The Economy has Bottomed
04/15/09
The Blue Chip Economic Indicators, based in Kansas City, surveys 50 economic forecasters every month and collects forecasts for economic growth, inflation, interest rates and other data. "Real GDP contracted very sharply during the first quarter of 2009 and will continue to shrink, albeit more slowly in the second quarter before turning very modestly higher in the third and fourth quarters," the survey said. This became important in April because it is the first time that the 50 economists have stopped lowering their estimates. The change from the March survey was exactly - zero. One more downtrend seems to have bottomed and that is good news. Research has generally shown that the broad consensus has a better track record than any single forecaster or group of forecasters, as described in "The Wisdom of Crowds" and mentioned in our newsletter from May last year. The forecasters expect the third quarter to run about flat with the second (up 0.4% annualized), with some growth resuming in the fourth quarter (up 1.6%). The Blue Chip survey also publishes the 10 most optimistic and the 10 most pessimistic projections. Even the pessimists see a bottom in the fourth quarter of 2009 with slow growth resuming in 2010. The fact that even the pessimists are no longer expecting deterioration is important. Something in the economic data must have convinced them that downside surprises have come to an end. Let us see what that might be.
The first chart above shows total business inventories, which fell 1.2% in February, the sixth straight monthly decline and a cumulative decline of about 5.8% or $89 billion. The six-month dip appears to be the largest percentage decline of the past 50 years and will help sow the seeds for stabilization in industrial output and the overall economy. Car sales for example are stabilizing now at an annual rate of 9 million vehicles. When one considers that some 13 million cars are being scrapped every year then we must conclude that the difference will be made up by existing car inventories on dealers' lots. The same is true for the rest of the economy. Declining inventories (second chart) are the first step towards recovery. The combination of falling inventories and stabilizing sales brought the inventory-to-sales ratio down to 1.43 months from 1.45 in January, although it is still well above the record low of 1.23 months set last June. It seems that companies have adjusted their production sufficiently to the new, lower levels of demand. This should begin to reduce the rate of decline in output, although no meaningful increase in output is likely until inventories are brought down significantly more. Economic growth in other words will be sub par. That is the bad news. The good news is that the economy seems to have transitioned from a free fall (depression) to a consolidation at a low level (recession). Yes, we are still in a recession, but over time we will whittle down inventories to a lower level so that manufacturers can increase output again and start re-hiring their laid off workers. The time, however, until this re-hiring can begin is the issue where smart people disagree. As mentioned above, the optimists think it will take another quarter or two before re-hiring can begin. The pessimists think, it will take another three, four, five or more quarters, before re-hiring starts and the unemployment rate can stabilize. For that to happen, however, we need to see the capacity utilization rate improve. We have been at record lows of about 67% to 68%. It seems like a long way from those levels to the high 70s where effects on unemployment are starting to be felt. What seems no longer at issue at least is the concept that the inventory cycle is turning. The effect on employment is unclear, but we may attempt a guess by first looking at the Congressional Budget Office official economic outlook report and a (very cool chart) and then at a section of the GDP report:
The second chart above shows the three sub-sets of the personal income & outlays reports. The real (inflation adjusted) personal consumption expenditures measure how much individuals spend on durable goods (cars, washing machines etc.) nondurable goods (paper, clothes etc.) and how much on services. You see that services dominate and indeed have been expanding their dominance over the past 50 years. Some 76% of our economic output is services related and the chart shows also that spending on services has continued to grow throughout 2008, while spending on durable and nondurable goods suffered the greatest loss since the great depression. Real gross domestic product plummeted at an annual rate of 6.3% in the fourth quarter of 2008, the worst since the first quarter of 1982. But quite unlike the early-'80s, the services portion of real GDP actually increased at an annual rate of 1.9%. A couple of years ago we had mentioned the book Our Brave New World by GaveKal Research. The book is a must read! It explains that of the three corporate functions (design, produce, sell) the production part is the most capital intensive and volatile. Over the past 50 years, that portion of the economy (including the manufacturing jobs that go along with it) had been successfully outsourced to countries like Mexico, India or China. The result was not only the loss of those high-paying but notorious unstable manufacturing jobs but also (and more importantly???) the decline in employment volatility in this country. The fact that spending on services did not even flinch in the face of a perfect economic storm proves the notion that service sector jobs are more stable than goods producing jobs. Consequently, we must watch the goods producing sector for signs of an economic recovery. And here the outlook is relatively upbeat. Last week, for example, the Institute for Supply Management reported that the new orders component (last chart above) of its monthly Purchasing Managers' Index jumped in March, thereby posting the biggest three-month gain since 1983. That, coupled with lower inventory readings, indicates that a rebound in manufacturing is not far away. These low inventories will need to be rebuilt. The stock market has sensed that the outlook for manufacturing is improving. Nearly 89% of stocks are above their 50-day moving average, the highest reading since mid-2006. This implies that a sizable correction is imminent. This correction may turn out to be more severe than we wish. After all, earnings season is upon us and will remind investors that risks are still substantial. The coming week will tell us more about the market's mood. The character of the coming correction will be instructive as to whether we are still in a bear market or not. Meanwhile, if you have profits, take them.
Hermann Vohs
"Crowdsourcing" is "the act of taking a task traditionally performed by an employee or contractor, and outsourcing it to an undefined, generally large group of people, in the form of an open call."
Wikipedia
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
