David Rosenberg on the Economy

David Rosenberg is out with a good post that takes on the double dip theme that everyone is talking about.  As you would expect, he has a bearish spin. To the degree you want counterfactuals, I really like what Morgan Stanley has to say in their research piece "Just Say No to the Double-Dip."  The bottom line for me is that a double dip is not a done deal. It is a worry and it is my baseline given the political environment. But, double dips are rare and there is nothing yet which says it’s definitely going to happen.

Since everyone is focused on the ECRI data, here’s what Rosenberg says about it:

We discuss the ECRI weekly leading index below and recall how it dipped below zero in August 2007 and Mr. Market still rallied for another six weeks and hit the all-time peak six weeks later. The message here: keep your eyes on the road in front of you; let the folks on Bubblevision gaze at the rear-view mirror.

Clearly what Rosenberg is saying is that the data are not in double dip range but they are getting close. He sees –10 as the number to watch but he does give double dip an insanely large 80% probability. In a fuller explanation, he says the following under the section header "Double Dip, Anyone?:

The smoothed ECRI leading economic index fell in the opening week in June for the fifth week in a row and now down in nine of the past ten. The index, went from +0.3% to -3.5%, the weakest it has been in a year. After predicting the V-shaped recovery we got briefly in the inventory-led GDP data when the index soared off the bottom in late 2008, at -3.5%, we can safely say that this barometer is now signalling an 80% chance of a double-dip recession. It is one thing to slip to or fractionally below the zero line, but a -3.5% reading has only sent off two head-fakes in the past, while accurately foreshadowing seven recessions — with a three month lag. Keep your eye on the -10 threshold, for at that level, the economy has gone into recession … only 100% of the time (42 years of data).

Double-dip watch: The ECRI weekly leading index has now swung from +0.3% to -3.5% for the week ending June 11.

Suffice it to say, when the ECRI was drifting lower in 2007, it got to -3.5%, where are we are now, in November and unbeknownst to the consensus at the time that a recession was only one month away. Remember that the economics community did not call for recession until after Lehman collapsed — nine months after it started; and go back to 2001, and the consensus did not call for recession until after 9/11 and again the economy had been in recession for a good six months). We should probably point out here that real M3 has contracted at the fastest rate since the early 1930s, as John Williams has published, and declines in the broad money measured has foreshadowed every recession in the past seven decades.

To be sure, the Fed has not raised rates and the yield curve is steep but there has been a visible tightening in financial market conditions that poses a significant risk for what has been a very fragile recovery in dire need of recurring rounds of policy stimulus. The widening in credit spreads and decline in the stock market represent a sizeable increase in the debt and equity cost of capital. The Fed has stopped expanding its balance sheet (and now we have Fed presidents Hoenig clamoring for rate hikes and Plosser for reducing the size of the Fed’s balance sheet) and end of the housing tax credits implies a major withdrawal of federal government support at a time when restraint is accelerating at the State and local levels (the States have a $127.4 billion aggregate deficit to close for the fiscal year beginning July 1st so right there we have a one-percentage point drag on baseline GDP growth).

The data suggest that we are now seeing the consumer sputter with what looks like a very weak handoff into the third quarter. The housing sector is collapsing again. The export-import data are pointing to a sudden deceleration in two-way trade flows. Commercial real estate is dead in the water. Bank credit is in freefall right now (down 0.3% or $32 billion in the first week of June — the third decline in a row and has now contracted in six of the past seven weeks and at an 11% annual rate. In the last three weeks, bank credit has contracted a total of $119bln, which is the steepest decline since the week of November 19, 2008 when the economy was deep in recession.

There is still something left in the tank as far as capex and inventory investment is concerned, but by the fourth quarter, we could well be looking at a flat or even negative GDP print. This is exactly what happened in the second half of 2002, when by the end of the year real GDP converged in real final sales near the 0% mark after a sharp but truncated mini-inventory cycle. That may not have been classified as a double-dip recession, but it was a growth collapse nonetheless — an aborted recovery for a consensus that went into the second half of that year, much like this one, with a consensus forecast of 3% real economic growth. The lesson, is that expectations had surpassed reality to such an extent that it didn’t even take another recession to take the equity market down to new lows, which happened in October 2002 (not October 2001!), fully 11 months after the downturn officially ended.

Rosenberg also mentions the dismal retail sales numbers as another bullet point. Good numbers to back up his view. But, 80% probability?  That seems too bearish for me, really.

On the market data, Rosenberg is more sanguine. He notes that the Nasdaq is the first major US index to pop back above its 200-day moving average. I flagged the fall as a bearish signal, but we’d have to see the averages maintain this position for longer. The pop up by the Nasdaq gives some sense this won’t necessarily happen. Also, Rosenberg notes that the rally in gold is looking tired, at least-near term.

My takeaway here is that Rosenberg is still very bearish and sees the ECRI data as confirmation of his downbeat view.  While I am also bearish, I am less bearish than he is. I’ll wait until the –10 threshold he’s talking about.

Read the full post via registration at the link below.

Source: Breakfast with Dave, 14 Jun 2010

  1. J. Powers says

    Edward, you’ve been pointing to improving manufacturing data and positive trends in retail spending as evidence of a recovery, right? But it seems to me (correct me if I’ve misread you) that you’ve been maintaining for years now that this whole mess is a debt problem. Which data would you point to that suggest that the global debt clusterf— has improved?

    1. Edward Harrison says

      You can kick the can down the road for a long time as we have seen through successive business cycles. So just because the debt is a problem doesn’t mean it is fatal to one particular cyclical upturn.

      “The problem I have with the recent history of growth in the United States, the United Kingdom, Spain and Ireland in particular is that the growth was underpinned by high debt accumulation and low savings. As debt is a mechanism through which we pull demand forward, the debt and consumption has meant we have been growing today at the expense of future growth.

      Low quality growth can go on for a long time

      This dynamic can continue for a very, very long time. In the United States, by virtue of America’s possession of the world’s reserve currency, an increase in aggregate debt levels has been successfully financed for well over twenty-five years. Mind you, there have been a number of landmines along the way. But, time and again, these pitfalls have been avoided through asymmetric monetary policy and counter-cyclical fiscal expansion.

      So, poor quality growth can continue for very long indeed. And it is this fact which allows the narrative of easy money and overconsumption to gain sway.”

      I am looking to decreased debt-to-GDP, debt-to-income and debt servicing costs in the household sector as the real signs that the debt problem can be contained.

      1. J. Powers says

        Edward, thanks for the reply. Very helpful.

        If we use debt to “pull demand forward” (nice turn of phrase), then doesn’t the repayment of debt replenish our well of _potential_ demand rather than acting as current demand? Concerning the here and now, paying down debt doesn’t actually push the economy forward, it just repositions us to borrow more (pull more future demand forward) in the future.

        We need demand now in, but we’ve already drained the debt well. Were the stimulus packages enough to jump start things? You must be looking at households or corporations to provide the additional demand. Have I got all that right?

  2. icIncome says

    Short-term improvements in US manufacturing data, while government spending skyrockets, is like cash advances on a maxed-out credit card. We have short-term speculative gains now, but the long-term outlook is dangerous.

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