All Is Just Fine (Or, A Recession Remains Very Possible)

All is Just Fine!

Posted on Mar 5th, 2007

http://usmarket.seekingalpha.com/article/28696

Barry Ritholtz submits: The complacent Goldilocks crowd is hoping that if it just keeps repeating the mantra "All is well" enough times, people will believe it.

The question is, does a recession seem a plausible scenario in the current circumstances... with inflation near post-World War II lows, corporate profit margins at record highs, an unprecedented global awakening underway, financial signals [credit spreads] still at good-time lows? Please!

-JPMorgan economist Jim Glassman

That approach is less effective than it was in days gone by, thanks to the interconnected nature of global markets. A slowdown in the U.S. impacts most other markets whose economies rely on exporting goods to us. In other words, mere happy talk here cannot stave off sellers halfway around the world. With Japan, China and the rest of Asia getting whacked again, and Europe following suit, the open here is likely to see some bloodshed.

What are the hopeful pleas of the soft landing proponents? Consider this short list, and our counters:

1) Corporate America remains healthy

The good news is that corporate balance sheets are the best they have been in years. The bad news is that matters a lot less than you would think. The lift under major corporate strength has been earnings -- which have been decelerating for quite some time now, and are likely to get worse, not better in the near future.

The strength there is somewhat deceptive. A vastly disproportionate amount of S&P500 earnings have come from Oil & Material companies. As the economy slows, that will slip. We also see a lot of M&A/Private Equity driving the Financial sector. A shift in Psychology is underway, and that is likely to look different if this selloff accelerates. Third, a lot of financial engineering has occurred. Share buybacks are responsible for about a third of earnings gains. Bottom line: S&P500 earnings remain a lot more vulnerable than most people realize.

Then there's the profits at a cyclical peak: Earnings cannot grow faster than GDP + inflation indefinitely. As we have pointed out before, this profit cycle has been driven by cheap labor, cheap money, and tax breaks -not organic demand.

2) The GDP report wasn't all bad

That's true: 2.2% isn't zero.

However, it is not 3.5%, either. And it's trending lower. Even more importantly, it does not reflect the thesis that helped the markets power higher from December through February: That growth was reaccelerating, that the soft patch was behind us, that a soft landing might not even be necessary due to the robust economic environment.

That turned out to be dead wrong: Housing is already in a recession, as is Autos and most Manufacturing that is not cheap dollar export dependent. Durable goods have been weakening along with Housing, and Business Investment - which the Bulls have been forecasting for 3 years - is near a 3 year low, with more weakness likely on tap.

The "contained sub-prime debacle" and the "not dependent on housing consumer" turned out to be Fairy Tales - like Goldilocks herself.

3) Jobs remain key

It's stunning that this keeps getting trotted out, but let me repeat it in CAPS for those who have have somehow missed it: THIS HAS BEEN THE WORST JOBS RECOVERY IN POST WAR HISTORY.

We've mentioned this repeatedly over the past 3 years, most recently here and here.

4) Federal taxes keep pouring in

Temporarily true, primarily due to a number of factors and one time events.

But if you want to get closer to where "the rubber meets the road," have a look at State and Local tax receipts. They are in near crisis mode in many places, as Income gains, and Hiring and Consumer Spending are all off of where they should be at this point in the cycle. Productivity gains are clearly a double edged sword this cycle also.

For The Liscio Report's prior take on State Tax reciepts plummeting, see #3 here.
~~~

Of course, whether you should be listening to the sunshine crowd in the first place is an entirely different story. Consider this last detail, via the Sunday NYT:

The Economist reported that in March 2001 — the month the last recession began — 95 percent of American economists believed that there wouldn’t be a recession. In February 2001, the 35 professional forecasters surveyed by the Federal Reserve Bank of Philadelphia collectively predicted growth at an annual rate of 2.2 percent for the second quarter of 2001 and 3.3 percent for the third quarter. It’s as if meteorologists stood outside as the storm clouds approached and informed television viewers that endless sunshine was ahead.

Bottom line: A recession remains a much higher possibility than most economists acknowledge. Watch their ongoing denial for signs of acknowledgment - and then go the other way.

 

Good post. I agree with all of it. USA is in recession by yr end in my opinion. I've been thinking this for months.

 

Wow, you are only about 5 years late on that conclusion.

Seriously, even while this "recovery" was being preached, there were nonstop reports of job layoffs by major corporations. There never was a recovery, just cost cutting and an overly liquid bond market. Consumer debt was driving consumption, so was the real estate boom.

Only CA had any real recovery, as the semis rebounded on top of the real estate bubble. NYC had real estate and the IB growth, although the cost cutting never stopped. Now that the LBO wave might be done, watch the heavy layoffs at all the major IBs. They are ruthless when it comes to cutting back and the effect trickles down all through the city.

The last thing you want is the mainstream to officially believe that there is a recession. Cause if GDP ever goes to 0.0% or lower, that's serious problems for US debt.

 

The bulls are still banking on 2 more ace cards up their sleeve.

1) Rate cut. (they still think the Fed is gonna bail them out, Mr. B is huffing and puffing a lot, but the bulls are not buying it, they think there will be a cut to prevent recession.)

2) Oil down. (they have driven prices up to unseen heights, they would easily unload and drive prices back to relatively low prices to artificially stimulate a tax cut by tanking oil, I mean, everyone uses oil)

 

the talking heads on cnbc said this is just a minor sell off and that buying should resume within the next month or so.

 

Seems to be a recurring theme, i.e. "don't worry, everything is groovy, buy now!!"

 

I like the analogy that the FED has the keys to the car and their foot on the accelerator. If that car slows down, they add more fuel. But what I really believe right now, is that the FED has purposely slowed the car down enough for the people with the Adjustable Rate Mortgages to step out of the car safely. There are enough housing threads on this board so I don't want to start another here, but If I was at the Fed, I'd sure keep the rates a little higher than they needed to be to keep the economy slow to give folks a chance to bail out of their ARMS. I think this is why they are almost overly paranoid about inflation.

Now...who was on that grassy knoll?

SM

 

And the bears can never answer one important key question

What do you do with all that fiat cash?

 

That's the key just watch the broker/dealers.... They've led the way for 20 years....Tank first.... Lead out the bottom...