One of the world's most realistic people (which for some reason the permabulls take as an indication of extreme bearishness: which is fine - after all they themselves live in an imaginary world populated with market marking unicorns and benign computer programs), David Rosenberg has shared ten things that would make him bullish. Alas reading through these gives one the impression that Hades would first turn endothermic before any of these actually were to come true. And for some more practical views from Rosie, we also include his spot on interpretation of today's GDP data.
I was recently asked to provide a list of developments that would make me more bullish on the macro and market outlook. Here are a few:
1. Initial jobless claims below 400k on a sustained basis. This would lead to job growth strong enough to generate organic wage growth.
2. Improvement in housing inventories to a 5-6 months’ supply backdrop. This would help establish a floor under home prices.
3. Signs of a turnaround in the money multiplier, money velocity and the ratio of commercial bank non-liquid assets/total assets. Any sign that the debt deleveraging cycle has run its course.
4. A new "killer app" or some major technological breakthrough would be nice.
5. A sustained decline in oil prices that is induced by new supplies (or peace in the Mideast?) as opposed to demand destruction would act as a de facto tax cut.
6. Structural economic reforms in the world's "surplus saving" countries like China, India and Germany that stimulate their domestic demand, and hence bolster our exports and reduce the global reliance on the U.S. as the consumer of last resort, would be a huge plus.
7. A peaking out in the personal savings rate (the sooner we get to 6%-8%, the better) – get to a level consistent with pent-up demand.
8. Consumer confidence closer to 100 (typical of expansion) than the current 50 reading.
9. An end to the steep cutbacks at the state and local government level.
10. New and more effective political leadership globally – could the Cameron victory in the UK be a leading indicator towards fiscal probity?
And here is Rosie's take on today's most important economic data point:
The economy underperformed expectations in the second quarter with the initial estimate of real GDP growth coming in at a 2.4% annual rate. The revisions to the back-data also showed the Great Recession to be even greater than initially thought with the economic loss now totaling 4.1% from 3.7% previously. And the revisions also reveal a policy- and inventory-induced recovery that is now losing steam at a faster rate than was thought before, especially with respect to consumer spending – the 2.4% GDP pace is down from 3.7% in the first quarter and 5% in the fourth quarter of last year.
There are legions of economists out there who claim that it is normal to see the economy take a breather at this stage of the cycle, but in truth, what is “normal” in the context of a post-WWII recovery is that four quarters into it, real GDP expands at over a 6% annual rate. That puts 2.4% into a certain perspective. And with the revisions now showing the downturn deeper, the level of economic activity in real terms is still 1% below the pre-recession peak. Again, when you look back at 55 years worth of post-war data, what is normal 2-1/2 years after a recession begins is that by now we are at a new peak already (breaking above the prior high in GDP by 8%, on average).
The big story in the second quarter as has been the case for much of the past year was the contribution from inventories – there was a “build” of $75.7 billion and this added over a percentage point to headline GDP growth. This follows a “build” of $44 billion in the first quarter so this is no longer the case that companies are merely reducing the pace of inventory withdrawal. Businesses actually added to their stockpiles at the fastest rate in five years. And with sales lagging behind, this inventory contribution is likely to fade fast in coming quarters. Real final sales – representing the rest of GDP (excluding inventories) – came in at a paltry 1.3% annual rate last quarter and has averaged 1.2% since the economy hit rock bottom a year ago in what is clearly the weakest revival in recorded history.
Normally, real final sales are expanding at closer to a 4% annual rate in the year after a recession officially ends. Then again, we haven’t heard anything official just yet about the one that began in December 2007 – and so the fact that it is averaging at around one-third that typical pace in the face of unprecedented policy stimulus is rather telling. And frightening.
Looking at the components of GDP, it appears as though the economy is set to slow even further and a flattening in Q3 and perhaps even contraction by Q4, barring some positive exogenous shock, cannot be ruled out. First, one of the primary contributors to the renewal in economic growth, business capital spending, which has expanded at a double-digit annual rate for three quarters in a row – expanding at a 22% annual rate in Q2 – is starting the current quarter at a pace that is closer to high single-digit growth. That alone may trim a halfpercentagepoint from headline growth this quarter.
With durable goods inventories-to-sales ratios rising to eight-month highs and most manufacturing diffusion indices rolling over, it would stand to reason that the inventory contribution to growth is over. Though to be fair, that will also mean that the import boom will subside and provide some offset (foreign trade actually subtracted 2.8 percentage points from GDP growth last quarter). The government sector added 0.9 percentage points to second-quarter GDP growth with an apparent seasonal skew from defense spending and there was a rare increase in state & local spending, which is hardly going to be repeated this quarter as the budgetary cutbacks deepen. The housing tax credits triggered – get this – a 28% annualized surge in residential construction in the second quarter and while a tiny share of the economy now, this still added 0.6 percentage points to the headline. All the incoming data point to a huge reversal in the real estate sector in the current quarter.
In the final analysis, it is the consumer that is key. With a 70% share of GDP, even a tepid 1.6% annualized growth rate in Q2 – the consensus was looking for 2.4% – can end up adding 1.2 percentage points to GDP growth (which is almost as much a contribution as a 22% surge in capital spending).
But after back-to-back months of declining retail sales and consumer confidence running at half the level it usually does in the context of an economic expansion, the data are pointing to virtual stagnation in household spending this quarter. In fact, what really came to light in the revisions to the data was just how lacklustre the pace of consumer spending has been over the past year – so much so, in fact, that the savings rate is now estimated to have risen to 6.2% in the second quarter from 5.5% in the first (revised sharply higher than the prior estimate of 3.5%). We have long highlighted consumer frugality as crucial deflationary secular theme and the revisions to the savings rate go a long way towards bolstering that view – underscored by the near-0% annualized trend in the pricedeflator for Gross Domestic Purchases last quarter.
So even though the second quarter corporate earnings season was decent, one reason why the equity market is struggling of late is because you can only drive and gaze through the rear-view mirror for so long. At some point, you have to look through the front window, and the prospects for a double-dip or some facsimile thereof were bolstered, not hindered, by the contours of the second quarter GDP report.
If indeed, the inventory cycle is behind us, then what we have on our hands is an underlying baseline trend in GDP of 1.2% at an annual rate. And if we are correct in our assumption that the looming withdrawal of fiscal stimulus at the federal level and the cutbacks at the state and local government level subtract 1.5% from growth in the coming year, then it begs the question: How exactly does the economy escape a renewed moderate contraction over the next four to six quarters, barring some unforeseen positive boost? In turn, how does a strong possibility of such a contraction square with consensus views of a 35% surge in corporate profits to new record highs as early as next year? The answers to these questions are as painful as they are obvious.
Perhaps it bears pointing out that one may consider adjusted Rosie's new frugality concept: as Bloomberg pointed out, US consumers are only frugal if they can default on existing payment obligations. Because buying iPads while broke is not quite the frugal behavior one would expect out of rational, or in fact even normal, consumers (although it confirms what we have been saying for about a year now, that any marginal purchasing power in the US exists only courtesy of defaulting on mortgages, credit cards and other deferred payment plans by the evaporating middle class).