Recession

Back in May when we presented our humble and succinct analysis on what the preliminary 1.8% GDP looked like, we said "Ex the now traditional inventory build [of 1.2%], Q1 GDP growth was sub 1%" basically being the only party who said that aside for the "old faithful plug" better known as the traditional BEA fudge to get GDP to whereever the administration wants it, growth was where it ultimately ended up being: 0.4%. And the kicker? The primary cause of the downward revision was, you guessed it, Inventories, which imploded from 1.31% to 0.32% (see chart). In other words, the next time we are skeptical about government data in any format, believe us, and not "them." Which also goes for our skepticism when it comes to the predictive ability of one Goldman Sachs, most notably our take on Goldman's December 1 2010 "watershed" report in which Hatzius said: "This outlook represents a fundamental shift in the thinking that has governed our forecast for at least the last five years... Five years ago, we became very pessimistic about the US economic outlook...So why do we now expect growth to pick up?  In a nutshell, it is because underlying demand has strengthened significantly" Total and utter fail. Our summary then was also rather spot on: "Much more hopium inside. This is unfortunate. Jan Hatzius used to have credibility." Indeed, after waiting for so long, the firm once again capitulated per its most recent report released last night: "Our forecasts for 3%-3.5% growth in Q4 and 2012 are under review for probable downgrade." So with apologies for the self-backpatting, this brings us to the topic of this post. As we have said for over a year, the catalyst for QE3 will be none other than Goldman. Which is convenient because the title of Goldman's report is "The Fed's Easing Options." Pretty much as subtle as it gets.

Is a second recession in so short of a time in the offing? It certainly seems that way. The hope for a continued recovery has grown dim as of late as many of the economic indexes are moving towards contractionary territory.  As we posted recently in "EOC Index Shows Economic Weakness" there are several concerns pressing the US economy and, in the words of David Rosenberg, chief economist at Gluskin Sheff, “one small shock” could send us into a second recession.  With the recent release of the Chicago Fed National Activity Index our proprietary economic index is just one small step away from crossing the 35 mark which has always been a pre-cursor to recession. We have discussed many times recently that with the unemployment rate remaining high, housing prices slipping into a secondary decline, consumer and business spending slowing, while gas and food prices remain high eating up more than 20% of consumers wages and salaries.  Add on top of these factors the likelihood of a Greek debt default, a slowdown in the Eurozone, a weaker dollar and Washington locked in debate over the debt ceiling - well, the list of risks far outweigh the positives.  However, that doesn't seem to deter Wall Street economists and main stream media which seem to all be wearing an extremely thick pair of rose colored glasses these days.   However, it doesn't take an economist to figure out that any one of these factors could send us tumbling into a second recession.

You don't need a degree in macro economics to understand an economy. Just because an economy is complex, the analysis need not be. I've been studying the change in GDP from Q4 2010 to Q1 2011 to get a sense of where the economy is regarding contraction or expansion. I have a sense the economy stands today where it stood in December 2007 the very month the great recession began. I've shared various technical charts showing striking similarities with the 10 year treasury market and equity markets comparing the price action between May 2011 to present and October 2007 through December. The big component though was the macro picture. You could easily argue it is far closer to recession now than it was in 2007 when Q4 07 GDP was 2.9% only to print (.72)% the very next quarter. With Q1 2011 GDP at 1.9% the margin for error is far less than in 07. But that is not enough to base an investment decision upon.

Recently I compared the 2007 equity topping pattern to that of the current market. The premise being today as in 2007 the US economy is quite possibly entering economic recession. Long gone are the days of equity markets being forward looking as proven in 2007 when they peaked just two months before contraction began. A similar pattern is also playing out in the 10 year treasury. I suspect a topping market is more a function of psychology and less technicals or macro data. The money making bull is slowly dying while the bears are eager for their turn to shine. The result of this clash of views and buying power is dictated more by emotional, whipsawing action where convictions in one's position and volatile price action make coexistence difficult if not impossible.

In what is becoming a multi part series on how various products price in recession tonight it is time to check out the commercial paper markets. Below are two charts (1) showing the last two recessions and how commercial paper rates performed and (2) commercial paper rates since Q2 2009. Both charts utilize non financial AA rated 30 and 90 day terms. The results were similar for financial paper as well. Commercial paper seems to be an excellent market timer of economic recession. Notice the last two periods where rates began falling precipitously and the timing of economic contraction.

In a prior post I compared the 2007 SPX topping pattern to the current May 2011 high. The assumption being the US economy is on the verge of an economic recession now as it was in December 07 when the recession officially began. The similarities were unquestionable (chart below). The unknown is are we building point E. Those believing recession is at hand will say yes, those saying it is a soft patch will say no. Well what do the credit markets say and what explains this 40 basis point move in the 10 year. The end of QE1 actually showed yields falling so history would be on the side of the bond market catching a bid versus the relentless selling going on this week. Well the comparisons with the 10 year treasury in the second half of 2007 and the current period are again striking similar. Equally striking is that we have precedence for such a parabolic move in the 10 year yield.

I'm not going to even begin to try and make sense out of today's market. Watching fires burn and teargas fired in Greece, 100 pip moves in the EUR/USD in minutes and computer algos tripping over each other was surreal beyond words. This market right now is a lottery. Calling equities forward looking or a pricing mechanism is beyond ridiculous. It is during noisy times like these that investors must step back and keep things in perspective. Trading on days like today requires little skill and a lot of luck. When I step back I see a deteriorating economy and an equity market trying to understand what to do. Do they "price in" a soft patch or a full blow recession. Market participants are told it is in fact a soft patch. The slightest hint of positive data reinforces those views.

Then things fell apart. The government was peeling off its stimulus programs, gas and food prices had skyrocketed, and suddenly on May 17 tax collections fell versus the same period last year.

There may be those among the less than brainwashed lemmingerati out there who have noticed what, as we have pointed out for the past month when reporting on the various manufacturing and regional Fed indices, has been an epic collapse in the appropriate data series. As John Lohman so kindly demonstrates, the two month implosion has been beyond epic, and while certainly the biggest drop in the past decade, may also be the all time worst ever. To the point of this post: the last time we had an economic contraction of this magnitude was back in February of 2008, which was two months into the most acute recession in post-depression history. We are confident that once the groupthink wraps its head around the fact that the auto production based renaissance is not coming, and the economy officially tumbles into the commode of Ben Bernanke's fiat dungeon, the NBER will determine (with an appropriate 12-18 month delay), that the current recession started in April of 2011.

Not surprising existing home sales for May fell to 4.81 million units which is now resuming it's downtrend after brief upticks that were caused by government incentive programs that dragged forward future existing home sales. As the consumer has begun to deleverage their household balance sheet both new and existing home sales have decreased. High unemployment, concerns about current employment, stagnant wage growth and uncertainty about future economic conditions weigh on the consumptive attitudes of the consumer...The NAR believes, and continues to hope, that May will prove to be the year's bottom for the housing sector. They will be wrong as they were last year as well, oh, and the year before as the balance sheet recession continues and consumers hunker down to regain stability in a weak economic environment that will continue to plague the housing market for some time to come.

Despite Goldman's expectations of a +0.1% sequential move, and the broader economic lemming consensus of a modest -0.2% drop, the just released March Case Shiller housing data confirmed there is no end in sight for the housing double (or triple, or quadruple, or who cares: take out the Fed's $2.7 trillion and housing really has been in a non-stop plunge for 3 years now), missing expectations and printing at -0.23%. In addition the February data was revised even lower from -0.18% to -0.25% (expect failed career economists at Goldman and elsewhere to disclose this as a huge positive as it is really an increase). The Composite 20 dropped -3.61% on expectations of -3.4%. The press release says it all: "This month’s report is marked by the confirmation of a double-dip in home prices across much of the nation. The National Index hit a new recession low with the first quarter’s data and posted an annual decline of 5.1% versus the first quarter of 2010. Nationally, home prices are back to their mid-2002 levels." Cue QE3, 4, and so forth through QE 666, at which point we may see in uptick in worthless Bernankebux. And as we predicted earlier, bizarro day, with futures about to hit 3 year highs, now reigns supreme.

Some version of the latest Richard Koo presentation has already circulated in some form or another. The only addition to the core section (which as usual can be summarized with two words: "spend more") is Koo's take on recent developments in Japan, one of which focuses on the historical trade balance in Japan, and the second, far more important one, looks at an issue few have discussed: the role of electricity supply in a post-earthquake Japan. As Koo says, "electricity supply is the bottleneck for Japan's GDP recovery." Indeed, we have yet to hear anyone from Wall Street's rainbow and unicorn drinking brigade come up with an explanation for how this will be circumvented, especially over the summer when the Japanese government predicts a nearly 20% shortfall in electrical supply. And if Japan were to go the alternative route, how long before the current supply/demand equilibrium point in oil and nattie moves materially higher? As for the broader economic impact from the earthquake which is a double whammy, as Koo points, Japanese industrial production has now fallen to the level of 1987. And Wall Street "economists" still believe 2011 global GDP will be unchanged?

And for today's second most surreal piece of news (the first being that Osama was a fan of RedTube and Adult Friend Finder, whose stock tumbled 25% after its IPO on news that such a loyal customer is now dead), we turn to Reuters which brings us news of a "report" by centrist think tank Third Wave, due out on Monday, which finds that "the United States could plunge back into recession if inaction in Washington forced a debt default, according to a new analysis that arrives as the country reaches the legal limits of its borrowing authority....Some 640,000 U.S. jobs would vanish, the housing market's woes would deepen, stocks would fall and lending activity would tighten if the country were unable to pay its bills, according to a report by the centrist think tank Third Way due out on Monday." And yes, first Dow Jones and now Reuters confirms what we have been warning all this week, namely that "the Treasury Department is expected to hit its $14.3 trillion borrowing limit on Monday, making it unable to access the bond markets again. Lawmakers from both parties say they won't approve a further increase in borrowing authority without steps to keep debt under control." Yet back to the topic at hand: which is that someone actually paid money to discover what will happen to America when it filed for bankruptcy. If this was a paper out of the San Fran Fed we understand, but private industry? If there is one margin hike we approve of it is for the CME to hike the margin to 1000% cash in trivial common sense BS.

Speaking of spending money we don't have - $23Bn of POMO money will be handed out to the IBanks in the first 3 days of the week as the Government props 'till we drop.

From Reuters, quoting Bill Gross, who previously did not believe in another round of QE:

PIMCO'S GROSS SAYS WILL CHANGE HIS MIND ON SHORTING US TREASURIES IF THERE IS POTENTIAL FOR ANOTHER RECESSION

And of course, another recession will mean more QE, which means more debt monetization, which means that naturally, the first and last buyer for Treasury bonds, the Fed, will be there for ever and ever, which means more fiat printing, which means $5+ trillion in Fed "assets", which means more inflation expectations, etc, etc.