ps commentary 19.03.2010 - dear bear market rally, happy birthday! en

8/9/2019 PS Commentary 19.03.2010 - Dear Bear Market Rally, Happy Birthday! En

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The Alternative Investment Consultancy19.03.2010

In the last PS Commentaries China was analyzed in detail. After the emerging market excursion, its time to review the

validity of my forecast of a double-dip recession in the US. This assumption was first expressed last summer andconfirmed in the December09 PS Commentary. Its time for an update. Today's PS Commentary, therefore, analyzes thecurrent macroeconomic situation of the United States.

Happy Birthday!Last week (March 6th) we celebrated the one-year anniversary of the March09 lows. During that time the S&P500 fell to666.79, a top-to-bottom loss of 57.69% (Oct07-Mar09). The DJI marked its low at 6,469.95, after having reached a top at14,198.10, also in October 2007. Since then the indices rebounded strongly: + 63.31% (DJI) and +70.77% (S&P500).Economies in the US and around the globe are growing again (here, here and here), Financial Industry profits in 2009reached 2/3 of the 2007 highs and are thus already 3x higher than the 80-year GDP means. Politicians are proposing

austerity packages/tax increases for fiscal consolidation and discussing the distribution of future wealth. All in all, onemight think a new growth chapter has been opened.

Not at all, the US economy, in particular, is in a roller-coaster of emotions. The published macro-numbers since the endof February were uniformly weak. Consumer confidence is crumbling,New home sales are tanking,existing home salesare easing off, as well as the construction activity, while initial jobless claims are consistently above the 400,000 level.

But first things first. As shown in the December commentary, as the stimulus package unfolds, it creates artificial growththat is not sustainable (impact efficiency shown here and here). In addition to tax breaks, stimulus investment choiceslean towards projects with a short term impact on the economy. Most likely the growth impulse of ARRA (American

Recovery and Reinvestment Act) will fade out mid 2010 and, subsequently, will reduce the potential growth by anestimated 1% in 2011.

The Q4 GDP growth can be counted as a first positive interim result. US Q4 GDP grew +5.9% annually (revised to theupside) and represents the strongest quarterly growth in six years. As one might expect from an artificially stimulatedimpulse, it shows little prospect of sustainability. 3.9% of the growth came from business inventories.

www.panthera.mc

The chart on the right shows the overduerebound of inventories. After this one-timeshot in the arm, it now requires demand-driven growth to justify further inventory

expansion.

The more insightful final sales have beenrevised to the downside. In Q4 they increasedby +1.9%, after +1.7% in Q3/09.Disappointingly, in the period of the highestARRA impact, final sales only grew 1.8% onaverage in Q3 and Q4 2009.

In Q1/10 an annualized GDP growth of +3.1%is expected.

Why can it be assumed, that after the expiry of ARRA, demand will not be capable to compensate the artificial boost forcontinuing the economic recovery? The two usual suspects of a healthy recovery are. Both show no signs of a robust recovery, but only a stabilization at low levels. Consumers are still busywith their own deleveraging and, by doing so, they set wise priorities in their consumption behaviour.
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Real income less transfer payments (Chart 1) continue to run significantly below long-term average. The slight upwardstrend in US retail sales (Chart 3) can be explained with temporary tax cuts. For the past two years, Gallup interviewed1000 Americans/ day (Chart 7) about their consumer behaviour (food, gasoline, restaurants, online-shopping). Thesobering figures show a stabilization on a significantly lower niveau, across all income levels. The US consumer may be

able to maintain consumption level stable due to transfer payments (Chart 8). The conventional wisdom is derived fromthe fact that the US consumer does not prolongate his toxic behaviour of the prev business cycle, namely using hisproperty as ATM. Mortgage Equity Withdrawals (Chart 3) are still declining. After 11 months of declining consumercredits, weve seen a slight increase in January. Instead of turning bullish, it needs to be taken under consideration thatthe December numbers have been strongly revised to the downside, from USD -1.8 bln to USD -4.6 bln. Therefore theJanuary numbers can be interpreted as a slight rebound in response to the weak December numbers.

Currently the US consumer keeps the saving rate (currently at 3.9% / Chart 4) stable enough to continue his owndeleveraging at moderate speed, while securing that the consumer-driven economy is not fully running out of steam. Onecan say that a decreasing unemployment rate will widen the margin for consumers again. However, the labor marketcontinues to look bleak. The decline in the unemployment rate from 10.2% to 9.7% in the last few months was driven bya) seasonal adjustments and b) strong governmental hiring for the 2010 census, but not by momentum-gaining economicactivities.

The employment population ratio (Chart 5) continues to decline. Especially seasoned employees face strongly increasingunemployment pressure. (Chart 6). Like in Europe, US SMEs represent the most important pillar of the economy when itcomes to hiring. Instead of an optimistic outlook, the confidence of US SMEs in an economic recvovery is sinking again.SMEs currently do not hire. In a recently published Reuters survey amongst SMEs, the issue was concluded pragmatically:"The biggest problem continues to be a shortage of customers.

www.panthera.mc

To summarize, the air for the consumer

remains very thin. They can not beexpected to compensate expiring stimuliwith demand-driven growth. The chart tothe right (Feds Flow of Funds) clearlyoutlines that consumer deleveragingearned some quick wins, but will not becompleted for years. The gap to the meanwill require USD 1.5 trn in added wealth,respectively reduced debt.

Additionally, the Flow of Funds Reportrecorded a slight increase in household networth in 2009 (chart to the right). Thereport identifies the not overwhelminglysurprising fact that the net gain was solelydriven by the price increase in financialassets. Its disconcerting though, on howvulnerable and fragile legs this increase isbased.

If the government and Fed begin towithdraw their temporary liquidity anddemand stimuli, the consumer will faceanother severe stress-test.
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4/6


Residential investments are a second indicator of a healthy recovery. But again, there are no signs of relief. Only a

stabilization on low levels can be noted. Bernankes MBS program will fade out at the end of March. Currently, 98.4% ofthe total tranche is invested. The Fed chairman can call the program a success since mortgage rates have remained low.The big question remains: what will happen in early April? Now, its about time for the markets to respond to normalmarket forces (estimates vary between +50 to +200 bps). The higher the rate, the more the consumers liquidity marginwill be reduced and the longer his deleveraging will take. Early April will tell.

www.panthera.mc

Even without a strong increase in mortgage ratesthe current situation justifies serious concerns.Freddie Macs Delinquency Rates continue toincrease at a fast pace (right chart). BetweenDec09 and Jan10, an increase of 3.87% wasreported. A massive wave of foreclosures willcontinue to be another recovery millstone.

Homebuilders share the same burden. Despitehaving received USD 2.3 Mrd in tax breaks fromthe US government, the Builder ConfidenceIndex of the National Association of HomeBuilders (NAHB) is quoted close to its all time low(right chart). The same is true for private homes.Caused by a large number of vacancies, Single

Family Starts run sidewards for the past year (redline).

Yales Robert Shiller highlights the difficultsituation in an interview on Mar 4th:

At the end of February, First American CoreLogicpublished a report about the mortgage quality inQ4/09. Result: 11.3 mln residential properties withmortgages were in negative equity. We are talking

about 24% (!) of all residential properties whichwere financed with a mortgage loan. The right chartshows the percent of homeowners under water perstate. Nevada leads the crowd with more than 70%in negative equity. Consumer consolidation will takelonger than what is priced in on Wall Street.
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5/6


In recent months I criticized several times the missed opportunity to use

the crisis for initiating structural reforms. The US economy is still waitingfor the implementation of imminently important reforms in healthcare,financial markets and economical competitiveness.

In both, healthcare and financial market reform weve finally approachedthe home stretch. Especially the healthcare bill contains a series of smartelements. Reconciliation efforts will definitely pay-off. The right chartclearly states how Main Street remains in a holding pattern and iswaiting for some type of banking reform to provide relief. Bank balancesare still full of toxic assets, market concentration has increased,transparency has not been enhanced, etc (see prev PS Commentaries).Obamas presented plan to double US exports withing 5 years soundsambitious. If everbody wants to import prosperity by exporting more, weneed to finally include extra-terrestrial life to our potential consumerlandscape. No matter what. All three areas of reform will only unfoldtheir growth contribution in the medium term. Until then the USGovernment will risk a strong set-back in case of a withdrawal ofeconomic life support.

Probably in growing recognition of this fact, Obama nominated JanetYellen as Vice Chairman of the Fed. Shes a good choice. In recent

months Yellen was speaking strongly in favour of respecting the long-term constraints of public debt financing but also about understandingthe remaining risk of a depression as part of the political agenda.Andrew Scott got it right in his analysis that the US will not risk its safesovereign debt status for years. Having Yellen on board, there is agreater chance that the government and Fed will work hand in hand onre-stimulating the economy a second time. Apart from USD 100 bln for ajob program, no stimulus extension is prepared. I suppose a triple packof healthcare bill, financial market reform and a stimulus II would haveoverstrained Obamas political capital by far. Therefore, I assume that

www.panthera.mc

we need an upcoming W-formation before momentum can coalesce to push for another economic life support package.The US government will be confronted with no other choice than buying the consumer more time for its consolidation.

Inflation is not an issue in the near future. Just the opposite. Deflationary tendencies are much more pronounced. PimcosGross predicts a core inflation close to zero over the next 12 months. The US economy still faces significant excesscapacity and a depressed labor market. Both indicators are inflation suppressors. The Fed shows confidence in its abilityto smoothly withdraw injected liquidity (here, here and here). It will have to show proof first. As the Fed will break newground when starting the withdrawal, I am expecting a trial & error driven, volatile sidewards oriented economic periodahead in which, starting with an approaching W formation, a new stimulus will become necessary. The chorus ofrenowned voices, who are concluding that the probability of a W is increasing: Christopher Thornberg (frm UCLAprofessor), Ewald Nowotny (ECB Governor), Nouriel Roubini (RGE Monitor), Wen Jiabao (Chinesischer Premier), Jrgen

Stark(ECB Member of the Executive Board), to name a few.Clarification: this edition of the PS Commentary is solely about the US economy. It does not imply an easier recoverytrajectory for Europe or Emerging Markets (see PS Commentary about China).

ConclusioMid 2009 I formed the hypothesis of a W formation in the economic recovery of the UnitedStates. Todays update confirms the hypothesis to be intact.
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