Whither Goldilocks?
Every good adventure -- be it an advertising campaign, religious evangelism, political battle, or even a war -- requires a memorable phrase, repeated over and over again, as part of the broader marketing effort. It can even something as pedestrian as a catchy jingle or theme song.
Market rallies too need their marketing spin, something to give comfort to its adherents in times of stress. For the Bulls who have enjoyed the rally off of the summer lows, that mantra has been "Soft Landing / Goldilocks Economy."
This despite a plethora of evidence that shows that a soft landing is an exceedingly rare and mythical creature. Consider the 1994 soft landing -- the one true soft landing out of 16 Federal Reserve tightening cycles. It is the equivalent of performing successful neurosurgery with a shovel and mallet.
After the 1990 recession ended, we saw an upswing in manufacturing and industrial production. When that softened a few years later, there were numerous other economic sectors to pick up the slack:
- The wireless build-out was accelerating;
- The internet expansion was still very early stages;
- The PC upgrade cycle was in full swing (286/386/486/586);
- Windows 95 was a big economic event;
- Markets were in the middle of an 18 year bull run.
The question at present is simply this: What will step up to replace Housing as the prime economic driver? So far, there is little on the horizon to act as the wireless/internet/pc build out of the 1990s.
Recent macro reports confirm what we have been calling the slow motion slow down; Yesterday, we saw the worst Philly Fed report since the 2001 recession:
"The pace of activity in the region’s manufacturing sector slowed in September, according to firms polled for this month’s survey. Indicators for general activity, new orders, and shipments fell substantially from their readings in August and suggest no growth this month. Overall employment, however, was slightly higher. Firms continued to report a rise in prices for inputs, although these cost increases were less widespread than in previous surveys. The region’s manufacturing executives were significantly less optimistic about future activity, with most indicators dipping to their lowest readings in six years." (emphasis added)
Even the deservedly disparaged re-jiggered Leading Economic Indicators -- gamed by its cheerleading creators to be overly bullish -- has been down 5 of the past 8 months. Jeez, the folks at the Conference Board have to be wondering what the hell they must do to make these LEIs positive -- if you can't win even by cheating, it should make you at least wonder WTF is up.
Let's consider specific sector evidence:
• Housing, the prime driver of the lion's share of economic growth over the past 5 years, is contracting rapidly.
• Sectors directly related to Real Estate are showing stresses; Washington Mutual, the nations largest mortgage writer, said the current environment in the banking industry is "difficult" and is expected to remain "very difficult" on the revenue side for some time. Masco, one of Home Depot's largest suppliers, cut their outlook for 2006 profitibility due to "the severity and rapidity of the current housing decline;"
• Advertising is the canary in the coal mine. Yahoo, magazines, upfront TV sales, newspapers are all showing signs of sales stress. Niche targeting is gaining versus broad advertising campaigns -- a clear sign that advertisers are pulling in their dollars;
• Revolving credit has replaced mortgage/HELOC as the consumer's last option for spending cash;
• The hottest market sector recently has been semiconductors; Yet the book to bill ratio has slipped to "parity" -- meaning little or no additional growth is expected; Both Japan and Germany semi sales are down on either a month-to-month or year-over-year basis;
• Transports have been notably mixed; For each Fed Ex, there's been a UPS, for every CSX there has been a Norfolk Southern; A robust economy does not typically see such disappointing numbers or lowered guidance from the Trannies;
• Earnings ex-expenses? One final note: I have not been a believer that Labor costs are rising terribly; However, I took notice when Federal Express announced a 20 cent per share hit to their 2007 earnings, which was then dutifully reported ex labor costs; Are we now going to report profits ex-expenses?
The issue isn't soft landing or not; It is between whether we have a hard landing or a recession -- with all that it means for profits, and equity prices . . .
>
Sources:
Business Outlook Survey
Federal Reserve Bank of Philadelphia
September 2006
http://www.phil.frb.org/files/bos/bos0906.html
U.S. LEADING ECONOMIC INDICATORS
The Conference Board U.S. Business Cycle Indicators
AUGUST 2006
http://www.econbrowser.com/archives/2006/09/can_it_be_that.html
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Comments
It seems to me that things have moved from a possibility of a hard landing, to just about a sure thing. The builders are only just now really slowing construction and the effects of this are only beginning to be felt by the resty of the economy.
Now the question is, what are the chances for a really hard landing. A while ago, Barry and others spoke of the debt bubble. Each player in the financial markets seem to think they have off-loaded the risks from mortgage defaults onto others.
Who is holding the first loss positions in all these CDOs/CMOs? I'm sure the mortgage lenders are holding some, but how much? How many pension funds are invested in these?
There was a story in the WSJ the other day on the use of exotic mortgages that "found that 9% of recent home buyers obtained a payment option mortgage, compared with 4% in a survey conducted last year. "
The really interesting figure was the number of people who didn't know what typew of mortgage they had: 41%
Posted by: Bob_in_ma | Sep 22, 2006 8:52:08 AM
Stephen Roach was on Bloomberg TV yesterday (the clip is still available on their site) and he said that he heard anecdotally from people in the biz that commercial construction is also cooling rapidly now.
Posted by: Craig H | Sep 22, 2006 9:11:11 AM
Good points Barry. The only one I would quibble with is that revolving credit is the consumer's last resort. Not true - when the CC's get maxed out, it will then be time to cash out those retirement accounts.
Posted by: ticktock | Sep 22, 2006 9:28:19 AM
We're all smarter than average, right?
Our intellectual advantage enables us detect precise tops and squeeze out every last basis point of performance.
In musical chairs, we always get a seat when the music stops. It's always the other guys who are left standing.
Posted by: S | Sep 22, 2006 9:28:27 AM
BTW, great synopsis.
Profits ex expenses - too funny!
Posted by: S | Sep 22, 2006 9:33:02 AM
Hey I know! Let's start selling houses to the Chinese! All those empy condos in Vegas and Florida will be just the thing for all those US dollars the Chinese have been piling up by the truckload lately. RE Brokers better learn Mandarin along with Spanish.
Posted by: lurker | Sep 22, 2006 9:33:12 AM
Do you know of Micheal Shedlock (Mish)?
http://globaleconomicanalysis.blogspot.com/2006/09/kiss-goldilocks-goodbye.html
Its weird he's had a very similiar outlook to you but he thinks our problem is deflation not inflation.
Posted by: crack | Sep 22, 2006 9:34:54 AM
I'll play devil's advocate. What about economic growth in BRIC countries with a build-out of infrastructure not unlike the IT build-out that occurred here in the 1990's?
Posted by: Grodge | Sep 22, 2006 9:49:15 AM
" he heard anecdotally from people in the biz that commercial construction is also cooling rapidly now."
I never bought that argument. Why would commercial take off when the consumer is faced with a steep slowdown.
It is the same that business investment will takeover. The "best economic" climate ever, booming economy, and business sat flush with their cash on the sidelines, and now that the consumer is finally maxed they are going to invest and hire? Duh.
Posted by: me | Sep 22, 2006 9:51:41 AM
lurker - remember, we sold 'everything' to the Japanese back in the 80's. (they lost their shirt)
I guess that ploy would work again.....
Posted by: diva | Sep 22, 2006 9:52:56 AM
@lurker
Doesn't Century 21 already have an ad where the agent learns some chinese dialect?
Posted by: crack | Sep 22, 2006 10:23:49 AM
Been a believer/beneficiary in/of the US housing hard landing for last 18 months.
What does the panel think of real estate outside of US?--specifically eastern europe? Romania/Bulgaria etc.?
Posted by: HT | Sep 22, 2006 10:34:35 AM
4 possilbilities:
1.Soft Landing: Growth weakens mildly, but doesn't cause overly big reduction in capacity
2.Hard Landing: This is what 2001 was. No real contraction in growth, but stagnation for a few quarters leading to reduced capacity and higher unemployment
3.Recession: Last one was 90-91. Similiar to a hard landing but harder to recover from as quickly and capacity is further reduced.
4.Crash/Depression: See, 1929...
Posted by: Cherry | Sep 22, 2006 10:34:40 AM
Was there supposed to be a link with the FedEx item? Did someone really report "ex labor costs" or are you kidding?
Posted by: david foster | Sep 22, 2006 10:44:12 AM
HT:
Capital is still sloshing around somewhere: so where will it go? Foreign RE seems like a good investment, especially if worlwide infaltion is on the rise.
But how does an individual investor get into that market?
I have bought some international RE through the ETF: RWF and the mutual fund: IRFCX, both run by Cohen & Steers. Not much exposure to Eastern Europe, though.
Any other thoughts?
Posted by: Grodge | Sep 22, 2006 10:48:28 AM
Crack:
Interesting article my Mish. He seems to contradict himself a bit, but maybe I'm not appreciating the nuance.
At one point he says that the condo and new home build-out is continuing as well as as the build-out of strip malls, but then he says that this about to stop precipitously. Seems to me that Mish is corroborating the natural economic brake that will be put on a deflationary bias.
Another thought: can we have relative deflation at home, but see inflation in developing markets, especially foreign real estate?
Posted by: Grodge | Sep 22, 2006 10:53:53 AM
The 1994 soft landing had the benefit of oil prices that had declined since the 1990 recession, which I think was a bigger factor than the Fed managing to walk the tightrope.
This time we had 3 years of escalating oil prices.
The rapid drop in oil prices now I think is a result of the rapid cooldown in the US and probably China. I don't think it's going to improve the situation in the short term as some people do.
Posted by: mh497 | Sep 22, 2006 10:56:05 AM
Treasurys are begging the FED for a surprise 50bps cut. I don't see how the FED can accomodate given the language from the last meeting and with Lacker dissenting.
Pressed my short bet.
Posted by: S | Sep 22, 2006 10:57:08 AM
Grodge--
Mainly through, unfortunately, illiquid LP arrangements. Goldman does a lot of these [large $ commitment] but so does smaller boutique firms. Typically on commercial side-- hotels/resorts etc have been what I’ve seen. If nothing else, could be a good tax right off to go visit possible investment....
BR--any thoughts?
Posted by: HT | Sep 22, 2006 11:15:45 AM
@Grodge
I think he is referring to projects/developements that are already sufficiently far along that not completing them would be worse than completing them and taking a hit. Think high rise condo buildings and large strip malls. New projects aren't being started, but existing ones may be being finished.
Posted by: crack | Sep 22, 2006 11:22:48 AM
Barry-
Maybe instead of the "Goldilocks Economy" it was the "Pamela Anderson Economy" all along. Looked good from a distance but up close and "personal" it was another story.
Posted by: Mark | Sep 22, 2006 11:41:13 AM
crack--
do you have specific info as to eastern europe? agree completely about US market
Posted by: HT | Sep 22, 2006 11:42:43 AM
"Maybe instead of the "Goldilocks Economy" it was the "Pamela Anderson Economy" all along. "
Two big asset bubbles, but no real substance? ;-)
Posted by: Bob_in_ma | Sep 22, 2006 11:50:01 AM
One recently rehabbed empty office property where I work (and there was a great need at least judged by its prior shape) is advertised as "proposed biotech/medical devices space".
Posted by: cm | Sep 22, 2006 11:55:43 AM
Doesn't Century 21 already have an ad where the agent learns some chinese dialect?
Crack,
That's Mandarin they are all speaking in that ad.
Posted by: Kevin_r | Sep 22, 2006 12:24:04 PM
