Sunday, December 10, 2006

Data Indicate No U.S. Recesssion-Yet

Unlike last week's fairly consistently bearish economic news, this week's data were relatively bullish. The ISM service index rose, employment growth was positive. Jobless claims was a bit more mixed with initial claims falling while continuing claims rising , while consumer sentiment fell.

What this is indicating is that while the construction sector is in a recession, and the manufacturing sector on the verge of a recession, the service sector and the mining sector is still growing. This was confirmed by the sector specific details of the employment report which showed shrinking employment in construction and manufacturing and increasing employment in services and mining.

This indicates Nouriel Roubini's forecast for 0% growth in the fourth quarter is a bit too bearish. Growth will probably end up a lot lower than the 2.2% current third quarter estimates, but it will be a bit higher than zero. The main reason why growth have stayed above zero despite the housing bust is that lower energy prices have boosted consumer purchasing power (so much for the idea that price deflation is necessarily bad for the economy) enough to offset much of the negative impact of the housing bust. All of this is in line with my analysis from late October.

For 2007, the case is much stronger for Roubini's recession call. Oil prices have now started to stabilize and indeed recover somewhat from their lows (at least in dollars ) and will provide no further support for the economy henceforth. While the falling dollar should boost U.S. exports, the dollar fall have been too small in trade weighted terms and the export sector play a too small role in the economy to provide a significant boost to the overall economy.

Meanwhile, the housing bust should continue as construction spending is still way above the historical average and as housing equity continues to erode. Which brings ut to the latest flow of funds report. While the increase in household debt was actually somewhat lower than I had expected, this probably reflects that the sharp increase in bank ledning in the week between September 27 and October 4 was attributed to the fourth quarter, which means that the debt increase then will be much higher. Even so, household debt relative to disposable income rose during the third quarter to a record 130.4%, up from 129.4% in the previous quarter.
Meanwhile, housing equity fell to a record low of 53.6%.

This means that construction spending will continue to contract, while the room for further home equity withdrawals will be limited, which in turn will limit consumer spending.

The one thing remaining to support the U.S. economy is business investments. One of the factors determining it, corporate profits reached a new record high during the third quarter, something which creates a case for believing in continued boom in business investments. However, while corporate profits are an important factor for predicting business investments, it is not the only one. What matters to business decisions to invest is not current profits per se, but expected future profits from further investments. If companies expect future profits to fall, then the current high level of profits will only have a limited effect in increasing business investments.

The last factor, the high level of business profits and the support it is likely to give to business investments is the strongest argument against the bearish case and makes it impossible to declare a 2007 recession a certainty. But, as all other indicators support that case, its likelyhood is over 50%


Anonymous Anonymous said...

Business investment is not really increasing despite the high profits. Foreseeing a very difficult 2007, businesses have preferred to spend their excess cash in stock buybacks. So you will not see increased business investment. The residential sector is already in a recession. Non-residential construction has diminished in the last two months, so it is also entering recession. Manufacturing recently showed its first contraction (below 50) and the auto sector is entering recession also. 4QR GDP growth will be below 1% and 3QR growth final number may be revised lower than the 2.2%. The housing bust will reduce consumer spending through a lower wealth effect, lower availability of home eqity withdrawal and lost jobs in both the construction sector as well as the housing marketing and mortgage financing sector. Although the services sector represents about 70% of the US' economy, consumer spending accounts for over 2/3 of GDP growth. So a reduction of consumer spending will trigger negative growth next year for at least 2 quarters. The Fed will feel forced to cut rates although it will be too late to stop a housing led recession, which is normally inelastic to interest rate changes. The big effect on foreclosures that the adjustable mortgage rates will cause as they lock into higher rates next year could have been averted if the Fed would have stopped it's rate increases at 4.25/4.50%. I warned Merrill Lynch of the coming big economic slowdown and possible recession on an email sent February 7, 2006. But they had another consensus view at that time. They may be starting to revise their consensus. And my possible recession call was assuming the Fed would hike rates to 5%. Now, with the rate at 5.25% it no longer possible but highly probable. The ever higher probability that the Fed will move to cut rates will continue stimulating the stock market which has not absorbed the latest negative economic data because there also has been positive data. These mixed signals always happen at turning points. Only when the market starts getting a big majority of soft numbers will it correct downwards and the US dollar will start a sustained decline. Being the world's biggest economy, a US recession, if severe as it appears to become, will lead to a global slowdown of the world economy. Exports to the US will decrease in a big way, hitting principally Japan and China and, to a lesser extent, Europe as the Euro appreciates against the US dollar. Also, central bank reserves with a high dollar content (Japan, China, South Korea, oil exporting countries) will lose value as the dollar loses value. The picture is not rosy and definitely not Goldilocks. We should all be prepared for this. You, in Sweden, should not be affected severely since your economy does not depend so much on exports to the US and the krona will probably stay in line with the Euro or slightly appreciate against it. Although big Swedish exporters like Ericsson, Volvo, Alfa Laval, Asea BB and other companies of the Wallemberg group will see sales and profit decreases.


7:33 AM  

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