As usual, some terrific points from the man who was far too smart for Merrill Lynch. We are also glad that Rosie caught our observation over the weekend that securitized loans have plummeted by trillions recently: easily the single biggest argument for QE2.
From Breakfast with David:
YOU KNOW YOU ARE IN A DEPRESSION WHEN ...
Congress moved to extend jobless benefits seven times, as has been the case over the past two years, at a time when almost half of the ranks of the unemployed have been looking for at least a half year.
The unemployment rate for adult males (25-54 years) hit a post-WWII this cycle and is still above the 1982 recession peak, and the youth unemployment rate is stuck near 25%. These developments will have profound long-term consequences – social, economic and political.
The fiscal costs of the depression continue to mount, with the White House on Friday raising its deficit projection for 2011 to $1.4 trillion from $1.267 trillion. That gap in the forecast – $133 billion – was close to the size of the entire budget deficit back in 2002. Amazing.
You also know it is a depression when you find out on the weekend that the FDIC seized and shuttered another seven banks, making it 103 closures for the year. What a recovery!
Meanwhile, how are the surviving banks making money? By cutting their provisions for bad debts (at a time when the household debt/income ratio is still near record highs of 120% and at a time when one-quarter of the consumer universe has a sub-600 FICO score – which means they are also ineligible for Fannie or Freddie mortgage financing. The banks thus far have reduced their loan loss reserves between 23% (Cap One) and 73% (First Horizon) – as Jamie Dimon said last week, these are not real earnings.
You also know it's a depression when a year into a statistical recovery, the central bank is still openly contemplating ways to stimulate growth. The Fed was supposed to have already started the process of shrinking its pregnant balance sheet four months ago and is now instead thinking of restarting Quantitative Easing. Of course, we are in this bizarre environment where bank credit continues to contract – last week alone, bank wide consumer credit outstanding fell $2.2 billion; real estate lending contracted $9.2 billion; and commercial & industrial loans slid $5.1 billion.
What did the banks do this past week? They replaced cash with government securities – the $47.5 billion net buying was the second largest in the past three years. As the banks find few opportunities to lend – households are either not creditworthy enough to lend to or are busy paying off debts and companies that do have any expansion plans have enough cash on their balance sheet to finance their initiatives – they are likely to use their $1 trillion in excess reserves buying government and related securities, especially with the yield curve so steep and the Fed ensuring that it has no intention of taking the 'carry' away for a long, long time.
Did we mention that you also know you are in some sort of depression when after two years of record $1+ trillion deficit financing to kick-start the economy, the yield on the 5-year note is sitting at 1.8%? What do you think that tells you? It tells you that the private credit market is basically defunct, especially when it comes to the securitized loans, which played such a critical role in promoting leveraged economic growth from 2001 to 2007 – the amount of securitized credit that has vanished since the credit bubble burst two years ago is $1.4 trillion – 40% of this market is gone. And what replaced it was this rampant government intervention into the economy – aimed at putting a floor under the economy. But insofar as the government stimulus fades and the contraction in credit persists, it will be interesting to see what sort of spending, output and income growth we are going to see in the near- and intermediate-term.
And as a must read tangent, here is Rosie on the market's most recent addiction to barbiturates, lithium, xanax and geodon all at the same time (not to mention the Fed's daily bouts of monetary heroin withdrawal, coupled with the market regulator's taxpayer funded pornography addiction bills). That probably explains it - to trade one really has to be stoned 24/7, or to at least do the 180 degree opposite of what makes sense.
Everyone seems to be basing their view on the economic outlook from what the stock market is telling them – so one week it is a return to recession, and now that the market is surging, we must be in some sort of boom. Coincident indicators out of Europe has everyone convinced that the backdrop is solid and yet the massive fiscal tourniquet has to be applied. Investors are caught in bouts of monthly euphoria and depression – it is amazing that we have all this joy for a market that has made its way back to the middle of the range and a market that is basically flat for the year.
Program trading, algorithms, momentum trading, technicals – all are at play. Meanwhile, the Treasury market has steadfastly refused to budge from a double-dip view, with real rates still under downward pressure, and while the breadth of the market has been decent, this rally has continued to lack volume – down a further 2% on Friday on the NYSE. Meanwhile, we are at another key technical juncture – the Dow and Nasdaq have retaken their 200-day moving averages while the S&P 500 and the Nasdaq are caught between the 50-day and 200-day m.a.'s.
It is amazing that Mr. Market has been able to look through some of the blemishes of the Q2 earnings season, the recent spike in jobless claims, the latest hot spot for sovereign default risk (Hungary), and the ECRI hitting a level that is more negative now than in the worst point of the 1990-91 recession. Even with the recent recoveries, the downdraft in most industrial metal prices since mid-April has been breathtaking – down 18% for aluminum, down 13% for copper, down 27% for nickel, and down 15% for steel. Since China has accounted for 40% of global consumption of base metals over the past year, these price moves would seem to suggest that the economic landing there might be less soft and harder than is generally perceived.