Mish's Global Economic Trend Analysis

Surprising Optimism in Face of Weekly Global Equity Carnage; Foolish Comments of the Day; "Beat the Street" Bullsweet
Stocks Rally on News ECB to Buy Italian Bonds; Italy Seeks Constitutional Amendment to Require Balanced Budget; Ball in Germany's Court
ISM and Recessions - Is there any Predictive Value? Can the US already be in Recession?
Another Gap-and-Crap on Payroll Report - Jobs +117,000, Unemployment Rate 9.1% - Actual number of Employed (by Household Survey) declines by 156,000
Bloodbath in Europe Follows Bloodbath in Asia; Don't Worry, It's Orderly; First Rule of Panic

Surprising Optimism in Face of Weekly Global Equity Carnage; Foolish Comments of the Day; "Beat the Street" Bullsweet

Posted: 05 Aug 2011 02:06 PM PDT

Wall Street is unwavering in its outlook that the S&P will hit 1400 this year. That is nearly a 17% rally from here.

Please consider Strategists Sticking With 17% S&P 500 Rally by Year-End on Rising Profit

Wall Street has never been more sure that the Standard & Poor's 500 Index will rally in 2011, even after speculation the U.S. economy is heading for a recession prompted the biggest plunge since the bull market began.

Chief strategists at 13 banks from Barclays Plc (BARC) to UBS AG (UBSN) see the benchmark measure of American equity surging 17 percent through Dec. 31, the average estimate in a Bloomberg survey. Their projection that the index will reach 1,401 hasn't budged in four weeks, while mounting concern U.S. growth is slowing drove the S&P 500 down 11 percent since July 22, including yesterday's 4.8 percent tumble.

Strategists say earnings growth will fuel gains. S&P 500 profit will rise 18 percent in 2011 and 14 percent in 2012, according to the average per-share analyst estimates in a Bloomberg survey. More than 75 percent of corporations in the index have exceeded earnings estimates for the second quarter, with total income topping projections by 5.2 percent.

Credit Suisse Group AG (CSGN) and HSBC Holdings Plc (HSBA) advised investors to buy equities today. Andrew Garthwaite, a London- based strategist at Credit Suisse, reiterated an "overweight" recommendation on stocks even as he cut his year-end forecast for the S&P 500 to 1,350.

"Our economists are not forecasting a recession and, indeed, are looking for U.S. growth to accelerate in the second half," Garry Evans, global head of equity strategy at HSBC in Hong Kong, wrote in a note today. "Investors should look to raise equity risk gradually over the summer."

Foolish Comments of the Day

The foolish comment of the day award is a tossup.

Garry Evans, global head of equity strategy at HSBC in Hong Kong, said "Our economists are not forecasting a recession and, indeed, are looking for U.S. growth to accelerate in the second half".

Even if that preposterous statement was true, stocks are priced for perfection here.

Jonathan Golub, the chief U.S. market strategist at UBS in New York said: "I'm reluctant to overreact to some shorter-term weakness, no matter how real it is, because the market has proven to be unbelievably resilient. If you would have been acting that way for the last two years, you would have gotten killed by this market."

Wonderful. That same ridiculous philosophy would have gotten you killed in 2008.

"Beat the Street" Bullsweet

I mock the statement "more than 75 percent of corporations in the index have exceeded earnings estimates for the second quarter". Quite frankly it is total bullsweet.

Nearly every quarter, even in 2008 and 2009 the majority of firms beat estimates. Here is the way the process works:

Corporations give analysts "tips" regarding profit expectations.
Those profit expectations are purposely low.
Wall Street analysts lower estimates, if necessary, as the quarter progresses such that corporations can "beat the street".
If corporations are going to miss and need an extra penny, they change tax assumption or make other "one time" adjustments as necessary.
Corporations beat the street by a penny with "pro-forma" (after adjustment) reporting.

When they miss they often miss big, throwing everything but the kitchen sink into the open so they can handily "beat the street" the next quarter.

That is not true with every corporation and every analyst but it is true in general. Thus most corporations, no matter what the market, recession or not, "beat the street".

Optimism in the Face of Market Plunges is Seldom Rewarded

Wall Street analysts sticks with targets that make no fundamental sense. They also call for second-half recoveries instead of recessions.

If you are a bull, optimism in the face of a sinking market is the last thing you want to see. Such optimism is seldom rewarded.

Markets rally after people throw in the towel and there are few bulls left. Judging from this group, there is much more decline to come.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Stocks Rally on News ECB to Buy Italian Bonds; Italy Seeks Constitutional Amendment to Require Balanced Budget; Ball in Germany's Court

Posted: 05 Aug 2011 12:11 PM PDT

Stocks surged in a mid-morning to early-afternoon ramp on news the ECB will step in to buy Italian bonds and that Italy has agreed to balance its budget by 2013.

Please consider Italy pledges to balance budget by 2013, make balanced budget a constitutional requirement

Italy is pledging to work for a constitutional amendment requiring the government to balance its budget as Rome feverishly tries to assure domestic and foreign investors its finances are sound and calm nervous market.

Finance Minister Giulio Tremonti also told a hastily convened news conference Friday night that Italy aims to balance its budget in 2013, a year before previously scheduled. Premier Silvio Berlusconi, saying he conferred with world leaders, announced that G-7 finance ministers will meet "within days" of the exploding financial crisis.

Analysts at Rabobank International called the current fund "hugely inadequate" to cover Italy and Spain, not least because it would lose the pro-rated contributions those countries make if they needed to be bailed out with loans.

They calculated the fund would need euro665 billion ($941 billion) to cover Italy's funding needs for three years.

The EU's Monetary Affairs Commissioner Olli Rehn returned to Brussels in an attempt to shore up investor confidence following the recent spike up in the two countries' borrowing costs.

"Such dramatic changes in the markets are incomprehensible," Rehn said. "It is not as if the fundamentals of the Italian or Spanish economies have changed overnight."

He reiterated previous calls to increase the capacity of the bailout fund and said recently agreed changes to the fund's powers should be ratified by all governments by early September.

Dissent at ECB Wider than Reported

Via email from Barclays Capital Research

ECB round-up: reports suggest that there could have been as many as four dissenters to re-opening SMP purchases

Since yesterday's disclosure by ECB President Trichet that the decision to re-activate sovereign debt purchases (the SMP) had not been "unanimous", various reports have emerged concerning the likely dissenters, with reports this morning from Reuters, the FT and Dow Jones suggesting that there were three (or even four, based on the Reuters report), out of the 23 member Governing Council.

A Dow Jones report this morning cited "a person familiar with the matter" as saying that ECB Executive Board member J Stark had also opposed reactivating the SMP. This is interesting, for the usual procedure is for the ECB's six person Board to agree a common line by a majority vote in advance of the Council meeting, and so it has been our understanding that dissent from officials on the Board is highly unusual. As well, the DJ report said that there was "at least one central bank from the Benelux region [who] also opposed restarting the SMP".

I commented on the feud yesterday in Another Major Feud Between the German Central Bank and the ECB Over Resumption of Bond Purchases; Will Germany Leave the Euro?

Today we see the feud was wider than initially reported. We also see Trichet is going to do what he wants and a majority of the puppets are willing to go along. The key point is there is seldom as much dissent as we now see.

Questions Abound

Will Mario Draghi, head of the central bank of Italy, carry as much influence over the board when he takes over from Jean-Claude Trichet in October?
Can Italy really balance the budget?
Will all the governments ratify the proposed changes to the Maastricht Treaty?
What is the potential cost of this backstop?
How many pledged has Trichet broken in the past 2 years? Does anyone have a count?

That is more questions than I have answers. Moreover, please note that changes to the Maastricht Treaty must be unanimous. Germany and Finland will be very reluctant at best. Germany's constitution may need modification first. This is far messier than it looks, and it looks quite messy.

German Taxpayers on the Hook

Zero Hedge does a good job at question 4 in his post Explaining How The Just Announced ECB Market Rescue Pledged 133% Of German GDP To Cover All Of Europe's Bad Debt

Basically what just happened an hour ago, is that the ECB gave a green light to use the SMP program to buy Italian and Spanish bonds. The problem is that the SMP's unsterilized purchasing capacity is de-minimis and it is merely a stopgap until the sterilized EFSF is enacted in its final form.

The question is precisely what this final form will be: will it be €1.5 or €3.5 trillion? Nobody knows yet which is why Rehn refused to answer the question twice already today.

And here is where Germans get angry, because explicitly they end up backstopping everyone in Europe! And the cost to them becomes 133% of their entire economy in a worst case scenario, which of course in this centrally planned world, is now guaranteed.

So the ball is now basically in Germany's court.

Ball in Germany's Court

Without saying so explicitly, ZeroHedge just asked the question I asked yesterday: "Does Germany accept the monetization of foreign bonds at German taxpayer expense or does Germany leave the Euro?"

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

ISM and Recessions - Is there any Predictive Value? Can the US already be in Recession?

Posted: 05 Aug 2011 10:33 AM PDT

Reader Jamie at the research department of the University of California asks an interesting question about the predictive capability of ISM data.

Hi Mish,

I'm wondering what a 3-mo rolling average of the ISM reports would look like, plotted against the quarterly GDP report of annualized growth. If there is any predictive value in the ISM reports, I'd expect GDP to roll over into negative territory, and the Q2 number to be revised down a bit. How much noise is there in the ISM? Does these reports work as coincident indicators with any degree of accuracy? Just thinking this might make for an interesting post.

Jamie

Thanks Jamie, let's take a look.

Manufacturing ISM Noise

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There are many false signals on manufacturing ISM, where a contraction does not imply a recession. Other manufacturing ISM charts show the same noise.

Let's turn our attention to the services ISM. Unfortunately, the series only dates to 1997.

Service ISM New Orders

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Service ISM Business Activity

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14 years is not a lot of data. Moreover, there is even less data for the index than the components, at least on FRED where I picked up the charts. However, the pattern for the data we do have is somewhat clear.

A dip in 2003 did not precede a recession, but that dip was short-lived.

There are 73 charts in the ISM series so inquiring minds may wish to take a closer look.

I commented on the services ISM Business Activity number on Wednesday in ISM says "Business Conditions Flattening Out"; Why Services Number Worse Than It Looks; Unsustainable Conditions.

Unsustainable Conditions

Production [business activity] is +2.7 while new orders, employment, and deliveries are down. Also note that backlog of orders has plunged over the past two months. Meanwhile new export orders is not only in a free-fall, but also in contraction for the first month as the global economy cools.

Supplier deliveries are on the verge of contraction, and inventories were +3 points to 56.5.

In short, one of these numbers does not make sense in relation to the others, in relation to the manufacturing ISM, in relation to the financial industry, and in relation to the global economy.

That 56.1 production reading at +2.7 simply does not fit in, and is not sustainable if the other conditions remain in current "slowing" condition.

The possibility of a much bigger decline next month seems very real. In fact, that is my call in advance.

Real GDP Percent Change From Year Ago

There is plenty of recession predictive or coincident capability in "Real" GDP (inflation adjusted GDP)

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Nearly every time Real GDP dips below 2%, the economy was either in recession or headed for recession.

Services ISM confirms as do many other data points including consumer spending and jobs. This chart suggests we are headed for recession if not already in one.

More Than Meets the Eye

I wrote the above several days ago. There was so much other immediate news that I never got around to publishing it. Since then I read an article by John Hussman essentially saying essentially same thing.

Please give Hussman's post More Than Meets the Eye a well-deserved look.

The components of our recession warning composite might be called "weak learners" in that none of them, individually, has a particularly notable record in anticipating recessions. The full syndrome of conditions, however, captures a critical "signature" of recessions. That signature of "early warning" conditions is based on financial market indicators including credit spreads, equity prices and yield curve behavior, coupled with slowing in measures of employment and business activity. Every historical instance of this full syndrome has been associated with an ongoing or immediately impending recession.

The components (which I've reordered for simplicity) are:

1: Widening credit spreads: An increase over the past 6 months in either the spread between commercial paper and 3-month Treasury yields, or between the Dow Corporate Bond Index yield and 10-year Treasury yields.

2: Falling stock prices: S&P 500 below its level of 6 months earlier. This is not terribly unusual by itself, which is why people say that market declines have called 11 of the past 6 recessions, but falling stock prices are very important as part of the broader syndrome.

3: Weak ISM Purchasing Managers Index: PMI below 50, or,

3: (alternate): Moderating ISM and employment growth: PMI below 54, coupled with slowing employment growth: either total nonfarm employment growth below 1.3% over the preceding year (this is a figure that Marty Zweig noted in a Barron's piece many years ago), or an unemployment rate up 0.4% or more from its 12-month low.

4: Moderate or flat yield curve: 10-year Treasury yield no more than 2.5% above 3-month Treasury yields if condition 3 is in effect, or any difference of less than 3.1% if 3(alternate) is in effect (again, this criterion doesn't create a strong risk of recession in and of itself).

At present, both measures of credit spreads in condition 1 are widening, the S&P 500 is within about one percent of its level 6 months ago, the Purchasing Managers Index is at 55.3%, total nonfarm payrolls have grown by only 0.8% over the past year, the unemployment rate is up 0.4% from its March 2011 low, and the Treasury yield spread is just 2.7%. From the standpoint of this composite, we would require only modest deterioration in stock prices and the ISM index to produce serious recession concerns.

Wells Fargo's senior economist Mark Vitner reiterated the point last week, noting that since 1950, year-over-year growth in real GDP has dipped below 2% on 12 occasions. In 10 of those instances, the economy was already in recession or quickly entered one. The exceptions were 1956 and 2003.

For our part, we've always believed that the strongest evidence is obtained by combining multiple data points into a single "gestalt." So I have difficulty concluding that the U.S. is on the verge of recession simply because the year-over-year growth rate has stalled. At the same time, we are closely monitoring a much broader set of data, because the deterioration has been very rapid. I should be clear - the evidence is not yet convincing that a recession is imminent, but it is also important to recognize that the developing risks are greater than most investors seem to assume at present.

Definition of Recession

The NBER, which is the official arbiter of recessions describes recessions this way.

The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

"Sufficient" Does Not Mean "Necessary"

Two declining quarters of GDP is a "sufficient" recession condition, however, not even one quarter of declining real GDP is a "necessary" condition.

The recession that started in November of 2007 did not have one full quarter of declining Real GDP growth.

Real GDP

Notice that chart shows declining "growth". GDP was actually rising at the time the recession started.

Real GDP Percent Change vs. Year Ago

Those waiting for contraction before they concede the US is in recession may wake up one day and discover, just as happened in 2008, that the recession was 1/3 over before they saw it "coming". Indeed, some recessions may not be spotted until they are already over.

Might the US be in recession now?

One thing is for sure: At a minimum, the US is certainly on the border of one. Economist Dave Rosenberg raised his odds of recession this week from 99% to 100%. That is how certain he is.

For the average guy on the street out of work and unable to find any job, the last recession never ended.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Another Gap-and-Crap on Payroll Report - Jobs +117,000, Unemployment Rate 9.1% - Actual number of Employed (by Household Survey) declines by 156,000

Posted: 05 Aug 2011 06:44 AM PDT

Thoughts on the Jobs Report

European stock market rallied from a potential bloodbath on news of a "good" US jobs report. What passes for "good" decreases with time.

US futures were solidly in the green at the open but it was an immediate "sell the news" reaction.

Here is an overview of today's numbers.

US Payrolls +117,000
US Unemployment Rate -.1 to 9.1%
Participation Rate -.2 to 63.9% accounting for drop in unemployment rate
Actual number of Employed (by Household Survey) fell by 38,000
Unemployment rose by 156,000
Those dropping out of the labor force rose by 374,000
Civilian population rose by 182,000, Labor Force declined by 193,000
Average Weekly Workweek was unchanged at 34.3 hours
Average Private Hourly Earnings Increased by 10 Cents
Government employment decreased by 37,000 - a genuine bright-spot

Recall that the unemployment rate varies in accordance with the Household Survey not the reported headline jobs number, and not in accordance with the weekly claims data.

Many of those millions who dropped out of the workforce would start looking if they thought jobs were available. Indeed, in a 2-year old recovery, the labor force should be rising sharply as those who stopped looking for jobs, once again started looking. Instead, the labor force is not expanding at all.

Were it not for people dropping out of the labor force for the past two years, the unemployment rate would be well over 11%.

June 2011 Jobs Report

Please consider the Bureau of Labor Statistics (BLS) July 2011 Employment Report.

Total nonfarm payroll employment rose by 117,000 in July, and the unemployment rate was little changed at 9.1 percent, the U.S. Bureau of Labor Statistics reported today. Job gains occurred in health care, retail trade, manufacturing, and mining. Government employment continued to trend down.

Unemployment Rate - Seasonally Adjusted

Nonfarm Employment - Payroll Survey - Annual Look - Seasonally Adjusted

Notice that employment is lower than it was 10 years ago.

Nonfarm Employment - Payroll Survey - Monthly Look - Seasonally Adjusted

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Between January 2008 and February 2010, the U.S. economy lost 8.8 million jobs.

Ignoring the effects of the census, in the last 10 months of a recovery 2+ years old, the economy is averaging about 129,000 jobs a month. That is very poor as recoveries go.

Statistically, 127,000 jobs a month is enough to keep the unemployment rate flat.

Nonfarm Employment - Payroll Survey Details - Seasonally Adjusted

Average Weekly Hours

Index of Aggregate Weekly Hours

Average Hourly Earnings vs. CPI

"Success" of QE2

Over the past 12 months, average hourly earnings have increased by 2.3 percent. The consumer price index for all urban consumers (CPI-U) was up 3.4 percent over the year ending in June.

Not only are wages rising slower than the CPI, there is also a concern as to how those wage gains are distributed.

BLS Birth-Death Model Black Box

The BLS Birth/Death Model is an estimation by the BLS as to how many jobs the economy created that were not picked up in the payroll survey.

The BLS has moved to quarterly rather than annual adjustments to smooth out the numbers.

For more details please see Introduction of Quarterly Birth/Death Model Updates in the Establishment Survey

In recent years Birth/Death methodology has been so screwed up and there have been so many revisions that it has been painful to watch.

The Birth-Death numbers are not seasonally adjusted while the reported headline number is. In the black box the BLS combines the two coming out with a total.

The Birth Death number influences the overall totals, but the math is not as simple as it appears. Moreover, the effect is nowhere near as big as it might logically appear at first glance.

Do not add or subtract the Birth-Death numbers from the reported headline totals. It does not work that way.

Birth/Death assumptions are supposedly made according to estimates of where the BLS thinks we are in the economic cycle. Theory is one thing. Practice is clearly another as noted by numerous recent revisions.

Birth Death Model Adjustments For 2011

BLS Back in Outer-Space

Do NOT subtract the Birth-Death number from the reported headline number. That is statistically invalid. However, in my estimation the BLS is back in outer-space.

It is clear the economy is slowing and the BLS model has not picked it up. The model is horrendously wrong at economic turns.

-18,000 may look reasonable but bear in mind that January and July are revision months where the BLS adjusts for prior errors. I believe the BLS has missed another economic turn, and the BLS is terribly wrong following turns.

Household Data

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In the last year, the civilian population rose by 1,781,000. Yet the labor force dropped by 400,000. Those not in the labor force rose by 2181,000.

Were it not for people dropping out of the labor force, the unemployment rate would be well over 11%.

Table A-8 Part Time Status

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There has been almost no improvement in part-time employment in a full year. 8.4+ million workers want a full time job and cannot find one.

Table A-15

Table A-15 is where one can find a better approximation of what the unemployment rate really is.

click on chart for sharper image

Distorted Statistics

Given the total distortions of reality with respect to not counting people who allegedly dropped out of the work force, it is hard to discuss the numbers.

The official unemployment rate is 9.1%. However, if you start counting all the people that want a job but gave up, all the people with part-time jobs that want a full-time job, all the people who dropped off the unemployment rolls because their unemployment benefits ran out, etc., you get a closer picture of what the unemployment rate is. That number is in the last row labeled U-6.

While the "official" unemployment rate is an unacceptable 9.1%, U-6 is much higher at 16.1%.

Things are much worse than the reported numbers would have you believe. Moreover, the unemployment rate is barely better than it was a year ago. It would actually be worse than a year ago were it not for people dropping out of the labor force.

Mass Layoffs Rise, Robots to Replace Workers

In case you missed it, please see Mass Layoffs Rise; One Million Robots to Replace Workers; Looking Ahead: Dismal Job Situation No Matter What Job Report Shows for why this payroll report may be as good as it gets for a while.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Bloodbath in Europe Follows Bloodbath in Asia; Don't Worry, It's Orderly; First Rule of Panic

Posted: 05 Aug 2011 01:30 AM PDT

Bond yields of Italy, Spain, and Belgium continue their relentless march higher. Yields are at record or near-record highs in all three countries relative to Germany.

Italy 10 Year Government Bonds

Spain 10 Year Government Bonds

Belgium 10 Year Government Bonds

Italy debt yields nearly touched Spain debt yields at the highs near 6.41%

Sarkozy Meets With Merkel, Zapatero

Bloomberg reports Sarkozy to Discuss Debt Crisis With Merkel, Zapatero After Markets Roiled

French President Nicolas Sarkozy and German Chancellor Angela Merkel will discuss the euro region's debt crisis today after concerns that it will spread to Italy and Spain helped trigger a global market rout.

Sarkozy will also speak with Spanish Prime Minister Jose Luis Rodriguez Zapatero, according to an official at the French president's office in Paris. Sarkozy spoke with European Central Bank President Jean-Claude Trichet yesterday and the previous day, said the person, who cannot be identified under government policy. The official wouldn't give details on the timing of the calls.

European officials are now trying to prod leaders into announcing new measures such as increasing the size of the bailout fund to put a firewall around Italy and Spain, the euro region's third and fourth-largest economies. Parliaments may also be pushed to speed up the ratification of new measures designed to empower it to buy government bonds.

The meeting was useless. There is nothing they can do or say.

European Equities Rout

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Many of the numbers are fluctuating wildly. Difficult to predict the close.
Eyes are now on the US jobs Report.

Don't Worry, It's Orderly

Bloomberg reports Stock Plunge Erasing $780 Billion Seen as 'Orderly' as Brokers Keep Bids

The rout that erased about $780 billion from U.S. share values yesterday reflected orderly selling by institutional investors, unlike the crash of May 2010, traders said.

The Standard & Poor's 500 Index fell 4.8 percent to an eight-month low, the biggest drop since February 2009. The tumble that became known by traders as the flash crash on May 6, 2010, wiped out $862 billion in less than 20 minutes and briefly sent the S&P 500 down 8.6 percent.

While 497 stocks in the S&P 500 fell yesterday, declines were smaller than in the 2010 crash. So-called circuit breakers that halt trading when shares rise or fall 10 percent in five minutes were triggered once yesterday. The swings on May 6 were so wide that the curbs would have been set off more than 600 times had they existed, according to data compiled by Ana Avramovic, a New York-based analyst at Credit Suisse Group AG.

"Liquidity is fine," Dave Lutz, head of ETF trading and strategy at Stifel Nicolaus & Co. in Baltimore, wrote in an e- mail. "I have not heard any chatter of brokers pulling in bids, and I don't see any 'panic'-type selling from our clients. The market is operating just fine -- this is a bad sell-off, but very orderly."

Please remember the first rule of panic: If you are going to panic, do so before everyone else does.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Mish's Global Economic Trend Analysis

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