Posts filed under “Think Tank”

Confidence, Housing, and Unemployment are All Intertwined

Good Evening: An unexpected drop in consumer confidence today spoiled what investors had hoped would be a rousing finish to an otherwise strong second quarter for U.S. capital markets. Other data points, including those in the all important housing sector, were mixed. How confidence, home prices, mortgage delinquencies, unemployment, and the financial markets interact in the coming months may decide whether the highly touted green shoots take root or whither. And this process will, in turn, affect investor attitudes toward the state of our nation’s financing needs during the second half of 2009. It might turn out that Great Britain’s fate in dealing with a similar set of circumstances will prove to be one of either helpful guidance or cautionary tale.

With end of Q2 party hats affixed, U.S. stock market participants pushed share prices above yesterday’s highs in the early going this morning. Both the Chicago PMI figures and Case-Shiller home price survey results were largely non events when compared to expectations, but the smaller home price drop did cause none other than Robert Shiller himself to sit up and take notice. “At this point, people are thinking the fall is over,” Shiller, co-founder of the home price index that bears his name, said in a Bloomberg Radio interview today. “The market is predicting the declines are over.” (source: Bloomberg article below)

Perhaps the month over month price gains seen in 8 of the 20 cities fueled some of this optimism, as did word late last week that Citi and JP Morgan were beginning to expand their lending to seekers of jumbo mortgages (see below). Slowing price declines and more loan availability at the previously credit starved high end would be welcome news indeed, particularly for U.S. banks and holders of RMBS. It will be a race against time, however, as another story today indicated that the delinquency rate for high quality, prime mortgages doubled to more than 2% in the latest reporting period (see below). As the unemployment rate approaches 10% (we will see June numbers on Thursday), and as at least another 10% of the workforce fears becoming part of those grim statistics, housing might continue to be a source of drag on our economy. How these factors interact and create various feedback loops will be crucial. It might just come down to the critical variable of confidence.


Unfortunately, at least as the Conference Board measures it, consumer confidence was a definite disappointment (see BAC-Merrill’s take below). The whole green shoots theory rests not upon the economic data getting better, only that it gets worse at an ever slower rate. Coming in at 49.3 in June versus expectations as high as 57, the Conference Board’s reading was an incontrovertible step backwards. It is easy to make too much of any one data release, but investors immediately registered their disappointment with this lynchpin indicator by selling equities.

The major averages gave back their early gains and didn’t stop going down until they were off between 1% and 2% as the lunch hour approached. Stocks then settled into a summer-like sideways range for the rest of the session. Both NASDAQ and the Russell 2000 held in relatively well, as did defensive stocks. Risk aversion wasn’t exactly an overwhelming theme, but it was a persistent one. A small rally during the final hour was cut short at the closing bell, leaving the averages down between 0.5% (NAS, RUT) and 1% (Dow, S&P). Treasurys had been down when the confidence data hit the tape, and they recovered to finish with modest losses. Yields were up by 2 to 6 bps as the curve steepened a bit. The dollar benefited from a negative story about the state of finances in the U.K. (more on this below), and the U.S. dollar index advanced 0.4%. This uptick in the greenback didn’t help commodities, but a bearish crop report for corn, wheat, and soybeans was even less helpful. Energy prices also declined, leaving the CRB index the worse for wear by almost 2%.

Today’s market action may or may not have been truly meaningful in terms of future market direction, but there may have been something else bothering Mr. Market other than just a decline in consumer confidence. The final story you see below had some impact today, at least in terms of hurting the British pound. Called the “cable” on dealer desks, the British pound sterling looked a bit frayed by day’s end, and it seems as if the deteriorating finances of the U.K. government are to blame. The overextension of credit during the boom years by eager banks for everything from real estate, to hedge funds, to LBOs left the large British financial institutions in a spot of bother. Showing that dumb lending and clumsy bailouts know no borders, London and New York share more than just a common ocean. In finance, they share the same leveraged language.

The results have been similar, too, as the U.K. just issued its worst GDP report card since 1958. Its propped up banks are struggling to delever, Gilt issuance has soared, and the Bank of England’s version of quantitative easing has created more paper than all the goats in Scotland could consume. According to former Chancellor of the Exchequer, Nigel Lawson, the “solution” of debt issuance is more harm than cure. “The amount of borrowing the government will have to do as a result of the deficit is very worrying.” He says yields on U.K. debt will have to climb to attract buyers. “Bond investors have real doubts about the fiscal stability of the U.K., and they want some kind of risk premium,” he says. (source: Bloomberg article below).

U.S. investors might be tempted to write this story off as “just a problem in Britain”, but we might be headed down a similar path if we don’t soon get our own fiscal house in order. Team Obama agrees that our great nation faces structural deficits that demand attention, but the current order of business is to spend a ton of money now in the hope we can recoup it through stronger growth, lower healthcare costs, and a green energy industry that will have the world beating a path to our door. It had better work — and fairly soon — because we’re attempting to impose massive changes in the middle of a recession. Which takes us full circle back to the interplay between confidence, home prices, mortgage delinquencies, unemployment, and the financial markets.

Today’s consumer confidence reading may actually be meaningful, as will Friday’s nonfarm payroll figures. If unemployment continues to worsen, then mortgage delinquencies among even decent borrowers will continue to rise, putting further pressure on home prices. It could further harm confidence and create a feedback loop that prevents economic growth from gaining a foothold. In such an environment, tax revenues won’t grow, but deficits will, and the whole bill will go on the global credit card known as Treasury auctions. If, like the Bank of England, the Fed feels the need to buy government debt and monetize it, then we’ll just be begging for a currency and/or funding crisis down the road. It’s not a pretty picture; just ask Great Britain. Housing, consumer confidence, and unemployment — these numbers will be particularly important data not only this week, but in the months ahead as well.

– Jack McHugh

U.S. Stocks Decline, Trimming S&P 500’s Best Quarter Since ‘98
Yale’s Shiller Sees ‘Improvement’ in Rate of Home-Price Decline
JPMorgan, Citigroup Expand in ‘Jumbo’ Home Mortgages
Delinquencies Double on Least-Risky Mortgages, U.S. Report Says
Sterling Crisis Looms as U.K. Unraveling Points to Budget Cuts
Confidence drops.pdf

Category: Markets, Think Tank

Consider the components of equity returns

Consider the components of equity returns The raison d’être of investment or wealth management is to maintain, or hopefully improve, one’s standard of living, i.e. to earn a real return on the investment amount. This sounds easy enough if one considers that the S&P 500 Index (and its predecessors prior to 1957) delivered a nominal…Read More

Category: Think Tank

Fed President Bullard on exit strategies

Fed President Bullard is giving a speech on exit strategies for the Fed and begins by saying “monetary policy is very accommodative now…It will remain very accommodative for an extended period…This is appropriate, given low inflation and weak economic conditions.” He believes the liquidity facilities that are in place should “wind down naturally” as they…Read More

Category: MacroNotes

Consumer Confidence and the Chicago PMI

Consumer Confidence was 6 points less than expected at 49.3 and down from 54.8 in May as both the Present Situation and Expectations components fell. The overall # is still about twice the lows of Feb but the improvement has been almost solely due to Expectations. This # has risen to 65.5 from 27.3 in…Read More

Category: MacroNotes

Gasoline prices

With just days ahead of the July 4th long weekend, the average price of a gallon of gasoline, as of yesterday, has fallen for 8 straight days and is down .06 to $2.633 during this span according to AAA. This follows 54 straight days of gains that took prices to $2.693 from $2.048 (and up…Read More

Category: MacroNotes

Case/Shiller HPI

The April S&P/CaseShiller 20 city home price index fell 18.12% y/o/y but was better than the forecasted drop of a fall of 18.63%. It’s the smallest rate of decline since Oct ’08. The fall off the high in July ’06 is now 32.6% up from 32.2% in March. All 20 cities still have y/o/y drops…Read More

Category: MacroNotes

Jim Welsh: June Letter



In February I thought the stock market was on the cusp of the largest rally since the bear market began in October 2007, and that it would be ignited by economic statistics showing that the rate of decline in the economy was getting less bad. I thought the optimists would jump to the conclusion that less bad equaled recovery. Despite this expectation, the shift in psychology regarding the economy’s prospects has been remarkable. Four months ago, investors felt they were staring into an economic abyss deeper than the cosmic void. When the first series of less bad statistics suggested the economic hole was only as deep as the Grand Canyon, the sense of relief was palpable. Within weeks the phrase ‘green shoots’ was included in every serious discussion about the economy. Virtually over night any economist worth their salt had become a gardener. Initially, a few brave economists ventured that the economy might turn up in the first half of 2010. As additional stats in April and May improved from being extraordinarily bad to simply just awful, the notion that the recovery might begin before the end of 2009 took root. And after the Labor Department reported that only 345,000 jobs were lost in May, confidence that a V-shaped recovery blossomed. By mid June, conviction that a V-shaped recovery was so high the Federal funds futures were pricing a 70% probability that the Federal Reserve would raise rates in November. Green shoots had grown into mighty oaks in a matter of weeks. Who says economists don’t know a thing or two about hydroponic gardening?

As discussed in the April and May letters, GDP will likely be positive in the fourth quarter, and maybe in the third quarter. As noted, most of the improvement will be statistical nonsense. In the first quarter, business slashed inventories, which sliced 2.8% from GDP. With sales stabilizing and likely to improve as fiscal stimulus lifts demand, companies will increase production to restock their inventories. This will cause the inventory component within GDP to swing from deeply negative to a slight positive. The wholesale inventory-to-sales ratio jumped from 1.09 months in June 2008 to 1.34 in January. In April, it dipped to 1.31 months, so it is still fairly high, and suggests sales will have to improve more before companies will actually need to increase production. The large decline in exports lowered first quarter GDP by -4%. This drag on GDP will moderate as the global economy helps U.S. export volume to be less bad in coming quarters.

By the end of 2009, the bar chart of GDP will show how the economy plunged from a growth rate of 2.8% in the second quarter of 2008 to a negative 6.1% in the fourth quarter, before reviving into positive territory again. It sure will look like a V-shaped recovery. For those economists who didn’t see the deepest recession since the depression coming, or grossly underestimated its depth, the V will
also mean Vindication. For politicians, the V will be heralded as a Victory of policy. In lieu of a parade, the electorate will endure weeks (months?) of chest thumping and back slapping. A few ingrates will question whether spending trillions of dollars we don’t have actually qualifies as ‘policy’. But as they say, you can’t please everyone, even when you’re dolling out trillions.

The stock market has rallied smartly since its low in March, as have a number of commodities. The V-shaped recovery crowd has been quick to point out that since markets look ahead six to nine months, the run up in stock prices and oil are telling us a real recovery is afoot. In recent weeks, I’ve heard at least one expert every day make this statement on CNBC or Bloomberg. And every day I hope the television anchor will ask the expert a couple of simple questions. “If the stock market is so good at looking forward six to nine months, what was the S&P telling you about the credit crisis in October 2007 as it made an all-time high? When crude oil sold for $147 a barrel in July 2008, what was it telling you about global demand? And given how wrong the stock market and oil market were, why are you so sure now that they are sending the correct message?” Like Don Quixote, believing markets possess a paranormal clairvoyance adds a bit of mystery, even romanticism to the mundane task of tracking daily fluctuations in prices. The truth is far more straight forward, and absolutely impersonal. At every top and bottom, the market is always wrong.

According to the International Energy Agency, there was enough oil in storage at the end of March to satisfy 62.4 days of demand, 14.7% more than a year ago. Last week, the IEA said global inventories in OECD countries jumped 10.4 million barrels in April and another 30.5 million barrels in May. In the first quarter, OECD countries accounted for 55% of global oil demand, while China accounted for 9%. According to Reuters, Chinese crude-oil demand rose 3.9% in April over the previous year, but demand was down almost 2% in the OECD countries. Since OECD consumption is 6 times larger than Chinese demand, total global demand is falling. GaveKal estimates commercial crude oil inventories are six billion barrels. With oil around $70 a barrel, that represents more than $400 billion of working capital tied up in holding onto all that oil. With prices rising, holding inventories is easy. But if prices crack, some of the excess inventory will be sold into a falling market.

Oil prices have risen from $34 a barrel to $72 on the growing perception of a V-shaped recovery and the decline in the dollar. When the dollar topped in early March, crude oil was $45 a barrel. Oil has run up from $50 to $72 since late April, as the dollar index fell from 87 to below 79 in early June. After peaking in July last year, crude oil collapsed, as the dollar rallied 25% between July and November. This suggests any decent rally in the dollar will trigger a decline in oil prices that could be fairly sharp since the underpinnings of oil demand are so weak.

In order for the V-shaped recovery in GDP to become a self sustaining economic expansion, private demand will need to be strong enough to carry the economy forward, after fiscal stimulus has run its course. Since the consumer represents 70% of GDP, most of the heavy lifting will be dependent on consumer spending. Obviously, the primary driver behind consumer spending is job growth, which is not going to improve for a long time. The Labor Department reported that 345,000 jobs were lost in May, after adding 220,000 jobs based on their Birth/Death adjustment model. In other words, the real number of jobs lost in May was near 565,000, or worse. From January through May, the average monthly job losses reported by the Labor Department were 584,000. If the faulty B/D model adjustment is excluded, monthly job losses averaged 652,000. On the surface, the 345,000 figure is 41% below the 584,000 five month reported average, which is a noticeable improvement. However, the improvement is only 13%, if the B/D adjustment is excluded (565,000 vs. 652,000). In May, nearly 25 million (16.4%) Americans were either unemployed, underemployed, or had given up looking for a job. The average work week for those with a job fell to a record low 33.1 hours. In the last year, average weekly earnings rose just 1.2%.

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Category: Markets, Think Tank

Are we there yet? Yes kids, in about 8 hours

Are we there yet? Yes kids, in about 8 hours. The S&P 500 will see its first quarterly gain since Q3 ’07, a streak of 6 negative quarters in a row, the longest since 1969-1970 and its on track for the best quarterly performance since Q4 1998. Overseas markets have similar stats with Japan in…Read More

Category: MacroNotes

2008, 2009, and the Madoff Legacy

Good Evening: In an attempt to finish a strong second quarter on a high note, investors began this holiday-shortened week by pushing stocks, bonds, and commodities higher today. Ex the Madoff sentencing and another rally in crude oil, market participants focused their waning attention spans on word from China that it was unlikely to radically…Read More

Category: Markets, Think Tank

The King Report: China’s Reserve Currency

> China called for a new reserve currency, again. This killed the dollar, again. One can assume that China is unhappy with Bernanke and the status quo FOMC Communiqué. Income increased 0.3% due to tax rebates and increased entitlements, including unemployment pay. Most economists and pundits trumpeted the income gains as sign of economic recovery,…Read More

Category: Currency, Think Tank