Wednesday, August 25, 2004

Economy: Durable Goods Report Worse Than June,

Well it is, though you wouldn't know to hear it from the gushing spin put out by the economic journalists. Look at this story by CNN and you'll see my point.

July durable goods orders jump 1.7%

Larger-than-expected increase attributed to demand for passenger aircraft.
August 25, 2004: 8:40 AM EDT

WASHINGTON (Reuters) - Orders for U.S. durable goods -- items meant to last at least three years -- posted a larger-than-expected rise in July, boosted by an increase in demand for passenger aircraft, a government report Wednesday showed.

Orders gained 1.7 percent in July, their biggest monthly gain since March, said a Commerce Department report.

At this point the article might be considered honest journalism, except for the next upcoming paragraphs.
The July number was well above Wall Street expectations, which had been an estimated 1 percent gain.

The data is good news for the U.S. manufacturing sector, which has regained steam in recent months after being hit hard by the 2001 recession. From January 2001 through July, about 2.7 million U.S. factory jobs have been lost.

Recently, however, the job picture has stabilized and output, driven by a boom in worker productivity, has increased. The Federal Reserve said U.S. factories ran at their fastest operating rate -- 76.3 percent of full capacity -- in more than three years in July.

In the Commerce Department report, overall transportation-related orders rose 5.6 percent, as orders in the volatile civilian aircraft category more than doubled from June's tally, offsetting declines in demand for autos and military aircraft.

But other sectors also showed strength. Orders for primary metals were up 5.8 percent while orders for machinery grew 2.1 percent. Durables orders excluding defense-related goods were up 2.7 percent.

This is almost rah-rah-rahing. Nice how they can dig up numbers to confuse the issue. However briefly mentioned before all of this and also down at the very very bottom and almost uncommented upon are two simple facts that they also report.
Orders aside from transportation were up a smaller 0.1 percent. June durables orders were revised up, to a 1.1 percent advance from a previously reported 0.9 percent jump...

Orders for civilian capital goods aside from aircraft -- considered by some a gauge of business investment in new plants and equipment -- were up 0.6 percent after being up 1.4 percent in June.

So what's the real story? The real story is that business investment overall actually went down from June. The real story is that outside of transportation, the overall orders hardly budged at all - 0.1% by their recollection. And while I'm happy over Boeing's recent good fortune, even this article admits that airplane manufacturing has a "volatile civilian aircraft category". In other words, you can't depend on that kind of one-time goose in order to boost numbers up consistently in the long term. It's a more one shot deal, like the big boost in military aircraft orders that masked last month's dismal report.

Is the oldman being unduly pessimistic? Well let's look at other indicators in the economy. Let's look at new home sales.
Big drop in new home sales

Higher mortgage rates blamed for 6.4% fall; Northeast especially weak.
August 25, 2004: 10:24 AM EDT

WASHINGTON (Reuters) - New home sales fell more than expected in July to their lowest pace since December, as higher mortgage rates cooled the housing market, a government report showed Wednesday.

Sales of new homes tumbled 6.4 percent to a seasonally adjusted annual rate of 1,134,000 units last month from a downwardly revised 1,211,000 in June, the Commerce Department said. Analysts polled by Reuters were expecting sales to slow more gently to a 1.3 million clip from the originally reported 1.33 million unit pace.

Inventories of homes available for sale at the current sales pace ballooned to a 4.2 months' supply, the highest level since February 2003...

Sales of new homes plummeted 15.9 percent to 522,000 in the South, the region where most new homes are sold. Sales dipped 1.7 percent to 290,000 in the West, and collapsed by 23.5 percent in the Northeast to 62,000. Sales rocketed to a new high in the Midwest, rising 21.5 percent to 260,000.

Sales of already-owned homes also dipped last month, but still posted the third highest pace on record, the National Association of Realtors reported Tuesday.

In addition, it's not a fluke either. The pipeline of new mortgage applications has dropped as well.
Mortgage applications fall

Industry group said activity down 6.3% in latest week as 30-year rates edged higher.
August 25, 2004: 7:16 AM EDT

NEW YORK (Reuters) - New applications for U.S. home loans fell last week after a brief bounce, as 30-year mortgage interest rates edged up, an industry group said Wednesday.

The Mortgage Bankers Association said its seasonally adjusted market index, a measure of mortgage activity, declined for the week ended Aug. 20 by 6.3 percent to 646.3 from the previous week's 689.4.

The Washington trade group's purchase index, a gauge of new loan requests for home purchases, fell last week by 5 percent to 443.7 from 467.1 in the prior week.

Furthermore, foreclosures are up according to this CNN web-video.

Foreclosure pains
In some states, foreclosures are a bigger problem now than ever before. CNNfn's Ceci Rodgers reports from Indiana.

Furthermore, Buttonwood of The Economist has reported that Moody's debt rating service has lowered the average rating of US corporate debt to junkstatus.
The conventional view of corporate America is that it is in splendidly lean shape. Low interest rates and giddy profits have enabled firms to pay off debts and extend the maturity of those loans still outstanding, thus making them less vulnerable to rising interest rates. Indeed, the repair of their debt-heavy balance sheets was the main justification for the sharp contraction in the spreads of corporate bonds over Treasuries last year, and provided extra oomph to shares. Even though this process really only involved a transfer of debt from companies to individuals, who have borrowed mightily to spend and buy houses, even Buttonwood, ever the sceptic, was prepared to concede that it had taken place.

Too soon, perhaps—for evidence that corporate debt has fallen in the economy as a whole is scant. For one thing, you would have thought that companies paying off their debts at a rate of knots would have attracted a nod of approval from the credit-rating agencies. But the average rating of American firms from Moody’s, which crunched the numbers for The Economist, has actually fallen over the past three years, from the lowest investment-grade rating, Baa3, to Ba1, or junk. Small wonder, perhaps: CreditSights, an independent research firm, calculates that while companies have become a bit less leveraged recently, total debts for a sample of 175 firms are still almost 40% higher than they were in 1999. Measured as debt compared with market value, leverage has fallen. But this is almost entirely due to rising share prices, not falling debts.

There is, of course, no denying that companies have been raking it in lately. But if they haven’t been paying off debt or investing (and investment has been lacklustre), what has happened to that money? According to the NIPA figures, an astonishing 90% of it has been paid to shareholders. In an era of low interest rates, investors presumably want money up front.

But in the absence of investment and with balance sheets still heavy with debt, jam today does not necessarily mean jam tomorrow. [emphasis added]

In other words, American firms are highly over-leveraged as a group, and there are reasonable projections indicating that returns on equities will be substantially lower in the next quarter century than they have been in the last quarter century. Again, from The Economist.
His sobering forecast is based on two assumptions, both very reasonable. The first is that, because of lower inflation, company profits are unlikely to rise by more than 5% a year over the next decade, a bit slower than the average of 7% a year over the past 50 years. In the long run, profits tend to grow in line with GDP, and America's nominal GDP is thought likely to grow by around 5% a year over the next decade (3% real growth plus 2% inflation). Although profits have outpaced GDP over the past couple of years, this is unlikely to continue because pre-tax profit margins are nearly at their highest in 35 years. And since firms now operate in a world of greater competition, profit margins are, if anything, more likely to fall than to rise.

Mr Barnes's second assumption is that there is little scope for a sustained rise in the valuation of shares. The S&P 500 is currently trading at around 18 times historic operating profits. That is far below its ratio of almost 30 at the peak of the bubble, but still higher than its 50-year average of 15. Mr Barnes's “optimistic” scenario assumes that the p/e ratio stays flat over the next decade as a whole and the S&P 500 rises in line with profit growth of 5% a year. Adding in dividends, this would give an average annual return of 6.7%. That implies an average real return of only 4.7%, compared with almost 10% in the half century to 2000. However, history suggests that there is a risk that the p/e ratio could fall over the next decade. In an alternative scenario, Mr Barnes assumes that the p/e ratio reverts to its historic average of 15. If so, the annual return would be a measly 4.7%.

If we add on top of this, a story brought to us by Dan Drezner (proving that he is only soft in the head about subjects he wishes to be soft in the head about) a great deal of these companies have underfunded pension liabilities which there is every fear based upon history that they will attempt to unload on the Federal taxpayer.
The pension shortfall among U.S. companies may force the federal agency that insures retirement plans to seek a taxpayer bailout similar to the one during the savings and loan crisis, according to the Cato Institute, a policy research group.

The Pension Benefit Guaranty Corp. had a record deficit of $11.2 billion last year after taking over plans for 152 companies, including Bethlehem Steel Corp. and US Airways Group Inc.

Without changes to funding and premium rules, that deficit is likely to swell to $18 billion in the next 10 years and may reach more than $50 billion, said Richard A. Ippolito, who wrote the study for Cato, a policy research group, and is a former chief economist for the pension agency.

"If exposures create claims that reach catastrophic levels, taxpayers will be called upon to provide a bailout," Ippolito said...

Unfortunately, Congress has failed to adequately address the problems of the PBGC. In temporary legislation passed in April 2004, Congress reduced the required contributions companies must make to their defined-benefit pension plans by an estimated $80 billion over two years by changing the formula used to calculate pension liabilities. Congress also provided additional relief of approximately $1.6 billion to steel and airline companies with heavily underfunded pension plans.

Rather than place the PBGC on sounder financial footing, those measures will likely worsen the agency's financial condition.

In other words, the economic structure is rotten to the core. It's not just a matter of the corporate governance of a few "maverick" companies that were the worst perpetrators, but the entire economic infrastructure of the capital markets, corporations, and financial footing of this country is skating on rather thin ice. The big picture in every sense confirms the notion that we should disregard the one-time pops in the durable goods order, and focus in on the core trends which show a slowing economy. Other reports from parts of the economy show significant slowing and softening, and it should be remembered that $45 pb lsc oil only looks good now because recently we've all had a scare that it might break $50 pb lsc. Compared to a year ago, it's still a significant price rise and economic brake.

Yet Greenspan is waxing agnostic (Bloomberg) about the possibility of a housing bubble.
Greenspan Calls Data on Housing Bubble Inconclusive (Update1)
Aug. 24 (Bloomberg) -- Federal Reserve policy makers don't have the data to accurately tell whether U.S. home values are overheating, Fed Chairman Alan Greenspan said in a response to a lawmaker's questions about the potential for a housing bubble.

``House price increases have outstripped gains in income and rents in recent years,'' Greenspan wrote as a follow-up to his July 20 congressional testimony. While that ``raises the possibility that real estate prices, at least in some markets, could be out of alignment with the fundamentals,'' he added ``that conclusion cannot be reached with any confidence.''

This is Greenspeak for, 'yes of course it's a housing bubble you fools, but I can't say so because that would make it worse.' Worse, Greenspan is similarly spreading spin about the 'global economic recovery'.
Greenspan: Global recovery strengthening
Aug 25 08:59

US Federal Reserve chairman Alan Greenspan says global growth has picked up over the past year but some countries like Japan face a significant threat if oil prices remain high.

That's putting it mildly. Nothing Greenspan is saying is technically untrue. However he is attempting to imply that things are better than they are. A person reads this headline and comes off with the suggestion that Greenspan thinks things are getting better everywhere. What is about to happen is that there is about to be a aggregate demand crunch starting here in the USA that can not be ameliorated by moentary policy, and export-dependent and oil-import dependent nations like Japan and possibly China are about to have the equivalent of their quarterback sacked by a big ugly mean linebacker. They're going down, and hard.

If you simply pay attention to all the data, it's rather quite discouraging. Just not as discouraging enough to pop the bubble of sanitized and white-washed rhetorical creative interpretation confusing people about what are the facts of the situation. The facts of the situation is that there have been hard frosts and sometimes killing ones in Winnipeg and Minnesota, threatening or wiping out wheat and soybean crops, and that as far south as Salt Lake City, Utah there have been hail and freezing temperatures at night. In August. Yet you will rarely find these reported facts played up, on something other than background in national stories or in local farm community or rural newspapers.

Yet people keep on treating the food component of the CPI inflation as a "volatile" to be screened out, despite that commodity price futures are already rising.


At August 28, 2004 at 2:04 PM, Anonymous Anonymous said...

What? No comments??

The Thursday Bangkok Post reported 2 articles Quoting the Thai big wigs saying that they expect the world economy to drop in the next year and ahalf. The Asian media was reporting for at least one and ahalf years before the US economy crashed in 2000, that America was going to crash. Is the Asian midia ahead of the curve (compared to American midia) in predicting what's going to happen in America?

After the crash of 1997, many of the Thai listed corporations stock, debt etc was lowered to junk status. More or less like corporate debt of US corporations are now.

One would hope, inregards to company pension funds, if the fund managers did not sell off the fund "silver ware" ie. good stocks, that the value of the fund would go back up once the mismanaged corporations were brought back in line, and started to show a profit instead of a loss. (lot to hope for, will take 4-5 years, if those fund managers didn't act out their compleat ignorence)---This pension fund fiasco remineds me of the "Savings and Loan" looting.

The signs are pointing to my mini-crash happening (demand crunch, demand for the discounted products evaporating).

Jim Coomes

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