Capital Markets Monitor August 23, 2010

 

Weak final demand remains the crux of our current economic situation.  Consumers are in the early stages of de-leveraging.  Consumer debt is down only 6.5% from its peak in Q3 2008, yet serious delinquencies continue to rise.  Frugality is a core theme that is likely to be with us for some time as housing prices and employment remain challenged.  Businesses are not investing, despite low borrowing costs as most industries have excess capacity.  While capacity utilization has improved it remains well below prior levels of economic expansion that would encourage businesses to invest.
 
As David Speer, CEO of Illinois Tool Works said, "I could borrow $2 billion tomorrow for 3.5%, but what am I going to do with it?"  Excess capacity or lack of demand - and therefore lack of new investment - is a key reason why the recovery is sluggish.  Reports this week from Fidelity that a record number of 401ks have been tapped for hard ship withdrawals adds to our negative outlook on the state of the end consumer.
 
The Empire Manufacturing Survey came in a 7.1, slightly below expectations but above June's level, indicating that conditions improved slightly and the expansion is holding.   Employment was a positive, as employment levels and the average workweek expanded in August, reversing declines in June and July.  Worrisome though was the 13 point drop in new orders to -2.7.  The first drop in a year indicates we could see further weakness in the Empire in coming months.
 
The Philly Fed Survey, at -7.1, was simply shocking. Expectations were for a +7.0 reading.  The survey has now fallen consistently from 21.4 in May, a precipitous drop.  New Orders, inventories, backlogs, and the employment component were all firmly negative.  The drop in the inventory reading and the employment components were particularly sharp.
  
Weekly Jobless Claims have now climbed three weeks in a row and are established in an upward trend (up 4 out of the last 5 weeks).  Breaking the 500,000 number was a psychological blow.  This past week was also the survey week for the non-farm payrolls for August.  Despite recognition that Census workers are inflating the number, the latest data increases our caution come the first week of September.  David Rosenberg has repeatedly noted the 500k level has historically been a clear signal of recession.  His latest missive warns if the 4 week moving average reaches this level, a double dip is a "fait accompli".
 
We saw further weakness in the housing market this week.  Homebuilder sentiment hit the lowest levels since March of 2009.  Single family housing starts fell to a 432k annual rate in August.  With inventories elevated, new household formation reduced, this measure would have to fall 25% and stay there for a year, for the excess housing supply to be worked off.  Homeownership rate at 67% remains above the pre-bubble mean of 64%.  Simply put demand will remain week and prices will fall further.
 
The Mortgage-Refi index showed some life this past week, jumping 17% to the highest level since May of 2009 as extraordinarily low mortgage rates are encouraging more homeowners to lock in lower payments.  One economist notes that if the U.S. enters a double dip recession home prices could fall another 20% before stabilizing in early 2012. That compares to a baseline forecast that calls for another 5% decline in home prices and a bottom early next year.  
 
The Conference Board's index of leading indicators came in at +0.1%, yet the yield curve's impact is estimated at +0.3%.  If you believe that the weak final demand limits the benefit of the steep yield curve, then one can make the case that the LEI reading should really be -0.2%.  Absent the impact of the yield curve and the stock market, the LEI has barely budged since March of 2009.  As Rosenberg also notes, the LEI has an 81% correlation to a 6 month lag of Industrial Production.  This further bodes poorly for the months ahead.