Reversion to the mean

That is what came to mind when I saw the following graphs (from David Rosenberg of Gluskin Sheff):

These two trends also seem unsustainable:

Chinese consumer spending (in % GDP) and Chinese gross national savings (in % GDP)

Chinese CPI versus M1 growth

Is this correlation going to hold?

(YoY change in Chinese M1 growth versus YoY change in Chinese CPI)

What if…?

What if the US recovery was sharper than expected?

In an Op-ed published in the WSJ (on Sept. 19), James Grant made the following case:

“As if they really knew, leading economists predict that recovery from our Great Recession will be plodding, gray and jobless. But they don’t know, and can’t. The future is unfathomable.

Not famously a glass half-full kind of fellow, I am about to propose that the recovery will be a bit of a barn burner. Not that I can really know, either, the future being what it is.

(…) Though we can’t see into the future, we can observe how people are preparing to meet it. Depleted inventories, bloated jobless rolls and rock-bottom interest rates suggest that people are preparing for to meet it from the inside of a bomb shelter.

(…) The recession that sunk its hooks into the U.S. economy in the fourth quarter of 2007 has set unwanted records in such vital statistical categories as manufacturing and trade inventories (the steepest decline since 1949), capacity utilization (lowest since at least 1967) and industrial production (sharpest fall since 1946).

(…) Growth snapped back following the depressions of 1893-94, 1907-08, 1920-21 and 1929-33. If ugly downturns made for torpid recoveries, as today’s economists suggest, the economic history of this country would have to be rewritten. Amity Shlaes, in her “The Forgotten Man,” a history of the Depression, shows what the New Deal failed to achieve in the way of long-term economic stimulus. However, in the first full year of the administration of Franklin D. Roosevelt (and the first full year of recovery from the Great Depression), inflation-adjusted gross national product spurted by 17.3%. Many were caught short.

(…) To the English economist Arthur C. Pigou is credited a bon mot that exactly frames the issue. “The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. This new error is born not an infant, but a giant.” So it is today. Paul A. Volcker, Warren Buffett, Ben S. Bernanke and economists too numerous to mention are on record talking down the recovery before it fairly gets started. They collectively paint the picture of an economy that got drunk, fell down a flight of stairs, broke a leg and deserves to be lying flat on its back in the hospital contemplating the wages of sin. Among economists polled by Bloomberg News, the median 2010 GDP forecast is for 2.4% growth. It would be a unusually flat rebound from a full-bodied downturn.

(…)

I promised to be bullish , and I am (for once)—bullish on the prospects for unscripted strength in business activity. So, too, is the Economic Cycle Research Institute, New York, which was founded by the late Geoffrey Moore and can trace its intellectual heritage back to the great business-cycle theorist Wesley C. Mitchell. The institute’s long leading index of the U.S. economy, along with supporting sub-indices, are making 26-year highs and point to the strongest bounce-back since 1983. A second nonconformist, the previously cited Mr. Darda, notes that the last time a recession ravaged the labor market as badly as this one has, the years were 1957-58 —after which, payrolls climbed by a hefty 4.5% in the first year of an ensuing 24-month expansion. Which is not to say, he cautions, that growth this time will match that pace, only that growth is likely to surprise by its strength, not weakness.

And that is my case, too. The world is positioned for disappointment. But, in economic and financial matters, the world rarely gets what it expects. Pigou had humanity’s number. The “error of pessimism” is born the size of a full-grown man—the size of the average adult economist, for example.”

How the FED policy became purely pro-cyclical

There is not much to add, it is a great post:

How Well Has The Federal Reserve Performed for America?

By George Washington of Washington’s Blog.

How well has the Federal Reserve performed for America? Mainstream pundits, of course, say that Bernanke has saved the world . . . . but they said the same thing about Greenspan.  So let’s look at the actual historical record to determine how well the Fed has done.

Initially, Milton Friedman and Ben Bernanke have both said that the Federal Reserve caused (or at least failed to cure) the Great Depression through its poor monetary policy.

Many also blame the Fed for blowing an unsustainable bubble between 2001-2007 through artificially low interest rates. If this sounds too much like an Austrian economics perspective, that may be true. But remember that Hayek won the Nobel prize in 1974 partly for arguing that artificially low interest rates lead to the misallocation of capital and to bubbles, which in turn lead to busts.

Moreover, one of the Fed’s main justification has been that it can provide a “counter-cyclical” balance. In other words, during boom times it can put on the brakes (”take the punch bowl away right as the party gets started”), and during busts it can get things moving again. But as economist Jane D’Arista has shown, the Fed has failed miserably at that task:

Jane D’Arista, a reform-minded economist and retired professor with a deep conceptual understanding of money and credit [has a] devastating critique of the central bank. The Federal Reserve, she explains, has failed in its most essential function: to serve as the balance wheel that keeps economic cycles from going too far. It is supposed to be a moderating force in American capitalism on the upside and on the downside, the role popularly described as “leaning against the wind.” By applying its leverage on the available supply of credit, the Fed can slow down a boom that is dangerously overwrought or, likewise, stimulate the economy if it is sinking into recession. The Fed’s job, a former chairman once joked, is “to take away the punch bowl just when the party gets going.” Economists know this function as “counter-cyclical policy.”

The Fed not only lost control, D’Arista asserts, but its policy actions have unintentionally become “pro-cyclical”–encouraging financial excesses instead of countering the extremes. “The pattern that has developed over the last two decades,” she wrote in 2008, “suggests that relying on changes in interest rates as the primary tool of monetary policy can set off pro-cyclical foreign capital flows that tend to reverse the intended result of the action taken. As a result, monetary policy can no longer reliably perform its counter-cyclical function–its raison d’être–and its attempts to do so may exacerbate instability.”…

The Fed is also supposed to act as a regulator for banks and their affiliates, but failed miserably in that role as well.

Indeed, the central bankers’ central banker – BIS – has itself slammed the Fed:

In a pointed attack on the US Federal Reserve, [BIS and its chief economist William White] said central banks would not find it easy to “clean up” once property bubbles have burst…

Nor does it exonerate the watchdogs. “How could such a huge shadow banking system emerge without provoking clear statements of official concern?”

“The fundamental cause of today’s emerging problems was excessive and imprudent credit growth over a long period. Policy interest rates in the advanced industrial countries have been unusually low,” [White] said.

The Fed and fellow central banks instinctively cut rates lower with each cycle to avoid facing the pain. The effect has been to put off the day of reckoning…

“Should governments feel it necessary to take direct actions to alleviate debt burdens, it is crucial that they understand one thing beforehand. If asset prices are unrealistically high, they must fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off.

“To deny this through the use of gimmicks and palliatives will only make things worse in the end,” he said.

As PhD economist Steve Keen has pointed out, the Fed (along with Treasury) has also given money to the wrong people to kick-start the economy.

Remember also that Greenspan acted as one of the main supporters of derivatives (including credit default swaps) between the late 1990’s and the present:

Greenspan’s regular congressional testimony attracted financial analysts, journalists and linguists in equal numbers. An industry in interpreting Greenspan’s prognostications has developed. Without a hint of self-parody, Greenspan himself provided guidance to interpreting his pronouncements. “I know you believe you understand what you think I said, but I am not sure you realize that what you heard is not what I meant,” the Maestro once offered as explanation. He further clarified his position with unusual directness. “If I have made myself clear then you have misunderstood me.” (David James “Wot’s all this then, Alan?” (10-16 July 2003) BRW)

Now, Greenspan turned his considerable elocutionary powers to the defense of derivatives. During the height of the Internet boom, he held forth lyrically and at length on the impact of technology on productivity. Greenspan’s infatuation with derivatives appeared no less intense.

“By far the most significant event of finance during the past decade has been the extraordinary development and expansion of financial derivatives….. As we approach the twenty-first century, both banks and non-banks will continually reassess whether their own risk management practices have kept pace with their own evolving activities and with changes in financial market dynamics and readjust accordingly. Should they succeed I am quite confident that market participants will continue to increase their reliance on derivatives to unbundle risks and thereby enhance the process of wealth creation.” Remarks at the Futures Industry Association, Boca Raton, Florida (19 March 1999).Thus spake Greenspan.

Greenspan was also one of the main cheerleaders for subprime loans.

The above list is only partial. And it ignores:

(1) allegations that the Fed has manipulated the markets; and

(2) claims that the Federal Reserve System saddles the U.S. government and American people with trillions of dollars in unnecessary debt (that would not be incurred if the government took back the “power to coin money” granted to the government itself in the Constitution).

Even so, it shows that the Federal Reserve has performed very poorly indeed.”

Excuses of a bear, a confirmation signal?

I was surprise by the following comment from David Rosenberg:

“I stand accused of having missed the turn and that accusation comes from the throngs who believe that the only way to generate a positive return is through the equity market. You see, for so many pundits, you are labeled a “bull” or a “bear” based on how you feel about the equity market. (…)

I never did turn bullish enough at the lows, which is true. But I did turn neutral and while I did see the prospect of a complete throw-in-the-towel move towards 600 on the S&P 500, I can recall putting in print that the good news was that the bear market was about 95% over. Why quibble about another 60 points at that juncture. And, in the name of keeping an open mind, in my final report at Merrill Lynch, I played a game of Devil’s Advocate with myself … what if I was unduly bearish?
I didn’t stay bearish at the lows, which is contrary to popular opinion. I was basically neutral. And I continued to — still do, by the way — frame what we have experienced in the context of a bear market rally as opposed to the onset of a new secular bull market (the first you rent, the second you own).”

Half an excuse, although not a full one. But still, it shows how the sentiment has turned. Bears are now under serious pressure and have to explain themselves. Could it be a contrary indicator?

Pheonix stocks

Below an interesting post from William Hester at the Hussman Funds:

“The most notable characteristic of a durable stock-market advance, which failed to appear in the recent advance, is a strong expansion of trading volume. When you adjust the trading volume data for a handful of mostly lower-quality financial stocks (or Phoenix Stocks), the picture gets worse.”

(Phoenix stocks being Fannie Mae, Freddie Mac, Citigroup, AIG and Bank of America)

US “Imbalanced”

In October 2008, CreditWriteDowns.com had a very interesting post regarding US macro imbalances.  Although some adjustments are starting to happen (the commercial deficit is going down while the saving rate is increasing), this post is still spot on:

“The United States had been living beyond its means for a very long time before the credit crisis finally hit. The truth of the matter is that U.S. monetary and fiscal policy rewarded risk-taking and leverage at the expense of prudence and saving.

The goal of government it seemed was to avoid the pain of recession and keep the economy growing at all times. Every time the U.S. economy would hit a stumbling block, the Federal Reserve would lower interest rates and flood the economy with money. Market participants learned to trust in the Greenspan Put — an understanding that they would be bailed out by Fed policy at the first signs of trouble.

This irresponsible monetary stewardship seemed to work wonders as GDP in the U.S. continued to rise year after year. Yet, large macro imbalances increased steadily year after year.”

The Home ATM has now been closed…

… for a few quarters:

According to then Fed’s Flow of Funds report, for Q2 2009, the Net Equity Extraction was minus $48 billion, or negative 1.8% of Disposable Personal Income (DPI).

Source: CalculatedRisk

This was the main source of cash for households during the last period of expansion. Now “closed”, it is hard to imagine what could be the new driving force enabling the American consumer… could it be the stock market? It is probably what the FED is hoping…

Note: “As most homeowners pay down their principal a little each month (unless they have an IO or Neg AM loan), so with no new borrowing, equity extraction would always be negative.” (Source: CalculatedRisk)

Sustainable correlations?

Quoting an analyst from LCM: “Is there any historical or theoretical reason to assume these relationship have become permanent?”

WTI spot prices vs. S&P 500 since 1989 (125 days correlation):

and WTI spot ptices vs. the dollar index (DXY) since 1989 (125 days correlation):

Retail Sales for August. Good or not good?

This number is seasonally adjusted (so a bit tricky this year…) headline is +2.7% vs. +1.9% expected:

It is a surprise. Could the US consumer be back? (albeit from a lower base…)

Well, it is only one number, so we should be careful not to read too much into it. Also cash for clunkers boosted car sales strongly, as well as the increase in gasoline prices increased the gasoline sales. So if we take out those components, we see a different picture:

Up by +0.6% vs. -0.4% last month, knowing that according to the Liscio report late back to school shopping moved some July retail sales into August (by an estimated +0.5%). So in the end adjusted retail sales where pretty much flat.

Total vs. ex. Auto * Gas: