record number of U. President Obama's approval rating among independents is all the way down to 37% (from 58% in early 2009). more than 3 million homeowners will receive at least one foreclosure notice (oh. up 5% sequentially and 38% from a year ago (RealtyTrac data). The banks took over 269.0% to 10.9 4.962 properties.000 homes — they are on now track for over a million in 2010! And. versus 38% rating it as “fair” and a mere 8% said the macro backdrop was “good”.0% to -10.6 10. banks repossess 100.S. far worse without HAMP. What really caught our eye was the 67% who are “opposed” to more government stimulus — only 24% are in “favour” of more support from Uncle Sam (obviously to Paul Krugman's chagrin). REAL GDP AVERAGES ONLY 0. In a normal year. 2010 – BREAKFAST WITH DAVE CHART 3: TWO QUARTERS FOLLOWING A MOVE IN ECRI INTO A RANGE BETWEEN -5% TO -10%.8% United States: Average Real GDP Growth Rate Two Quarters Following Various Ranges in the ECRI Leading Index (percent change at an annual rate) 4. homes in the second quarter.0% and over 5. Ricardian Equivalence is likely setting in (the laws of diminishing returns as it pertains to fiscal policy). right?). this means that fewer and fewer Americans believe the interventions are working and as such.5 1.0% -5. so the headline news of slower foreclosure notices was a bit misleading. Therefore. but a Time poll that was just published showed that 52% of the public believe the economy is in “poor” shape. In the meantime. Page 8 of 12 .3 3.0% To Zero Zero to -5.0% 5.8 -0. Gluskin Sheff MAIN STREET ALREADY SEEN THE DOUBLE DIP It may be hard to believe following all the rampant government stimulus.0% and Over ECRI Weekly Leading Index Growth Rate Range Source: Haver Analytics. the Democrats are starting to show some signs of desperation as the polls are now showing that both the House and Senate are up for grabs this coming November (see Headwind is Stiffer and the Hill is Steeper for Democrats on page 3 of the FT).
• Motor vehicle production sagged 14.5%.8% YoY in the steepest downtrend since November 21.I.8 from 55. • Retail sales fell 0.8% and is down to for three of the past four weeks – lowest level since January 9. (including intermodal) collapsed 13.2 in June from 59. • The NAHB homebuilding sentiment index dropped to a four-month low of 17 from 22. • ISM fell to 56. This all follows a very bad May and June … so what we have is a downtrend in the making. • The NFIB small business sentiment index sagged from 99.P. it may be reasonable to assume that S. • Railway carloadings in the U.7 to 52. the low-water mark for the year • The non-manufacturing index fell to 53.4% in June for the sharpest decline since May 2009.9% to their lowest level since January 9th.S.0. likely for years. the shadow bank inventory will inevitably flow into the market and continue to depress real estate prices .9. a four-month low. not a blip. It’s an unmitigated disaster.4.. cut consider the most up-to-date data for the second week of July: • Bank credit contracted at a 7% annual rate. has now been north of 300.1%.S.7.000 for sixteen months in a row.R. 2010 – BREAKFAST WITH DAVE So. Double-dip odds are clearly not zero. 2009. • Mortgage applications for new home purchase fell 3. the second decline in a row..000 after a 35. • Manufacturing output fell 0. the fourth straight The level of foreclosure filings in the U. Based on these trends. • The Conference Board’s measure of consumer confidence collapsed from 62. • Household employment fell 301. And. to a new 14-year low. but it’s not the change but the continued astronomical levels that is the real story — north of 300.July 19. Page 9 of 12 .000 decline in May. 2009. • ABC consumer confidence slipped to a four-week low of -44 from -42. THE ECONOMY HITS A MAJOR SPEED BUMP We will get to the monthly data in a moment.7% and is down three weeks in a row to a three-month low.2 to 89. • Raw steel production slipped 1. the headlines last week read that foreclosure filings were down 7% YoY.000 for 16-months in a row decline. – safety and income at a reasonable price – is pretty prudent portfolio to pursue. • Coal production fell 4.
We continue to believe that second quarter GDP will line up on the soft side. what the news headlines and some analysts missed. The headline seemed great. with the housing index slowed dramatically. especially given how dramatically the housing market has slowed over the past five months. Page 10 of 12 . There are definite cracks in the housing market. What will be key for BoC policy going forward is how the second half of the year shapes up – and early glimpses of data suggest a considerable loss of momentum. the largest decline since March 2009. is that the unsmoothed index (much more of a real-time indicator in our opinion) was very weak. On this basis. with a 1. the market remains nearly fully priced for a 25bps BoC interest rate hike this week and all 12 primary dealers are also calling for a hike. The big caveat to this data is that they are reported on a smoothed basis (using a five-month average). which is weaker than current consensus estimates. painting a much softer picture of the economic growth then the cheerful headlines. furniture and appliances sales. with eight of 10 increasing on the month. In fact. new orders. the June index fell 0. beating expectations and the upward revisions to the May/April data added to the strength. Last week’s leading indicators data were case in point. 2010 – BREAKFAST WITH DAVE CANADIAN LEADING INDICATORS – NOT AS GREAT AS HEADLINES IMPLY While the Canadian economic data has turned a bit mixed lately. and manufacturing finished products were all down. housing index.0% MoM gain June.6% MoM. durables goods. at under 3%. Components were strong as well.July 19. from over 50% YoY early this year to just 6%. The decline was broad-based with seven of the 10 components falling and six of these were ‘real economy’ components — manufacturing hours. so it’s not really a real-time indicator.
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