What Is The Sustainability Of The Economic Recover
JoBar : What Is The Sustainability Of The Economic Recover
The headlines of the Wall Street Journal on Monday of this week showed “Industrial Output Rises 0.5%, Signaling Rebound” and the article discussed how this statistic provided more evidence that the beleaguered manufacturing sector is regaining lost ground. On the surface, since this number was larger than expected, the news gave hope for a sustainable recovery. Most of the short-term charts on the subject also depict a much stronger recovery. We have attached two longer-term charts on Industrial Production, which tell a somewhat different story.
The Leading Economic Indicators (LEI) were released today and surprised on the upside as well. However, with only half of the indicators showing improvement, the leading index reinforces the picture that the economy is showing some recovery, but not with any certainty. The Conference Board even mentions in this release that the leading index is moving in a manner similar to 2001 and early 2002, when an increase in the leading index was followed by an increased economy, but one that proved to be temporary. We have also attached a chart showing how the LEI acted in past recoveries and how it looks now. Notice the flatness on the index during this recovery.
The Philly Fed Index also surprised on the upside and was positive for the third straight month, climbing to 22.1 in August. This again, looks a lot better on a short-term chart than the attached chart showing how the index dropped significantly in recessions and had major thrusts up during recoveries. The manufacturing executives’ expectations for growth in employment and capital spending have not shown significant improvement.
Taken all together it looks like we will have a better third quarter than the soon to be revised 2nd quarter to about 3%, however, we also have had an enormous stimulus package that we do not think can effect a self sustained economic recovery. Do you think corporate executives will make capital expenditures on new plant and hiring based upon tax rebates that may stimulate a couple of quarters of GDP, but are unlikely to contribute to a sustained economic expansion?
As Greg Ip stated in a Wall Street Journal article earlier this week, “A recovery, it appears, has begun. A potent jolt of monetary and fiscal stimulus is lifting consumer spending, and business confidence is reviving. But the real challenge stretches into the next year: When the adrenaline rush of lower interest rates and big tax cuts ebbs, will the expansion have gained enough momentum to continue? Or will it fade, as earlier, stimulus-stoked expansions did in 2002 and again earlier this year?”
Greg is more positive on the second half of this year than we are, but we are in agreement that this expansion will fail again. One of the potential catalysts for the failure and the start of the deflation, we have been concerned about, is a decline or possible collapse of real estate. The probability of this happening is discussed in the Atlantic City “Money Show” presentation (which we are still attempting to include on our home page). And we briefly talked about this in the Barron’s article late last year on our home page in Comstock in the News, “Prospering Bears”. The logic expressed back then, for example, the spread between rents and real estate prices has only gotten wider. We still believe that this is similar to a P/E ratio for stocks and we have come close to the P/E extremes of the stock market bubble in the late ‘90s.
According to ISI, the existing home prices of the most extreme areas were Los Angeles which rose 69.4% since 1999 and 20.6% over the past year, New York- 72.7% and 15.5% over the past year, Washington-61.9% and 14.4% over the past year, Pittsburgh 23% since ’99 and 8.3% this year. The nationwide average this year is up 7.4%. Therefore, it’s the bubble areas that are at the most risk, in our opinion.
A loyal viewer also just sent by email a report by the Center for Economic and Policy Research (CEPR) entitled “Homeownership in a Bubble: the Fast Path to Poverty?”-- which is in complete agreement with our assessment. We will attempt to include a link to the report. In case this becomes a problem we will quote from the executive summary, “There is good reason to believe that the nation is experiencing a housing bubble very similar to the stock bubble of the late nineties. Nationwide, the rise in home prices has exceeded the overall rate of inflation by more than 30 percentage points since 1995. This sort of run-up in home prices has no precedent in the post-war period. No economist has been able to put forward a plausible explanation for such a sudden run-up in home prices, apart from a speculative bubble. In metropolitan areas that have been especially affected by the housing bubble, the rate of price appreciation has been even greater. In the most affected areas (largely in California and the East Coast north of Washington, DC), home prices have risen in real terms by more than 70% over the last five years. These areas are likely to see especially large price declines when the bubble bursts.”
To summarize, the statistical releases, are not strong enough to sustain the expansion and the risk of the bubble in real estate bursting is a major negative to any expansion.