Monday, July 12, 2004

Oldman Back: Doubters Beware!

Hello faithful readers, the oldman is back, and lo and behold he has discovered some persons out there still spewing optimisitic gibberish about the economy. Albeit suave and sophisticated sounding gibberish.

SCSUScholars blog here is watching the affect of the economy upon the election. That I cannot predict, though Democratic allies and friends of this old conservative who had been formerly defending Kerry's lackadasial campaigning approach may be less complaisant in the face of Bush's numbers coming back, but I can refute the moronic economic forecast that is being passed around.

Which we're not.The National Association of Business Economists has an industry survey of 104 firm and industry economists this week in which they note employment is performing very, very well.
Employment is booming. The net rising index (NRI, percent reporting rising demand minus percent reporting falling demand) rose to 22 percent from seven percent last quarter. This compares with a historical average of minus 2.5 percent; an NRI of 22 percent is in the top ten percent of historical responses. Hiring plans also improved, with those expecting to increase employment rising to 41 percent from 34 percent last quarter.

Their May Outlook (which is a survey of professional forecasters) had only 2 forecasters predicting GDP below 4%. That's before the latest revisions to first quarter GDP, taking the number from 4.4% to 3.9%, and before the June employment report. But that's not necessarily going to mean much. My own forecast uses levels data rather than rates of change, and the impact of the changes were quite minimal. I will go out on a limb right now and say second quarter GDP comes in over 5%. And that money is filtering over into real disposable income as well.

I'm not exactly sure where they dig up these morons to "predict" the economy. First of all they have a terrible track record. Second of all, years of learning theory generally damages their ability to see the facts when they are presented to their faces. Frankly I have more respect for meterologists. But don't take the oldman's word for it. He's just a cranky guy trying to change careers. Take the word of that radical anti-Establishment rag called Forbes speaking about systemic risk rife in the markets.
Unfortunately, this did little to stamp out the excesses, which simply shifted into housing and consumer spending. With low rates, money for mortgages and credit cards remained ample. Tax cuts and leaping government spending helped fuel the spend-a-thon. The value of owner-occupied residences mushroomed from $8.7 trillion in the fourth quarter of 1997 to $15.2 trillion in the first quarter of 2004, bringing along with that much higher debt burdens. The home equity craze allowed people to plunge even deeper into debt to buy flat-screen TVs, boats and vacations.

A nationwide fall in house prices, the first since the 1930s, would be devastating to the 69% of American households that own their own abodes. Big mortgage financers Fannie Mae and Freddie Mac, with $1.7 trillion in debts, could require government bailouts.

Securities speculation has lived on as well, merely changing form. Despite the Nasdaq's 78% fall from peak to trough, memories of the 18-year bull market proved hard to extinguish. Investors never reached the puke point, where they swear never to buy stocks again. Those investors who still believe 20% annual returns are their birthright moved from equities to hedge funds, which leveraged their $800 billion with derivatives and doubled-up trades.

Low rates spurred the hedge funds, banks and other financial players to pour into the carry trade. With a 1% federal funds rate here and a zero central bank rate in Japan, they had a lovely time borrowing short term and investing long, where the yields were higher. Open interest in 10- and 30-year Treasury futures contracts as a percentage of outstanding issues rose from 15% in early 2001 to 35% recently.

Speculators also borrowed cheap short-term money to buy commodities, foreign currencies, U.S. junk bonds and emerging market debt and equities. Sure, other reasons existed for strength in these areas. Copper benefited from robust U.S. home building and reviving global growth. As usual, however, speculation carried price rises to extremes. Copper's price jumped 110% from October 2001 to March 2004.

But when strong employment gains appeared in early April and the Fed made clear its rate-hike plans, markets immediately ran way ahead of the central bank. Since Apr. 1 the year-end federal funds rate anticipated in the futures market has jumped a full percentage point. The same occurred with inflation-sensitive ten-year Treasurys. Junk bonds, emerging market stocks and bonds, commodities and foreign currencies all nose-dived. Copper prices dropped 15% from their March peak.

Still, few speculative trades have been unwound so far. This is vexing since leverage is much greater than in 1994 when Fed rate increases also caught speculators off guard and killed broker Kidder Peabody, the finances of Orange County, Calif. and the Mexican economy. For example, overnight borrowing to finance fixed-income investments, in relation to the total size of the fixed-income market, has doubled since then. Which large financial institutions might succumb this time?

Hedging techniques are better than they were ten years ago. Yet remember that hedging can transfer risk but not eliminate it. The basic question: On balance, is risk being transferred from weak to strong hands or from strong to weak? I'd bet on the latter. Weak, desperate players are assuming big financial risk.

But hey that's just one columnist right? Come on oldman don't you have anything better than that? Well as a matter of fact, thanks to the NYT the oldman does.
THE warnings from technology companies came fast and furious last week, cuffing investors who had bought their shares on hopes of super earnings generated in a hot economy. Individual investors and hedge funds alike had piled into tech stocks and enjoyed the ride through 2003, convinced that 2004 results would justify the shares' soaring prices...

But the biggest trouble spots on Mr. Hickey's horizon are the ballooning inventories on tech companies' balance sheets. Already rising in the first quarter, these inventories will probably show a surge for the second quarter, he said, because few tech companies appear to have cut production in recent months...

IN the first quarter of 2004, inventories jumped 21 percent to 61 percent, year over year, at such tech stalwarts as Dell, Cisco Systems, Intel and Texas Instruments. And that was when the economy was cooking. So Mr. Hickey expects inventories to show a surge for the second quarter. When inventories rocket, profit margins are hurt. Hefty write-downs are another common result.

The sales shortfalls at some technology companies will become most evident in the third quarter, Mr. Hickey said, making for some very ugly earnings comparisons from the same period in 2003. Back then, tax rebates were propelling consumers into the stores and gross domestic product soared 8 percent, annualized. Computer notebook sales in the third quarter of 2003, for example, were up 60 percent.

But this year, personal computer sales in the United States are growing at rates in the single digits or low teens. PC and notebook sales are also slowing in Europe and are actually declining in Japan.

In addition, the tax rebates, courtesy of the White House, are spent, mortgage refinancings have peaked and rising oil prices are pinching consumers. So it's no wonder that sales of tech gear have slowed.

As you can see, the tech sector is merely acting like the canary in the coal mine. It is slowing sectorwide and the causes are endemic to the economy. As such it is indicative of future things to come. If there are still any doubters out there, courtesy of the NYT and Bloomberg we can see that the rising inventories in the computer industry are being matched by rising inventories at the wholesale level throughout the United States.
Wholesale inventories rose 1.2 percent in May, more than forecast and the ninth consecutive gain, the Commerce Department reported yesterday, saying that companies kept more goods in stock to keep up with orders.

More machinery, electrical equipment and imported cars brought the value of stockpiles to $305.5 billion, after a 0.2 percent gain in April, the department said. Sales increased 0.5 percent in May after a 0.9 percent rise.

Supplies at distribution centers, warehouses and terminals in May were enough to last 1.13 months at the current sales pace after April's record low of 1.12 months, the report said. The need to build inventories may spur economic growth for the rest of the year, said Richard Berner, the chief United States economist at Morgan Stanley.

Inventory rebuilding "is now shifting into higher gear," he said. "Producers will continue to scramble to catch up with demand and inventory accumulation may contribute as much as one percentage point to growth this year."

Economists had expected wholesale inventories to increase 0.5 percent in May, according to a survey by Bloomberg News. They had expected sales to rise 0.7 percent.

Weaker than expected sales and higher than expected inventory levels are a classic indicator of slowing aggregate demand. No, the economy is not going to drop off the cliff tomorrow. What will happen however is that the discounting will become steeper and steeper to maintain sales, inventories will build, and eventually after sales decline despite discounts and inventories become much larger than production will slow down. Typically the process takes six months. If the recent downturn is indicative of a short term peak in aggregate demand we would be looking at a serious scaling back in production by November and December. Just in time for X-mas but just past the election in other words.

This isn't "magic". It's not rocket science. It's just paying attention to well reported facts and using basic reasoning. It's just spooky however that economist after economist can pile on and throw themselves into the gaping pits of pathetic forecasting by ignoring sound fact checking. They can rationalize anything it seems in the name of their theories. Like the economist in the above citation suggesting that increasing inventory levels will spur growth. Production will continue so that inventories can be stocked for a time, yes, but if aggregate demand doesn't increase then we'll enter into a recession cycle of scaled back production eventually. I'm sure in some class some where this incredibly obvious fact was pointed out to this economist but he chooses to ignore it.

As for the argument that spurred production will spur demand, I would remind everyone that this was only mainly true so long as many goods were produced domestically. There is no logical reason to conclude that spurred production in factories overseas will lead to more hiring and consumer spending. Modern economists have long touted the deflationary and anti-inflationary aspects of producing costs overseas. It's about time they faced up to the equally obvious fact that moving production overseas also breaks the traditional relationship between increased production and aggregate consumption. You can't have it both ways. If you want significantly lowered consumer prices from overseas produced goods, then you can't expect increased inventory stocking to cause an uptick in hiring or related consumer spending.


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