To all those fewer and fewer optimists who believe the economy may avoid a double dip (or alternatively suffer the realization it never really got out of the depression in the first place), David Rosenberg provides a glimpse just how tenuous the so-called recovery has been, even despite the unprecedented attempts by everyone at the top to shepherd the economy into growth at any cost, and the daily reminder from Ben Bernanke that risk is dead and the Fed will never let capital markets drop again. As for the future, Rosie asks the logical question: how is it that earnings are expected to grow by 20% in 2011, when it is becoming increasingly obvious that GDP growth next year will be negative?
From Gluskin Sheff's Breakfast with Dave:
Let’s look at the situation from a top-down view. We have seen real U.S. GDP growth average 3.2% at an annual rate during this statistical recovery from the 2009 bottom. Of that, 2.1 percentage points came from the inventory swing — or about two-thirds of the growth. The remaining 1.2% average annual growth rate of GDP excluding inventories — otherwise known as “real final sales” — is the weakest post-recession recovery on record. The weakest ever, despite a 10% deficit-to-GDP ratio, a debt-to-GDP ratio rapidly heading to 100%, a near zero Fed funds rate, record low mortgage rates, an unprecedented tripling in the size of the Fed balance sheet, shifting accounting rules to help rejuvenate profit growth in the financial sector, cheap and easy FHA financing to virtually anyone who wants to buy a home, relentless government pressure on banks to modify defaulted loans, and bailout stimulus galore (Fannie and Freddie are now de facto “Crown Corporations” and their stock still trades!!) — and with all that, all we get for our money is a paltry 1.2% growth rate in final sales. Yuk.
And, just in case it is still unclear, Rosie sees much pain in the future:
Well, what’s past is past. Where are we going? It's pretty clear from the manufacturing components of the last payroll report and the latest ISM index that the inventory cycle is either reaching its peak or it already has. The inventory plan components of the small business survey for June hardly pointed in the way of more contribution.
We can see from the latest auto sales reports that absent cash-for-clunkers, sales are, at best, stuck in neutral near 11 million annualized units at a time when replacement demand is closer to 14 million. That this is happening with auto loan rates down 40bps year-to-date and down 100bps over the past year attests to the view that motor vehicles, like housing, is working off years of excess consumption. At least the used car market is thriving, but that doesn’t end up adding a whole lot of jobs to the economy outside the car lot.
Speaking of housing, sales and mortgage purchase applications are hitting new lows despite mortgage rates at record lows and this also attests to the degree of excessive demand from the prior bubble that is still being worked off — not to mention the fact that when appropriately measured with the shadow inventory of foreclosed properties held off the market, we are talking about close to a two year backlog of unsold homes overhanging the outlook for residential real estate valuation. Commercial construction is beset by high and still-rising vacancy rates in the office and shopping centre space.
It would be nice to see an export boom but the overseas economies, to varying extents, are tightening either monetary or fiscal policy to rein in growth. China is certainly not going to be in the same position it was back in late 2008 in terms of being a leader on the policy front that could ignite a power surge for the global economy. In fact, we just saw the U.S trade deficit widen quite unexpectedly in May to an 18-month high and trigger a wave of downgrades to second-quarter GDP growth. The consumer is not exactly rolling over, but spending fatigue seems to be setting in, along with a natural rise in the personal savings rate, whenever a quick fix fiscal policy gimmick runs its course and expires.
Perhaps capital spending will be a lynchpin, but at 7% of GDP, at most it will contribute a handful of basis points to headline growth. It certainly doesn’t seem to be generating a whole lot of new jobs; however, corporate spending growth, along with a sharp eye on cost-cutting, you may want to stay long your Intel stock a while longer. But, what it means for the economy beyond tech capex probably isn't very much.
Then we come to the near-20% chunk of the economy, the government sector. Two-thirds of that comes from the beleaguered State and local government sector, which is in a full-fledged retrenchment mode as it cuts services, raises taxes, and lays off 10,000 employees month in and month out, to reverse the flow of red budgetary ink. This will likely persist well through 2011.
In addition, we now have the federal government, with 70% of the ballyhooed spending stimulus behind us. Look at the bright side, the President recently said at a town hall meeting — at least the unemployment rate didn’t go to 15% or 16%. Let’s uncork the champagne, folks! What a way to measure success — my kid got an F but at least they didn’t throw him out school.
Congress passes the laws anyway, and in a midterm election year, as always, the opinion polls hold sway for the incumbents — and the survey says, there is no more public appetite for more fiscal largesse. We’ll see the extent to which this sentiment shifts as three million unemployed Americans roll off the jobless benefits data (since Congress refused to go beyond 99 weeks of support) just in time for the holiday shopping season — lost transfer-income of up to $100 billion heading into the most critical time of the year for the retailing community. And then there are the tax hikes slated for 2011, whether they be income, capital, dividends, or death!
After contributing about two percentage points annually to OECD growth over the past two years, fiscal policy in the industrialized world is set to subtract a percentage point in the coming year. In a world of small numbers, that’s pretty big. In the U.S., the fiscal withdrawal will be closer to 1.5 percentage points of GDP. So, if the peak inventory contribution is behind us, and all we have left is a baseline growth trend in real final sales of 1.2%, then how does the economy not contract in the coming year — when the consensus expects to see peak earnings?