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Forex Blog - The Economic Blue Screen of DeathThe Economic Blue Screen of Death
October 17, 2008
The Psyche of the American Consumer
The Consumer Weakens
The Paradox of Thrift
An Economic Blue Screen Of Death
Those Wild And Crazy Analysts
London, Stockholm, Malta, and Becoming a Grandfather
This week I am in California giving two speeches to the Financial
Planning Associations of San Diego and Orange County. This and next
week's letters will be the broad outline of the speech. We will look at
how the retreat of the American consumer will affect the stock market.
Has the recent drop (can we say crash, gentle reader?) in stock market
valuations given us an opportunity to find value? We look at some very
powerful evidence that suggests that may be so. Then we look at the
counter to that view. Are we at the bottom, or is there more pain? And
given the current state of affairs, how should we then invest? Where do
we put our money to work when the dust settles, as it surely will.
I noted above, this will be a two-part letter, finishing up next week.
It will also print out a lot longer than normal as I have a lot of
PowerPoint slides that are really important for you to see. A note to
the 25% of my one million-plus readers who are outside the US: I am
using illustrations from the US stock market to discuss timing and
valuations, but the principles will translate to markets worldwide. In
fact, considering that most stock markets worldwide are down even more
than the US markets, they may be even more applicable. The time to
become bullish on a lot of markets may be closer than we think. Let's
jump right in.
The Psyche of the American Consumer
You have to have a bit of humor, and I think this cartoon says a lot.
psyche of the American consumer has been seared, and perhaps
permanently, reminiscent of the manner in which our grandparents who
lived during the Great Depression were permanently scarred with the
memories of that time. How it works out will be different this time, of
course, and we will explore that later on. But one thing that is very
likely is a major impact on consumer spending going forward. Let's look
at a few facts on the state of the consumer.
The Consumer Weakens
sales have fallen for the last three months. This is the first time
sales have fallen in such a manner since the record keeping began. They
are falling at an annual rate of 2%, which is unprecedented.
sales are down, virtually in freefall, with many auto company sales
down more than 30% (Volvo is down 50%!). And it may get worse. GMAC,
the financing arm of GM, has announced it will not lend to anyone whose
credit score is not 700 or more! Only 58% of Americans qualify. That
means, for a large swath of the consumer marketplace, cheap auto
financing is a thing of the past, unless auto companies underwrite
loans with guarantees.
However, what we are seeing is auto
companies abandoning leasing programs and other traditional marketing
avenues in order to search for elusive profits. Where you could buy a
car two years ago for little or no money down, many dealers are now
requiring an average of 12% down. While this makes sense, it is
definitely a change.
And it is not just in the US. Auto sales
throughout Europe are off significantly, especially in countries that
had their own equivalent of the US housing bubble.
How bad is it?
We are becoming a morose nation, staying at home to drown our sorrows -
even bar sales are down, almost 1%. While I am sure this audience is
doing its part to help out the bartenders of the world, our clients are
Falling consumer and retail sales are not surprising, given
the fact that almost one million jobs have been lost in the last 12
months, bringing unemployment to 6.1%. California, which is a
bellwether state, has seen its unemployment rise to 7.7%. That is a
(sadly) reasonable target for nationwide unemployment.
Back-of-the-napkin analysis suggests that means at least another
million jobs will be lost this cycle.
Falling consumer sales
are showing up in the share prices of retailers and shopping mall
REITs. Many are down to prices last seen 12-16 years ago, with price
drops far below the market averages. Think Vegas is immune? MGM and
Trump, to name just two, are down 90%!
But we lost a lot of jobs
in the last (2001-2002) recession, and consumer spending did not go
down. Won't the present trend reverse soon? Might it not just be from
the shock of the credit crisis? And with gasoline prices down, giving
us a $100 billion plus "tax break," is the worst not over?
is reasonable therefore to ask why it should be different this time.
Predicting the demise of the American consumer has been a favorite
pastime of bearish analysts for over 50 years. And they have always
been wrong. The American consumer has proven resilient through feast
and famine, war and peace. But, the data and circumstances suggest this
time may be different.
Let's look at the data that came out this
week on the delinquency rates of various types of consumer debt. The
delinquency rate on auto loans is 3.8%, up from 2.9% two years ago.
Consumer finance? Up to a very high 8.3%. Credit card delinquencies are
4.8%, rising from 4%. Is it any wonder credit card companies are
cutting credit lines and raising interest rates to try and stem the
bleeding? Mortgage delinquencies have doubled from 2.5% to a current
5%. Consumer credit in general is up to 5% delinquent, more than
two-thirds higher than two years ago. This is all illustrative of a
consumer in trouble.
Look at this next chart from John Burn Real
Estate Consulting. He surveys hundreds of homebuilders nationwide. The
long and short of it is that new home sales forecasts are at all-time
lows. Traffic (potential buyers) looking at new homes is dismal. In my
own area in Dallas, there are brand new homes which builders are
willing to lease at very attractive rates in order to generate some
cash flow, at much less than the cost of buying. And given the level of
prospective buyers looking for a new home, that is a trend likely to
should note that this morning housing permits fell to a 26-year low,
around 786,000. But that statistic can be misleading. Back in 1982, the
population of the US was 230 million. Today it is 305 million. We are
roughly one-third larger. If you adjust for population, the number
would be in the 600,000 range, which is far worse than a mere 26-year
low. Those permits mean jobs, and permits need to rise with the
population to maintain the job base.
And since we're looking at
today's data, the Michigan consumer sentiment number simply fell off a
cliff, plunging to 57 from over 70 last month and an average of 85 last
year. It was only a few years ago that the number was over 100. The
last time it was this low? We were in the midst of a very serious
recession in 1982.
Let's get back to housing. This next chart is from www.dismal.com,
showing the fall-off in mortgage applications. Mortgage applications
for purchase are down by over 30% since the end of 2007, and down much
more than that from the peak of 2006, as the subprime lending market
pay particular attention to the fall-off in applications for
re-financing, down by almost 60%. This was the source of mortgage
equity withdrawals, which fueled consumer-spending growth even in the
face of the last recession. Let's look at a graph I used two years ago,
from work done by James Kennedy and Alan Greenspan, on the effect of
mortgage equity withdrawals (MEWs) on the growth of the US economy.
that in both 2001 and 2002, the US economy continued to grow on an
annual basis (the "technical" recession was just a few quarters). Their
work suggests that this growth was entirely due to MEWs. In fact, MEWs
contributed over 3% to GDP growth in 2004 and 2005, and 2% in 2006.
Without US homeowners using their homes as an ATM, the economy would
have been very sluggish indeed, averaging much less than 1% for the six
years of the Bush presidency. Indeed, as a side observation, without
home equity withdrawals the economy would have been so bad it would
have been almost impossible for Bush to have won a second term.
let's look at the update that James Kennedy posted last week to his
numbers. While he does not have an update to the chart above, we do
have the actual numbers for new mortgage equity withdrawals through the
second quarter of this year. And what they show is MEWs simply
withering on the vine. The engine of our GDP growth has essentially
been turned off. Look at the fall in the numbers for yourself:
2005 there was almost $595 billion in mortgage extractions that went
into some kind of consumer spending. Remember, according to the graph
above, that translated into a 3% rise in GDP. In 2007, MEWs were down
to $470 billion, for a boost of 2% to GDP.
The second quarter of
2008 saw an anemic $9.5 billion. At that run rate, we could see a
drop-off of over 90% from 2005! Now, think what the second quarter
would have been without the federal stimulus program of $150 billion.
It might have looked and felt like this quarter!
card growth has indeed risen to take up some of the "slack," it is
nowhere near the previous levels of MEWs. With almost 20% of American
mortgages either now or soon to be "under water," and because lending
standards are tightening, it will be a long time before we see a
significant upsurge in home equity withdrawals. Whatever growth we see
in the next few years will have to come from old-fashioned sources,
like real productivity and reality-based lending. Homeowner
hallucinations are a thing of the past.
And for those of you who like to digest your numbers visually, here is the chart of the decrease in MEWs.
is likely that whatever recovery we see will be slow in coming. Without
MEWs, the period from 2001-2007 would have seen GDP growth of less than
1%! What has changed for the better? It is going to be a rather serious
recession and a slow Muddle Through recovery of several years. Unless
Obama, Pelosi, and Reid push through their tax increase. Then it will
be a lot longer. Maybe even a repeat of 1980 and 1982, where we had
back-to-back recessions in two years. Increasing taxes in a recession
is the worst possible economic policy. You increase taxes, from an
economic perspective, in good times.
Last year, I predicted we would see three things as a result of the bursting of the housing and credit crisis bubbles:
1. We are in a period where earnings disappointments are going to be the rule, not the exception.
2. Lower corporate profits puts pressure on the stock market,
3. Resulting in lower than expected long-term returns.
Let me add a fourth. The psyche of the American consumer has been seared, and perhaps permanently.
The Paradox of Thrift
are (finally!) going to see US consumers start to increase their
savings. Increasing home prices and increasing stock prices made many
consumers feel comfortable that their retirement future was assured.
Now that feeling has been crushed. Home values are not likely to bounce
back for a very long time. And as I have written for a long time, we
are facing a low-return environment for stocks.
Now, while it is
a good thing for an individual to save money, it is not good for the
economy as a whole, at least in terms of consumer spending and GDP
growth. This is the Paradox of Thrift.
An Economic Blue Screen Of Death
lack of the ability to borrow on homes, coupled with the need to save
more money, is going to put a large dent in the US and world economy.
My older readers will remember the Microsoft "blue screen of death"
that would pop up from time to time when your computer froze. All you
could do was hit the reset button. It is as if we have hit a giant
economic blue screen of death. All we can do is hit the reset button.
We are going to a new, lower level of consumer spending on an absolute
basis, and perhaps as a percentage of GDP. Once that new level has been
reached, we will start slowly growing from there; but until that point,
the growth of the US economy is going to be severely challenged. We got
ahead of ourselves through borrowing and confidence in the bull market,
and now we have to deal with the new reality.
corporate earnings for many US companies are going to come under
increased pressure. And as we will see below, the drop in corporate
earnings is in line with the drop in the stock market.
Those Wild And Crazy Analysts
at how the projections for earnings per share for the S&P 500 have
dropped over the past year. Every few months, estimates have dropped.
It will get worse (teaser for next week: we look at graphs which show
where earnings may go if they drop as much as in the last recession.
And remember, that recession had growing consumer spending!).
the malaise and mood of the US consumer, the already low numbers for
this year are likely to be revised down again. Let's go to the chart:
Now let's look at 2009 projections.
that in February of 2008, earnings for 2008 had been revised downward
to $71.20. But analysts were still bullish. They projected the next
month an almost 10% increase in earnings for 2009. They are now down to
$48. Remember the old Limbo song, "How Low Can You Go?" 2009 earnings
can go a lot lower.
One last graph for this week and then we will
call it a day. This is the actual data from S&P, which I copied
from their web site. Notice the huge disparity between the as-reported
earnings and operating earnings estimate for 2009. The operating
earnings are literally double the reported earnings. Reported earnings
are what companies use for tax purposes. They are also the basis for
any historical comparisons you see. Operating earnings are what I call
EBBS or Earnings Before Bad Stuff, or whatever term you use for BS.
operating earnings estimates are "bottom up" (no pun here). That means
that S&P gets the estimates from each of the analysts that follow
the individual companies, and add them up for the estimate. The
top-down estimates take into account economic conditions. It makes a
HUGE difference as to who is more accurate. If the optimists are right,
we are at single-digit price to earnings ratios (around 8). If the
as-reported team is right, we are at relatively high levels, even after
the recent large drop. How high? As of 11 AM Pacific, the 2009 P/E
projected ratio is 20.2. That is not a level from which major bull
markets are launched.
is that the level we should be looking at? As we will see next week, if
you take a longer-term view of a few years, you can make a case that we
are getting closer to a secular bear price-cycle low. Next week, we
look at how secular bear markets work and where we could go, and then I
offer a few areas where you can look to place your portfolio. I am
getting closer to the time when I can be cautiously optimistic.
will get through this current crisis, and the falls in prices of assets
of all types are beginning to create some real opportunities. We will
explore those thoughts and a lot more next week.
London, Stockholm, Malta, and Becoming a Grandfather
noted at the beginning of the letter, I am in California, but will fly
home this afternoon. Tomorrow I explore some of the local Dallas
housing values (leasing) and then fly on to London in the late
afternoon, meeting with my London partners, Absolute Return Partners
for a fast few days, and then on to Stockholm where I speak and will
chair the day's events for Kaupthing Bank, which was a branch of the
Icelandic bank a few weeks ago but now has been taken over by the
Swedish government. I expect to learn a lot. And I get to spend some
time with old friend Marc Faber. The original focus for the day, many
months ago, was "Investing in an Age of Scarcity," but we will expand
the topics covered with a nod to current affairs.
Then an ungodly
early wake-up call, and on to Malta on Friday, where I will be involved
in a series of board meetings of various hedge funds. Even more
interesting. Saturday I start to work my way back to Dallas, and then I
am mostly home for the next three months, where I will be researching
and writing with Tiffani our new book, called We have been interviewing
millionaires from all levels and from all over the world, but their
stories have some common threads. This has had a huge impact on both
Tiffani and me. I hope we can convey in the book what we are learning.
It is changing my outlook and habits, I can tell you.
I got a
text message late last night from my oldest son Henry. He assumed I was
already asleep, but I was still up working. He wrote: "I know you
wanted us to wait a little longer, but you are going to be a grandpa."
He wrote a few more nice thoughts, along the line of wanting my advice
and wisdom, etc. Like I have a clue. I feel supremely lucky that my
(7!) kids have turned out so well. And we all enjoy and love one
another, and I get to spend time with them as young adults. And I guess
almost 60 is not be that bad to be a first-time grandfather. Should be
an interesting and fun new chapter in my life, if my many friends who
have traveled that road are any indication.
It is time to hit the
send button. I have this speech to do in an hour, and my really good
friend Rob Arnott is coming to have lunch. Life is a lot of fun. Enjoy
your week and remember that friends, family, and health are where our
true wealth is.
Your thinking more about the Big Stuff analyst,
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