Sunday, April 05, 2009

Recovery On The Way?

Economic data were mixed but mostly weak. The most important report, the employment report showed continued significant job losses and a full 1% drop in hours worked. Initial and jobless claims also continued to rise.

The ISM manufacturing index improved slightly, while the non-manufacturing fell slightly. The ISM manufacturing improvement incidentally contradicts the manufacturing numbers in the job report which indicated an accelerated downturn. Construction spending showed further declines in residential investments while nonresidential investments were stable after a really big decline the previous month. Car sales showed somewhat smaller declines, though as James Hamilton points out, that was a mere base effect caused by a very weak March 2008.

What this tells us is that the economy clearly continues to contract, but that the pace of contraction is no longer accelerating.

But perhaps more interesting than the issue of whether there is still a deep recession, is the issue of whether we are seeing the first signs of a coming recovery. Robert Wenzel thinks so, but I am not equally sure.

His main argument is that money supply has increased fast, something which will provide a short-term boost to the economy. And indeed, the high money supply growth clearly increases the chance of some kind of recovery, but there are strong forces working against a recovery.

Moreover, to the extent that higher money supply reflects higher money demand [for non-transaction purposes] and/or it causes higher price inflation, it will not boost real output. Money supply grew fast in late 2007 and early 2008, yet that didn't cause a recovery.

As for the stock market, it is true that it has had a rally for the last few weeks. But as Nouriel Roubini points out, the stock market has predicted six out of the latest zero economic recoveries. Or in other words, there have been 6 bear market rallies previously during this bear market, most recently between late November 2008 and January 2009. It is very likely that this is just another bear market rally, as it will again be apparent that the underlying fundamentals are very weak (The recent move to "mark to wishful thinking" accounting practices may mean that it will take longer time for investors to figure it out, but eventually the truth will come out).

But didn't durable goods orders boom in February? Technically yes assuming no further revisions, but not really in any meaningful sense. The apparent positive number was entirely the result of a massive downward revision of the previous months number. The initially reported number for non-defense, non-aircraft capital goods orders for January 2009 was $52.55 billion. The currently reported number for non-defense, non-aircraft capital goods orders for February 2009 is $52.16 billion. That number is 11% lower than 3 months earlier. Given this, it seems more likely that the apparent upswing reflects the measurement problems and inherent volatility in monthly numbers than any genuine upswing.

The fact that hours worked in the durable goods manufacturing sector fell as much as 2.6% in March compared to February(compared to a year earlier, the decline was 19.3%) certainly doesn't suggest that we've seen the beginning of a recovery in the most cyclical sectors (Other cyclical sectors like construction and mining saw even bigger declines).

In short, there is simply no sign yet of any recovery. At some future point in time, a recovery will of course come as slump (or boom) lasts forever, but it certainly hasn't come yet. And no evidence exists that it will come soon (by "soon" I mean the coming months).


Blogger Eric Dennis said...


Are you aware that marking-to-market mortgage securities requires exactly the kind of mathematical models that you have recently been dismissive of?

What is the market to be marked to? Something like the ABX index. How do you translate ABX prices into valuations of the actual securities you have on your books? A mathematical model.

1:42 AM  
Blogger stefankarlsson said...

Eric, first of all, I am not against the use of mathematics in any and all circumstances. I am only against it when it is unnecessary and/or misleading. And obviously (almost by definition), some kind of math is necessary when analyzing quantitative values.

And while I admit that I don't know the exact valuation methods being used by American banks as I do not work as an accountant for these banks, I know that market values exist for mortgage backed securities and that you can therefore estimate what value a particular banks securities have on the market using valid valuation methods.

12:09 AM  

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