Rosie's Observations On The GDP Number, On Bernanke's Address, And On The Market

David Rosenberg has provided his typically succinct summary of the day's heavy dataflow, starting with the GDP number, parsing though Bernanke's speech, and concluding with a broad overview of where the market is heading, which is now so disconnected form a bond-implied FV in the upper 700s it is no longer funny.



Boy oh boy, 1.6% never felt so good. Bonds are getting hammered and the stock market is surging on a GDP growth number that basically represents stagnation in real per capita terms. But the consensus was looking for 1.4% and the “whispered” number was actually below 1%, so for Mr. Market, at least on a day-to-day basis, it is all about how things do benchmarked against expectations. The data were weak but not a disaster and so we are seeing a temporary bounce in yields and equity prices, which likely won’t last for very long once Q3 GDP estimates grind down from their current 2.5% forecast to something closer to 0% — or even negative — by the time the first report is published at the end of October.

The bright light in the Q2 revision was the uptick to consumer spending, to a 2% annual rate from 1.6%, while at the same time we had the inventory line revised lower to a $63.2 billion build from $75.7 billion. This configuration is alleviating concerns that a move to take inventories down in the third quarter will be necessary since household spending held up better than earlier expected.

1.5% increase. Strip out the energy components, and consumer spending did not improve at all from the last Q2 report we were issued a month ago. In other words, if not for the fact that more of the household budget was diverted to the energy bill in Q2, consumer spending would have shown a 1.6% growth rate and GDP would have actually come in BELOW consensus, at +1.3%. Notably, consumer spending on big-ticket durable goods came in lower than initially estimated — trimmed to a 6.9% annual rate from 7.5%.

Business spending on equipment and software (capex) improved to a 24.9% annual rate from 21.9% on the prior report, and this was flagged by the upward revisions we just saw in the July durables report. But commercial construction was marked down to a near flat figure (+0.4%) from the initial read of +5.2%. Outside of the fact that net exports showed an even deeper deterioration on the back of higher import growth and lower export growth (subtracting 3.4 percentage points from headline GDP growth versus the 2.8 percentage point drag shown in the prior ‘advanced’ report), there were no sizeable revisions.

Here’s what is important to take away:

  • We had 5% real GDP growth in the fourth quarter of last year, followed by 3.7% in Q1, 1.6% in Q2 and now what looks to be little better than 0% this quarter. So the notion that the economy has hit stall speed has not changed in this report —if anything, it was enhanced.
  • Real final sales — GDP excluding inventories — was actually marked down in this report to a meager 1% annual rate. That is really soft and underscores the overall weakness in the demand guts of the economy. We know from the monthly data that much of this paltry 1.6% growth in Q2 was baked into April — four months ago! — and that the pace of activity has weakened markedly ever since.
  • The monthly GDP data have actually shown declines for two months running and there is a negative “build in” so far for Q3. There is practically no growth in real consumer spending heading into the current quarter and we know that back-to-school sales so far have been sluggish.
  • From the durable goods report for July we see that capital spending intentions, the lynchpin for the economy, are slowing markedly as we move into Q3. And the manufacturing surveys strongly suggest that the mini-inventory cycle is behind us (and even with the revised markdown, this line-item still managed to account for almost 40% of the GDP growth we saw last quarter).
  • Nothing is happening in commercial construction to get us excited and we know from the latest batch of data that housing is back plumbing the depths.
  • The cutbacks at the State and Local government level will also be a very big drag in Q3 after what seems to have been a statistical Q2 respite

So, we are looking for a flat reading on Q3 GDP (possibly negative) at a time when the consensus is at 2.5% and our best guess is that the stock market is looking for 1.5-2.0%. We have no visibility on Q4, but again it would seem as though the 2½% consensus forecast is going to have to come down.

One more comment on Q2 — just to put 1.6% into context. Historically, four quarters following a bottom in GDP, growth is running over a 6% annual rate. Rejoicing over 1.6% because it wasn’t 1.4%, particularly in the context of the most radical bailout, monetary and fiscal stimulus in U.S. history, totally misses the point that we are operating in a totally abnormal and fragile economic environment.

On Bernanke's Jackson Hole speech:


As wishy-washy as it gets, but in the end, hope won out over despair.
The speech by Fed Chairman Bernanke was all over the map and was noncommittal in terms of offering an iron clad forecast despite the title being The Economic Outlook and Monetary Policy.

The sermon was littered with caveats in the form of “should”, “despite”, “although”, “possibly”, and “however” — but in the end, he expressed optimism (then again, what else can he do in public?). He obviously learned his lesson from using words such as “unusually uncertain”, which he used to describe the economic outlook at his recent Congressional testimony in July when the Dow responded by diving 109 points (as if things haven’t become even more uncertain since, but why tell anyone?).

Here are some of the snippets from the speech — Mr. Bernanke seems to have a different crystal ball than we do, as he is optimistic that growth will be sustained in the second half of this year and improve next year. At the same time, he acknowledges that the economy has not improved as much as the Fed was forecasting earlier (that is old news). But what really stood out in his speech was the extent to which it was so “on the one hand, but then on the other hand”, which of course is why economists are constantly ridiculed.

On the one hand …

“For a sustained expansion to take hold, growth in private final demand — notably, consumer spending and business fixed investment — must ultimately take the lead. On the whole, in the United States, that critical handoff appears to be under way.”

“Expansionary fiscal policies and a powerful inventory cycle, helped by a recovery in international trade and improved financial conditions, fueled a significant pickup in growth.”

“Stronger balance sheets should in turn allow households to increase their spending more rapidly as credit conditions ease and the overall economy improves.”

“I expect the economy to continue to expand in the second half of this year, albeit at a relatively modest pace.”

“Despite this recent slowing, however, it is reasonable to expect some pickup in growth in 2011 and in subsequent years.” [Ed note: the markets picked up on this].

“Despite the weaker data seen recently, the preconditions for a pickup in growth in 2011 appear to remain in place.”

“Consumers are reducing their debt and building savings, returning household wealth-to-income ratios near to longer-term historical norms. Stronger household finances, rising incomes, and some easing of credit conditions will provide the basis for more-rapid growth in household spending next year.”

… But on the other hand

“However, although private final demand, output, and employment have indeed been growing for more than a year, the pace of that growth recently appears somewhat less vigorous than we expected.”

“Notwithstanding some important steps forward, however, as we return once again to Jackson Hole, I think we would all agree that, for much of the world, the task of economic recovery and repair remains far from complete.”

“At best, though, fiscal impetus and the inventory cycle can drive recovery only temporarily.”

“Incoming data on the labor market have remained disappointing. Private-sector employment has grown only sluggishly, the small decline in the unemployment rate is attributable more to reduced labor force participation than to job creation, and initial claims for unemployment insurance remain high. Firms are reluctant to add permanent employees, citing slow growth of sales and elevated economic and regulatory uncertainty. In lieu of adding permanent workers, some firms have increased labor input by increasing workweeks, offering full-time work to part-time workers, and making extensive use of temporary workers.”

The prospect of high unemployment for a long period of time remains a central concern of policy. Not only does high unemployment, particularly long-term unemployment, impose heavy costs on the unemployed and their families and on society, but it also poses risks to the sustainability of the recovery itself through its effects on households' incomes and confidence.”

“Although what I have just described is, I believe, the most plausible outcome, macroeconomic projections are inherently uncertain, and the economy remains vulnerable to unexpected developments.” [Ed note: the market did not pick up on this].

In the final analysis, if there was a commitment made, it is that Mr. Bernanke will use all of his power to ensure that the recovery will remain intact:

“The Committee will certainly use its tools as needed to maintain price stability--avoiding excessive inflation or further disinflation--and to promote the continuation of the economic recovery …. the Federal Reserve remains committed to playing its part to help the U.S. economy return to sustained, noninflationary growth.”

What is interesting is the choice of the word “return” to “sustained” growth, which implies that despite his high hopes for the future, this is a state (the word “return” by definition means “revert to a previous state”) we have to achieve (sustainable growth) which is remarkable when one considers all the radical efforts that the central bank and the government have made to bolster the economy. As we are finding out, even with an extremely aggressive central bank, just because you turn the key doesn’t mean the engine turns over.

And on the market in general:

Well, the bulls took heart on Wednesday because the market rallied in the face of adverse news (new orders, home sales). The hope was that it was a sign that a lot of bad news was already priced-in or that this market had just become so oversold that the selling pressure had exhausted itself.

Then, we get what appeared to be a better than expected jobless clams report, and what does the market do? It took the Dow back below the 10,000 mark for the umpteenth time and the S&P 500 trading perilously close to that 1,040 line in the sand. And, what more can you say about the bond market; both the 10- and 30-year bonds rallying back six basis points.

There has been some talk that the recent wave of M&A activity is bullish for the equity market but from our lens, this is happening primarily because companies know that they can’t grow revenues adequately in a deflationary backdrop; therefore, they are “buying” a greater revenue stream via acquisition. It says nothing about the market but says a lot about the amount of excess capacity lingering in many sectors. Moreover, there are other sources of supply coming from equity mutual fund redemptions, which continue unabated. As Fidelity recently disclosed, a growing share of 401(k) participants are liquidating, and the IPO calendar, which has been quite active this year (171 companies have become public so far this year and that compares to 120 filings in 2009 and 153 in 2008). Be that as it may, the pipeline has thinned of late in light of the jitters that has gripped the market (it is, after all, down 14% from the interim April highs).

As for the bond market, the yield on the U.S. 10-year Treasury note seems to have hit some major resistance at the 2.5% level — look at how far it is come in four months: down a whopping 150 basis points. A rest would not be out of the question but the trend in yields is still clearly down. With so much air still under the current consensus estimates on GDP growth and corporate earnings, the odds that we see a resumption of this monster bull market in Treasuries is very high, in our view. And people should actually want this to happen — it is totally a humanitarian cause to be bullish on bonds because when they rally, good stuff happens, like mortgage rates get pulled down (the 30-year fixed-rate just hit a new low of 4.36% for the past week). Everyone seems to view equity market bears as pariahs but in fact, the bond bears are the real enemy. How exactly do higher borrowing costs end up helping out the market for homes, autos and other big-ticket items?

Yesterday’s economic data flow had some interesting details. While everyone gazed at the headline jobless claims figures, what stuck out beneath the surface was the total backlog of continuing claims, which moved back above the 10 million mark and is sure to expand even more in coming weeks and months (this number soared 260,000 during that survey week, which was two weeks ago). This goes to show how there is absolutely no hiring going on — an assertion backed up by the JOLTS data and Challenger survey we have discussed in this space recently.
With respect to the housing and mortgage data, lenders initiated 279,685 foreclosures in July, up sharply from 225,700 in June (and the highest in six months). The banks are getting more aggressive because these folks now being foreclosed on have been living for free for an average of 15 months (no wonder retail sales have held in, but this sweet deal is coming to an end.

By living for free these borrowers in serious delinquency were able to make their credit card payments on time — a fascinating comment on human behaviour — as credit card losses are falling fast — see Surprise Slowdown in Credit Card Losses on the front page of today’s FT). This is both good and bad — the good is that the sooner the backlog is cleared, the sooner we will be able to achieve some equilibrium in the real estate market. The bad part is that this new supply, at a time when demand is still faltering, will exert more downward pressure on home prices over the near- and intermediate-term; ‘For Sale’ signs will be in full view.

The number of people who are “upside” down on their mortgage is still around 11 million or 23% of the mortgage population. That number has actually come down in part because of some have defaulted and others are moving to pay down debt — but further home depreciation could well cause this number of people “under water” to start to rise again. Meanwhile, 14.4% of borrowers have missed at least one mortgage payment or are in the foreclosure process, which is a tad better than the 14.7% in Q1 but amazingly still higher than the 13.5% share a year ago when the economy was still struggling to get out of recession.

The op-ed section of the WSJ today is chock full of good material; Time For Obama to Pull a Clinton (as if) on page A15, Public Pensions and Our Fiscal Future on page A17 (by Arnold!) and the one right beside that titled FDR and the Lessons of the Depression. And, as we always say, you don’t have to like Paul Krugman, or agree with him, but you’re doing yourself a real disservice by ignoring him or dismissing what he has to say — have a read of his This is Not a Recovery piece on page A19 of the NYT.