U.S. Economy in pictures

Submitted by Lance Roberts

I have written extensively about the data behind the headline media reports. I have also discussed the importance of the relationship between the underlying data trends relative to broader macroeconomic perspectives.  However, it is sometimes helpful just to view the various economic indicators and draw your own conclusions outside of someone else’s opinion.

With the economy now more than 5 years into an expansion, which is long by historical standards, the question for you to answer by looking at the charts below is:

“Are we closer to an economic recession or a continued expansion?”

How you answer that question should have a significant impact on your investment outlook as financial markets tend to lose roughly 30 percent on average during recessionary periods.  However, with margin debt at record levels, earnings deteriorating and junk bond yields near all-time lows, this is hardly a normal market environment within which we are currently invested.

Therefore, I present a series of charts which view the overall economy from the same perspective utilizing an annualized rate of change.   In some cases, where the data is extremely volatile, I have used a 3-month average to expose the underlying data trend.   Any other special data adjustments are noted below.

Leading Economic Indicators

Durable Goods


ISM Composite Index

Employment & Industrial Production

Retail Sales

Social Welfare

The Broad View

Economic Composite

(Note: The Economic Composite is a weighted index of multiple economic survey and indicators – read more about this indicator)

If you are expecting an economic recovery, and a continuation of the bull market, then the economic data must begin to improve markedly in the months ahead. The problem has been that each bounce in the economic data has failed within the context of a declining trend. This is not a good thing and is why we continue to witness an erosion  in the growth rates of corporate earnings and profitability.  Eventually, that erosion combined, with excessive valuations, will weigh on the financial markets.

For the Federal Reserve, these charts make the case that continued monetary interventions are not healing the economy, but rather just keeping it afloat by dragging forward future consumption.  The problem is that it leaves a void in the future that must be continually filled.

In my opinion, the economy is far too weak to stand on its own two feet. With the Fed easing off the current rate of bond purchases, it will be interesting to see what happens in the months to come. While there will certainly be positive bumps in the data, as pent up demand is released back into the economy, the inability to sustain growth is most concerning. From this perspective, it could become increasingly difficult for the Federal Reserve to remove their “highly accommodative stance” anytime soon.

Reality-Optional Economics

The total tonnage of economic malarkey being shoveled over the American public these days would make the late Dr. Joseph Goebbels (Nazi Minister of “Public Enlightenment and Propaganda”) turn green in his grave with envy. It’s a staggering phenomenon because little about it is conspiratorial; rather, it’s the consensual expression of a public that wants desperately to believe things that are untrue, and an economic leadership equally credulous, unmanned, and avid to furnish the necessary narratives that might preserve their jobs and perqs.

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The Next Economic Disaster Might be Closer Than You Think

We are believers in the “from the outside in” principle of markets: When trouble starts, it nearly always does so out in the weaker periphery before creeping towards the core.

We saw this in the run-up to the 2007 housing bubble collapse as sub-prime mortgages gave way before prime loans. You can see it again in Europe, as smaller, weaker economies like Greece, Ireland, and Cyprus have fallen first and hardest.  We see this today in accelerating food stamp use among poorer U.S. households.  In each case, the weaker economic parties give way first before being followed, over time, by the stronger ones.

Economic CollapseUsing this framework, we can sometimes get weeks or months of advance notice before trouble erupts closer to the center.

Today we’re receiving a number of new warning signs.  The periphery is giving way.

Ever since the current economic “recovery” began, we’ve been warning of the high risk of a renewed financial crisis.  That risk is now uncomfortably high.  This is because nothing that led to the first round of troubles was actually resolved.  Instead, those troubles were simply papered over with central-bank liquidity, leaving structural weakness intact for instance, our “too big to fail” banks are just as big (or even bigger), and our sovereign debt levels are even worse than they were pre-2008.

The next crisis will be larger and more damaging than the last one, principally because nothing got fixed, lots of capital – both political and financial has been spent and trust has been eroded, leaving everyone depleted and ready to bolt for the financial exits.

With the periphery failing, we may have weeks perhaps a month or two until the next big dislocation hits.

Déjà Vu (All Over Again)

We’ve been here before.  We’ve seen trouble start on the outside and progress inwards, and not all that long ago.

In 1999 and 2007, we saw the financial markets blithely trundle along higher, even as clear signs of trouble at the margins were abundant.

One of the common myths about the stock market, often repeated in the press, is that it peers into the future.  The market is the ‘great discounting machine.’

But the stock market powered higher into the new millennium, despite being the most overvalued it had ever been in history, before diving violently in 2001.  So much for peering into the future.

And again, the stock market went to new heights in 2007, even as the housing market was obviously deteriorating and about to suffer a truly historic break after an unprecedented and bubbly run to the upside.  The great discounting machine ended up reacting to trouble rather than anticipating it.

Despite these two obvious failures, many still hold to the belief that the stock market is a useful indicator of future health or distress, which means this view is more a matter of faith than fact.

Our view has always been that the stock market is a “great liquidity detecting machine” – something that fits the data very well – and that it’s reacting to liquidity in the system more than anything truly fundamental.  This has not always been the case, but ever since Alan Greenspan opened the Federal Reserve printing presses to each and every minor financial sniffle in the mid-1990s, Fed-supplied liquidity has been the dominant driver of equity prices.

To tilt the conversation slightly, one of the enduring mysteries to me is how we have managed to experience not one, not two, but three full bubbles in the space of less than 15 years.  Tech stocks, then housing, then all stocks and bonds; three bubbles, each bigger than the last.

The current all-time highs in both bond AND equity prices (with bonds collectively including everything from 1-month T-bills to the worst junk paper you can buy), is nothing more than the biggest financial asset bubble in history.

In order to believe this will all turn out well, you have to believe that this time will be different… not just a little bit different, but 180 degrees away from literally every single other financial bubble in all of history.

This is precisely what is being asked of us each day by the financial press, the Federal Reserve, the Bank of Japan, the European Central Bank (ECB), and the politicians in the Western power centers.

It is never different.  To that we’ll add:

  • A crisis rooted in too much debt cannot be “solved” by creating more debt.
  • Prosperity cannot be printed out of thin air.
  • Rigged systems and markets destroy trust.
  • Nothing can grow forever, except for the number of zeros printed on your currency.

Collectively, the above list boils down to Anything that cannot go on forever…won’t.

Deficits and Debts Do Matter

Deficits don’t matter! Dick Cheney once famously growled, putting to words the belief system that envelops the U.S. today, especially its financial and monetary authorities.  Because we’ve managed over the past three decades to dodge any serious consequences from racking up debts, these folks believe that will always be true. Absence of evidence becomes evidence of absence.

Sticking just to the economic “E” (leaving aside energy and the environment), our diagnosis of the current difficulties is simply that the OECD economies left reason aside and instead embarked on a sustained period of borrowing at a rate nearly twice as fast as underlying economic growth.

That is, we collectively fell for the idea that one could simply borrow more than one earned… forever.  It is surprising by how an entire culture can collectively believe in something that no individual would ever hold to be true.

We know that we cannot individually borrow more than we earn forever.  And we are equally sure that this remains true if we pool ten people together.  But we accept the idea that a sovereign nation can somehow magically pull this off.  This either represents a profound inability to apply logic, or a form of cultural schizophrenia, or both.

Hot-Money Bubble Dynamics

For years now, ever since central banks embarked on the global rescue plan that involved little more than flooding the world with historically unprecedented amounts of freshly printed money (a.k.a. “liquidity”), that money has been sloshing around looking for things to do.

With interest rates on “safe” investments at 0% (or close enough), that “hot” money has been looking for anything that resembles a decent yield.  This “yield chasing” went to every corner of the globe and piled into any and every market that it could.

Some of these markets were the headline U.S. and European equity and bond markets, and some of them were so-called “emerging markets”, such as Brazil, India, Thailand, the Philippines, and Indonesia.

As this hot money flowed into these emerging markets, the respective countries in order to prevent their currencies from rising too much did the usual and recycled the money-flows back into U.S. Treasury paper, German Bunds, and other sovereign debt instruments.

Now, all of this is being undone.

It is a hot-money machine running in reverse, and it is creating the usual distortions, difficulties, and hardships for the afflicted countries.  Currencies are plummeting, as are local equity and bond markets.

In short, to understand where our financial markets are and where they are headed, you don’t need to know much about fundamentals at all.  Earnings, GDP, job growth, etc. are secondary to liquidity flows.  That’s why the various markets are so keyed on the Fed’s next statements and when and how extreme the “tapering” might (or might not) be.

That’s all that really matters. Well, that’s not entirely true.  For reasons that cannot be entirely explained nor controlled, sometimes bubble dynamics just end.  People stop believing.  And what was once a virtuous cycle suddenly morphs into vicious one.

I believe that moment is near.  And, as always, it’s starting from the outside in.

Bernanke goes before Congress–what that means for stocks

Stock market bulls consistently cite one force for their positive outlook. Federal Reserve policy. They say…

“Forget the fact the global economy is slumping from Europe to Asia” …

“Forget the fact the U.S. economy is slumping fast” …

“Forget the fact earnings stink!” and …

“Forget the fact the euro currency keeps falling to new lows, along with European peripheral bonds!”

Why? “Because the Fed is going to save us and when it does, stocks will go up!”

The “Bernanke Put” may be a comforting thought. But it’s also wrong –here’s why.


The Sorry State of the Real Economy

Fed Chairman Ben Bernanke went before Congress last week as part of his semi-annual testimony on the economic outlook. He didn’t mince words about the state of the economy, saying in response to questions that we were just “muddling through” while most of Europe was “already in recession.”

His prepared testimony went further, noting that GDP grew at a slower rate in the first quarter than in the second half of 2011, and that the 2012 second quarter looks even worse. He also pointed out that payroll growth has plunged by 63 percent … that household confidence in future income remains low … and that business spending is waning.

Meanwhile, several other commentators are getting even more negative:

  • The International Monetary Fund just cut its global growth forecast for 2013, citing Europe’s downturn and the slowdown in emerging markets.
  • Goldman Sachs just slashed its U.S. GDP growth forecast for the second quarter to 1.1 percent from 1.3 percent, not very far from stall speed.
  • Pimco’s “Bond King” Bill Gross just said the U.S. is “approaching recession when measured by employment, retail sales, investment, and corporate profits.”
  • A leading economist at the prestigious Economic Cycle Research Institute, Lakshman Achuthan, just said never mind what hyperactive stock traders say on CNBC. We’re already in a contraction!

What Bernanke Can’t Do about It

That’s a seriously broad-based indictment of the economic environment, with little reason to expect a turnaround any time soon. Yet stock traders have tried to ignore that fact, figuring Bernanke is in their back pocket.

This week, Fed Chairman Bernanke offered Congress his grim assessment of the U.S. economy.

What are the “tools” Bernanke cited in his testimony last week:

  1. Bernanke said policymakers could cut the interest rate paid on excess reserves (IOER) the banks hold at the Fed. The idea is that doing so would prompt banks to lend out their reserve funds rather than just park them at the Fed. 

    The problem? The IOER is already a rock-bottom 0.25 percent. Cutting it by a few basis points to 0 percent will have practically no impact on the willingness of banks to lend. If anything, it could hurt the economy by driving money market funds out of business, draining a vital source of savings for economic expansion!

  2. He said the Fed could use “communications” tools to guide market expectations. That’s Fed jargon for promising to keep rates lower for longer than the current “at least through late 2014″ pledge. 

    But the fact is, nobody expects the Fed to do anything with the federal funds rate anyway! Plus, the Fed’s long-term projections have proven wrong so many times that a promise to hold rates low through 2015 … 2016 … or 2040 for that matter isn’t worth the paper it’s printed on. So that kind of move won’t help at all.

  3. Bernanke said the Fed could consider another round of quantitative easing, or QE. This seems to be the bulls’ biggest hope of all. They’re all assuming that as soon as Bernanke pulls the trigger, the stock market will be off to the races.  

    QE1 came at a time when the lending rates were very high and the credit markets were in complete disarray. It was a brand new policy nobody expected, and it had a huge impact in terms of bringing down spreads, rates, and risk levels. QE2 was less effective in terms of impact because market dysfunction was already largely fixed and because the underlying economy was weakening. Moreover, other similar programs from the European Central Bank’s LTRO1 and LTRO2 to Operation Twist 1 and 2, have had even less of an impact than QE2!

    Consider: A Credit Suisse note from a few days ago chronicled the findings of several studies on the impact of QE on 10-year Treasury Note yields. Several researchers estimated QE1 lowered yields by around 90 basis points to 100 basis points. But they also concluded that QE2 moved rates by as little as 13 basis points!

    That was the supposed impact on the financial markets. The impact of several hundred billion dollars worth of QE on the real economy— meaning GDP — was as paltry as 40 basis points. That’s the difference between 0 percent growth and 0.4 percent growth – a drop in the bucket! 

    Yet we’re supposed to believe that QE3 — the THIRD iteration of a policy that’s having less and less impact on financial markets, not to mention a near-zero impact on the real economy — will somehow be different? 

    Is there anyone on the planet who really believes that 3.56 percent 30-year mortgage rates — the lowest in the history of the United States — are holding back the housing market? 

    Or that 1.45 percent 10-year Treasury Note Yields — also the lowest in history — are hindering the broad economy? 

    Even IF QE3 succeeded in lowering yields by another 10 or 20 basis points, can anyone seriously argue with a straight face that it will make a major difference on the financial markets or economic outlook?

Those are bad bets to make. I continue to remain bearish on most stocks and asset classes!

This article originally appeared in Money and Markets.

Seven Fallacies of Mainstream Economics

The Global Financial Crisis (GFC), the extreme inequality of wealth world-wide, the materialism of modern life – seeming over consumption for consumptions sake and the environmental abuse we shower on our planet are not accidents, nor are they unavoidable consequences of the natural order of things.  They are the result of the modern practice of Keynesian economics, which makes fundamental errors of accounting, evidence, perception and theory.

Many of these fallacies have been observed for decades by a dissenting fringe of economists and informed others.  Their message is drowned out by the relentless repetition of the mainstream mantra.  Many people may be uncomfortable with economists’ pronouncements, but few seem to realize how frequent and basic are the errors, or how far-reaching the consequences.  Here are seven of the primary fallacies.

  1. The measure of economic success worldwide is growth of Gross Domestic Product (GDP).  But, GDP is simply the total of all activity involving money, with no accounting taken of whether the activity is useful, useless or even harmful.  The costs of disasters, pollution and “defensive expenditures” like insurance are added to the GDP.  A proper accounting would use a balance sheet and subtract the costs from the income, as every shopkeeper understands.  As a result exploitative and polluting activities are encouraged because they boost GDP. GDP also measures purchasing using borrowed money just as purchases made with savings or income. That begs the question, is spending borrowed money a viable measure of productive activity?
  2. Clear evidence of poor performance is ignored.  Growth, unemployment and inflation measures since 1980, have not been as good as those in the 1950s, 1960s and 1970s.  In the economies of the west the unemployment averaged 3.2 percent for those early years, inflation averaged 4.5 percent and GDP growth 4.9 percent.
  3. Money and debt are excluded from economic models.  Money is excluded because economists treat economic exchange as barter, claiming money is only a neutral intermediary.  Debt is excluded because private debt is claimed to have little influence on economic performance.  Economists claim “one person’s debt is another person’s asset”, so net purchasing power is not changed by loans.  That would only be true in a barter economy, or if banks only loaned from savings deposits.  However, banks create new money to make loans, so purchasing power is boosted and money is no longer neutral.  Because banks have been deregulated and the banks’ incentive is to increase debt, private debt has increased dramatically over recent decades.  It was the collapse of a mortgage debt bubble in the U.S. that triggered the GFC.  Their discounting of debt is why most economists failed to see the GFC coming, and have little idea how to recover from it, as they are demonstrating in Europe.
  4. Modern free-market theory, called the neoclassical theory, predicts the economy will always be close to equilibrium.  If that were true it should tick along steadily and sudden changes should only occur in response to large external events like natural disasters or wars.  Yet many times over the past two centuries financial markets have suddenly collapsed without any external cause.  Some of the more recent examples occurred in 1987, 1997, 2001 and 2007.  In 1987 stock prices dropped by 30-40% in a day, though thirty percent of the world’s factories had not been bombed overnight.
  5. The neoclassical theory is based on assumptions that are patently absurd or clearly shown by other disciplines to be untrue.  Among the patently absurd, it is assumed our collective guesses about the future are accurate, yet people in 1890 could not have conceived how cars, airplanes, two world wars, nuclear weapons, computers and digital communication would radically transform the world.
  6. It is assumed that people are innately individualistic, competitive and coldly “rational” calculators.  However psychologists have clearly documented our tendency to favor cooperation by punishing cheaters, even at a personal cost.  Almost every mammalian species lives in groups, and social groups have an innate, and healthy, tension between individualism and cooperation.  Most people understand they are better off if they balance their own wishes with those of their family and community.  We are obviously strongly motivated by love, envy, fashion and insecurity, and marketers ruthlessly exploit these foibles.  Psychologists have also clearly documented our tendency to other “non-rational” behaviors such as weighting a risk of losing more heavily than an equal chance of winning.  Neither the fashion industry nor the marketing industry would exist if economists were right.
  7. Economists assume there are no economies of scale beyond a point of diminishing returns, ignoring the lesson of Henry Ford’s assembly lines.  Economies of scale allow the biggest firm to undercut other firms and grow faster, until it dominates a market.  The existence of many such dominating firms, such as Microsoft, McDonald’s and Facebook, is also ignored.

The consequences of these errors are not trivial, they distort our perception of the behavior of economies.  Free-market theorists allow that there are “market imperfections”, but don’t appreciate that abandoning any of their central assumptions leads to radically different predictions of pervasive instability and unsteady behavior.

A new concept of economic behavior based on complex systems is developing on the fringes of economics.  Many insights are recounted in Eric Beinhocker’s book The Origin of Wealth (Harvard Business School, 2006).  There are also immediate overarching implications.  For example, there is not just one way to organize economies, there are many ways, and they can be tailored to the wishes of each human culture.

This article originally appeared on Steve Keen’s Debtwatch site.