Search results matching tag 'Recession'

If This Is Recovery…

JohnMauldin — Sat, 14 Nov 2009 05:31:00 GMT

If This is Recovery, Where Are the Taxes?
Last Business Standing
Stimulus, What Stimulus?
The Reality of Unemployment
Let the Good Times Roll
The Quick Double-Dip Scenario
Phoenix, New York, and Thoughts on the Internet

No one goes into Wal-Mart and asks to pay extra sales tax. Thus sales taxes are reasonable barometers for retail sales. This week we look at how taxes are doing in a period of economic recovery. Then we turn our eyes to a very interesting (and sobering) analysis of possible future unemployment rates. This is an anecdote to the happy-face analysis of employment numbers you get from establishment economists. There will be a lot of charts and tables, so this letter may print a little longer, but I think you will find it very interesting.

If This is Recovery, Where Are the Taxes?

I keep reading about surveys that show that retail sales are up. But as noted above, no one pays extra sales taxes, or decides they need to pay more income taxes. The surest way to measure retail sales is sales taxes. Want to know how incomes are doing? Look at income tax receipts. Let's look at sales taxes first.

First off, I can find no single source of recent sales tax information. It is all one-off, but it is consistent. Sales taxes in my home state of Texas are down 12.8% year-over-year, and we're in the fifth straight month of decreases of 11% or more. Projections are for sales taxes to continue to decline into 2010.

There is a very revealing study by the Pew Center on state taxes, called "Beyond California" (http://www.pewcenteronthestates.org/). Everyone knows how bad California is. The Pew Center looks at how the rest of the states are doing, and focuses on 10 states that also have severe problems. Sales tax receipts are down 14% in Arizona, and state income taxes are down 32%.

On average, revenues are down almost 12%. Oregon has seen their revenues collapse a stunning 19%. New York is down 17%, with a deficit of 32%. Illinois has a projected deficit of 47% of its budget, second only to California with 49%. You can see how your state fares at http://downloads.pewcenteronthestates.org/Beyond_California_Appendix.pdf.

The Liscio Report notes that all states had negative year-over-year sales tax collections in October, and the weighted average decrease was 10.2%, down from a negative 7.2% in September. (www.theliscioreport.com)

Sales at Wal-Mart stores slipped by 0.4% in the third quarter. Actual government figures show that retail sales were down 1.5% in September from the previous month and 5.8% year-over-year. So how do we keep seeing headlines about retail sales being up, as unemployment keeps rising?

Remember that such reports are usually based on surveys, and generally cover mid-sized and up retailers, leaving out smaller businesses. Further, if you are a retail chain that has closed 10% of its stores, the remaining stores should in theory benefit from getting your loyal customers into them.

Last Business Standing

Yesterday I was with an associate, and I hesitated in asking them how their business was doing, because I knew things had been tough at the beginning of the year. But I did ask, and they said sales were up over the last months and business was looking better. Surprised, I asked them what made the difference. "Ah," they said, "less competition. Our competitors have gone out of business."

Best Buy and other electronic retailers had to benefit from Circuit City disappearing. That is Schumpeter's creative destruction at work. Not very good for total employment, but it does help the profitability of the survivors.

So, if things are so bad, how did we have 3.5% growth in the third quarter? First off, things are not as bad as they were in the past year. We are in fact getting close to an economic bottom, at least for now. Second, the 3.5% number is a preliminary estimate. A study by Goldman Sachs suggests that the number will be revised down by at least 0.5% and maybe as much as 1%.

Why? The estimate does not really take into account how poorly small businesses are performing. If you look at small-business indexes and compare them to historical GDP numbers, you get the smaller number mentioned above. And since at least 2% of the GDP was from the stimulus package (Cash for Clunkers, houses, tax cuts), the economy on its own was flat. That begs the question, what happens when the stimulus runs out?

And the answer is that we won't know for some time, as the stimulus is just getting ramped up. "According to CBO estimates, only 21% of [the stimulus] spending will occur in 2009; another 38% will come in 2010, and 22% in 2011. After that, its effect will dissipate quickly." (The Liscio Report)

But David Rosenberg notes that what the federal government is giving, the states are taking away. The Pew Study shows that at least nine other states are in appalling shape, so it is no wonder that David writes:

Stimulus, What Stimulus?

"Fully nine states are in fiscal distress and only two have balanced budgets. States like Michigan are planning 20% budget cuts for the coming year. Indiana is planning a 10% spending cut in light of a 7.4% YoY revenue decline. How can the economy really be out of recession if government revenues are still deflating?

"The states are filling around 40% of their fiscal gaps with the federal stimulus (so much for spending on "shovel ready" infrastructure projects). Even after the fiscal help from Washington, the state governments will still face a projected deficit of $142 billion for 2011 (versus $113 billion in 2010). All in, the restraint in the state and local government sector is estimated to drain a full percentage point from U.S. GDP growth in 2010 and more than fully offset the stimulative efforts from Washington. The U.S. economy is more likely to post growth of little more than 2% next year, rather than the 5% currently being discounted by the equity market."

The Reality of Unemployment

All this is, of course, going to put continued pressure on employment. As I noted last week, the number of unemployed actually soared by 558,000, to 15.7 million, as measured by the household survey, not the 190,000 you read about in the mainstream media. Unemployment is sadly continuing to rise by significant amounts.

In August, I did an interview with CNBC from Leen's Fishing Lodge in Maine. The unemployment numbers had just come out. I did a back-of-the-napkin estimate that we would need about 15 million new jobs over the next five years just to get back to where we were when the recession started.

That works out to a need for about 125,000 new jobs each month to handle new workers coming into the market (which comes to a total of 7.5 million over five years), plus the 8 million and rising jobs we've lost. That is a daunting number. It amounts to 250,000 new jobs a month every month for five years. And we are still losing more than that number a month, let alone adding the needed 250,000.

Look at the chart below. It shows the establishment survey employment figures for the last ten years. Only once, in 1999, did we actually add over 250,000 jobs a month for a whole year. And that was during the internet boom.

Sadly, the private sector has shed over 300,000 jobs since 1999. Think about that. We have had a decade where there have been no new jobs added by the private sector. Real incomes are roughly where they were, and the stock market is down. Talk about a lost decade.

I love it when someone does the really heavy lifting for me, and my friend Mike Shedlock of Sitka Pacific Capital Management has done a wonderful job of taking that speculation of mine and putting it into a spreadsheet that helps us get a real handle on what unemployment is likely to look like for the next ten years. I am going to make use of his basic analysis and then modify some of his assumptions in the spreadsheet he provided me, in order to think about different scenarios.

All three scenarios are based on assumptions, so let's see what Mish started with. There is a wealth of data available from the Bureau of Labor Statistics and the Census Bureau. According to the Census Bureau Population Estimates we are going to add about 2.5 million working-age (16 years old and up) citizens a year, from now until 2020. The numbers varies slightly year to year. Mish used an estimate of the average, summing up the buckets from 16 to 100+ for the years in question and rounding the result.

You can go to the BLS site and look at Table A-1, which shows the civilian noninstitutional population (those over 16 not in prisons), the participation rate (those who are working and/or want to work), the unemployment rate, the number employed, those not in the labor force, and those who want a job. Those are starting numbers for the charts below.

For those interested, you can read Mish's very full (and quite detailed) analysis at his blog site http://globaleconomicanalysis.blogspot.com/2009/11/mish-unemployment-projections-through.html). But let's look at his assumptions:

Job losses are likely to continue for a minimum of another year.
When job gains start, they will be very slow at first, then pick up.
An extremely generous monthly job gain stat over the course of the year would be 150,000 jobs.
A falling participation rate (boomers retiring) will continue to mask reported unemployment.
Starting in 2013 the labor pool will start decreasing because of Boomer demographics.
The noninstitutional population will rise by 2.5 million workers a year.

The spreadsheet below needs a little explanation. Let's start with the assumptions. Mike starts with current working-age population and adds 2.5 million people a year. He assumes that Boomers will retire at 65 (something which all the surveys say is not going to happen). And his last estimate is what the unemployment numbers will be. Everything else is based on those assumptions, which leads to the first column, or the expected unemployment number.

By the way, we know that everyone will want to make different assumptions. I am going to create three scenarios, but you can go to Mike's blog and at the bottom of the post is a link to the actual spreadsheet. Have fun. Let's look at scenario 1.

This assumes there is no double-dip recession, and jobs roughly rise along the same lines as the last recovery. Actually, Mish is far more optimistic, as in the very first chart you will notice that job losses were negative in the first year after the end of the recession and flat the second year. Mish has jobs rising by 120,000 next year and 600,000 the second year (2011), and then a fairly robust recovery. Below is the graph of the unemployment numbers under such a scenario.

Notice that unemployment stays at or above 11% for three years. Pessimistic? Mainstream and usually very optimistic Mark Zandi of www.economy.com predicted this week that unemployment would rise to 11% by the middle of next year, right in line with this scenario. Also note that total jobs rise by 14 million over ten years. Hardly doom and gloom. Again, Boomers all retire on time and there is no double-dip recession.

Let the Good Times Roll

What would it take to get back to 5% unemployment? I played with the spreadsheet and came up with the following numbers, which get us below 5% by 2020. I assume no recessions for the next ten years, and 2 million new jobs a year after 2011, which I start off with almost 1.5 million jobs. Of course, we have never done that, but let's be optimistic.

And the graph below shows the unemployment numbers for the Good Times Scenario.

Want to get to 5% within five years? Add 3 million jobs a year starting now. With no housing recovery, a smaller auto industry, and financial firms getting leaner.

The Quick Double-Dip Scenario

When I called the last two recessions about a year before they happened, it was not all that hard. We had inverted yield curves, falling leading indicators, and a lot of other data that pretty much pointed to a recession. Believing that we had a housing bubble and a looming credit crisis also helped my conviction in calling the last recession.

I think we are in for a double-dip recession in 2011, yet I readily admit there will be little if any statistical evidence in advance this time. This is more of an instinct call. I have serious doubts that we can have what amounts to the largest tax increase of all time in what will be a very weak (albeit growing) economy, without putting us back into recession. And Speaker Pelosi thinks it is a smart thing to add another 5.4% surtax on what will already be a rising capital gains and dividend tax.

Taxing small businesses, and that is what the tax increase amounts to, is a very bad idea in a weak economy. Small businesses are where the job growth comes from. Taking money from productive businesses and giving it to government is a fundamentally flawed concept.

Now, if they decide to postpone the tax increase, or phase it in slowly, then maybe we avoid the double dip. But right now it doesn't look like that will be the case. So, let's quickly see what a double-dip scenario might look like. Let's be optimistic and assume we only lose another 1.2 million jobs in the next recession, since we have already lost so many in this one (8 million and counting). And then the economy comes roaring back in 2012 with 1.5 million jobs and continues to grow rather smartly for the rest of the decade. No further recession. We absorb the tax increases and move on with our economic lives.

Unemployment under such a scenario would rise to just under 13% and stay above 10% for 8 years. Take a look at the chart and graph.

Think 13% is too dire? This week David Rosenberg said unemployment would rise to between 12-13%. The former Merrill Lynch economist was one of the few mainstream economists who called the recession and the credit crisis. The so-called "Blue Chip" economists told us at the beginning of 2008 that unemployment would peak out at 6%. While Rosie is not optimistic of late, he has a rather solid record of being right.

We are at 10.2% unemployment today. The economy lost jobs for 21 months after the end of the last recession. That would easily take us into 2011. Another million lost jobs will take us well over 11% and close to 12% (remember, you have to add in the increasing population), even without my double-dip scenario.

The letter is getting long and it's getting late, so let me close with a few thoughts.

First, 12% unemployment is horrendous by American standards. But Spain is now at 20%, and much of Europe has been in the 10% range for years.

Second, Americans are not used to the concept of 12% unemployment or 10% rates for extended periods. That is going to cause a serious backlash across the political spectrum. Couple that with the discomfort over $1.5-trillion deficits and there could be some serious political changes in the coming years. I think the message will be more anti-incumbent than one party or the other.

Third, the only way out of this morass is to create an environment where small business can thrive. As I've noted for the last several weeks in this letter, government spending does not increase GDP over time. It is a temporary nonproductive stimulus. It takes private investment to create jobs and increase productivity. Over the next few months, I will write more about how to do that.

Phoenix, New York, and Thoughts on the Internet

Next week I take a quick one-day trip to Phoenix, then back to do a satellite-remote speech to a South African hedge fund conference. I will be in New York the first weekend of December (the 4th) for Festivus, a great fundraiser for kids sponsored by Todd Harrison and the team at Minyanville (http://www.rpfoundation.org). Interestingly, they hold it every year at a "Texas" barbecue joint. Look me up if you are there.

The 7 kids, spouses, and grandkids are starting to gather. We will all have brunch Sunday and then a shower for Tiffani. She has another 6 weeks before she is due, and she is really uncomfortable. Walking is literally a pain.

Permit me to reminisce. A little over 9 years ago I started this letter on the internet with about 2,000 email addresses. It was a new version of what had been a print letter, as that was the business I knew. The internet was still a new thing to me, but it seemed like a good idea at the time. Little did I know.

I am still amazed at the growth and the direction my business and life have taken. My letters are sent out by various publishers and affiliates to over 1.5 million readers and posted on dozens of web sites, and the numbers have been growing rapidly of late. I am grateful. But I wonder what would happen if I started it today. Ten years ago there was little in the way of free economic letters. Not a lot of competition.

Today, there is so much free information that it's staggering. There have to be thousands of blogs and hundreds of free letters, some with very large circulations. It seems a new star is born every few months. While much of it does not add to the level of conversation, some of it is quite excellent. I think I am lucky to have started when I did.

And I am grateful for the kind attention you give me. As I turn 60, I note that this has been a rather overwhelming last ten years. A lot of changes for me, and almost all of them very good. But there are more to come. The last two flights I was on I was connected to the internet at 35,000 feet. I sense a lot more changes coming. I am thinking a lot about how to keep up and not get left behind, how to make sure that you, gentle reader, continue to get my best. That is what, at the end of the day, drives me.

Have a great week. I know I shall. Dad loves it when his kids (from 15 to 32) and spouses and grandkids are all under one roof.

Your amazed at it all analyst,

John Mauldin

Catching Argentinian Disease

JohnMauldin — Sat, 31 Oct 2009 02:47:00 GMT

Catching Argentinian Disease?
The Ascent of Money
The Independence of the Fed Threatened
A Few Quick Thoughts on the Dollar, GDP, and the Recession
Uruguay, Philadelphia, Orlando, and then...

I have been in South America this week, speaking nine times in five days, interspersed with lots of meetings. The conversation kept coming back to the prospects for the dollar, but I was just as interested in talking with money managers and business people who had experienced the hyperinflation of Argentina and Brazil. How could such a thing happen? As it turned out, I was reading a rather remarkable book that addressed that question. There are those who believe that the United States is headed for hyperinflation because of our large and growing government fiscal deficit and massive future liabilities (as much as $56 trillion) for Medicare and Social Security.

This week, we will look at the Argentinian experience and ask ourselves whether "it" - hyperinflation - can happen here.

The Ascent of Money

I will be quoting from Niall Ferguson's recent book, The Ascent of Money. I cannot recommend this book too highly. In fact, I rank it up with my all-time favorite book on economic history, Against the Gods, by the late (and sorely missed) Peter Bernstein. There are very few books I read twice. There are too many books and not enough time. This book I will have to read at least three times, and soon, and I have a lot of underlines and mark-ups in it already.

If there were one book I could require every member of the Congress to read, it would be this one. As I read it, I am struck again and again by how fragile and yet resilient our economic systems are. Fragile in the sense that governmental policy mistakes, no matter how well-intentioned, can destroy the wealth of a nation, and resilient in that it doesn't happen more often.

In his introduction Ferguson writes, "The first step towards understanding the complexities of the financial institutions and terminology is to find out where they came from. Only understand the origins of an institution or instrument and you will find its present day roles much easier to grasp."

As is often said, those who do not understand history are doomed to repeat it. If you want to understand what is happening in the economy, what the consequences of our choices could be, then I strongly suggest you get The Ascent of Money. It is easy to read, engaging, full of moments where you are led to pull together different ideas into an "Aha!" Ferguson is a brilliant writer and historian, and we are lucky to have this book at a time when it is sorely needed. (order it at Amazon.com)

As I have been writing, the United States in particular, and the developed world in general, are faced with a series of very unpleasant, if not downright bad choices. The time for good choices was ten years ago. Now we face the prospect of painful decisions, no matter what we do. It is not a matter of pain or no pain, of somehow avoiding the consequences of our bad decisions, it is simply deciding how much pain we will take and when, or allowing the pain to build up to a climactic event. Today we look at what I think would be the worst choice of all.

Catching Argentinian Disease

At the beginning of the 20^th century, Argentina was the seventh richest nation on earth. It's very name means "silver." "As rich as an Argentine" was a byword. Even after falling from the heights through a series of bad decisions, the country was still so wealthy that, in 1946 when new president Juan Peron first visited the central bank, he could remark that "There was so much gold you could barely walk through the corridors."

Argentina had actually defaulted on its debt in the late 19^th century, not once but twice! But still they managed to avoid destroying the currency and devastating the country. But in 1989, after years of massive budget deficits that were financed with borrowing from abroad and Argentinian citizens, the country was left with so much debt and no one was willing to lend it any more money, that the leaders felt compelled to resort to the printing press.

My Uruguayan friend and Latin American partner, Enrique Fynn, tells me of his experience of going to Buenos Aires and buying a pack of cigarettes one evening. He went into the store the next morning for another pack, and the price had doubled. He came back that evening and the price had doubled again (thankfully for his health, he has quit!). There were no prices on any items in the grocery stores. There was a man with a microphone who would announce the prices of various items, often increasing the price every few hours by 30% or more.

Workers would get their pay in cash and rush to the store to buy anything, as by the end of the week their pay would be worthless. Of course, shelves were empty. The US dollar was king, and could purchase things at amazing prices. I heard stories that were truly compelling. (It made me wish I had gone shopping in Buenos Aires at the time!)

Interestingly, the dollar is still the real medium of exchange. I was told by several people that if you want to buy a house for half a million dollars, you bring the physical cash to the closing. One person counts the money and the other checks the paperwork and title. Argentina has the second largest hoard of physical dollars in the world, only exceeded by Russia. Is it any wonder they are concerned with the value of the dollar?

Let's look at some quotes from Ferguson (emphasis mine):

"The economic history of Argentina in the twentieth century is an object lesson that all the resources in the world can be set at nought by financial mismanagement... To understand Argentina's economic decline, it is once again necessary to see that inflation was a political as much as a monetary phenomenon...

"To put it simply, there was no significant group with an interest in price stability...

"Inflation is a monetary phenomenon, as Milton Friedman said. But hyperinflation is always and everywhere a political phenomenon, in the sense that it cannot occur without a fundamental malfunction of a country's political economy."

Look at the chart below. Using realistic assumptions, It suggests that the annual US government fiscal deficit will approach $2 trillion in 2019. How can we come up with what looks to be about $15 trillion over the next ten years? The Argentinian answer was to print the money.

In the US, the short answer is that unless the US consumers become a massive saving machine, to the tune of 8% or more of GDP and rising each year, and willingly put their savings into US government debt, it's not going to happen. So sometime in the coming years, interest rates are likely to start to rise in order to compensate bond investors for what they perceive as risk. That will bring us to some very difficult and painful choices.

As I wrote a few weeks ago, this scenario could be averted IF the Obama administration produced a credible plan to lower the deficit over time and stuck to it. But today's thought process is about what happens if they don't.

Ferguson pointed out in the quotes above that hyperinflation is always and everywhere a political decision. Governments have to choose to print money. In theory and in practice, what would happen if the Fed decided to accommodate a politicized US government that wanted to spend money on favorite projects and support groups, maybe even deserving programs like health care or defense or pensions or Social Security? Money they could not borrow?

Then Peter Schiff and like-minded thinkers would be right. Once you start down that path, it is hard to stop short of the brink. Brazil got to 100% inflation per month and has really lowered that level over time, but it is not easy.

In such a scenario, you want to own hard assets. Gold. Foreign currencies. Stocks. Almost anything other than the currency that is being printed.

I was asked at almost every speech about that scenario. In Latin America, hyperinflation is not a theoretical issue; it has been reality. More than one person commented on that no one in US economics schools studies hyperinflation. It is required material in Latin America. For many Latin Americans, the dollar has been their safe haven. And now they are worried, with good reason.

For the record, I do not think the US will experience hyperinflation as long as the Fed maintains its independence. Read the speeches from various Fed governors and regional presidents. These are strong personalities, and they understand that going down that path ends in massive tears. Bernanke warned just a few weeks ago that the government needs to get serious about the fiscal deficit. Watch the rhetoric from the Fed heat up after his reconfirmation and the confirmation of two new governors in the first quarter.

The Fed has committed to buy a fixed amount of government debt in its quantitative easing program. That commitment will be finished by the end of the first quarter (if I remember correctly). Then comes the tricky part.

I have been writing for a long time that the main force in the economy right now is deflation. The Fed will fight deflation tooth and nail. But they don't have to buy government debt to fight deflation. They can buy mortgage securities, credit card securities, commercial paper, etc. That will have the effect of easing without encouraging the government to run massive deficits. And such debts are naturally self-liquidating, while government debt is not, at least not in the same way.

I believe the Fed will maintain its independence. Not to do so is to court economic disaster of the first order. These are bright and serious men and women. They get it.

The Independence of the Fed Threatened

The risk is that something changes to compromise their independence. And sadly, there is some risk. Let me quote my fishing buddy friend David Kotok:

"It's now official. The proposed legislation to reform America's financial service supervision includes granting the Secretary of the Treasury a veto over Section 13(3) emergency action by the Federal Reserve Board of Governors. If this becomes law, it will be a sad day for the independence of America's central bank.

"The Secretary of the Treasury, a very senior cabinet position, is appointed by the President and meets with the President in the Oval Office weekly. The governors of the Federal Reserve Board are also appointed by the President. Both cabinet officers and Federal Reserve governors are confirmed by the US Senate. There are supposed to be seven governors; politics has purposefully limited this to five throughout the three-year financial crisis period.

"The Federal Reserve governors are supposed to serve staggered 14-year terms with all seven seats filled. Instead, we have been governed by the present five-member, politically configured board.

"The original seven-governor construction was designed to insulate them from political pressure, for very good reasons. Decades of monetary history throughout the world have disclosed what happens when political influence on a central bank intensifies. The Weimar Republic and Zimbabwe are evidence of the worst inflationary effects of politics. The Great Depression in the US and the nearly two-decade deflationary recession in Japan demonstrate that monetary policy is not only inflation-prone. When central banks are under political influence you can get fire or you can get ice.

"In Japan, the central bank contends with two members of the cabinet sitting in on its deliberations. There is no way to know how much of the last 15 years of deflation and recession is attributable to the inside political pressures placed on the governors of the Bank of Japan. But there is evidence to suggest political influence, especially when you observe how little the Bank of Japan has engaged in asset expansion during this crisis."

This is the nose of the camel under the tent. Starting down this road is very worrisome indeed. I find it appalling that Tim Geithner and Larry Summers went along with this. This is a very clear attempt by the political class to put political pressure on the Fed. I hope the Fed responds with vigor. I can tell you that the officials of whom I am aware will not take kindly to pressure. And that might be an understatement.

(Yes, I am aware of the problems of the Fed being able to decide whom to bail out and why. It is not a perfect world. But better the Fed than Congress.)

All that being said, if the Fed starts to increase its buying of government debt above its initial commitment, then my "optimistic" scenario of a very rough economic patch, which I have been outlining the past few months, is far too rose-colored. I do not think it will happen, but I can guarantee you, I and a lot of other people will be watching.

A Few Quick Thoughts on the Dollar, GDP, and the Recession

Just a few quick notes. When world trade collapsed, so did the need for US dollars, which is what the world uses to transact business. The data looks like world trade is finding a bottom and maybe even recovering somewhat. That means there will be the need for more dollars. And since everybody and their mother are short the dollar, there could be a vicious snap-back rally. I am still bearish the US dollar (and the yen and the euro and the pound) over the long term, but there is the potential for a real rally here.

And my friend Mish Shedlock commented on the US GDP report, which said the US GDP rose 3.5%:

"Today the market is cheering over what is actually an ugly report. A misguided Cash-for-Clunkers added a one-time contribution of 1.66 percentage points to GDP. Auto sales have since collapsed so all the program did is move some demand forward. Government spending increased at 7.9 percent in the third quarter which is certainly nothing to cheer about. Personal income decreased $15.5 billion (0.5 percent), while real disposable personal income decreased 3.4 percent, in contrast to an increase of 3.8 percent last quarter. Those are horrible numbers. The savings rate is down, which no doubt has misguided economists cheering, but people spending more than they make is one of the things that got us into trouble. The only bright spot I can find is exports. However, even there we must not get too excited as imports rose much more."

John Williams notes that one-time stimulus or inventory items represented 92% of the reported quarterly growth. The nature of the stimulus-related gains was that they tended to steal business activity from the future. The months ahead are the future. Accordingly, fourth-quarter quarterly GDP change will likely turn negative, again. (The King Report)

And David Rosenberg writes: "Only economists see the recession as being over; the man on the street sees it a little differently, perhaps less enthused by the fact that a lower rate of inventory destocking is arithmetically underpinning GDP growth at this time. Put simply, a Wall Street Journal/NBC News poll just found that 58% of the public believe the economic recession still has a ways to go -- and that is up from 52% in September and means that the private investor, unlike the hedge fund manager, is not interested in adding risk to the portfolio even after a 60% surge in the equity market.

"Only 29% of those polled believe the economy has hit bottom -- imagine having that psychology with nearly zero interest rates, a bloated Fed balance sheet and unprecedented fiscal deficits (poll was taken from October 23-25). Nearly two in three (64%) said the rally in the stock market (still a bear market rally -- not the onset of a new bull market) has not swayed their view (or ours for that matter)."

Uruguay, Philadelphia, Orlando, and then...

I am finishing this letter in Montevideo, Uruguay. I have been in Buenos Aires, Sao Paulo, and Rio de Janeiro this week. I must say that Rio is beautiful, very green and lush with marvelous beaches, which I sadly only got to drive past. I will come again. I fly back Sunday and am home for a week, then speaking trips to Philadelphia and Orlando. Then my schedule only shows a few days in New York in early December for Festivus with the gang from Minyanville, and Europe in January. I am sure other things will come up, but I am looking forward to being home for awhile.

My friends at International Living have been writing about Uruguay, and I was really looking forward to visiting the country. I have spent a few days with partner Enrique Fynn in this delightful place. Turns out it is the Switzerland of South America. Reasonable bank secrecy laws, and trades zones where you are not taxed on any business you do outside of Uruguay. Many international companies set up their headquarters here. Beautiful beaches, friendly people, and the charm of a small country, plus what will be a brand new airport in a few weeks, which can get you several times a day to any part of the region, directly to Europe, and one hop away from any major city in the world. You can learn more about the country, and other countries you may want to live in or have a second home in, by subscribing to International Living.

One of the laugh lines I use in my speeches down here is that if the Fed actually does start to monetize the debt, I will have to move to Uruguay. I could make worse choices.

Have a great week. I think this weekend I will switch it up from the heavy reading I have been doing and find some science fiction. Reality is way too scary.

Your ready to be in his own bed analyst,

John Mauldin

Quarterly Review and Outlook - Third Quarter 2009

JohnMauldin — Mon, 12 Oct 2009 20:32:18 GMT

I look forward at the beginning of every quarter to receiving the Quarterly Outlook from Hoisington Investment Management. They have been prominent proponents of the view that deflation is the problem, stemming from a variety of factors, and write about their views in a very clear and concise manner. This quarter's letter is no exception, where they once again delve into the history books to bring up fresh and relevant lessons for today. This is a must read piece.

Hoisington Investment Management Company (www.hoisingtonmgt.com) is a registered investment advisor specializing in fixed income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $4-billion under management, composed of corporate and public funds, foundations, endowments, Taft-Hartley funds, and insurance companies. And now let's jump right in to the essay.

John Mauldin, Editor
Outside the Box

Quarterly Review and Outlook - Third Quarter 2009

Ponzi Finance

The Federal Reserve reported that as of June 30, 2009 total U.S. debt was $52.8 trillion. Total U.S. debt includes government, corporate and consumer debt. Importantly, however, it does not include a few trillion in "off balance sheet" financing, contingent unfunded pension plans for corporate and state and local governments, or unfunded liabilities of the U.S. government for such items as Medicare, Social Security and other programs. Currently GDP stands at $14.2 trillion, so there is approximately $3.73 in debt for every dollar of output in the United States, a level unprecedented in our history (Chart 1). Normally, debt levels as a percent of GDP would be uninteresting and immaterial; however, the current level of debt is unique in two ways. First, the asset side of the balance sheet purchased by the debt is falling in price. Second, the money that was borrowed to purchase those assets was often fraudulently expended. Neither the borrower nor the lender really expected the debt to be serviced. Rather, each party expected the asset price to rise extinguishing the debt.

This type of financial arrangement was correctly analyzed by the famous American economist Hyman Minsky in his paper, "Financial Instability Hypothesis", in which he described three phases of debt financing. The first is "hedge finance", where the lender expects a return on both principal and interest. The second is "speculative finance" where the lender expects to get interest on the loan but perhaps not the principal. The third case, where the lender expects neither the principal nor interest to be returned, is referred to as "ponzi finance". This was typified in the last business cycle by loans issued without documentation, no down payment home loans, extremely low cap rates on commercial real estate, and the high leverage borrowing ratio of private equity funds. Even ponzi finance works as long as asset prices are rising. But once the bubble is pricked, the debtor is left with declining asset values that preclude the rollover of their obligations.

Presently, in this worst of all post-war recessions we are witnessing the collapse of asset prices that were inflated by the speculation of earlier years. The aftermath of that speculation and its impact on the economy has been thoroughly studied prior to our present business cycle by the economists of yesteryear who marveled at the mania in the collective mindset of private citizens and their elected representatives who produced such bubbles. The most famous of these economists was Irving Fisher (1867-1947), who in 1933 wrote about this problem of over-indebtedness (Irving Fisher, 1933, Econometrica, "The Debt-Deflation Theory of Great Depressions"). He stated flatly that over-indebtedness was the difference between normal business cycles (recessions), which occur frequently through "over-production, inventory misjudgment, or commodity price fluctuations" and extreme business cycle fluctuations (depressions). Based on his analysis of the great depressions of 1837, 1873, and 1929 he outlined a pattern of economic developments that will take place when the debt cycle is broken. Seemingly old news, but it is interesting to apply his sequence of events to today's economic developments as there are disturbing similarities.

A Downward Spiral

Fisher posited that debt liquidation leads to distress selling, contracting bank deposits and declining velocity of money, all of which contribute to the fall in price levels. This accurately describes today's circumstances. Distress selling is rampant, with home foreclosures reaching all-time highs. Additionally, rapidly rising foreclosures in commercial real estate are causing the closing of financial institutions and the liquidation of their portfolios. Money supply (M2), an imperfect measure of bank deposits, is essentially flat over the last six months even though the monetary base is 100% higher than it was a year ago (Chart 2). Further, the velocity of M2 has contracted at a 12.7% rate over the past two years. The Personal Consumption Expenditure Deflator (goods purchased by consumers) has fallen from a 2.7% growth rate 12 months ago to a yearly increase of only 1.3% presently, and appears to be heading for a zero reading in 2010. GDP has recorded its greatest contraction since the 1930's, and probably is not yet at its lowest level for this cycle.

Fisher then noticed that this distress selling would lead to a fall in the net worth of businesses, a decline in profits, and a reduction in employment. Fisher may have been talking about 1929 and the 1800's, but that is precisely our present situation. Despite a 19% gain in stock prices this year, the S&P 500 has declined about 30% from its peak and stands lower than it was a decade earlier. Corporate profits are down approximately 13% on a year over year basis, and in 2008 S&P 500 profits fell for the first time since 1933. The net worth of hundreds of banks and other large corporations has fallen below zero, with some surviving only because of a massive rescue effort by the federal government. Despite these efforts, consumer net worth has fallen, price levels of homes are down about 30% from their peak levels, and business net worth has been impaired by an almost 39% decline in commercial real estate from its peak levels. Industrial production is down 13.3% since its peak, the largest 20 month decline in the post war period (Chart 3). Including potential revisions, the U.S. has lost eight million jobs in this recession, and currently 17% of the labor force is either underemployed, partially employed, or out of work seeking employment.

Fisher seems to be not so historical as prescient. He states that all the above problems create disturbances in the rate of interest, particularly the fall of nominal money rates and the rise of real interest rates. The federal funds rate is now effectively zero, and yet with the steady downward movement in price indices, real interest rates are rising. This, of course, is of concern to debtors.

The uncomfortable conclusion of Fisher's analysis is that major business cycle fluctuations are, in fact, caused by over-indebtedness and the fall in asset prices. Our present situation appears to mirror the exact sequence of events that have occurred in previous depressions. This suggests that our current "great recession" may morph into a more serious and elongated downward business cycle.

The Impossible Promise

The federal government's promise to extricate the U.S. economy from this recession involves more spending (increasing public debt) and more subsidies for consumers, such as car rebates and home buying incentives (more private debt). In other words, more debt is supposed to solve the problem of over-indebtedness. The truth is that this policy merely indentures its citizens further without providing any income for repayment of debt. In previous letters we have discussed the fact that the government spending multiplier is zero (read Professor Robert Barro's book, Macroeconomics - a Modern Approach, p. 370). This means there is no long term income benefit from stimulus programs. According to the latest academic research, the most recent $800 billion stimulus plan will boost economic activity in the short run, but will surely depress economic activity over time. The government problem is complicated by the fact that the tax multiplier is 3, meaning that a 1% change in taxes will change GDP by about 3% over time. More recent research (Barro & Redlick, September 2009, "NBER Working Paper 15369") suggests that a 1% cut in the marginal tax rate would raise GDP in the ensuing year by 0.6%. With the deficit rising due to a zero spending multiplier, the tendency will be to try to raise taxes to pay for this higher level of expenditures, which will further depress aggregate spending and output.

From a fiscal policy perspective the outlook for economic growth appears to be one of stagnation for several years due to the size of the federal debt, which is expected to rise 35.7% from 2008 levels to 76.5% of GDP over the next ten years according to the Office of Management and Budget (Chart 4). This exercise in government spending is, of course, an exact replica of the Japanese experience from 1989 to the present. Their debt to GDP ratios have gone from about 50% in 1988 to about 178% today, and yet their nominal GDP is no higher than it was 17 years ago, and their employment stands at twenty year ago levels. It is somewhat unsettling that as of the last employment report the United States employed 131 million people, a level that was first reached in 2000, which means the United States has had no net job gains for almost ten years. Indeed, it appears that the fiscal chain around the free market neck is sufficiently onerous to restrain growth for several years. The promise of the government to revive growth through increased indebtedness is, indeed, an impossible promise.

The Hesitant Fed

As Fisher stated, the write-down of debt and distress selling tends to destroy money deposits and lower the velocity of money. Despite the historical evidence of that fact, our current Fed authorities appear to be oblivious to the lessons of the past. Their initial reaction to the liquidity crisis has to be applauded for their heavy work in insuring the liquidity of the financial system. Similarly, the expansion of their bank balance sheet to $2.1 trillion from $1 trillion was the precise reaction needed to counter the emerging deflation of asset prices. However, their actions increased inflationary expectations, and they have encountered a plethora of critics. In responding to this criticism the most recent statistics suggests they are beginning to lose the fight against the deflationary impulses. Consider that the monetary base rose 1000% in the three months ending December 2008, but has been held essentially flat since then (Chart 5).

The Fed's purchases of assets to increase this base automatically created deposits that positively charged the money supply growth to a 15.2% six-month growth rate (Chart 2). If the economy were operating near full capacity, a healthy banking system would take these deposits and multiply them roughly nine times; that circumstance could be inflationary. Unfortunately the banking system is not healthy, as evidenced by the fact that we have closed 95 banks this year, more than the cumulative total of the past 15 years, and another 416 banks are on a list destined to become extinct. With consumers' asset prices falling so rapidly and banks increasingly afraid of failure, banks are more interested in collecting loans than in lending. So with fewer consumers now credit worthy, loan volumes are collapsing. As loans are paid off, deposits are destroyed, and the money multiplier that should stand at nine has gone to zero. This is evidenced by the fact that the six-month change in M2 has fallen to a 1% growth rate, meaning that monetary stimulus is on hold. Get set for negative GDP in 2010.

Dollar Weakness

The inflation outlook from the monetary and fiscal standpoint looks truly deflationary, yet some believe that dollar weakness will reverse this circumstance and create inflation. This is unlikely. First, our imports are about 13% of GDP, and even if the dollar were to halve in value, the price of imported goods would not only have to compete with U.S. producers, but also their price adjustment would have to offset the other 87% of factors included in the pricing indices. Second, unlike the 1930's a 50% decline in the dollar would be difficult to engineer. Fisher recommended to Roosevelt that the U.S. should exit the gold standard, which he did in April of 1933. That was a fixed exchange rate system, and within three months the dollar lost more than 30% against the gold block countries and fell to 60% of its former value within the next five months. This spurred our exports and provided some price inflation (2.9% per year, GDP deflator) for the next four years. Then, in 1937 the tax increases (the next policy mistake) reversed the positive growth rate of the economy and drove price levels and economic activity downward again. However, even with that small period of price increases the overall price level never recovered from the 25% decline that occurred from 1929 to 1933, and thus deflation reigned. Today the declining dollar is a good thing in terms of our trade balance, but the modest change will be insufficient to offset the negative forces of insufficient domestic demand.

Next year the core GDP deflator will fall to zero, with the possibility of negative levels. Likewise, long-term interest rates, which are highly sensitive to inflation, will continue to move toward lower levels. As stated in previous letters, we see no reason why longer dated Treasury interest rates will not mirror those of Japan, which provides a modern signpost for a deflationary environment. Currently the Japanese ten-year note stands at 1.3% with their thirty-year bond yielding 2.1%.

Van R. Hoisington
Lacy H. Hunt, Ph.D.

Welcome to the New Normal

JohnMauldin — Sat, 26 Sep 2009 04:59:00 GMT

What We See
And What We Don't See
The Statistical Recovery
A Double-Dip Recession?
Welcome to the New Normal
Birthdays, New Orleans, and then the Road Trip from Hell

Unemployment is high and rising. But if the recession is over, won't employment start to rise? The quick answer is no. We look deeper into the Statistical Recovery and find yet more reasons to be concerned about near-term deflation. This week we consider all things unemployment and ponder the need to create at least 15 million jobs in the next five years to return to a full-employment economy - and the implications for both the US and world economies if we don't. Economic is often about what we can clearly see, and yet it is understanding what we can't see that gives us true insight. We start with a collection of facts that we can see and then begin a thought exercise to find the implications.

What We See

First, the unemployment rate is now officially at 9.7%. We are approaching the official high we last saw at the end of the double-dip1982 recession. In the chart below, notice that unemployment rose throughout 1980 and then began to decline, before rising rapidly as the economy entered the second recession within two years. Also notice the rapid drop in unemployment following that recession, as opposed to the recessions of 1991-92 and 2001-02, which have been characterized as jobless recoveries. Unemployment was as low as 3.8% in 2000 and saw a cycle low of 4.4% in early 2007.

(For the record, all this data is available on the Bureau of Labor Statistics website. There is a treasure trove of data. They are quite open about what they do and how they do it. When I call to ask a question, they are quite helpful. How people interpret the data is not their fault.)

This headline unemployment number (9.7%) is what we see when we read the paper. What we typically don't see is the real number of unemployed. For instance, if you have not actively looked for a job in the last four weeks, even if you would like one, you are not counted as unemployed. You are called a "marginally attached" or "discouraged" worker. Often there are very good reasons for this. You could be sick, dealing with a family emergency, going back to school, or not have transportation.

Right now, about one-third of marginally attached workers actively want jobs but have not bothered to look because they believe there are no jobs in their area, at least not for them. If you add that extra 758,000 to the unemployment data, you get what is called U-4 unemployment, which today is 10.2%. If you count all marginally attached workers the unemployment number is 11% (U-5 unemployment).

And if you add those who are employed part-time for economic reasons (i.e., they can't get full-time jobs) the unemployment number rises to 16.8%. (That is called U-6 unemployment.)

Now, stay with me for the next two tables taken directly from the BLS website. The first is the total number of people in the US civilian work force. Notice how each year the number of potential workers rises. In fact, the number of workers has risen by about 15 million over the last ten years. This is from population growth and from immigration. Also notice that the normal rise did not happen last year. That is because the number of discouraged workers has risen rapidly and, as noted above, they are not counted. We will revisit this point later. But for now, there are 154,577,000 people in the available work force.

Next we look at the tables for the actual level of employment. Here we note that we are down almost 8 million jobs sincd the onset of this recession, and that there are almost 15 million people unemployed.

Going back to the part-time workers, there are roughly 9 million people who are working part-time because of business conditions, or those are the only jobs they could find. The average work week is at an all-time low of 33 hours. The chart below is from my friend David Rosenberg.

David wrote in a special report today:

"What does all this mean? It means that when the economy does begin to recover, when we finally get to the other side of the mountain, companies are going to raise their labour input first by lifting the workweek from its record low. Just to get back to the pre-recession level of 33.8 hours would be equivalent to hiring three million workers. And, the record number of people working part-time against their will are going to be pushed back into full-time, which will be great news for them, but not so great news for the 125,000 - 150,000 new entrants into the labour market every month. They won't have it so easy because employers are going to tap their existing under-utilized resources first since that is common sense. Also keep in mind that there are at least four million jobs in retail, financial, construction and manufacturing jobs lost this cycle that are likely not coming back. In fact, the number of unemployed who were let go for permanent reasons as opposed to temporary layoff rose by more than five million this cycle. This compares to the 1.2 million increase in the 2001 tech-led recession and in the 1990-91 housing-led recession (when Ross Perot talked about the sucking sound of jobs into Mexico)."

Then there is the matter of average weekly earnings. If you adjust for inflation, workers are making roughly what they did in 1980. The chart is straight from the BLS website.

And What We Don't See

Those are the facts. Now it's time to look at what we don't see, and what you don't read or hear from the mainstream media.

We saw above that we are adding about 1.5 million workers to the workplace every year. That means over the next five years we are going to need 7.5 million jobs just to maintain that growth, or about 125,000 a month. That is on the low side of what economists normally estimate, which is around 150,000 per month. If we used the 150,000 estimate, it would mean we need 9 million jobs.

There are at least 1 million (and probably more like 2 million) discouraged workers who would take jobs if the economy got better. You can derive that number by going back to early 2007 and seeing the level of discouraged workers. That means, by the end of 2014 we are going to have 163 million people in the work force (see table above).

Today we have 139.6 million jobs, and that number is likely to slip at least another half million (last month the economy lost 216,000 jobs, with a very suspicious birth-death ratio accounting for a lot of job creation). So let's call it 139 million current jobs.

Let's assume that we would like to get back to a 5% unemployment rate. That would not be stellar, but it would certainly be better than where we are today. Five percent unemployment in late 2014 will mean 8.1 million unemployed. To get to 5% unemployment we will have to create 14 million jobs in the five years from 2010-2014. (163 million in labor pool minus 8 million unemployed is 155 million jobs. We now have 139 million jobs, so the difference is roughly 15 million.) Plus the equivalent of 3 million jobs that Rosenberg estimates, just to get back to an average work week. And maybe the extra 1.5 million a year I mentioned above.

But let's ignore those latter jobs and round it off to 15 million. Let's hope that by the beginning of next year we stop losing jobs. That means that to get back to 5% unemployment within five years we need to see, on average, the creation of 250,000 jobs per month. As an AVERAGE!!!!!

Look at the table below. It is the number of jobs added or lost for the last ten years. Do you see a year that averaged 250,000? No.

If you take the best year, which was 2006, you get an average monthly growth of 232,000. If you average the ten years from 1999, you get average monthly job growth of 50,000. If you take the average job growth from 1989 until now, you get an average of 91,000 a month. If you take the best ten years I could find, which would be 1991-2000, the average is still only 150,000. That is a long way from 250,000.

Want to get back to 4%? Add another 25,000 jobs a month to 2006.

Let's jump forward to next September. We will need at least 1.5 million jobs to take into account growth in the population. Plus another half million jobs that we are likely to lose before we start to grow again. What is the likelihood of average job growth of 160,000 a month? Anyone want to take the "overs" bet?

Go back to 2003, the year after the end of the last recession. A few hundred thousand jobs were created. Why so slow? Because employers gave more time to those who were already employed and to part-time workers. Because of the near-certain loss of jobs for the next few months and the slow recovery, it is a very real possibility that unemployment will still be well over 10% a year from now.

Even with robust growth of 200,000 jobs a month thereafter for the next two years, unemployment will still be close to or over 9%. That would only be an additional 1.8 million jobs (making the most optimistic assumptions) over the new jobs needed for population growth.

A Double-Dip Recession?

And that is before this administration makes the economically suicidal move to raise the top tax rate by 10%. The popular image is that those who pay the highest tax rate are Wall Street execs, bankers, and corporate moguls. The reality is that 75% of them are small business owners, and they are responsible for the large majority of new jobs that are going to be needed, not to mention a large part of consumer spending. If you tax them more you are going to get fewer jobs (as they will have less to invest) and less consumer spending.

A tax increase of the size being contemplated, with unemployment at today's level, will guarantee a double-dip recession, which of course means that unemployment will rise, not fall. Go back and look at that chart on unemployment. Notice the very steep rise in the second recession of the early '80s. That is what we could be facing.

Without getting too political, think about elections in 2010 with unemployment levels still rising. And fast-forward to 2012, with deficits (optimistically) projected to be almost $1 trillion and rising. With a tax increase giving us another recession? Will the bond market provide another $4 trillion? My question is, from where?

There has never been a period of serious inflation in the US without wage inflation. But real incomes are falling, and there is little reason to believe we will see wage pressures within the next few years. The opposite is likely to be the case.

Today's Wall Street Journal tells us that 5 million people have been unemployed for over 6 months. And the longer you are unemployed, the harder it is to get a job. That means you have to settle for a job with less income than you had before.

The only group to see a rise in employment? Those over the age of 55, as they have to take a job, any job, so they can save for retirement.

The Statistical Recovery

The economy is in the process of bottoming. The year-over-year comparisons are getting easier. We will find that new level of spending and economic activity and grow from there. But it is going to be awhile before we get back to full employment. While the numbers may say recovery, it is not going to feel like one.

Let's review quickly what I have written about the last four weeks. We have enormous excess capacity - capacity utilization is about 68%. Banks are cutting back on their loans, and consumers and businesses are borrowing less. Housing is likely to be in a funk for at least two years. We are deleveraging, which is causing the velocity of money to slow.

All of this is very deflationary. Will the Fed print enough money to reflate the economy? You better hope so. Will we have to deal with it later? Of course. We have no good choices. We are in for a long five years, at the least. Yes, there will be opportunities, and new industries will be created. But it won't happen overnight.

Welcome to the New Normal.

Birthdays, New Orleans, and then the Road Trip from Hell

Next weekend I celebrate my 60^th birthday, and family and friends from around the world are flying in. We are going to party for at least 2-3 days. All I can say is, I have a very eclectic group of friends and it is going to be fun for all of us. If I write a letter, it will be earlier in the week.

I will be in New Orleans the following weekend, then start a 17-day trip with only a few nights in my bed, and every day a plane or new city. Although I enjoy traveling and meeting people, this may be a little much, though I must say I am looking forward to Argentina, Brazil, and Uruguay. It has been awhile since I have been south.

I stopped by to visit my #2 daughter (Melissa) last night. She works in a local watering hole while going to school. It is quite popular and is usually quite crowded. Last evening it was untypically quiet.

I asked, "What's up?" The manager and Melissa began talking about how slow things were getting, about how friends who were regulars had lost their jobs and had to move back in with parents. With few exceptions, it is slower than a few years ago everywhere I go. A recent Gallop poll said 71% of people are cutting back and 90% are watching what they are spending. 33% said their companies are cutting back on hiring.

Every poll or survey I see shows businesses deciding to cut back. Talking with my kids (the six who are young and in the work force), it is a rather difficult time. But then I think that I had to enter the workforce in 1975, not a very good year or decade. And we all made it, if not very easily. We lived very modestly (to say the least) for those first years.

And so it goes. Each generation has to learn how to deal with adversity and the problems of starting out. Many of those in my generation are now trying to figure out how to deal with a retirement that does not look nearly as comfortable as it did a few years ago.

I still hope we can Muddle Through.

Have a great week. I see parties, barbeque, golf, and lots of friends in my week ahead. And you make some time to enjoy life as well.

Your glad to get to 60 analyst,

John Mauldin

On the Economy & Obama's Trillions

GaryHalbert — Tue, 08 Sep 2009 20:33:00 GMT

IN THIS ISSUE:

The Economy - More Signs of Recovery
Is the Recession & Credit Crisis Over?
Obama Adds $2 Trillion to Debt Forecast
Economic Assumptions Still Too Optimistic
What in the World Are They Thinking?
Do They Want Control Even If It Ruins The Economy?

Introduction

In my June 16 E-Letter, I reprinted the non-partisan Congressional Budget Office's (CBO) projections of annual federal budget deficits over the period from fiscal 2009 to fiscal 2019, which estimated that the national debt will more than double over that 11-year period - not including over $1 trillion for nationalized health care (if it passes) and several trillion more that will be required to rescue Social Security, Medicare and Medicaid over the next decade.

The White House Office of Management & Budget (OMB), which is partisan, runs budget deficit projections similar to those of the CBO. The OMB's deficit projections over the same period, 2009-2019, showed the national debt increasing over $2 trillion less than the CBO's forecast of $11.11 trillion. However, on Friday, August 21, the White House quietly announced that the OMB had revised upward its deficit projections to fall in line with the CBO's. So, it's official.

The only good news on the deficit front is that both the CBO and the OMB recently revised downward the fiscal 2009 budget deficit, which closes out at the end of September, from the earlier reported $1.8+ trillion to around "only" $1.6 trillion. Time to break out the bubbly, right? Wrong! We will look at the latest deficit projections as we go along, but the problem is still the same; Obama seems intent on spending this country into financial ruin.

But first, there is more good news on the economic front. More and more forecasters now believe that GDP has moved into positive territory in the 3Q, and perhaps it has. Unfortunately, we don't get our first 3Q GDP estimate until the end of October. The latest GDP estimate for the 2Q was unchanged at -1.0%, which was better than expected. I will cover the latest encouraging (and not so encouraging) economic news just below.

The Economy - More Signs of Recovery

We have seen considerably more positive signs than negative over the last month. Let's begin with the ISM manufacturing index which rose sharply to 52.9 in August, up from 43.4 in July. It is the highest reading since June 2007. A reading above 50 in the ISM index indicates that the economy is recovering. The ISM "new orders" index jumped 9.6% in August to 64.9, which confirms that inventory rebuilding is intensifying, albeit from very depressed levels.

Durable goods orders jumped 4.9% in July (latest data available) following -1.3% in June. Industrial production increased 0.5% in the same period. The factory operating rate also increased modestly in July. Construction spending, however, was still down slightly in July.

The Index of Leading Economic Indicators rose for the fourth consecutive month in July (latest data available) with a rise of 0.6% following a gain of 0.8% in June. Four consecutive up months in the LEI is quite encouraging, indicating that the worst of the recession is likely behind us, and the economy may move into positive territory before year-end.

The Consumer Confidence Index bounced back in August to 54.1 versus 47.4 in July. After rising sharply in the spring, the Index drifted lower in June and July so the latest recovery was welcomed. The University of Michigan Consumer Sentiment Index also closed out higher at the end of August.

Unfortunately, the rise in consumer confidence that began in the spring has not translated into significantly higher consumer spending. Retail sales in July fell 0.1%. Personal consumption expenditures, another measure of consumer spending, were up only 0.2% in July. Most Americans are still very concerned about the economy, and many are choosing to save rather than spend. The Commerce Department reports that the personal savings rate rose to 5% of disposable income in the 2Q, the highest rate in over a decade.

On the housing front, there was some good news in the last month. Pending home sales rose 3.2% in July following a gain of 3.6% in June. Actual sales of existing homes rose 7.2% in July to an annual rate of 5.24 million units. Sales of new homes rose 9.6% in July, the largest monthly gain since February 2005. Much of the increase in home sales in recent months is attributed to the up to $8,000 in tax incentives for first-time home buyers; yet no one knows what will happen when this stimulus program ends later this year.

The Labor Department announced last Friday that the US unemployment rate jumped to 9.7% in August, up from 9.4% in July, and above pre-report expectations. In August, the official number of unemployed persons increased by 216,000. The Labor Dept. also reported that there are now 14.9 million unemployed Americans, and this number is likely headed even higher in the months ahead.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Is the Recession & Credit Crisis Over?

In the 30 years that I have been writing about the markets and the economy, a "recession" has consistently been defined as two or more consecutive quarters of negative growth in GDP (or GNP back in the old days). Likewise, two consecutive positive quarters meant that the recession was over. Be that as it may, if the initial GDP report for the 3Q is even mildly positive (which we won't get until the end of October), you're going to hear virtually everyone declare that the recession is over - whether or not that proves to be the case.

While I remain a bit skeptical, most of my trusted sources believe at this point that 3Q GDP will be at least mildly positive, and that the 4Q will be as well, in large part due to inventory rebuilding. But most of these same sources are not predicting a strong recovery in the economy. Some believe that there is still a real chance that we will slip back into recession in late 2010 or 2011, especially if consumers continue to save rather than spend.

As for the credit crisis, I think it is fair to say that it is no longer a crisis. But as anyone who is trying to get credit for a business knows, the banks are still not lending remotely as they were before the subprime blowup occurred. New lines of credit are few and far between. Many banks still have too many bad loans on their books, so they're not looking for new ones.

According to the FDIC, 84 US banks have failed so far in 2009, a record pace. So while it may be safe to say that the credit "crisis" is over, we are still far from being out of the woods. There are now 416 banks on the FDIC's "problem list" (up from 305 in March), so there will continue to be multiple bank failures every month for some time to come.

Then there's the 800-pound gorilla in the room - the Fed. At some point, the Fed will have to unload the $2+ trillion in questionable securities and toxic assets on its balance sheet. The Fed can't continue to print money ("quantitative easing") indefinitely; likewise, it will have to shrink the money supply at some point; and finally, short and medium-term interest rates will have to be allowed to rise somewhere down the road, especially if the economy rebounds.

Obviously, no one short of Ben Bernanke knows when this will happen. My best sources believe that because of the deflationary forces created by deleveraging, the Fed has at least a year to maintain its current stimulative policies without risking higher inflation. Similarly, they believe the Fed can wait a year or so before having to begin unloading assets and trim its balance sheet.

Virtually, everyone I read in the financial/investment world agrees that the Fed faces a daunting challenge when the time comes to unload these assets. This problem, above all, will continue to hold the threat of a double-dip recession over the economy and the markets. We all need to keep this in mind even if the economy goes positive for a few quarters.

Obama Adds $2 Trillion to Debt Forecast

2009	$1.845	trillion	2015	$785	billion
2010	$1.379	trillion	2016	$895	billion
2011	$970	billion	2017	$945	billion
2012	$658	billion	2018	$1.023	trillion
2013	$672	billion	2019	$1.189	trillion
2014	$749	billion

TOTAL $11.11 Trillion

As noted in the Introduction, both the CBO and the White House Office of Management & Budget (OMB) recently reduced the budget deficit forecast for fiscal 2009 from the $1.845 trillion noted in the table above to apprx. $1.6 trillion. So, the $11.11 trillion shown above would now be reduced to apprx. $10.87 trillion (if the latest projections prove to be correct).

Note that this astronomical amount does not include over $1 trillion for nationalized health care (if it passes) and several trillion more that will be required to rescue Social Security, Medicare and Medicaid over next decade as the Baby Boomers retire. Nor does it include the existing national debt of $11.7 trillion. The $10.87 trillion is merely the sum of annual budget deficits over the 11 years from 2009 to 2019.

Given that September is the end of fiscal 2009, the talk is now focused on record budget deficits for the 10 years from 2010 to 2019. Never mind that the 2009 deficit will be apprx. $1.6 trillion, almost four times larger than our previous worst deficit in history, which was $438 billion in fiscal 2008 under President Bush.

If you take out the $1.845 trillion 2009 deficit from the table above, the CBO deficit estimate for 2010-2019 is $9.02 trillion. This is $9 trillion that we will add to the national debt over the next 10 years, based on Obama's budget projections. Yet for months now, the Obama administration has taken flack because its own OMB has maintained that the 2010-2019 deficits would only total apprx. $7 trillion. But that has recently changed.

Now if you're the President of the United States, and you have some news that is not flattering to release to the public (especially in a recession), you might decide to quietly release that news at the end of the day on a Friday, and hope that it doesn't get much play on the weekend news shows. That is exactly what happened on Friday, August 21.

At the end of the day on Friday, August 21, a senior White House official announced that the Office of Management & Budget had revised its deficit forecasts for 2010-2019 from $7 trillion to apprx. $9 trillion. At long last, that puts Obama's forecast in line with the CBO's forecast.

Obama Administration officials acknowledged that they relied on overly optimistic assumptions about the economy when they forecast in March that President Barack Obama's budget plans would generate deficits of $7.1 trillion over the next 10 years. After factoring in the severity of the recession and the prospect of a more sluggish recovery, the White House concluded that the budget outlook is significantly worse and revised the 10-year tally of deficits to $9.05 trillion.

Some in the media welcomed the presumably more accurate deficit forecast; some even went so far as to note that such huge spending will be just fine, such as liberal commentator Paul Krugman of the New York Times. Others, however, were quite critical and seriously questioned how the Obama Administration could have been off by $2 trillion in its forecast.

The conservative Weekly Standard published a scathing article on August 31. Here are some excerpts:

"What's $2 Trillion Among Friends?

$2,000,000,000,000. That's the amount by which the Obama administration raised its ten-year estimate of the nation's budget deficit from the one it made only a few months ago. Now, $2 trillion is a lot of money. But even more significant is the fact that this revision represents almost a 30 percent increase -- no tiny percentage of the earlier $7 trillion figure. It seems that expenses are higher -- up 24 percent this year, the largest increase since the height of the Korean War -- than originally estimated, and revenues are lower. The resulting deficit, says Peter Orszag, Obama's budget director, is ‘higher than desirable'. He might have added that the administration's critics had it right when they claimed that the earlier estimate represented a turn around the dance floor with that old seductress, Rosy Scenario.

There's worse: the new estimate assumes that Medicare and Medicaid spending will be cut by $622 billion, even though Congress has made it known that it is reluctant to make any such cut. Then there is the $600 billion in revenue included for the sale of [carbon] emission permits, despite the fact that the House has given away so many permits in order to buy support for the cap-and-trade emission-reduction that the program will produce at most $450 billion. Those two items alone come to almost another trillion dollars in red ink. Throw in another trillion-plus for Obamacare, and it is no surprise that senior economist Bill Gale, at the liberal Brookings Institute, says that the deficit will hit over $10 trillion over the next decade, a figure he finds ‘deeply alarming'.

This year, the deficit will come to 11.2 percent of GDP, and by 2019 the [national] debt will be equal to 76 percent of the [projected] value of the nation's output of goods and services, almost double the 41 percent when Obama took control of the nation's finances. No problem, say White House economists. Unsustainable, says Warren Buffett, among others."

Economic Assumptions Still Too Optimistic

Warren Buffet is absolutely correct. Whether it's $7 trillion or $9 trillion, it's way too much and unsustainable. Over the next five years alone, 2010-2014, the debt swells by $4.5 trillion. In fact, these projections could actually be too low based on the economic forecasts used in the projections. I should point out that this is not just an Obama phenomenon. White House budgets, whoever was president, have been laced with optimism, and no president has forecast a recession in these 10-year projections.

(By the way, all presidential administrations produce these 10-year forecasts on spending, revenues and the budget deficits/surpluses, even though they won't be in office 10 years from now.)

Consider the latest OMB projections for growth in GDP in the next several years in real terms, exclusive of inflation. The White House projects that GDP will grow by 3.8% in 2011 and climb above 4% a year for the next three years, followed by two years above 3%. This is far higher than historical norms; the economy has not seen such a period of growth since the 1960s.

And we can almost be assured of at least one more recession, if not two, over the next 10 years, what with the government running massive deficits every single year. Remember, the Fed will have to unload some $2 trillion in troubled assets at some point in the next few years. And, most forecasters agree that at some point, foreigners are going to curtail US dollar purchases, which will likely drive interest rates higher, at the least, or a currency crisis at the worst.

Excessive Obama optimism is not limited to economic growth. Despite the enormous monetary stimulus pumped out by the Federal Reserve in 2008-2009, bank credit that is widely regarded as potentially inflationary, the Obama administration assumes that inflation will actually decline from 2.1% in 2008 to 1.5% in 2009 and then to 1.3% in 2010 and 2011, and not rise above 1.8% through 2019. While it is true that inflation is declining now, thanks largely to the big drop in energy prices over the last year, we are almost certain to see higher inflation down the road.

What in the World Are They Thinking?

Most Americans that keep up with the economy and rising government spending, even remotely, are very alarmed about the exploding debt that President Obama has proposed for the next decade. Many of us wonder, what in the world could they be thinking? Do they want to purposely wreck the US economy? Frankly, I'm beginning to think so, as I will discuss later on.

Here is a snapshot of how many liberals on the left think about the perpetual rise in government spending and exploding deficits over the next decade. What follows is an August 23 editorial in the New York Times by liberal commentator Paul Krugman. He boldly attempts to explain why Obama's massive spending and deficits won't be a problem. He is wrong, of course, and I have inserted many bracketed words to help his column be more readable. I will elaborate afterward:

"How big is $9 trillion?

There's been some hysteria [no kidding] about the [Obama] administration's new estimate that the cumulative deficit will be $9 trillion over the next decade. Don't get me wrong: this is bad. But it's being treated as an inconceivable sum, far beyond anything that could possibly be handled. And it isn't. [really?]

What you have to bear in mind is that the economy — and hence the federal tax base — is enormous, too. Right now GDP is around $14 trillion [annually]. If economic growth averages 2.5% a year, which has been the norm, and inflation is 2% a year, which is the target (and which the bond market seems to believe), GDP will be around $22 trillion a decade from now. So we're talking about adding debt that's equal to around 40% of GDP [this figure is bogus - see comments below].

Right now, even if we do run these [trillion dollar annual] deficits, federal debt as a share of GDP will be substantially less than it was at the end of World War II. It will also be substantially less than, say, debt in several European countries in the mid to late 1990s. (There are some technical issues in comparing these various numbers — gross debt versus net (mainly about Social Security) and overall government debt versus federal, but they don't change the basic picture.)

Again, the debt outlook is bad. But we're not looking at something inconceivable, impossible to deal with; we're looking at debt levels that a number of advanced countries, the US included, have had in the past, and dealt with."

Wow! So record trillion dollar deficits don't matter, Mr. Krugman? There are so many ways to debunk this article, I almost don't know where to start. Let's first look at Krugman's most egregious misrepresentation. In the second paragraph, he states that the $9 trillion in new debt will be only 40% of GDP by 2019. What he fails to note is that we already have $11.7 trillion in national debt today. If we add another $9 trillion, the debt will be $20.7 trillion - or 94% of GDP - by 2019!! Nice try, Mr. Krugman.

Second, it's a lame attempt to compare the economy today with the period just after World War II. We had the most robust economic growth in history just after WWII when we were rebuilding Europe, veterans were buying homes, durable goods, cars, etc. as never before and our manufactured goods faced very little foreign competition. May I remind you, Mr. Krugman, that we are not in that position today!

Third, why should we all just assume that the US economy will average 2.5% annual growth over the next 10 years, despite doubling the national debt, just because it is some historical average? As discussed earlier, we will almost certainly see another recession in the next decade, as foreign buyers of our massive debt may require higher interest rates or dump the US dollar.

Do you honestly believe the US economy will grow by 2.5% annually for the next 10 years when consumer spending is stagnant and Americans are increasing savings at the highest rate in over a decade? We've just been through the worst financial crisis since the Great Depression, and we are very likely looking at several years of below-trend economic growth. On top of that, if we spend the $9 trillion, taxes will have to go up on almost all Americans at some point, which is also bad for the economy.

Like your liberal cronies, you make these assumptions and leave out certain facts to justify your belief that bigger government and higher taxes are the answer to all of our problems. Mr. Krugman, take a look at Social Security, Medicare and Medicaid - and more recently President Bush's prescription drug program. Give me one example of how these government-run programs have been anything but a fiscal disaster. You can't.

Finally, Mr. Krugman (in case you happen to read this), let me say that I enjoy reading your columns and watching you on the TV talk shows. You give me insight and understanding as to the thinking of those on the far left.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Do They Want Control Even If It Ruins The Economy?

As noted earlier, I have thought about this question for many years. Why do the liberals want the government to control most everything in the economy and our lives? While members of Congress have the best healthcare in the world, they will have dozens of family members and friends and countless colleagues that will be subject to the House healthcare bill, if it is passed. So why are they so hell-bent on passing it?

The answer can only come down to two questions. Question #1: Do they really believe that their proposed national heathcare program is the very best we can offer the American people? And if so, why doesn't Congress adopt it for themselves? Or Question #2: Is this really just a massive power grab that puts the government in control of our healthcare and our lives?

President Obama would like us to believe that nothing will change if healthcare reform is passed - that if you like your current insurance plan, you can keep it. But that is patently false and abundantly clear if you read the onerous House healthcare bill, or even just the highlights that are readily available on the Internet. If they ram this down our throats, I firmly believe that the quality of our healthcare will suffer and the costs will far exceed any estimates being put forth by President Obama and the Democrats.

At the end of the day, I have to conclude that nationalizing healthcare (one-sixth of the US economy) is nothing more than a giant power grab by the liberals. In addition, if our government racks up $10+ trillion in cumulative deficits over the next 10 years, as Obama proposes, we are on our way to financial ruin.

Bill Clinton never scared me; he was too much of a political animal to swerve too far from the center. Unfortunately, the same could be said of George W. Bush, who routinely strayed from his supposedly conservative principles. Not so with President Obama. Sadly, many of those who voted for him did not do their homework or they would have known that he is a left-wing ideologue, as I warned in these pages last year.

Sorry to end on such a negative note, but it is what it is.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Federal deficits to bankrupt America
http://washingtontimes.com/news/2009/sep/04/looking-behind-the-curtain/

ObamaCare's Crippling Deficits
http://online.wsj.com/article/SB10001424052970203585004574393110640864526.html

Massachusetts & the ObamaCare Mistake
http://www.realclearpolitics.com/articles/2009/09/05/obamacare_increases_costs_wait_times_98176.html

Obama Cannot Escape Hard Choices in September
http://www.realclearpolitics.com/articles/2009/09/07/obama_cannot_escape_hard_choices_in_september_98192.html

When Does the Spending Charade End?
http://www.ibdeditorial.com/IBDArticles.aspx?id=336955542241664

Stocks push the currencies higher...

ChuckButler — Thu, 20 Aug 2009 15:16:53 GMT

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In This Issue..

* Stocks push the currencies higher...
* Norway pulls out of recession...
* Jackson Hole boondoggle...
* Oil helps rally commodity currencies...

And Now... Today's Pfennig!

Stocks push the currencies higher...

Good day... We had more rain here last night, but the storms have cooled things off and it is starting to feel a bit like fall around here. Chuck flies off to San Francisco today to speak at the Money Show, so I will be bringing you the Pfennig for the next few days. The dollar has rallied just a bit overnight, clawing back some of the losses which occurred mid morning yesterday.

And what, you might asked, caused the dollar to rally yesterday? You can re-read a bit of yesterday's Pfennig for the answer: "The data cupboard has been emptied out and is looking to get restocked today... So the only thing besides sentiment moving the markets today will be the direction of stocks..." Yes, Chuck was right on in predicting what would drive the currency markets yesterday, as the dollar got sold off as stocks moved higher.

Without any data to push the markets one way or another, investors began moving back into riskier assets, selling their 'safe haven' US treasury holdings. The currency markets have been trading on the risk theme lately, and don't seem ready to break this pattern anytime soon. Risk appetite is the main driver of the currency markets, with the dollar gaining with investor worries, and falling back down as investors feel more confident.

I spoke at an investment conference last week in Chicago, and listened to several good presentations on the current state of the economy. While every speaker had differing opinions on how to invest during the next few months, they all seemed to agree on one thing; the recent rally and 'recovery' would reverse, and the US will likely head back into another downturn. The timing of this next downturn is hard to pin down, but most believe we will see the US economy falter again toward the first quarter of 2010. If and when this occurs, the dollar could see a temporary rally as investors flee back into US treasuries. But longer term, everyone at the conference was in agreement with what Warren Buffet said in his op-ed piece yesterday: the US$ will ultimately lose value.

Speaking of Buffet, I re-read his op-ed last night during dinner, and had to laugh a bit as much of what he wrote could have been taken directly from the presentation I gave last week. The following lines were especially poignant, so I decided to include them in the Pfennig:

"An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money. Let's look at the prospects for each individually - and in combination.

The current account deficit - dollars that we force-feed to the rest of the world and that must then be invested - will be $400 billion or so this year. Assume, in a relatively benign scenario, that all of this is directed by the recipients - China leads the list - to purchases of United States debt. Never mind that this all-Treasuries allocation is no sure thing: some countries may decide that purchasing American stocks, real estate or entire companies makes more sense than soaking up dollar-denominated bonds. Rumblings to that effect have recently increased.

Then take the second element of the scenario - borrowing from our own citizens. Assume that Americans save $500 billion, far above what they've saved recently but perhaps consistent with the changing national mood. Finally, assume that these citizens opt to put all their savings into United States Treasuries (partly through intermediaries like banks).

Even with these heroic assumptions, the Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing. Washington's printing presses will need to work overtime.

Slowing them down will require extraordinary political will. With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can't come close to bridging that sort of gap."

This is what we have been preaching over the past several years, that the deficits, if unchecked, will ultimately lead the government to put the printing presses in overdrive, and we will attempt to inflate our way out of debt. This will cause the value of the US$ to drop. Buffet ended his piece with the following line: "Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar's destiny lies with Congress."

Sorry to spend so much time on Warren Buffet, I know he isn't the most popular guy with many Pfennig readers. But you can't deny that he has been an extremely successful investor, and the piece he wrote for the NY Times was just right on in my opinion.

Lets get back to the currency markets. Good news helped propel the Norwegian krone higher overnight. Norway's economy grew last quarter, pushing the worlds fifth largest oil exporter out of recession. Norway's mainland economy (ex oil and gas) was able to grow .3% during the second quarter. Economists had predicted Norway's economy would contract by the same margin. The overall economy still contracted, as oil revenues declined, but the recent move higher in crude should help keep Norway on the growth path in the second half of 2009. Petroleum exports make up a quarter of Norway's output, so a global recovery is definitely good news for Norway. This currency, which was called the safest in the world by the NY Times, should be part of every investors portfolio.

The UK economy is doing quite as well as Norway's, as Britain reported a record $13.2 billion budget deficit in July. This is the largest deficit reported for July since records began. Quarterly tax payments usually boost the revenues in July, but the recession has taken its toll on tax revenue, and unemployment benefits are pushing outlays higher. The UK is predicted to have the biggest deficit in the G20 next year according to the IMF. The pound sterling was the largest loser vs. the US$ on the back of this reported deficit.

Minutes of the BOE's August 6 meeting were released yesterday, and it showed BOE Governor Mervyn King pushed for an even looser monetary policy. King pushed to expand the 'quantitative easing' which the BOE began in March. The pound lost more ground after the release of the report, as investors lost faith in King as an inflation fighter.

Chuck sent me this note last night and wanted me to include it in today's Pfennig:

"I forgot all about the fact that this is that time of year again when Central bankers and economists from around the world have a boondoggle at Jackson Hole Wyoming... You might recall that last year they all hunkered down and tried to think of ways to keep the financial mess forum worsening, only to have Lehman Brothers collapse a few weeks later!

Well... I'm sure we're going to hear a lot of rhetoric about the "recession coming to an end"... but they have it all wrong! this isn't a recession it's a depression...

With pockets of risk remaining, such as the collapsing U.S. commercial real estate market, and the double digit unemployment rate... I would think that these guys who missed seeing the subprime meltdown coming and then when it was presented to them, told us it wouldn't filter out into the economy... should just keep their opinions to themselves and read newsletters like The Pfennig and The Currency Capitalist, and the Daily Reckoning, and the 5-minute Forecast... OK I've had my say, thank you for letting me vent! Have a nice day!"

Yes, the 'top' economic minds (minus Chuck) will be meeting in Jackson Hole and Ben Bernanke will undoubtedly trumpet the fact that data shows the US economy is starting to pull out of its recession. This morning we will get the index of US leading economic indicators which is projected to show a move up in July; the fourth consecutive positive monthly move. The weekly jobless claims are also expected to be a bit positive, with a fall to 550k from last weeks 558k. But the jobless rate is still projected to reach double digits (the real number has been in double digits for a while!) and housing will continue to be a drag on the economy.

The administration will also announce the US deficit for 2009 will be slightly less than what was forecast in May. Yes, our government's deficit will total just $1.58 trillion, about $262 billion less than the previous estimate. But the change isn't due to increased revenues, it is mainly due to the administration's scrapping of a $250 billion contingency plan to aid the financial industry. With the recent signs that the economy is starting to pull out of recession, the Obama administration decided it no longer needed to hold the quarter trillion dollars in reserve to meet predicted bank failures. But I would still be a bit worried if I were the administration, as there will likely be a few more 'big' bank failures down the road. Personal bankruptcies continue to climb, and as Chuck pointed out above, the commercial real estate market still has a few 'surprises' in store for the economy.

Even after this adjustment, the deficit figure would amount to 11.2% of the GDP, the largest share since 1945 when we were paying for WWII. And unfortunately, with growing outlays for Social Security, and interest on the debt eating up a larger overall percentage, the deficits won't be shrinking in the near future.

A jump in oil prices and a reversal of risk aversion caused the South African rand, Mexican peso, and Australian dollar to rally. South Africa led all currencies vs. the US$ overnight, with a .54% appreciation. Mexico's peso rose for a second day as oil moved back above $72 per barrel. Oil revenue funded 38 percent of the Mexican government's budget last year, so the peso is somewhat linked to the price of crude. The jump in oil also helped the Canadian dollar reverse earlier losses.

The Australian dollar rallied as risk investors moved back into higher yielding currencies, and good news in the Asian stock markets continued the rally. The Aussie dollar also benefitted from the rally in oil, Australia's fourth most valuable raw material export. The Aussie dollar is one of the best performers over the past 3 months, with only the New Zealand dollar and Brazilian real out performing it vs. the US$.

Currencies today 8/20/09: A$ .8289, kiwi .6731, C$ .9105, euro 1.4219, sterling 1.6461, Swiss .9376, rand 7.9792, krone 6.055, SEK 7.1810, forint 191.02, zloty 2.9211, koruna 18.009, yen 94.15, sing 1.4477, HKD 7.7508, INR 48.695, China 6.8318, pesos 12.8717, BRL 1.8415, dollar index 78.62, Oil $71.92, 10-year 3.47%, Silver $14.01, and Gold... $943.27

That's it for today... I know Chuck already mentioned it, but Happy Birthday to Chuck's daughter Dawn and Christine's little buddy Jamieson!! Both are celebrating big milestones; Dawn is 30 and Jamieson is 5. The Cardinal's ownership is getting St. Louis pumped up about fall as they continue to set the team up for a nice run into the post season. The Cards signed veteran pitcher John Smoltz yesterday which made our #2 trader Jennifer extremely happy (she is a huge Smoltz fan). It sure looks like the Cardinals will be the ones to beat in the NL with the addition of another strong arm to our rotation. Christine just came in with the breakfast sandwiches, so I gotta get this out the door. Hope everyone has a Tub Thumpin Thursday!!

Chris Gaffney, CFA
Vice President
EverBank World Markets
1-800-926-4922
1-314-647-3837

You can't keep a good market down

steven j cook — Thu, 20 Aug 2009 13:29:00 GMT

Economics

   This Week’s Data

    Weekly mortgage applications rose 3.8%, the third increase in as many weeks.

    Weekly jobless claims were up slightly versus expectations that they would be down slightly (this article is short in length):
    http://www.calculatedriskblog.com/2009/08/weekly-unemployment-claims-increase_20.html

   Other

    A look at the decline (or lack thereof) in US manufacturing (short):
    http://www.cato-at-liberty.org/2009/08/13/harold-meyerson-is-part-of-the-problem/

    The climate bill’s cost in jobs (short/medium):
    http://thehill.com/business--lobby/climate-bill-could-cost-2-million-jobs-2009-08-12.html

    Barry Ridholtz always has an interesting perspective on key issues. Here is his take on the inflation versus deflation argument (short & charts):
    http://www.ritholtz.com/blog/2009/08/deflation-or-inflation/

    A thoughtful argument for why the recession isn’t over (short/medium):
    http://www.ritholtz.com/blog/2009/08/is-the-recession-really-over/

    Concern about China’s stimulus (short):
    http://ftalphaville.ft.com/blog/2009/08/19/67636/chinas-fiscal-stimulus-fading-fast/

    Greg Mankiw on the shape of the recovery (short):
    http://gregmankiw.blogspot.com/2009/08/blanchard-on-outlook.html

    Bank of England suggests recession is over (short):
    http://www.calculatedriskblog.com/2009/08/uk-bofe-forecasts-suggests-recession-is.html

    The latest on commercial real estate values (short):
    http://www.calculatedriskblog.com/2009/08/moodys-cre-prices-off-36-percent-from.html

Politics

Domestic

If you missed Warren Buffett’s editorial in the WSJ on monetary/fiscal policy (medium):
http://www.nytimes.com/2009/08/19/opinion/19buffett.html?_r=2&pagewanted=1&ref=opinion

Ann Coulter on healthcare (ignore the sarcasm [unless you like her humor]; but she makes great points) (medium):
http://www.anncoulter.com/

    Thoughts on healthcare from a slightly different angle (medium):
    http://article.nationalreview.com/?q=NTBmOTNmZjYzNzU3NTIwMWE2ZjYyZTU2Nzg2YjM2OWQ=

    This is your congress in action--threatening business to get its way (must read):
    http://voices.washingtonpost.com/capitol-briefing/2009/08/democrats_increase_pressure_on.html?hpid=topnews

    And this is your righteously transparent administration (short/medium):
    http://www.politico.com/news/stories/0809/26240.html

    And these guys claim that they can run 1/6th of the US economy (healthcare) more efficiently (short):
    http://cafehayek.com/2009/08/ious-for-suckers.html

International War Against Radical Islam

The Market

    Technical

    The Averages (DJIA 9279, S&P 996) closed within the up trend off their March lows (8696-10456, 953-1180). Stock prices dropped at the open and I just knew that we were going to get our chance to nibble. Not to be. Buyers stepped in again and we finished with another up day. Volume remains low; but the VIX, following a one day spike above its down trend off its October 2008 high, is now back below that boundary.

    Meanwhile, the lower boundary of the March to present up trend continues its inexorable rise. Risk/reward (assuming the current up trend is dominant) is now 43 points down and 184 points up--suggesting that the patience I so sagely counseled yesterday is nearing a point of diminishing returns.

   Fundamental

    More evidence on why you shouldn’t listen to the experts (short):
    http://bespokeinvest.typepad.com/bespoke/2009/08/strategists-follow-the-market-higher.html

      Headlines

    Almost no economic news yesterday; and except for more awkward bumbling on healthcare by the administration, the politicians were thankfully mute. Investors’ focus was initially on another bad performance over night in the Chinese stock market; and that got our own Market headed down. But as noted above, investors seemingly decided that a lower Chinese market wasn’t that bad and US stock prices reversed up and never looked back. Later in the morning, oil inventories were reported to have experienced their largest decline in six months and that added fuel to the fire (pardon the pun).

Is The Recession Over? Don't Bet On It

GaryHalbert — Tue, 18 Aug 2009 22:12:00 GMT

IN THIS ISSUE:

Economic Signs of Improvement
Fed Vows to Keep Rates Low
Market Comments from John P. Hussman, Ph.D.
Conclusions

Introduction

We have seen some encouraging economic news in recent weeks, and President Obama and his cronies in the mainstream media have declared that the worst recession in post-war history is all but over. The advance estimate of 2Q GDP was down considerably less than expected (-1.0%); the unemployment rate actually fell slightly in July to 9.4%; and the ISM manufacturing index posted a nice improvement last month.

While these reports were better than expected, and continue to suggest that the worst of the recession is behind us (as I have suggested often in recent weeks), this economy is far from out of the woods yet. Growth prospects continue to look muted, although a growing number of forecasters are suggesting that GDP will register a positive number in the 3Q due largely to the rebuilding of inventories, as I discussed in my August 4 E-Letter.

This week, we will look at the latest economic reports, as well as the Federal Reserve's latest decision on interest rates and purchases of Treasury securities. Also, the Fed says it will end its record large purchases of government agency debt in October. If indeed this happens, it will be the first step in ending the Fed's massive stimulus spending.

Next, so that we don't all get caught up in the latest hype that the recession is over, I will reprint excerpts from a recent Weekly Market Comment written by John P. Hussman, Ph.D. Dr. Hussman is best known as the president of Hussman Investment Trust, and he manages the Hussman Strategic Growth and Hussman Strategic Total Return Funds, which are actively managed and can go to cash in bear markets.

Dr. Hussman's latest analysis is consistent with the view many of us have that the recession, while improving in some areas, is not over yet, and that the ensuing economic recovery over the next year or longer will be disappointing -- even if there is a bump up in the 3Q. All of this should make for interesting reading, so let's get started.

Economic Signs of Improvement

Over the last several weeks, we've seen some encouraging economic reports. In some cases, "encouraging" simply means that the reports weren't as negative as expected. That was certainly the case with the advance 2Q GDP estimate at the end of June, which showed a decline of only 1% (annual rate) versus pre-report estimates which were considerably worse. Some analysts expect that number to be revised downward somewhat when the second estimate is released later this month.

On the manufacturing front, the ISM Index rose more than expected in July to 48.9, up from 44.8 a month earlier. Industrial production rose 0.5% in July, and construction spending and the factory operating rate both rose modestly last month as well. These are all signs that the recession may be leveling out.

On Thursday of this week, we get the latest Index of Leading Economic Indicators (LEI) for July, and the pre-report consensus is for a rise of 0.6%, following +0.7% in June. If the LEI is up for July, that will mean the fourth consecutive monthly increase. That would be very encouraging and a sign that we will likely be out of this recession by the end of the year.

The US unemployment rate unexpectedly dropped from 9.5% in June to 9.4% in July, as employers slashed 247,000 jobs, the slowest rate of decline in nearly a year. This news temporarily sent stocks to their highest level of the year since the pre-report consensus was for a rise to 9.6%

However, the July decline in the jobless rate came about not because more people had jobs, but because almost 800,000 "discouraged workers" - people who have essentially given up on looking for a job - were not counted as unemployed, thereby allowing the official unemployment rate to fall modestly in the latest jobs report. The number of long-term unemployed people - those who have been out of a job but looking for more than 26 weeks - rose by another 584,000. Thus, it appears we are still headed for 10% employment before this cycle reverses.

Despite the still troubled employment situation, investors welcomed the reports above, and more and more forecasters have apparently decided that the recession is over. I continue to believe that we are still at least a few months from concluding that the recession has ended. The Consumer Confidence Index fell for the second month in a row in July, and retails sales were down slightly last month. Therefore, it is premature to declare that the recession is over.

Fed Vows to Keep Rates Low

To no one's surprise, the Federal Open Market Committee (FOMC) announced last Wednesday that it will continue its policy of keeping interest rates at their historically low levels. The FOMC also maintained its position that interest rates could remain historically low for an "extended period of time." In other words, the floodgates of liquidity are still wide open.

About the only new revelation was that the Fed announced that it will stop buying long-term Treasuries in October of this year. This could be the ultimate case of good news/bad news, in that it's good that the Fed may no longer be printing money to buy Treasuries, but bad in that these securities will soon have to compete in the open market, and this could lead to higher interest rates. Remember that this is why the Fed committed to start buying Treasuries in the first place.

However, the Fed's printing press will not be idle as it said it will continue to purchase up to $1.25 trillion in agency mortgage-backed securities and other agency debt from Fannie Mae and Freddie Mac. The Fed's hope here is to keep a lid on mortgage rates in an effort to stimulate the housing market.

From an economic standpoint, the latest FOMC statement notes that US economic activity is "leveling out," meaning that the rate of descent has slowed. However, this simply means that the recession may not get deeper. The Fed's prospects for recovery, however, were modest, at best. The Fed expects economic activity to remain weak "for a time" (whatever that means) and a return to sustainable economic growth is likely to be gradual.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Market Comments from John P. Hussman, Ph.D.

Dr. John Hussmanis best known as the president of Hussman Investment Trust (a mutual fund family), and he manages the Hussman Strategic Growth and Hussman Strategic Total Return Funds. Dr. Hussman is also the chairman, president and controlling shareholder of Hussman Econometrics Advisors, Inc. which has published his Weekly Market Comment letters for years, and they always have some interesting points about the economy, the markets, etc.

As a mutual fund manager, Dr. Hussman is somewhat unique in that he not only actively seeks the best opportunities in the stock market, but will also move to neutral positions in his funds during market downturns. In other words, the investment strategies he employs are similar to those used by the active money managers my firm recommends.

The following excerpts are from Dr. Hussman's August 10, 2009 Weekly Market Comment. [Note that we have removed discussions about specific funds where possible.] Pay particular attention to Dr. Hussman's outlook for the economy.

QUOTE:

The U.S. economy lost a quarter of a million jobs in July. Meanwhile, over 400,000 workers abandoned the labor force (and are therefore no longer counted among the unemployed), which prompted a slight decline in the unemployment rate despite the job losses. In the context of an economy still strained by high levels of consumer debt and still record delinquency and foreclosure rates, labor market conditions are still troublesome. Still, the pace of job losses and new unemployment claims has clearly softened from the pace we observed early in the year.

If we knew that this was a standard economic downturn, we might conclude that the recent improvements are durable. However, nothing convinces us that this is a standard economic downturn. As for market action, the major indices have generally been strong, as has breadth (as measured by advances versus declines), but the "investor sponsorship" evident from trading volume has been uncharacteristically dismal compared with initial advances of past bull markets. So here too, we have very strong concerns that the recent advance may not be as durable as investors appear to believe.

All of that said, we aren't inclined to fight even what we view as errant analysis, and the Strategic Growth Fund has about 1% of assets allocated to near-the-money index call options -- about enough to gradually close down about 40% of our hedge in the event that the market advances markedly higher from here, but without putting us at risk of much loss in the event of failure. With investors now anticipating and pricing in a sustained economic recovery, as well as a spectacular earnings rebound, a lot of things will have to go right from here in order to sustain higher prices than we currently observe.

Frankly, our call option allocation here is something of a paean to a notion -- a sustained economic recovery and new bull market -- that I have no belief in whatsoever. But at this point, the broad strength in the major indices, even lacking volume sponsorship or favorable valuation, requires that we allow for the possibility of additional investor speculation. Even if we do observe such an outcome, it's difficult to envision that the S&P 500 will clear the 1000 level for all time, without revisiting it again in the months (not to mention years) ahead. To the extent that we don't clear 1000 permanently, establishing investment exposure here with anything but call options amounts to a game of trying to "ride" the market higher and to get out before it returns to or below current levels. With the market strenuously overbought already, that game strikes me as exquisitely difficult to get right. Hence the use of a modest allocation to call options only, without closing our downside hedges.

Call me skeptical. But if you look carefully at the economic data that shows improvement, and correct for the impact of government outlays, it is difficult to find anything but continued deterioration in private demand and investment. What we do see is a government that has run what is now a trillion dollar deficit year-to-date, representing some 7% of GDP. That sort of tab will undoubtedly buy some amount of Cool-Aid, but it has been something of a disappointment to watch how eagerly investors have guzzled it down. It is not at all clear that short-term, deficit-financed improvement necessarily implies sustained growth in the context of a deleveraging cycle. This is like somebody borrowing money from their Uncle and then celebrating that their income has gone up.

Moreover, it might be enticing to look at a chart of the S&P 500 and envision a quick return to 2007 highs and beyond, but it is important to recognize that those highs were based on profit margins about 50% above historical norms, combined with an elevated P/E multiple of about 19 against those earnings. Even if the economy is poised for a sustained recovery here, the belief that those joint outliers will be quickly re-established goes against historical precedent.

In any event, we've got some call option coverage to gradually allow participation if this run continues.

Post-Crash Dynamics

When markets crashes are coupled with changes in the fundamentals that supported the preceding bubble -- as we observed in the post-1929 market, the gold market of the 1980's, and the post-1990 Japanese market, and currently observe in the deflation of the recent debt bubble -- they typically do not recover quickly. Indeed, the hallmark of these post-crash markets is the very extended sideways adjustment that they experience, generally for many years.

The chart below updates the position of the S&P 500 (red line) in the context of other post-crash bubbles. The horizontal axis is measured in months. Note that very strong and extended interim advances have been part and parcel of similar experiences.

The intent here is not to argue that the U.S. stock market must by necessity follow the same extended adjustment that followed prior burst bubbles. Rather, the intent is to underscore that it is dangerous to infer that structural difficulties have vanished simply because a market enjoys a strong post-crash advance.

My friend James Montier at SocGen draws a similar pattern from a larger historical collection of post-crash bubbles - including the above instances, as well as others such as the South Sea Bubble and the Railroad Bubble of the 1840's. The underlying theme is that the adjustment period following the bursting of a bubble tends to be very extended.

I understand the eagerness of investors to put the entire credit crisis behind them and look ahead to a recovery of the prior highs, but these hopes are based on the assumption that a positive boost to GDP, once achieved, will propagate into a full-fledged recovery. Again, however, no economic improvement is evident in the behavior of consumer demand and capital spending, once you adjust for the impact of government spending (particularly transfer payments).

Yes, we have observed a massive reallocation of global resources from savers (who have bought newly issued Treasury debt) toward mismanaged financial institutions that made bad loans. Yes, there are certainly favorable short-run economic numbers that can be achieved by running a year-to-date federal deficit equal to seven percent of the U.S. economy. The problem is that this money does not come from nowhere. We have effectively sold an identical ownership claim on our future production to those individuals and foreign governments who bought the Treasuries. Government "stimulus" is not free money. The continued attempt to bail out bad loans with good resources (largely foreign savings) will end up costing our nation some of our most productive assets, which will be acquired by foreign countries and investors for years to come.

From my perspective, investors have gotten entirely too far ahead of themselves with the assumption of a sustained recovery. Nevertheless, we again have about 1% of assets in index call options to allow for further market strength if it emerges. I expect that if they move "in the money," we will leave their strike prices unchanged unless market internals deteriorate measurably. Leaving our call option strikes fixed would open us up to losing on any subsequent downturn whatever we make on a further advance, but again, our opening exposure is fairly limited. We'll let the market put us into a more constructive position if investors are inclined to continue their exuberance here. [Emphasis added, GDH.]

Market Climate

As of last week, the Market Climate for stocks was characterized by unfavorable valuation and mixed market action, but enough evidence of speculation (reasonable or not) to own about 1% of assets in index call options. We are otherwise hedged.

During earnings season, there are often days where most of the performance of the Fund is driven by significant movement in a small handful of Fund holdings. These movements can be positive or negative, and may cause the Fund to move differently than one would expect that the Fund "should" move based on our investment position, and on what the market did on a particular day. As I've frequently noted, short-term movements, particularly day-to-day, are not effective indicators of the Fund's investment position, or predictors of Fund performance. Performance is always best measured from the peak of one market cycle to the peak of the next, or over an extended period of years representing neither a peak-to-trough nor trough-to-peak movement in the market.

Based on our standard methodology, which considers normalized earnings (not the far more depressed level of current earnings) the S&P 500 is now priced to deliver 10-year total returns in the area of 6.9% annually. This is a figure that has historically been associated with bull market peaks, including 1969 and 1987. In most instances, such valuations turned out badly in reasonably short order. It is, however, true that prospective returns were even worse prior to the 1929 crash, and during the bulk of the period since 1996, so there have been some historical periods where speculators have driven valuations to higher levels, and during these times, it has not been particularly effective to stand in front of speculators saying ‘no, stop, don't.' [Emphasis added, GDH.]

Ultimately, all of those periods where valuations were driven to higher levels were followed by poor long-term returns, with stocks generally trading at lower levels at some point one or more years later. So we can say with a reasonable degree of confidence that even if the present advance continues, investors will most likely observe current levels again either within the current market cycle or (worse) several years out. Overvalued markets simply do not "run away" for good. Still, it can be painful or at least unenjoyable to remain defensive during a speculative advance.

In bonds, the Market Climate last week was characterized by relatively neutral yield levels and moderately unfavorable yield pressures. As usual, we will tend to increase our bond durations on spikes in yield (weakness in bond prices), and these are becoming more interesting -- though not strongly attractive. Our most recent extension of durations was in the 3.9%-4% area for 10-year Treasuries, and a push materially above that level would represent enough of a yield pickup to move a modest amount of short-maturity Treasury allocations into mid-maturities. As I've noted in recent weeks, we don't anticipate much in the way of extended directional movement in the bond market, so most of our portfolio activity will probably tend to be modest reallocations in response to yield fluctuations. At the point where we observe either fresh inflation pressure or general declines in Treasury yields (i.e. general downward pressure on real interest rates), I expect that we'll observe fresh pressure on the U.S. dollar and upward pressure on precious metals shares. For now, those markets are likely to be somewhat range-bound as well.

We've got an extended economic adjustment ahead. Most probably far longer than most investors presently expect. As always, we'll take our opportunities as the evidence emerges, with the objective of outperforming our respective benchmarks over the complete market cycle, and an additional emphasis on defending capital over the course of that cycle. [Emphasis added, GDH.]

END QUOTE

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions

While we have seen some encouraging economic reports over the last few weeks, it is premature to declare that the recession has ended. As discussed above, the unemployment rate is very likely to rise even higher before this cycle is over. Remember that consumer spending is still the main driver of this economy, and retail sales fell slightly in July well below the pre-report consensus. The Consumer Confidence Index fell a second month in a row in July.

On the positive side, the Fed remains committed to keeping interest rates very low for an extended period, and liquidity is plentiful for now. If this Thursday's Leading Economic Indicators report is positive, that will market the fourth consecutive monthly increase, which will be a very good sign that the recession will end by the end of the year.

I agree with Dr. Hussman that stocks are overbought at this point, as many investors who bailed out in February and March are now jumping back in. The stock market has felt like a mini-bubble since the March lows and especially in July. Thus, I would not be surprised to see the downward correction that began last week to continue in the weeks ahead.

Finally, I recently told you about our online webinar featuring the Potomac Guardian Program on August 6th. We had hundreds of investors register for the webinar and it was well-received. If you were unable to attend this webinar but would still like to learn more about the Potomac Guardian Program and its investment strategy, you can now find a recorded version on our Internet website at www.halbertwealth.com.

Wishing you profits in a difficult market,

Gary D. Halbert

SPECIAL ARTICLES

Stocks: Five Key Signals for Investors
http://www.businessweek.com/investor/content/aug2009/pi20090817_099111_page_2.htm

Why Obama's Ratings Are Sinking
http://online.wsj.com/article/SB10001424052970204683204574354383543314054.html

Public Spending's Day Of Reckoning
http://www.forbes.com/2009/08/12/public-spending-finances-economy-debt-opinions-contributors-desmond-lachman.html

Growth in Potential GDP

JohnMauldin — Mon, 17 Aug 2009 16:33:00 GMT

This week I offer you two short pieces for your Outside the Box Reading Pleasure. The first is from my friends at GaveKal and is part of their daily letter. They address the real difference between those who think we will have a consumer led recovery (Keynesian) and those who think we will have a corporate profit led recovery (classical economics or Schumpeterian). This is actually a very important debate and distinction. I find that GaveKal pushes me to think almost more than any other group, as they constantly challenge my assumptions. (www.gavekal.com)

The second piece comes from Dr. John Hussman of Hussman Funds (www.hussmanfunds.com). He offers us some very insightful analysis on the potential for growth going forward, which goes along with what I have been writing: We are in for a longer period of below trend growth, which does not bode well for corporate profits in the long run. I think you will get a lot out of these two items.

John Mauldin, Editor
Outside the Box

Daily Observations from GaveKal

We are hearing concerns, from some clients and friends, that the brutal corporate cost-cutting seen in the wake of the subprime crisis will delay the recovery, because this trend is killing the US consumer. In other words, how can one spend if he has lost his job or fears as much, or has seen his work hours drastically reduced, taken a pay cut, or expects his company pension system is about to implode? For us, this all boils down to a crucial question: do we need consumption to pick up in order to achieve a rebound in growth? The answer to this question very much depends on whether one accepts a Keynesian view of the economic process, or a Schumpeterian (or classical) view. We hope our readers forgive us, but we are now going to have to get a tad theoretical....

* In a Keynesian view, consumption is the motor of growth. If companies slash their payrolls, consumption contracts and we enter into a vicious cycle in which the subsequent decline in demand leads to a second wave of cuts, which then leads to a further decline in consumption, and so on and so forth. The Keynesian cycle may have been useful from 1945 to 1990, but in the past 20 years, globalization and just-in-time technologies have changed the nature of corporate management, which is why we believe a classical, capital-spending led view of the economic cycle will reassert itself.

* In a classical view, as exemplified by "Say's law" and reinforced by Schumpeter, corporate profitability is the cause, not the consequence, of economic growth. Thus, Schumpeter would see the current cycle as the destruction phase in the creative-destruction processes that propel the economic cycle. Capital and labor are currently moving from the sectors in decline (e.g., McMansions) to the sectors in expansion (e.g., tech, alternative-energy infrastructure, etc.). Once momentum in the growth sectors overwhelm the decaying ones, then macro growth resumes. Under this framework, consumption kicks in at the end of the cycle (for more on this, see the very first paper published by GaveKal, Theoretical Framework for the Analysis of a Deflationary Book).

Within our firm, Charles is the major proponent of the Schumpeterian view, and this thinking was apparent in his and Steve's recent ad hoc, A V-Shaped Recovery in Profits. Due to the quick reflexes that new technologies allow, corporates are managing their cash flow better than ever. Rarely ever, for instance, have companies (ex-financials) remained in such strong positions during a recession, which is yet another reason why we believe that capital spending, rather than consumption, will spark the recovery.

Indeed, the scale at which corporates have been able to cut costs and return to profitability, has laid the groundwork for a deflationary boom of epic proportions (which would be a major surprise for those who fear an easy-money inflationary nightmare). Of course, there is a major threat to this deflationary-boom scenario-and that is the increased government intervention we are seeing in most corners of the world. If government intervention manages to kill off return on investment capital, as it did in the 1930s, then the current opportunity will go up in smoke. Regular readers know we tend to err on the side of optimism; at this point we still hold out hope that a major lurch to a big-government era can be resisted-as exemplified, for example, by the unexpectedly strong fight we are seeing against the health-care bill, or the ability of so many US financials to pay back their debt to the US Treasury, thus lowering the extent of government influence on their business decisions. Thus, in our view, a period of deflationary boom is the likeliest scenario, and investors should focus on sectors and countries that will see the largest resurgence in capital spending.

Growth in "Potential GDP" Shows Limited Potential

By John P. Hussman, Ph.D.

Historically, two factors have made important contributions to stock market returns in the years following U.S. recessions. One of these that we review frequently is valuation. Very simply, depressed valuations have historically been predictably followed by above-average total returns over the following 7-10 year period (though not necessarily over very short periods of time), while elevated valuations have been predictably followed by below-average total returns.

Thus, when we look at the dividend yield of the S&P 500 at the end of U.S. recessions since 1940, we find that the average yield has been about 4.25% (the yield at the market's low was invariably even higher). Presently, the dividend yield on the S&P 500 is about half that, at 2.14%, placing the S&P 500 price/dividend ratio at about double the level that is normally seen at the end of U.S. recessions (even presuming the recession is in fact ending, of which I remain doubtful). At the March low, the yield on the S&P 500 didn't even crack 3.65%. Similarly, the price-to-revenue ratio on the S&P 500 at the end of recessions has been about 40% lower than it is today, and has been lower still at the actual bear market trough. The same is true of valuations in relation to normalized earnings, even though the market looked reasonably cheap in March based on the ratio of the S&P 500 to 2007 peak earnings (which were driven by profit margins about 50% above the historical norm).

Stocks are currently overvalued, which – if the recession is indeed over – makes the present situation an outlier. Unfortunately, since valuations and subsequent returns go hand in hand, the likelihood is that the probable returns over the coming years will also be a disappointingly low outlier. In short, we should not assume, even if the recession is ending, that above average multi-year returns will follow.

That conclusion is also supported by another driver of market returns in the years following U.S. recessions: prospective GDP growth. Every quarter, the U.S. Department of Commerce releases an estimate of what is known as "potential GDP," as well as estimates of future potential GDP for the decade ahead. These estimates are based on the U.S. capital stock, projected labor force growth, population trends, productivity, and other variables. As the Commerce Department notes, potential GDP isn't a ceiling on output, but is instead a measure of maximum sustainable output.

The comparison between actual and potential GDP is frequently referred to as the "output gap." Generally, U.S. recessions have created a significant output gap, as the recent one has done. Combined with demographic factors like strong expected labor force growth, this output gap has resulted in above-average real GDP growth in the years following the recession.

The chart below shows the 10-year growth rates in actual and potential GDP since 1949 (the first year that data are available).

The blue line presents actual growth in real U.S. GDP in the decade following each point in time. This line ends a decade ago for obvious reasons. The red line presents the 10-year projected growth of "potential" real GDP. This line is much smoother, because the measure of potential GDP is not concerned with fluctuations in economic growth, only the amount of output that the economy is capable of producing at relatively full utilization of resources.

One of the things to notice immediately is that because of demographics and other factors, projected 10-year growth in potential GDP has never been lower. This is not based on credit conditions or other prevailing concerns related to the recent economic downturn. Rather, it is a structural feature of the U.S. economy here, and has important implications for the sort of economic growth we should expect in the decade ahead.

The green line is something of a hybrid of the two data series. Here, I've calculated the 10-year GDP growth that would result if the current level of GDP at any given time was to grow to the level of potential GDP projected for the following decade. This line takes the "output gap" into effect, since a depressed current level of GDP requires greater subsequent growth to achieve future potential GDP. Notice here that even given the decline we saw in GDP last year, the likely growth in GDP over the coming decade is well under 3% annually - a level that we have typically seen in periods of tight capacity (that were predictably followed by sub-par subsequent economic growth), not at the beginning stages of a recovery.

The situation is clearly better than it was at the 2007 economic peak, where probable 10-year economic growth dropped to the lowest level in the recorded data, but again, the likely growth rate is still below 3% annually over the next decade even given the economic slack we observe.

Aside from a gradual recovery of the "output gap" created by the current downturn, there is no structural reason to expect economic growth to be a major driver of investment returns in the years ahead. With valuations now elevated above historical norms, there is no reason to expect strong total returns on an investment basis either.

The primary element that is favorable at present is speculation – excitement over the prospect that the recession is over. Investors are presently anticipating the good things that have historically accompanied the end of recessions (strong investment returns and sustained economic growth), without having in hand the factors that have made those things possible (excellent valuations and a large output gap coupled with strong structural growth in potential GDP).

The Statistical Recovery, Part 2

JohnMauldin — Sat, 15 Aug 2009 00:49:00 GMT

The Statistical Recovery, Part Two
A Recovery Statisticians Can Love
A Few Thoughts on the Housing Market
Some Thoughts from Maine
Tulsa, Birthdays, Weddings, and Paul McCartney

A few weeks ago I first used the term "statistical recovery" to describe the nature of today's economic environment. Today we are going to further explore that concept, as it is important to have a real understanding of what is happening. This coming "recovery" is not going to feel like a typical one, and those expecting a "V"-shaped recovery are simply making projections from previous economic recoveries, which, based on the fundamentals, are not warranted. And of course, a few thoughts coming back from Maine are in order. There is a lot to cover, and this may take more than one letter.

But first, let me note to subscribers to Conversations with John Mauldin that we have posted my Conversation with George Friedman of Stratfor and will soon post a very interesting Conversation I had with John Burns (of John Burns Real Estate Consulting) and Rick Sharga of RealtyTrac. These may be the two most knowledgeable people on the housing market in the country. There is a lot of poorly informed speculation about the housing market, and I think this Conversation will help clear away a lot of the fog. PLUS, they both agreed to allow me to post their eye-opening PowerPoint stacks to Conversation subscribers (normally only available to their clients), so you get a very special bonus. And finally, David Galland of Casey Research is allowing me to post a most thought-provoking interview he did with Neil Howe. This is one of the best things I have run across in a long time. I do work on giving my Conversations subscribers good value.

George and I are going to be doing a regular quarterly Conversation called Geopolitical Conversations with John Mauldin and George Friedman. We believe that these new Conversations will help you better understand not only the global political landscape but also how it affects the financial umbrella that we are under. In this first Conversation, we talked about the "exogenous" risks to the markets (those from outside the markets themselves) posed by the geopolitical world.

We will offer this service, which will be priced separately, at some point in the near future. Now, here is the important part: all current subscribers and anyone who subscribes now will receive these Geopolitical Conversations free, as a thank you. (Current members can log in now.) If you have not yet subscribed, you can do so and receive a discount by clicking the link and typing in the code JM47 to subscribe for $149. This is a large discount from our regular price of $199; plus, we are including the bonus Geopolitical Conversations that are worth $59. And now, to the regular letter.

The Statistical Recovery

The unemployment numbers came out last Friday, and Steve Liesman of CNBC did several interviews live from Leen's Lodge in Maine. I postponed an hour of fishing to be on air with Martin Barnes (of the Bank Credit Analyst) to comment on the numbers. Everyone seemed quite excited that the US lost "only" 247,000 jobs. However, it is still almost twice as large as a year ago, and at that time 128,000 lost jobs seemed pretty bleak. However, comparing it to the average of 692,000 lost jobs per month in the first quarter, those looking for good news immediately started talking about how a recovery is around the corner.

The unemployment numbers are some of the most seriously revised numbers in all of government data. The first monthly estimate is notoriously imprecise. Why people make investment decisions based on this release is beyond me. As I mention continuously, because of seasonal adjustment factors, the unemployment numbers understate job losses in a recession and also understate job gains in a recovery. About the most we can get from the current data is the broad trend. Admittedly, the trend is getting better, but we are still in a hole and no one has stopped digging.

What we can see is that we are down 6.7 million jobs since the beginning of 2008! We have roughly eliminated the job growth of the last five years. And that does not take into account the 150,000 new jobs that are needed each month just to maintain the employment rate because of the increase in population. It took 55 months once the 2001 recession was officially over to get back to the previous employment peak. That is 4.5 years, gentle reader, and we are further down now and faced with massive deleveraging. It is going to take a lot longer this time. Let's look at some of the reasons why.

I took a different tack in the CNBC interview. I pointed out that even though it is possible (likely?) we will see a positive number for GDP for the third quarter, it is not going to feel like a recovery for quite some time.

By the middle of next year (2010), when I think we will finally hit an unemployment bottom, we will be down close to 8 million jobs, wiping out all the jobs created since the middle of 2004. Unemployment is likely to be more than 10%, unless they keep playing games with the number.

A Recovery Statisticians Can Love

What I mean by that remark is that the unemployment number went down even though we lost 247,000 jobs. How can that be, you ask? Well, the government assumes that if you were not looking for a job within the last month, then you are not unemployed; therefore, on a statistical basis the number of people unemployed went down by 400,000. (There are 2.3 million such discouraged workers.) More in a minute on the problem that will cause down the road.

Assume that we will need 9 million jobs over the next five years (150, 000 jobs a month for 60 months) and add the 8 million lost jobs. That means we have to add 17 million jobs in the next five years to get back to the 4.5% unemployment of 2007, let alone the under-4% we saw in 2000.

That means we need to grow employment by about 12% over the next five years. But it's worse than that. What is known as U-6 unemployment is over 16%. There are another approximately 8.8 million people who are either working part-time but want full-time jobs or are among the 2.3 million discouraged workers as mentioned above.

(The definition of U-6 unemployment from the BLS web site: "Marginally attached workers are persons who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the recent past. Discouraged workers, a subset of the marginally attached, have given a job-market related reason for not looking currently for a job. Persons employed part time for economic reasons are those who want and are available for full-time work but have had to settle for a part-time schedule." http://www.bls.gov/news.release/empsit.t12.htm.)

Let's make the assumption that the part-time workers want to go to full-time (which they say they do). Typically employers will increase the hours of part-time employees before adding new workers. That will be a major drag on potential job growth. It is the equivalent of creating at least 4 million jobs, except that no new jobs are created. Plus, those who want jobs but are not looking will come back into the market if jobs are available. That adds another 2 million. Now we are seeing the need for 23 million new jobs in five years, to get back to the "Old Normal."

That is an increase of 15% total employment from today's levels over the next five years. That type of jobs growth will only happen with significant economic growth. Normally, you should expect the economy to rebound to at least 3% trend GDP growth. That is what has happened historically. But we are not in the Old Normal. We are entering the era of the New Normal, where looking back at historical trends will prove to be misleading at best.

On average, and VERY roughly, you would think you would need a minimum of 15% real GDP growth over five years to get us back to what we think of as acceptable levels of unemployment. Actually you would need more, as productivity growth lessens the need for more workers. Oh, and add in the Boomer-generation workers who are not going to retire because they now cannot afford to.

(I think we will be lucky to have 10% real GDP growth in the next five years, for a host of structural reasons that we will be going into below and over the next few weeks.)

Unemployment will be rising for at least another two quarters and probably through the middle of next year. That should not surprise us too much, as unemployment kept rising for almost two years after the last recession, which many dubbed "the jobless recovery." The recession ended in 2001, but as the graph below shows, the unemployment rate rose until the middle of 2003.

We may have a "statistical recovery." The numbers may be positive for a variety of reasons only a statistician could love, but it is not going to feel like a recovery to the rest of us. Maybe that is why consumer confidence took another hit today, dropping to its lowest level since March, helping to drive the market down.

The economists at economy.com, who normally have a bullish tinge to their writing, said it succinctly: "Confidence will struggle to gain ground in the months to come, as consumer budgets remain stretched. Little wage income, prospects for reduced bonus payments, reduced access to credit, and no capital gains are all constraining consumers' ability to meet their financial needs and recover from the sharp drops in wealth they have experienced. Many consumers are struggling to pay their debts. Supports are coming from reduced layoffs, equity market gains, and stimulus such as the cash for clunkers program, but that is proving inadequate to lift spirits so far. It will likely be some time before conditions turn enough for confidence to improve decisively. Key drivers of confidence include developments in the labor and housing markets and the path of energy and equity prices."

(My friend Bill Bonner described the Statistical Recovery as being just like a female impersonator. He is just like a real woman in every way, except for the essential ones.)

The consumer's sense of discomfort is shared in executive suites across the country. "Chief Executive Magazine's CEO Index, the nation's only monthly CEO Index, dropped to 63 in July, after showing gradual improvement. All components of the index are down, with Employment Confidence taking the largest hit...

"What's worse is that pessimism over employment is reaching new heights. The Employment Confidence Index declined 25 percent with 57 percent of CEOs expecting continued decrease in employment next quarter. Over 95 percent rate the current employment environment as bad—the highest level for 2009. Less than 5 percent think employment conditions are normal and virtually no one (0.4 percent) thinks they are good." (The Bill King Report)

A Few Thoughts on the Housing Market

Bill also sent me a link to a very interesting survey of the real estate market. Those in the real estate business will find this of value, although it makes for grim reading. (http://www.campbellsurveys.com/AgentSummaryReports/AgentSurveyReportSummary-June2009.pdf)

Three (of the sixteen) of their summary bullet points stood out:

The market for home purchases can be divided into segments of 26% for damaged REO, 23% for move-in ready REO, 14% for short sales, and [only!] 36% for non-distressed properties. [REO means "real estate owned," typically by a bank as a result of a foreclosure.]
43% of homebuyers are first-time homebuyers, 29% are current homeowners (relocation or retirement homes), and another 29% are investors.
Only 31% of non-REO home sale listings are unforced or optional; other major reasons for listings include financial stress (including short sales), long distance relocation, and divorce or estate sales.

Think about that for a minute. Two-thirds of home sales are either foreclosures or banks taking a loss on the mortgage. Of the remaining 36%, only 10% are as a result of something we could call a normal selling process. And that is nationwide. There are lots of places where foreclosures are low. Reading this report anecdotally, there are large areas (California, Nevada, Arizona, Florida) where almost the only housing action is distressed or forced sales, that is, sales at a significant discount to original asking price.

Look at the chart below from Rick Sharga at RealtyTrac. Today we learned from them that foreclosures set a new monthly record of 360,149 properties that received a default or auction notice or were seized last month. One in 355 households got a filing, the highest monthly rate in RealtyTrac records. Many hard-hit areas have rates higher than 1 in 39 homes! Foreclosures are now running about six times higher than just four years ago.

And there is little relief in sight. There is typically about one foreclosure for every 6-10 jobs lost. It will be higher this cycle, as so many homebuyers are underwater on their mortgages and have little incentive to try and keep up payments while they are unemployed. Further, there are 500,000 REO-owned homes that are not on the market as of yet (what Sharga calls shadow inventory), and a wave of foreclosures will result from option ARMs and Alt-A loans resetting next year. Note: July's record numbers are not in the chart below.

John Burns gives us the next graph, which is an estimate of foreclosures for the coming years. (www.realestateconsulting.com)

Notice that he estimates more foreclosures next year than this year, with very little relief until 2014! This does not bode well for housing prices, which are a big factor in consumer sentiment, which is a big factor in consumer spending.

It does mean that renters can find some very good deals, as there are now areas (like Phoenix) where it is cheaper to buy smaller homes than to rent. Remember the statistic above that first-time home buyers are 43% of the market and investors another 29%? Lower prices make housing more affordable, and with the government incentive programs for first-time buyers really working (for once), the lower end of the housing market may actually stabilize sooner than the overall market.

As I wrote almost two years ago, the housing market will not bottom before 2011 and maybe into 2012. We just built way too many homes in our exuberance; and with tightening lending standards (as there should be) the number of people who can qualify for a mortgage is down, although (again) falling prices make homes more affordable. The median price in California is down by 60%. (Although I saw today where Bill Gross bought a tear-down on the water in Newport Beach for $23 million. That will help the average some.)

Homeowner vacancy rates are close to 3% of total homes, which is well over 2 million homes. Many of these are not yet on the market.

Retail sales were down in July. And that was with Cash for Clunkers in full force. The headlines said that economists were shocked. Really? Consumers are saving more, and actually paying down credit-card and bank debt. We will go into those details more next week, as it is getting close to time to hit the send button.

Some Thoughts from Maine

Last weekend I got to go to Leen's Lodge at Grand Lake Stream in Maine (www.leenslodge.com - highly recommended) to meet with 35 economics types and their friends. This is a very knowledgeable group, with a lot of well-known names. We fish in the morning, meet at a campsite for lunch (drink wine and eat what we caught), fish some more, go back to the lodge, eat a gourmet meal and drink some more wine, and then go on talking. This goes on for 2-3 days. I throw my diet to the wind, and pay for it over the next month, but it's worth it.

On Friday Steve Liesman and some local guides bring out their guitars and entertain, with a lot of loud, if somewhat off-key, singing from the crowd. (Liesman, by the way, really can play the guitar quite well.) On Saturday night we bet on the future of the markets and events - typically small amounts, and lots of side bets. This year I won five out of six side bets I made last year.

As usual, bets were all over the board. But a few interesting ones surfaced. David Kotok and George Friedman offered rather (for this crowd) large sums to take on all comers that Bernanke would not be reappointed. I took part of that offer, as did a number of others (for the record, the Fed economists at the meeting do not bet and were quite closed on the topic). I was surprised at the intensity of that debate. This is a well-informed crowd when it comes to Fed policy and actions, and if this question is (politely) contentious among friends in July of 2009, what will it be like in the latter part of the year, when Obama has to make the appointment (Bernanke's appointment is up in January of 2010)? And among those who do not get along? This could be a very noisy appointment process.

A few years ago (2006 and 2007), I was repeatedly told I was "too bearish." Now, my Muddle Through prediction was seen either as overly optimistic or the most likely scenario by a large number of attendees. The concerns about the credit markets are still quite strong, with many thinking we will be facing banking problems for years. There were more than a few who bet that Citibank will not be around in its current form by this time next year. (I did not take that bet.)

A number of participants saw a double-dip recession as a distinct possibility. I think it is a probability in 2011 as the Bush tax cuts expire. If Congress moves up the increase in taxes to 2010, which is what the House Democrats want, that recession could start in 2010.

Tulsa, Birthdays, Weddings, and Paul McCartney

Today is my mother's 92^nd birthday, so I need to leave soon, as she eats early. The order of the day is Luby's Cafeteria. Interestingly, she had me when she was 32, and Tiffani is 32 and will have her first around Christmas. Other than her hearing, mother is still going strong, if a little more slowly, and shows no real signs of letting up. She is now bionic, with two new knees and hips over the last decade.

Next week I leave for Tulsa on Thursday to prepare to give away my daughter Amanda on Saturday to a nice young gentleman, Allen Porter. They (along with her twin sister Abigail) say they intend to move to Dallas after the first of the year, which will make Dad happy, as all the kids will be in the local area. A little golf on Friday morning with the new in-laws, parties, and so on. It should be a large wedding and a fun weekend. They have lots of friends, it seems. I do intend to write my letter as usual.

I also intend to be in the bar on Thursday night at the Hilton at 9:30-45, assuming Southwest is on time. If anyone cares to meet, feel free to drop by.

Thinking about Mother's birthday reminds me that I turn 60 on October 4. For whatever reason, it is not bothering me like 50 did. Maybe 60 is the new 45? Paul McCartney is now 66, and is on the road with what I am told is a very good show. I will find out Wednesday when he plays Dallas and I get to go to the new Cowboy Stadium to see him play. With most of his set scheduled to be Beatles tunes, I am really looking forward to being there. I got to see Eric Clapton last month. He is on top of his game. Maybe blowing through 60 is not all that bad.

Have a great week. I shall.

Your hoping I can avoid paying for another wedding for a few years analyst,

John Mauldin