From: glevy@PRATT.EDU
Date: Tue Oct 03 2006 - 08:41:27 EDT
From <http://wwww.GlobalMacroscope.com>
Autumn Chills the Goldilocks Economy
Max Fraad Wolff
Naturally, the passage of summer into autumn
entails a chilling of the air. Less natural
and more pronounced this year is the cooling
of the macroeconomy. Profit and GDP growth,
as well as, housing numbers and durable
goods reports, point to falling
temperatures. Fed rate hikes on pause and
cooling commodity prices offer more
evidence- if that were necessary. Thus far,
the market response has been August red hot
index appreciation. Renewed geo-political
risk suggested by recent events in Shanghai,
Mexico City, Budapest and Bangkok be damned,
the Dow is in record breaking mode. Some of
this may actually be a sign of agreement
with my cautionary thesis here today? The
Dow is populated by larger more global and
defensive firms with higher credit ratings
than the S&P. Thus, some of its rise may be
rotation from even more dangerous positions
elsewhere in the US equity orbit.
GMS October 2006
Max Fraad Wolff
Autumn Chills the Goldilocks Economy
Naturally, the passage of summer into autumn
entails a chilling of the air. Less natural
and more pronounced this year is the cooling
of the macroeconomy. Profit and GDP growth,
as well as, housing numbers and durable
goods reports, point to falling
temperatures. Fed rate hikes on pause and
cooling commodity prices offer more
evidence- if that were necessary. Thus far,
the market response has been August red hot
index appreciation. Renewed geo-political
risk suggested by recent events in Shanghai,
Mexico City, Budapest and Bangkok be damned,
the Dow is in record breaking mode. Some of
this may actually be a sign of agreement
with my cautionary thesis here today? The
Dow is populated by larger more global and
defensive firms with higher credit ratings
than the S&P. Thus, some of its rise may be
rotation from even more dangerous positions
elsewhere in the US equity orbit.
Sadly, it seems clear that most are driven
by the goldilocks outlook. This
"understanding" was made and stayed popular
beginning 2002. The goldilocks story runs
that we will artfully and profitably dodge
inflation and recession as we hop from sweet
spot to sweet spot. It is a mutant form of
the new economy/new era conception
popularized and universalized in the heady
days of the late 1990's. The US does not
have to save; we can run huge external
imbalances forever; The Fed can endlessly
run expansionary monetary policy; there are
no equity, bond, real estate bubbles; and we
can have rapid growth without inflation.
Goldilocks adherents believe this is being
done as we thread the needle between various
risks. How well does the macroeconomic data
confirm this outlook?
Early winter would seem the correct analogy
here. Housing starts, permits, mortgage
applications, prices and housing company
stock prices are down, foreclosures are up.
Durable goods orders fell .5% in August,
widely missing consensus forecast of a .5%
increase. Bright spots were autos and
defense spending, yet neither is likely to
be a source of macroeconomic strength moving
forward. Excluding transports, durable goods
orders declined by 2.0%. The Mortgage
Bankers Association (MBA) announced on
September 22, 2006 that its seasonally
adjusted index of mortgage applications
declined 5% on the week despite half year
lows in listed mortgage rates. The 5% one
week decline masked a more worrisome 21%
year-over-year slide. Home sales declines in
August were sharp in several vital and once
hot markets. The California Association of
Realtors (CAR) reported a 30% drop in sales
for August 2006. This is the largest decline
since 1982. The Florida Association of
Realtors reported a 50% August decline in
sales in Palm Beach County and a 6% fall in
median home price there. The Massachusetts
Association of Realtors revealed a 20%
decline in sales and an 8% decline in median
price. It is possible some of this weak
performance is related to the total lack of
growth and dynamism in personal income and
spending growth. The September 29, 2006
Personal Incomes and Outlays release form
the BEA reveals that August was a low point
for wage growth and personal consumption
expenditure. Only core inflation stayed
strong. Earnings and spending growth were
anemic while prices stayed high. This is the
mirror image of goldilocks. August 2006
marks another month with a negative private
savings rate (-.5%). [1] This has caused
little concern, likely because consumption
is a relatively unimportant 70% of US GDP.
The September 28, 2006 release of Q2 2006
GDP and national economic data has confirmed
more skeptical outlooks and spurred hardened
optimists to new levels of creativity.
Consensus estimates from private sector
economists of 2.8% GDP growth and advanced
estimates of 2.9% growth were disappointed
as the Commerce Department announced actual
growth of 2.6%. The Fed preferred price
index for personal consumption expenditure-
excluding food and energy- increased 2.9% in
Q2 down from 3.0% in Q1. Thus, our present
goldilocks economy most recently displayed a
3% drop in the rate of price increase and a
53% decline- quarter over quarter- in GDP
growth. This must be why indexes are soaring
and the soft landing, benign inflation
environment expectation has become dominant!
What of corporate profits, long a bright
spot in our economy?
Profits from current production (corporate
profits with inventory valuation and capital
consumption adjustments) increased $22.7
billion in the second quarter.
Current-production cash flow (net cash with
inventory valuation and capital consumption
adjustments) - the internal funds available
to corporations for investment-increased
$1.1 billion in the second quarter, compared
with an increase of $125.3 billion in the
first.[2]
It is fair to say that the corporate profit
picture is defined by deceleration in Q2.
This was particularly true for non-financial
corporations that underwent a rather
profound reversal of profit fortunes across
the quarter. Reported domestic profits for
non-financial corporations dropped by $32.8
billion in Q2 on the heels of a strong $94.5
billion increase in Q1. The profit picture,
while still a relative strong spot in the
economy, is less hot than it has been. The
most recent data, like the first cold winds
of autumn, are a reminder that winter is
approaching. Stagnant earnings, pressured
private consumption, decelerating profit
growth and robust price inflation are
showing up in the macro data.
So we are left to ponder a widely popular
consensus on the economy that is influencing
equity performance. It runs as follows:
eureka! The Fed has stopped tightening and
the economy is still growing well and highly
profitably. Of course growth and
profitability are still in respectable
shape- particularly the later. However, they
have remarkably cooled of late. Much like
rate increases. When rate increases slow we
celebrate the end of inflation risk, despite
the price change metrics reported. When GDP
and profit numbers slow, we refocus on their
strength in long run, global comparisons.
Thus, the goldilocks consensus is sustained.
The economy is not too hot, not too slow and
just right!
Remember the Goldilocks story? Cool days and
warm porridge lure Goldi into the bears'
house. There are two endings to the fairly
tale. In the friendly version she wakes and
flees in terror. In the harsher version she
is eaten by the bears. Either way, advocates
of the goldilocks economy may have much to
learn from the fable they have invoked.
Cooler data may be driving them to seek
follow in goldilocks' footsteps. It might be
just right now, but there is trouble lurking
in the near future! After all, the bears
return in all the versions of the story.
--------------------------------------------------
[1] BEA News Release: Personal Income and
Outlays. September 29, 2006.
http://www.bea.gov/bea/newsrel/pinewsrelease.htm
[2] BEA News Release: Gross Domestic Product
and Corporate Profits. September 28, 2006.
http://www.bea.gov/bea/newsrel/gdpnewsrelease.htm
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