(I just posted this commentary on the WesCorp website. Thought I would use it here as well. It’s interesting to watch these new bubbles developing. Make that interesting and scary. I have other comments I’ll add over the next few days. )
The stock market’s rally in September has sent a strong message to the masses – “It’s not the economy, stupid!” Most economic statistics took at least a moderate turn for the worse over the past month. The total weight of evidence is indicating this so-called recovery we’re in the midst of could turn out to be either very weak, very short, or both. Yet despite the news, bullish stock market traders and pundits found a way to turn things around. The most glaring example of this was the horrific Unemployment Report released on Friday, October 2. The Dow closed lower by a whopping 20 points the day of the release but rallied 260 points in the next two days. Half of that rally was supposedly based on a 25 basis point interest rate increase by Australia’s Central Bank. So stocks barely move on a monthly U.S. job loss of 263,000 but rally 130 points on a .25% rate increase in Australia? This is just one example of how Wall Street has decided to ignore economic red flags in order to keep stock prices moving higher.
Another Downward Spiral Ahead?
After declining by only 216,000 in August, economists were expecting the improvement in Nonfarm Payrolls to continue in September. The estimate was for a job loss of 175,000. Instead we got a job loss of 263,000, and that was the good news. The report got worse from there. The average workweek (a key leading indicator for jobs) fell back to the post WW II low of 33.0 hours after appearing to have turned the corner. Payrolls of temporary workers (another leading indicator) fell again. I had expected by this time that perhaps the construction and manufacturing industries would have fired enough people to be down to base levels. But, alas, those sectors each managed to find yet another 50,000+ workers to fire.
The Unemployment Rate rose to 9.8%, despite another huge fall in the labor pool. Wall Street continues to say a “jobless recovery” is normal in the early stages, and the Unemployment Rate typically does rise just after the end of a recession. But the reason the labor pool grows is because “discouraged workers” and others who declared themselves out of the labor pool are encouraged enough to return to job-seeking. That’s not what is happening this time as the overall participation rate in the labor pool is the lowest since 1986, and the labor pool has continued to shrink.
The Bureau of Labor Statistics (BLS) wasn’t done there. They also issued the estimate of annual benchmark revisions. They do this once a year for a one-year period dating back eighteen months. This period was for March 2008 to March 2009. This is when the BLS tells us how much they screwed up reporting Nonfarm Payroll numbers for that time period. The BLS reported a staggering undercount of job losses of 824,000. This is likely due to their erroneous birth/death adjustments for new businesses. The BLS model continued to show job growth in this category despite the recession. It was clear to all but the brain-dead that the BLS was understating job losses. But those birth/death adjustments didn’t stop in March of this year. The BLS has continued to use the same modeling assumptions and has continued to report phantom job growth in that category. As bad as the job losses have been since March, it’s a safe bet that they have been understated by at least 400,000 jobs. When you add this whole mess up, you come up with total Nonfarm Payroll losses officially over 8,000,000 since the beginning of 2008.
As for as the outlook for jobs, I still hope my whole theory of “running out of people to fire” plays out, but I feel we’re in a similar spot as we were in 2008. In mid-2008, monthly payrolls were declining by about 50k per month and the Unemployment Rate had moved up to 6%. Based on some of the leading indicators in the job report I said I thought the Unemployment Rate would move to 8-9%. But I also wrote and warned in presentations the risk was for a spiral in job losses. Unfortunately that risk was realized, not my “optimistic” forecast.
After some leveling off in job losses the last few months, I think we’re in the same spot we were a year ago. The leading indicators and internals in the jobs report have worsened. Additionally, we have to worry what happens during and after the Christmas season. Retailers’ expectations aren’t high, and they won’t be disappointed with a very small decline in sales. A significant shortfall in sales would likely trigger another scale down in operations for retailers and suppliers. This is what happened last year. Retailers were concerned about sales going into the season. During the season they and their suppliers, knowing the consumer was in full retreat, set off on an intense job-cutting spree (over 600k cuts per month November through March). At the end of 2008, I had to boost my top end forecast for the Unemployment Rate to 9-10%. Then by March I stepped it up to 10-11%. The risk is growing that the belt loop might have be moved one more notch higher.
You’ve probably read that adding in discouraged workers and full-timers forced into part-time jobs, we have a true Unemployment Rate of 17%. While technically we are out of the recession for at least one quarter, we are not out woods on the economy. But we are actually very fortunate in one important way. The only thing missing in this environment is newspaper front page pictures of people standing in breadlines ala the Great Depression photos. And the only reason we’re not seeing those photos is the broad safety net of unemployment benefits in place now unlike in the Great Depression. In the Great Depression, the Unemployment Rate was estimated at 25% for much of the time. At 17% we’re not that far away. Without the safety net we have now we would have pictures of breadlines on our front pages. Where do you think the stock market would be if that happened? It’s time to face the facts that until further notice, the only thing our system has going for it is government support. You might not like it, but it’s all we have now.
Whether liberal or conservative, no one is happy or unconcerned with the huge deficit growth we’re experiencing. We all know that we’re piling debt on top of debt for future generations. Unfortunately, until the job market recovers that’s likely to continue. Wall Street keeps telling us that job growth doesn’t really matter. I beg to differ. It matters in many ways.
The Power of Zero
Last month I brought up the potential of the real inflation to fear was inflation in asset prices, or new bubbles in other words. Low rates, or the power of zero as I call it, are making this all possible again. Of course our stock market seems overvalued, but it has a ways to go to reach bubble status. Still it bears watching. But it’s more than stocks. Since late April the Dow has rallied almost 2,000 points. Yet treasury rates are currently at the same levels prevailing in April. Some of that is due to the fact some very large money managers believe that deflation will ultimately win out, but much of it is simple due to the power of zero.
Banks are adding to their treasury portfolios at a record pace. While there is no credit risk there is interest rate risk. But banks aren’t alone, leveraged players around the globe have returned to playing the yield curve in leveraged transactions.
More aggressive managers have foregone buying lower-yielding treasury securities and have been buying more distressed assets, our friends the “toxic assets.” It was clear that at least through March of this year, many mortgage-related securities were being grossly undervalued due to the lack of demand in the market. That’s when the Treasury stepped in with the PIPP program designed to buy toxic assets off of bank balance sheets. You might recall at the time that the goal of the Treasury was to have the program up and running by July of this year with the eventual goal of buying up to $1 trillion in toxic assets. The Treasury has just announced that some of the partnerships are finally in place after a three-month delay. Based on the capital received, the total potential purchases of these partnerships are $12 billion. That’s quite a shortfall from $1 trillion. There are a number of reasons why this program can be labeled a failure, but maybe it should just be labeled as unnecessary instead.
Since the time the program was announced there has been a dramatic improvement in the market prices of some of these “toxic assets.” Clearly there are exceptions. Securities originally rated below AA and those already taking losses aren’t improving. But some of the grossly undervalued one-time AAA securities have soared in value. As an example, the price on one particular AAA went from 30 to 70. Those partners for the Treasury PIPP program have seen potential returns plummet, and banks are in no rush to sell any asset rising in price regardless.
The PIPP story is emblematic of the major turnaround we’re seeing in distressed asset values. That sounds like a good story until you consider that the actual underlying performance of the mortgages is deteriorating at an ever-increasing pace for most mortgage types. At WesCorp, we can attest that mortgage pipeline characteristics have not improved. Yet the power of zero is helping to drive demand for the most risky of assets as well as treasuries. Another debt bubble debacle is in the making.
In last month’s epistle I wrote that I felt the Bernanke Fed would be unwilling to risk sending a message to the markets that the Fed would act against dangerous bubbles. I still believe that, but we might have seen some glimmer of hope on that front. At least three Fed officials have recently stated that the Fed might need to start tightening before it was obvious, meaning before the Unemployment Rate declined. While they stopped short of stating this might be necessary due to asset bubbles, I think the implications were strong. This is still Bernanke’s Fed, but at some point in time a divided Fed could emerge.
Bernanke has resisted this whole line of fighting asset bubbles saying the Fed could not necessarily identify a developing asset bubble. To that, Mr. Bernanke, I say – something I can’t say here. Bernanke apparently believes the Fed can identify the dangers of inflation in the Consumer Price Index, which has multiple inputs and components, but they can’t discern an unsustainable surge in the price of a single asset class. Doesn’t add up to me.
I’m not ready for the Fed to tighten just yet, although it would be fun to watch the reaction in the marketplace. It would be hilarious watching all the color drain from Jim Cramer’s face. But the further that asset market values get out of alignment with the realities of a weak, job-starved economy, the more we might need to Fed to fire a warning shot. They don’t need to raise interest rates. They can just shut down some lending facilities (mostly unneeded now anyway), change reserve requirements, force margin changes on secured lending, or just increase the margin requirement on stock borrowings. Go after the banker-speculator where he lives. We can’t stomach Lehman II.
Dwight Johnston
