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Thursday, May 29, 2008

Real VS Relative Value

The preliminary GDP release should strike a note of caution in the hearts of investors. With preliminary we get the first assessment of corporate profits for the quarter, and here are the numbers stated by change from the preceding period (Table 12):
Corporate profits with inventory valuation adjustment:
Q2 2007: +101.2
Q3 2007: -17.4
Q4 2007: -48.9
Q1 2008: -162.6
By domestic industry category:
Financial Industry:
Q2 2007: +53.4
Q3 2007: -32.2
Q4 2007: -73.9
Q1 2008: -21.6
Nonfinancial Industry:
Q2 2007: +31.0
Q3 2007: -11.6
Q4 2007: -30.7
Q1 2008: -145.9
Yergle. Yikes. With the magic of capital and inventory consumption adjustments, a miracle happens and the quarterly change becomes positive, but the bottom line is that these companies are going to have to cut expenditures, which means that gross private domestic investment will continue to be negative a while longer, which means that not only are we in a recession, we aren't getting out of it any time soon. Which brings us to the employment release, which duly shows more weakening.

NSA and SA initial claims rose. NSA continuing claims dropped, but SA continuing claims rose. NSA continuing claims are running over 25% ahead of last year's. This is bad enough to create continuing downward momentum in the consumer side of the economy.

The Federal Unemployment Tax (FUT) receipts are showing a pronounced YoY drop. This is quite a change from just a few months ago. I expected them to go negative in May due to the increasing impact of construction at this time of year, but the amplitude of the decline indicates that a much broader weakness is evidencing itself.

I expect the next employment report to show an escalating unemployment rate. Eventually, perhaps years later, Business Employment Dynamics numbers will be in and employment figures will be revised downward for this period. The last release for Q3 07 showed 235,000 in net job losses for that quarter, which is a strong indication of recession.

How does this square with yesterday's rather good durables report? Well, freight figures continue to show that the production side of the economy improved beginning last year, but the consumer side of the economy is on a long, determined downward slope. So both can be true at once, but the consumer side of the economy is far more than 50% of the economy. Investment in production appears to be high, but investment on the consumer side is dropping. I believe we are in a very long period of rebalancing and that consumer consumption as a proportion of GDP will drop for years to come.

In terms of real value (i.e. internal comparisons) stock valuations are way too high. But if I look around the world, it appears to me that the US is greatly favored in comparison to most other markets, and that the US market is undervalued in comparison to many. Therefore on a relative value basis I expect the USD to strengthen and equities to continue to do relatively well. The Eurozone indicators look particularly weak, disturbingly so. It remains to see what is going to happen to the German/French expansion. Germany's unemployment rose, surprising many. There is a fuel price rebellion in France spreading to the UK, so maybe the EU will come to its senses and reduce some of the fuel taxes. This would be wise, and it would cut inflation!!!

Is the Fed going to raise rates? No. The Fed has, however, dusted off the Inflation Hawk suit and sent a member to fly around in it for a few months. I continue to believe that the Fed will hold rates through this year, and then probably drop next year to combat global conditions.

GDP is distorted as an economic measure by the inflation adjustments relating to energy. A better measure of what the economy is actually doing right now would be GNP. GDP for the last two quarters is now 16.8 > 26.2. GNP reverses that trend with 54.5 > 31.6. However net domestic product is rising over that period moving from 9.6 to 19.3, and I think that is the real trend.

There is an epic battle over fuel subsidies going on India. The fuel companies want to raise rates and have the government drop export duties. Several of them expect to be out of money this summer and unable to buy oil, which would cause a helluva problem a la Jimmy Carter. The Petroleum Minister has been duking it out with the Finance Minister, who had promised to control inflation and so couldn't afford to have a fuel hike. The PM was hoping to stave the problem off long enough to scrape by in the elections. We'll see about the May 31st decisioni date! The latest claim by the energy companies is that they are losing about 580 crore daily, which is about 136 million USD at the average exchange rate of the last few days. I believe the Indian banks are going to start refusing more financing.

There are constant power outages any way in quite a few areas of India due to development exceeding infrastructure. It was reported that the energy companies had resorted to capping deliveries to some customers and refusing new connections, but then that was denied. This global game of chicken with commodity prices is heading right to the wall.

Comments:
MoM i suspect the global game of chicken will end when the chicken hits the wall at 200MPH.Did you ever see a video of how they tested cockpit windows using an air cannon and a frozen chicken?
 
No, I don't think I ever did. But we do seem to be roaring toward a barrier of some sort.

I guess it's a question of how many of the speculators start bailing in larger numbers as the cliff looms up. I have the eerie feeling that some of these folks are the same ones who hit bottom a la Wile E Coyote, still clutching an armful of CDOs while whimpering "Mama".
 
For those who missed out on losing money in the tech bubble and the housing bubble, commodities are the last, best chance to lose money in a bubble. The fundamentals are not going to support rising commodities prices indefinately. when the bubble pops it will be even bloodier than the pop of the tech bubble.
 
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