general, we consider it a good thing to save money and to "owe
no man anything save love." But what happens when a debt-happy society
wakes up and decides that saving is a good thing for everybody? What happens
when banks and hedge funds decide (or are forced) to reduce their debt? What
happens when businesses of all sizes find it harder to get loans to operate?
this week's letter we discuss "The Great Unwind," that process of deleveraging
that we are now in the midst of. We also explore some recent economic data on
the economy. It's a lot of ground to cover, so let's jump right in.
1.2 Million Jobs and Counting
unemployment numbers came out today and they were ugly. October showed a loss
of 240,000 jobs. But the really bad part was the negative revision to August
and September, by a further loss of 179,000. As I have written in the letter
numerous times, downward revisions in a slowing economy are the rule.
Unemployment estimates are largely based on recent past performance. There is
no way the models can catch a change in the overall trend. All the statisticians
can do is go back and modify the data as hard information becomes available.
the data shows is that the economy has lost 1.2 million jobs since December,
with over half of those losses in the last three months as the problems from
the recession accelerate. While two-thirds of the losses are in manufacturing
and goods production, the service economy is also starting to show signs of
strain. One in five lost jobs are from the retail sector.
Dunne of The Liscio Report writes: "A
stunning fact: yearly job losses in private services, 0.4%, now match the worst
of the 1982 recession and exceed the worst of 1975; once upon a time, the
service sector wasn't very cyclical. Now it is."
as disturbing is the jump in the unemployment rate. It leaped to 6.5%, far
above even the most dismal of expectations. For reasons we will go into below,
it is likely we will see another 1 million jobs lost over the next year, with
the unemployment rate headed up as high as 8%. There are now ten million
unemployed Americans. You have to go back to 1982 and a double-dip recession to
find an 8% unemployment rate. Very few people under 50 remember what that is
at the chart below. Notice how swiftly unemployment rises during a recession
and continues to rise even after the recession is over. Since I do not think
the current recession will be over until the third quarter of next year, we
could see unemployment continue to rise for the next 8-10 months. At least, I
hope it doesn't last longer.
Be Careful of Geeks Bearing Recovery Data
we look at how weak the economic numbers were from both the manufacturing and
service sector surveys, let me cover an important point about recessions. You
are going to hear all sorts of analysts (including sometimes even this humble
analyst!) quote statistics that in general sound like: "Since the end of WWII
average recessions have lasted X months, and thus we are almost through the
current one, so buy what I am selling." Or the ever popular "Stocks tend to
find the bottom in the middle of a recession, so now is the time to buy."
will be lots of variations that all assume that past performance is somehow
indicative of future results. And such an assumption is a prescription for
there are not enough data points about recessions between the end of WWII and
now to have any statistical meaning. I count 11 recessions since WWII. In what
other human endeavor would we use just 11 data points and then decide to bet
our hard-earned money? While average data can have meaning and give some
grounds for comparison, it should be treated with heavy levels of skepticism
when used as an argument for investing with conviction.
me tell you what we do know. Each and every recession is
different from all the others and in different ways. That stands to reason, as
the background economic environment was different for each one. The '70s and '80s
were subject to serious levels of inflation. The recession at the beginning of
this decade saw fears of deflation. Some happen with a strong dollar and some
with a weaker dollar.
recession is the result of serious bubbles in the housing and credit markets
imploding. It is not the result of excess inventory or overinvestment in
manufacturing capacity. As I have written numerous times, these excesses took
years to build up and will take at least 2.5-3 years to correct. We are 15
months into the correction process. That is unlike any other recession we have
experienced. So be careful in your use of comparisons based on historical
more point: since we do not know how long this recession will last, nor do what
the results will be from further stimulus packages and hidden surprises, it is
a mug's game to try and pick a bottom in the stock market based on some
theoretical halfway point of this recession. You are going to hear over and
over that markets anticipate the recovery about six months in advance. Given
that this may be a very long and slow recovery that could be quarters away, be
very cautious when you hear some bullish commentator using that "anticipation"
with that said, let me now turn and look at some comparisons with past
recessions that do offer some insight. By looking at how severe this recession
is compared to previous ones, we can glean some idea of the level of problems
we face now.
Back to 1982
Institute for Supply Management released their October survey this week, and it
was a shocker, helping send the Dow down by 10% in two days. It showed much
more weakness than expected. This survey is collected from a large number of
manufacturing firms. The ISM then makes an index of the data. For instance, if
60% of the reporting companies see new orders rising, then that would yield an
index number of 60 for new orders. Anything below 50 shows negative growth.
Below 40 shows a serious recession
overall manufacturing number came in at a very weak 38.9. We are now down to
levels not seen since September 1982. (Chart courtesy of Paul Kasriel and
internal data was even worse. New orders fells to 32, suggesting further
weakness in the manufacturing world. Backlog of orders was 29. New export
orders, a source of growth in recent months, fell from 52 to 41, a rather large
drop for a single month. This shows the rest of the world is beginning to slow
down as well. Boding poorly for employment, only 43% of companies reported that
they were planning to add additional employees.
was that illustrated more than in the auto sector. Last year sales were running
at about 17 million new cars a year. Last month's annualized rate was 10.5
million, the lowest level since 1983. And a recovery might not be in sight for
is now about one car in the US for every person of driving age. An article in
the Financial Times estimates that an
extra 1.5 million cars a year have been purchased due to cheap financing,
rebates, etc. If consumers decided they did not need more than one car, which
would imply a flat growth rate, sales could drop by 3.5 million cars a year
from the pre-crisis levels, which means Detroit would have a lot of spare
capacity even after an economic recovery.
I remember buying a car as a young man and not expecting it to last more than
80,000 miles before it needed major work or replacing. I now drive a 4-year-old
Cadillac Escalade (I am a Texan, after all!) and it has 65,000 miles. I have a
friend with an identical car that has 270,000 miles on it, and it is still
running fine. My car could easily last me another four years, as could the cars
of many people who bought new ones in recent years.
Basically, automobile manufacturers,
in their drive to sell as much as possible, "brought forward" future sales of
cars and, as a side effect, put lots of still quite good used cars on the road.
New car sales are likely to be depressed for some time. It is somewhat like the
housing problem. There is just too much inventory on the road that will have to
be worked through. When Detroit gives me a real reason to buy another car, like
an electric-powered vehicle, I will. And a lot of Americans, with a need to
save money for retirement, are going to feel the same way.
noted above, it seems that the service sector is now cyclical. The ISM Non-Manufacturing Survey results show broad-based
weakness. The headline composite index dropped to 44.4 in October from 50.2 in
September. This is the lowest in the 11-year history of this index. Indexes
tracking new orders and employment also fell sharply, to 45 and 42
data shows that we are sadly not yet close to the end of this recession. It is
going to be a long slow Muddle Through Recovery. Do not expect a typical
The Problems of Deleveraging
is a quite humorous series of quote about the demise of the American consumer,
starting with a Fed chairman in 1954 and going through one after another major
financial figure in the ensuing decades. They have all been wrong. Predicting
that the American consumer will change his profligate ways has not been a
recipe for forecasting accuracy. This time, it may be different. Not because US
consumers really wants to change, but that they may be forced to.
at the explosion of consumer debt (credit cards, auto loans, bank loans) over
the last 20 years, rising to $2.6 trillion. Household debt, including
mortgages, skyrocketed from 47% of personal income in 1959 to 117% in the
fourth quarter of 2007. And from 25% of GDP in the first quarter of 1952 to
98%. (Gary Shilling)
look at some numbers. Since 1
January, 2008, owners of stocks of US corporations have suffered about $8
trillion in losses, as their holdings declined in value from $20 trillion to
$12 trillion. (Losses in other countries have averaged about 40%.) Homeowners
will soon see their equity down by as much as $8 trillion, and those losses are
likely to increase.
highlighted here repeatedly, mortgage equity withdrawals counted for a full 3%
of annual GDP growth in the period from 2002-2007. MEWs have fallen by 95%, and
are falling again this quarter.
Credit card debt is being reigned in. In fact, as the chart below shows,
bankers are not surprisingly tightening lending standards to consumers, and
raising their rates. (Again, from Haver Analytics, courtesy of Northern Trust)
of US GDP growth has been fueled by debt. And that debt is now going to be much
harder to get, as equity in both houses and stocks has fallen precipitously.
as detailed last week, US consumers are clearly cutting back. The retail sales
figures that came out this week are dismal. J.C. Penney stores are down 13%
year over year! At Nordstrom's, one of my favorite stores, sales are down
almost 16% (six months ago they were growing at 10%!). Sales at major
discounter Costco were down 1%. The Gap, The Limited,
Target - store after store is down. Limited Brand sales are down by 70%
from October of last year. All this does not bode well for Christmas sales.
(Thanks to Greg Weldon of www.weldononline.com
for that data.)
how I talked about how auto manufacturers had cannibalized future sales? Credit
cards have allowed many retailers to do the same. Money that goes to cut down
credit card debt is money not spent today.
leveraged their way to higher levels of consumption, and now are going to be
forced to reduce that leverage. Many others are going to see the need to
increase savings to shore up retirement funds. People (and not just in the US,
but throughout Europe) have learned that a home is not an investment.
funds are also being forced to de-lever. While for most styles of hedge funds,
leverage was not all that high (an average of about 1.4 times equity), large
redemptions, especially by funds of funds, are forcing sales of all types of
assets, but in particular stocks. As an aside, this selling is not over. Mutual
funds are seeing large withdrawals, and are also selling.
banks are being forced to reduce credit lines in order to shore up capital, as
they must deal with subprime debt and other mortgage-related problems. Smaller
banks are just now starting to deal with losses on commercial loans due to the
economic downturn. That means that they will have to reduce their loan
portfolios to meet capital requirements.
is happening all over the world. Whole countries are imploding. Iceland? What
were they thinking? Italian sovereign debt is now suspect, calling into
question their ability to meet their deficits.
as consumers used debt to buy "stuff" they wanted now, so did businesses, banks,
and governments. It powered a huge global growth boom. The Great Unwind will
have the opposite affect, softening demand and weakening spending and growth.
What leveraging did for growth, deleveraging will take back. It is likely to be
a long, Muddle Through trip.
IMF now projects that the developed world will slow by a collective 1% next
year, dragging world growth close to zero. The export growth that has been
powered by a cheap US dollar is destined to slow as world demand falls.
good news? Oil prices are likely to fall even more, which will free up some
money to be used in other ways. The ISM data showed that prices paid are
falling, making inflation less likely. The US government deficit, under
Democratic control, is likely to be $2 trillion in 2009, a staggering number to
be sure. Without the pressure of inflation, and with the threat of outright
deflation, it may even be that such a deficit can be managed. In the short
term, this massive debt will provide a stimulus, lessening the effects of a
sad thing is that our children will be saddled with the debt for a very long
time. Hopefully we spend it on things like infrastructure, which will be of
some use to them, rather than on an endless stream of consumer stimulus
packages that simply add to current debt.
investors, businesses, and employers/employees, we will have to deal with the
outcome of a major resetting of consumer spending. Unemployment will rise.
Whatever stimulus package is enacted will mostly be used to draw down debt, and
not actually spent. Businesses all over the world are going to have to rethink
their growth plans to the extent that they were based on ever-rising US
consumer spending. Earnings are going to be under real challenge in most
industries. This is going to become more obvious as time goes by, and is going
to challenge whatever bear market rally can be mounted.
is not gloom and doom. The last major recession and problem period, in the '70s,
saw a number of new businesses start and prosper (Microsoft, Apple, Intel,
etc.). Businesses that have access to capital are going to be able to take
market share and come out of this recession in much better shape. It is just a
recession, after all, and will end. But I would suggest keeping your powder dry
and being nimble. There are opportunities which will arise, as they do in every
downturn. Just don't expect this recession to be like any past recession. Make
your plans accordingly.
a note. I showed a chart a few months ago which illustrated that imports were
falling, even as the trade deficit was not. This was because of the high price
of oil. Oil at that time accounted for two-thirds of the trade deficit. When
they tally the trade deficit for November in a few months, I think everyone
will be surprised at how much the trade deficit has fallen.
is something we will discuss in a future letter, as a lower trade deficit means
there will be fewer dollars to buy US debt, just at a time when US debt will
explode. That means that US citizens must save and buy that debt, or the Fed
will have to monetize it, or rates will have to rise to attract capital. These
are somewhat counterintuitive concepts and need explaining. But not this week.
It is time to hit the send button.
New York, Birthdays, and Moving
will be in New York next month (December 4) for Festivus, a holiday fundraiser
sponsored by my friends at Minyanville.com. If you are there, be sure and look
#2 daughter, Melissa, turns 28 today. How do they grow up so fast? She is my
wild child, though in recent years she has started to turn almost conventional
in a few ways. We are going to celebrate her birthday next Monday evening with
family and her friends, which will make for a very fun evening.
both home and office in the space of two weeks is starting to look like rather
a serious logistical challenge. While the home I will be leasing is large
enough, so we can have room for my office (along with my small staff), it seems
that I have way too much furniture between home and office. Not exactly a good
market to try and get rid of used office furniture. And all those files? And an
extra washer and dryer? Oh, well. Good problems to have.
a great week.
Your trying to figure out how to grow his business in this
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