Since Mr. Rosenberg is leaving Merrill, I'm posting his entire farewell piece
Dave's Top Ten
The 10 major macro
themes of the past week
1) Do we see the recession ending by mid-year? Not so fast.
2) Have markets been too hasty pricing out deflation risks?
3) Interpreting the ISM index
4) Addressing the second-half restocking theme
5) Vanishing trade deficit is a great silver lining
6) Tighter lending standards across the board
7) Recession continues in service sector
8) Households move to pay down debt … in droves
9) Pace of job cuts slows, but remain substantial
10) Productivity boosted by slashing hours
1) Do we see the recession ending by mid-year? Not so fast.
We get asked all the time … “but your own forecast has real GDP growth positive in
the second half of the year, so even you see the recession ending by mid-year”.
Not so fast.
We are not sure this is widely known, but recessions generally occur when real
GDP is declining but the four ingredients that go into the business cycle are
(i) employment; (ii) industrial production; (iii) real retail/wholesale/manufacturing
sales; and (iv) real personal income excluding government transfers. It is not at all
clear to us that we will see the recession, in its classical sense, end until next year.
That is still up for debate, to be sure, but what is not is the historical record, which
shows very clearly that every recession in the past posted at least one quarter of
positive real GDP growth, and we wonder if back then all the media types and
economists were waving their pompoms on the sidelines and cheering over
‘green shoots’. Go back and you will see that the 1990-91 and 1980 recessions
included 1 quarterly GDP bounce; and the recessions of 2001, 1981-82, 1974-75,
1970, 1960, 1957-58 and 1953-54 all enjoyed two quarterly spasms to the upside in
real GDP. Something to ponder just in case this impressive equity rally of the past
two months has been merely technical in nature or whether it is rooted in the view
that this downturn is about to come to a close.
2) Have markets been too hasty pricing out deflation risks?
You really have to wonder whether or not the markets have been a tad too hasty
to price out deflation risks: There has never been a time in the post-WWII era
where the 12-month trends in wages, producer costs and consumer prices were
all in negative territory at the same time. This is the new reality. As the markets
focus on the noise from green shoots, we are focusing our attention on the
fundamental trends and the end-game – we are more than happy to buy these
selloffs in Treasuries and add scarce safe income to the portfolio. This move to
3.25% on the 10-year note resembles that inexplicable move to 5.35% back in the
summer of 2007, in our view. Yes, yes, yields are much lower today but the
inflation rate is 300 basis points lower too and the unemployment rate is 400
basis points higher. If we recall back in that summer of 2007, the equity market
was hitting new highs just as were bond yields … the trade then was to take
profits in the former and scale into the latter. After a near-40% surge in the S&P
500 and a near-60% surge in bond yields off their recent lows, it would seem
logical to us to embark on a similar shift this time around. Even if the recession is
to end soon, and that is still debatable, bond yields do not typically bottom until
we are well into the next cycle as inflation continues to decline even after the
downturn ends.
3) Interpreting the ISM index
Please help us on interpreting Friday’s seemingly ripping ISM index – as it rose to
40.1 from 36.3: We can’t tell you how much comfort clients seemed to obtain from
the diffusion index, not remembering that the improvement in March (35.8 to 36.3)
coincided with a 1.7% plunge in industrial production and that the jump in ISM
orders in March as well (to 41.2 from 33.1) coincided with a 0.9% falloff in total
factory orders. These surveys are only useful insofar as they are capable of
actually foreshadowing the actual data! The ISM is a diffusion index – if one
small company says things are better but a giant firm says things are worse, then
it’s a wash. But not for the economy, obviously.
Digging beneath the surface, the ISM showed that the grand total of 1 industry –
5.6% of the universe – posted growth in April. We have redefined what a ‘green
shoot’ is. For the third month in a row, not one industry added to payrolls. Yes, the
orders index improved considerably, but the share of respondents saying things got
better last month barely improved (28% to 31%). Much attention was focused on
the big improvement in terms of unwinding the excess inventory backdrop – but in
fact, the share of companies saying their customer inventories were “too high” was
the highest April result (21% – it was 12% a year ago) since 2001!
4) Addressing the second-half restocking theme
We really feel the need to address this widely-held view that great strides have
been made to pare inventories and that somehow, restocking is going to be the
second-half theme that propels the economy out of recession. Not so fast. To be
sure, inventories were pared by a record $137 billion at an annual rate in the first
quarter, which is why so many economists and market players took solace out of
that -6.1% GDP print. But real final sales were extremely weak – sliding at a
5.2% annual rate after a 5.8% contraction in 4Q (is that really a significant
improvement in the second derivative?). And we know from Friday’s factory report
that total manufacturing inventories may have been pared 0.8% in March, but
shipments fell an even larger 1.2%. And we know that we finished off 1Q with a
manufacturing inventory-shipments ratio of 1.46x, up from 1.45x in February and
1.26x a year ago (not to mention a 13-year high). The highest the I/S ratio ever
got during the tech bubble was 1.42x, and now, we are at 1.46x. And everyone is
banking in an imminent recovery. Good luck.
One more thing – we get so many factoids thrown our way, like “when you break 40
on ISM on the upside, you always go back to 50”. Well, we are sure we likely will
see 50, but exactly what year, who knows. What we do know is that the linear
extrapolation from the experience of recent cycles is going to prove faulty, as has
been the case so often this cycle which is why so many economists blew the call. If
Chrysler is shutting down its North American plants for the next 30-60 days as it
moves into the bankruptcy process, and if GM is about to close 13 of its factories for
the next eleven weeks, do you really think we are going to 50 on ISM anytime soon?
Furthermore, when the recession began in December 2007 – and it began due to the
problems in the housing and credit markets, not because of a manufacturing
overhang – the ISM was 49. Back in September, just before the economy fell apart
for a five-month span, the ISM was over 43. So excuse us if we don’t dance the
tango because we are now at 40 on this diffusion index. It’s still bad!
5) Vanishing trade deficit is a great silver lining
The ever-vanishing trade deficit is a really great silver lining in this era of consumer
frugality – we are becoming more self-sufficient, and relying more on import
substitution to meet our spending needs. The improvement in the external balance
of trade contributed 2 percentage points to real GDP growth in the first quarter – in
other words, absent the narrower trade deficit, the economy would have shrunk at
an 8.1% annual rate (as if being down 6.1% wasn’t bad enough!). Over the past
four quarters, the contribution from the shrinking trade deficit has been 1.5
percentage points. Now over 100% of this contribution has come from imports, not
exports, given the global downturn in demand which has also hit our outbound
shipments. But the slide in imports actually added 6 percentage points to GDP
growth in 1Q (and the average has been 4.4 percentage points over the past year).
