Another of the factors supporting the Model “T” forecast of a “UL” shaped recovery is tight credit (See “What the Model “T” says about the Economic Recovery). To understand the impact of credit on the current economy, we need to go back to September of 2008.
Just a few days before the start of the financial crisis, I was on the phone discussing the transportation market with my friend Tom (a big fan of this blog) who worked for a New York investment firm. Suddenly he became alarmed when one of the commercial paper markets he was following on his computer “stopped working”. I asked him if that was bad. He said he didn’t know, because he had never seen it happen before. We now know just how bad it was.
Much has been written about what was happening in the financial industry when the crisis hit, but not much has been reported on what happened in the manufacturing and small business sectors as a result. Most recessions begin because of decreased business spending as part of the ups and downs of the business cycle. This recession began in December 2007 and appeared fairly typical until the financial crisis hit in mid-September 2008. Before the shock, there were even some indications that the recession might end in 2008.
The financial crisis led to the so-called credit crunch. Suddenly, banks were reluctant to lend money to anyone for anything. Because much of business spending (especially capital equipment and small business) is reliant on credit, companies that were weathering the recession up to that point were forced to stop spending. The sharp, fast, pullback in business investment turned a normal recession into The Great Recession. Industrial orders dried up quickly and companies started laying off workers (both blue and white collar) and people panicked. Consumers then also cut purchases. Once a recession bites significantly into consumer spending, it starts a downward spiral that is difficult to contain and the economy spun out of control.
The government did try to help. Remember the TARP? (Troubled Assets Relief Program) The $700 billon program was done primarily to stabilize the financial system. However, the very important secondary goal of the program was to enable banks to start lending again at pre-crisis levels and to encourage them not to hoard cash to protect against future loan losses. It failed miserably in this regard. For example, one commercial trailer manufacturer had seven large orders at the beginning of December 2008. This was enough to continue production into mid-January 2009. Within two weeks, every one of the orders was cancelled due to lack of financing. Multiply this impact across business sectors and you end up with a -5.4% GDP in Q4, 2008 and a -6.4% in Q1, 2009.
If credit availability of C & I (Commercial & Industrial) loans is a key factor for economic recovery and the TARP failed to remedy this, you might think the government would try something else, a Plan “B” perhaps? No. They moved on to the stimulus, saving the auto industry and healthcare reform, etc.
So what has happened to business credit availability in the last 12 months? IT HAS GOTTEN WORSE! The Fed reported that banks were continuing to tighten their credit standards in October. Almost 90% of banks reported that credit standards were tighter than historical norms. (Barron’s). The National Federation of Independent Business (NFIB) Index of “Credit Difficulty” is very near the historic high that was set a few months ago. C & I loans in Q3 fell 28% from last year. (Market Watch). Outstanding revolving credit (used extensively by small businesses) recently plunged 7.8%, the largest decline on record (Wells Fargo).
What are banks doing with all that TARP money? The Wall Street Journal just reported that the country’s four largest banks are hoarding cash reserves to protect themselves against future losses. This is what the TARP was supposed to discourage, not encourage.
Barron’s is forecasting that credit availability may not improve until the second half of next year and will not return to normal levels until 2011. When businesses can’t borrow there is no business expansion, they have trouble meeting payrolls and they can’t refinance their debt. It is difficult to expect a strong economic recovery if businesses and consumers do not have access to affordable credit.
Disclaimer Statement
The information contained in this blog is for strictly discussion and reference purposes only. In no way and under no circumstances should the information presented here be intended as investment advice. Statement s made on this blog do not represent a recommendation on buying or selling equities or securities nor which ones to trade. Please make your own responsible investment decisions based on your own research. The information in this blog is solely the opinion of the writer (except for comments made by people to the posts or references in the posts attributed to other people).
Thursday, November 19, 2009
Thursday, November 12, 2009
The Housing Market Impact
One of the factors supporting the Model “T” forecast of a “UL” shaped recovery is a continued weak housing market recovery (See “What the Model “T” says about the Economic Recovery). Residential construction is very important to the model because it is based on commercial transportation factors and housing has a big impact on freight. Trucks are involved at all stages of the process. They are used to move dirt and raw materials, then construction materials and finally for consumer products to furnish and enhance the completed dwelling. During the housing boom, certain factors in the model rose in tandem with housing starts; of course they fell just as hard after the bust. Housing is not a leading indicator for freight. They tend to move together and how closely is dependent on housing’s overall influence on the total economy at the time.
Housing is also an important factor in economic recoveries. It has led the recovery in the previous seven recessions going back to 1960 (David Berson, PMI Group). Consumer spending has historically been the other key recovery factor.
If the housing market is so important to recovery, it is vital to determine the “basic economics” of the sector as we approach 2010.
Factors Impacting Demand
Demand for houses is being propped up by the first-time homebuyer tax credit, government backed FHA loans and very low interest rates. This has recently increased sales of existing homes, but this demand is not normal. A very high percentage (90%, Inside Mortgage Finance) of these sales are foreclosures, short sales (lenders agree to the sale of a home for less than the balance of their mortgage) and distressed sales (due to job loss).
September new home sales were at an annual rate of 402,000. While this is 22% above the January low (the low base number inflates the percentage increase!), it is 8% below a year ago and a whopping 48% below 2007 actual. New home sales, especially at the high end, are restricted by tight credit, weak consumer confidence and wage reductions. Future demand is limited by a declining number of first-time buyers, reduced FHA loans and possible higher interest rates.
Factors Impacting Supply
September housing starts were only 590,000 (seasonally adjusted annual rate). The numbers had been improving after bottoming out, but have now flattened. There is still 7.5 months of inventory, but this is better than earlier this year. Existing home inventory is 3.6 million and growing. There were 937,840 foreclosures in Q3.
The number of foreclosures is expected to rise due to:
- There are a large number of houses that are in the process of foreclosure or delinquent on payments
- Many adjustable rate mortgages will rest at higher rates in 2010 and 2011
- The number of voluntary foreclosures (otherwise known as strategic defaults, being underwater, etc.) caused by people with mortgages larger than the value of their homes is growing. There were 588,000 (1 out of every 5) of these defaults last year. Moody estimates that currently one third of all mortgages are underwater.
- More foreclosures are occurring on expensive homes and prime loans as higher income people lose their jobs and are unemployed for an extended time.
Amherst Securities Group forecasts that 7 million properties may be foreclosed upon and be dumped into the market. It would take 1.3 years to sell this inventory at current sales levels. Adding to possible supply increases is the “shadow inventory” (because it lurks behind the numbers and can’t be counted). This inventory consists of banks that are holding foreclosed and distressed properties off the market now, with plans to put them up for sale when the market (and prices) improve. It also includes home owners who need to sell, but are waiting for the same thing.
Impact on Prices
Housing prices are down 32% from peak (Case- Schiller, although this varies widely by market). Due to the strong expected increase in supply and the forecasted tepid increase in demand, Fiserv is forecasting prices to fall another 11%, bottoming in the summer of 2010. Moody’s says Q3, 2010. If the supply of foreclosed homes pours out on the market too quickly, prices could drop another 25%, back to 1998 “pre-bubble” levels.
The Forecasts
The WSJ Economic Panel is forecasting (averaged) housing starts at 840,000 a 260,000 increase over 2009. This seems optimistic considering September building permits were only at a rate of 573,000 and the National Association of Home Builders (NABH) Builder Confidence Index is at a very low value of 18. The NAHB 2010 forecast of 716,000 housing starts looks more realistic, but still could be high.
What it Means
The economy will have problems growing above trend next year (3%) with the housing market this weak. The commercial transportation market can expect another poor year (although better than 2009) in 2010. Which means the Model “T” predicts a sluggish stock market for most of next year.
Disclaimer Statement
The information contained in this blog is for strictly discussion and reference purposes only. In no way and under no circumstances should the information presented here be intended as investment advice. Statement s made on this blog do not represent a recommendation on buying or selling equities or securities nor which ones to trade. Please make your own responsible investment decisions based on your own research. The information in this blog is solely the opinion of the writer (except for comments made by people to the posts or references in the posts attributed to other people).
Housing is also an important factor in economic recoveries. It has led the recovery in the previous seven recessions going back to 1960 (David Berson, PMI Group). Consumer spending has historically been the other key recovery factor.
If the housing market is so important to recovery, it is vital to determine the “basic economics” of the sector as we approach 2010.
Factors Impacting Demand
Demand for houses is being propped up by the first-time homebuyer tax credit, government backed FHA loans and very low interest rates. This has recently increased sales of existing homes, but this demand is not normal. A very high percentage (90%, Inside Mortgage Finance) of these sales are foreclosures, short sales (lenders agree to the sale of a home for less than the balance of their mortgage) and distressed sales (due to job loss).
September new home sales were at an annual rate of 402,000. While this is 22% above the January low (the low base number inflates the percentage increase!), it is 8% below a year ago and a whopping 48% below 2007 actual. New home sales, especially at the high end, are restricted by tight credit, weak consumer confidence and wage reductions. Future demand is limited by a declining number of first-time buyers, reduced FHA loans and possible higher interest rates.
Factors Impacting Supply
September housing starts were only 590,000 (seasonally adjusted annual rate). The numbers had been improving after bottoming out, but have now flattened. There is still 7.5 months of inventory, but this is better than earlier this year. Existing home inventory is 3.6 million and growing. There were 937,840 foreclosures in Q3.
The number of foreclosures is expected to rise due to:
- There are a large number of houses that are in the process of foreclosure or delinquent on payments
- Many adjustable rate mortgages will rest at higher rates in 2010 and 2011
- The number of voluntary foreclosures (otherwise known as strategic defaults, being underwater, etc.) caused by people with mortgages larger than the value of their homes is growing. There were 588,000 (1 out of every 5) of these defaults last year. Moody estimates that currently one third of all mortgages are underwater.
- More foreclosures are occurring on expensive homes and prime loans as higher income people lose their jobs and are unemployed for an extended time.
Amherst Securities Group forecasts that 7 million properties may be foreclosed upon and be dumped into the market. It would take 1.3 years to sell this inventory at current sales levels. Adding to possible supply increases is the “shadow inventory” (because it lurks behind the numbers and can’t be counted). This inventory consists of banks that are holding foreclosed and distressed properties off the market now, with plans to put them up for sale when the market (and prices) improve. It also includes home owners who need to sell, but are waiting for the same thing.
Impact on Prices
Housing prices are down 32% from peak (Case- Schiller, although this varies widely by market). Due to the strong expected increase in supply and the forecasted tepid increase in demand, Fiserv is forecasting prices to fall another 11%, bottoming in the summer of 2010. Moody’s says Q3, 2010. If the supply of foreclosed homes pours out on the market too quickly, prices could drop another 25%, back to 1998 “pre-bubble” levels.
The Forecasts
The WSJ Economic Panel is forecasting (averaged) housing starts at 840,000 a 260,000 increase over 2009. This seems optimistic considering September building permits were only at a rate of 573,000 and the National Association of Home Builders (NABH) Builder Confidence Index is at a very low value of 18. The NAHB 2010 forecast of 716,000 housing starts looks more realistic, but still could be high.
What it Means
The economy will have problems growing above trend next year (3%) with the housing market this weak. The commercial transportation market can expect another poor year (although better than 2009) in 2010. Which means the Model “T” predicts a sluggish stock market for most of next year.
Disclaimer Statement
The information contained in this blog is for strictly discussion and reference purposes only. In no way and under no circumstances should the information presented here be intended as investment advice. Statement s made on this blog do not represent a recommendation on buying or selling equities or securities nor which ones to trade. Please make your own responsible investment decisions based on your own research. The information in this blog is solely the opinion of the writer (except for comments made by people to the posts or references in the posts attributed to other people).
Thursday, November 5, 2009
Did the Economy Really Grow at a 3.5% Pace?
The latest GDP figures released last week indicated the economy grew a 3.5% rate in Q3,the largest increase since Q4, 2004. This surprised many people and even some economists because it does not seem like the economy is improving that much.
Estimating GDP is a complicated process based on many calculations and assumptions. It is not an exact number, but it is the established standard in measuring economic growth. Ed Wallace (Business Week) believes that no one really knows where the economy now stands because all of our measuring tools do not work as well due to the scope and severity of this recession. See Article
One simple factor that impacts most economic statistics is that they are often quoted as a percentage change against a base number. Because these base numbers are much lower during this recession, it makes announced percentage increases sound better than they actually are. For example, take an industry where the average yearly output is 200,000 units. Due to the recession, 2009 output will be only 100,000 units. When it is announced next year that the industry has increased 20%, the real gain is only 20,000 units and the total output is still only 120,000 or 40% below average. This factor helps explain that while the economy may be growing, it is going to feel like we are still in a recession for awhile.
Is the economy really improving? Yes it is. Almost all other the major indicators are showing signs of life. The ISM (purchasing manager’s index) increased again in October; auto sales are growing, factory orders are up. The two major leading indicator indexes (ECRI and the Survey of Leading Economic Indicators) have been showing very positive signs. The economy did grow in Q3, although maybe not at 3.5% and the recession probably officially ended in July.
What Is Happening In Transportation?
Even though the transportation industry is a leading indicator going into a slump, it is a lagging indicator coming out of one. The transportation industry lags recovery because there is always slack (too much over capacity) that has to be consumed by economic growth before things improve. But if the economy really grew 3.5% in Q3, the transportation industry should be showing some improvement now in Q4. So what impact is a 3.5% growth rate having on the transportation industry?
Not much. Trucking firms have stopped shrinking their fleets, but freight volumes are improving slowly at an uneven pace. FTR Associates reported that freight did increase in September but was still down 7% from last year. The American Trucking Association Truck Tonnage Index fell in September after two increases. The CASS freight index slipped in October also after two increases. Similarly, rail carload freight remains down 10-14% from last year.
What About Q4?
Based on the evidence it does not appear the 3.5% growth rate, even if real, is sustainable. Only 17% of the Wall Street Journal’s Top Economists Panel are forecasting a higher Q4 GDP versus Q3. Even the Fed said that economic activity is likely to remain weak for a time. However, economic growth at a slow and steady pace should continue.
The stock market however may have priced in a stronger recovery. The 3.5% GDP is consistent with the recent increase in the S&P 500. If the economy continues at a 3.5% pace, stock prices will be able to hold and even increase. If growth slows, there is a danger that the market is overpriced and a correction would be expected.
Because the “Model T” is based on transportation industry factors and these factors have not improved much, the model is still predicting a bottom of around 580 for the S & P 500 Index. This bottom would be reached sometime in mid-2010, with a recovery starting late in the year.
Disclaimer Statement
The information contained in this blog is for strictly discussion and reference purposes only. In no way and under no circumstances should the information presented here be intended as investment advice. Statement s made on this blog do not represent a recommendation on buying or selling equities or securities nor which ones to trade. Please make your own responsible investment decisions based on your own research.
The information in this blog is solely the opinion of the writer (except for comments made by people to the posts or references in the posts attributed to other people).
Estimating GDP is a complicated process based on many calculations and assumptions. It is not an exact number, but it is the established standard in measuring economic growth. Ed Wallace (Business Week) believes that no one really knows where the economy now stands because all of our measuring tools do not work as well due to the scope and severity of this recession. See Article
One simple factor that impacts most economic statistics is that they are often quoted as a percentage change against a base number. Because these base numbers are much lower during this recession, it makes announced percentage increases sound better than they actually are. For example, take an industry where the average yearly output is 200,000 units. Due to the recession, 2009 output will be only 100,000 units. When it is announced next year that the industry has increased 20%, the real gain is only 20,000 units and the total output is still only 120,000 or 40% below average. This factor helps explain that while the economy may be growing, it is going to feel like we are still in a recession for awhile.
Is the economy really improving? Yes it is. Almost all other the major indicators are showing signs of life. The ISM (purchasing manager’s index) increased again in October; auto sales are growing, factory orders are up. The two major leading indicator indexes (ECRI and the Survey of Leading Economic Indicators) have been showing very positive signs. The economy did grow in Q3, although maybe not at 3.5% and the recession probably officially ended in July.
What Is Happening In Transportation?
Even though the transportation industry is a leading indicator going into a slump, it is a lagging indicator coming out of one. The transportation industry lags recovery because there is always slack (too much over capacity) that has to be consumed by economic growth before things improve. But if the economy really grew 3.5% in Q3, the transportation industry should be showing some improvement now in Q4. So what impact is a 3.5% growth rate having on the transportation industry?
Not much. Trucking firms have stopped shrinking their fleets, but freight volumes are improving slowly at an uneven pace. FTR Associates reported that freight did increase in September but was still down 7% from last year. The American Trucking Association Truck Tonnage Index fell in September after two increases. The CASS freight index slipped in October also after two increases. Similarly, rail carload freight remains down 10-14% from last year.
What About Q4?
Based on the evidence it does not appear the 3.5% growth rate, even if real, is sustainable. Only 17% of the Wall Street Journal’s Top Economists Panel are forecasting a higher Q4 GDP versus Q3. Even the Fed said that economic activity is likely to remain weak for a time. However, economic growth at a slow and steady pace should continue.
The stock market however may have priced in a stronger recovery. The 3.5% GDP is consistent with the recent increase in the S&P 500. If the economy continues at a 3.5% pace, stock prices will be able to hold and even increase. If growth slows, there is a danger that the market is overpriced and a correction would be expected.
Because the “Model T” is based on transportation industry factors and these factors have not improved much, the model is still predicting a bottom of around 580 for the S & P 500 Index. This bottom would be reached sometime in mid-2010, with a recovery starting late in the year.
Disclaimer Statement
The information contained in this blog is for strictly discussion and reference purposes only. In no way and under no circumstances should the information presented here be intended as investment advice. Statement s made on this blog do not represent a recommendation on buying or selling equities or securities nor which ones to trade. Please make your own responsible investment decisions based on your own research.
The information in this blog is solely the opinion of the writer (except for comments made by people to the posts or references in the posts attributed to other people).
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