09 January 2009

Pessimistic Economic Analysis from David A. Rosenberg at Merrill Lynch

Barry Ritholtz pointed readers to a compellingly pessimistic economic analysis by David A. Rosenberg from Merrill Lynch. Another reason why Barry's blog is the second site I read in the a.m. (and throughout the day), right after the Times.

It looks like Merrill Lynch disappeared this report, but I got my (virtual) grubby mitts on the thing before it vaporized into the ether. Here are several lengthy excerpts:
Market not discounting that recovery will take more time We have enjoyed a big equity market rally in the past six weeks that seems to be discounting a very quick end to the economic contraction with the arrival of the new administration and all of its political capital. However, I'm left wondering what the market reaction will be when it becomes clear that the recovery will require a lot more time, because history shows that it is not at all unusual to see the entire period of extremely weak economic performance last between two and three years in the aftermath of a busted asset and credit bubble of the magnitude we have just seen.
When will our economy recover? David Callaway, in my prior post, thinks when oil prices percolate northward.

Rosenberg points to housing for signs of economic recovery, i.e. when the median value of a house reverts to the mean.

As I've said before, when bubbles burst and manias subside, prices don't usually stop at the long-term mean. Prices collapse, falling below the mean, before returning to a quieter historical path. We don't have to dig through the stacks, or even turn back the clock very far to find an obvious example.

When Rosenberg writes about the weak performance two-to-three years after an asset-class' bubble bursts, I believe Rosenberg has in mind the NASDAQ from the early aughts. After the NASDAQ bubble burst in early 2000, the market fell precipitously and spent much of 2002 and 2003 below the long-term trend/historical mean.

The following three charts show the performance of the NASDAQ from 1996 through the end of 2005. The blue line represents the 200-week moving average, a useful approximation of the mean trend for explanatory purposes. The first chart shows the bullish dot.com-driven market of the late 90's:

The next chart shows the bull market peak in March 2000, and the collapse through the 200-week moving average by year's end:

Through 2002, the NASDAQ didn't revert to the mean trend; it fell hard to the downside:

Without the context of the late 90's, 2003's NASDAQ performance is quite stunning, until you realize the index is merely heading back towards its long-term trend, the 200-week moving average. Look carefully and you'll see that the NASDAQ traded below its 200-week moving average for almost three years.

Now that I've thoroughly documented my NASDAQ example, let's return to excerpts from Rosenberg's report re: housing:
Housing led us in and will likely lead us out

In the meantime, it's doubtful that anything is going to bottom in advance of the housing sector, which led the contraction in credit, the bear market in equities and the recession. Since housing led us in, I think it's going to have to be the area of the economy and the markets that leads us out, and I'm talking specifically about home prices, which peaked in the summer of 2006. I remain convinced that there is at least another 15% downside to nationwide home prices as the problems on the coasts migrate to the financial centers in the Northeast.

Still plenty of helium to take out of this balloon

The excess supply is acting as a deadweight drag on prices. Basically, at just over $180,000 the median value of an existing home is back to where it was when we published our inaugural "bubble" report back in 2004. To actually go back to the home price levels that prevailed when real estate was in the "mania" stage in 2001 would mean a retreat toward $150,000 or another 15-20% downside from here. The move all the way down to $180,000 today from the bubble peak of over $230,000 in the summer of 2006 sounds big at -22% – and it is for anyone who was buying at that time – but keep in mind that median prices are still 40% higher now than they were a decade ago. In other words, there's still plenty of helium to take out of this balloon.
Housing isn't the only problem for economic recovery--the consumer has stopped spending altogether. Or just about:
Sharpest retrenchment in consumption on record

For the here and now, the triple combination of declining employment, eroding wages and the conscious effort to raise the savings rate is triggering a near collapse in consumer spending, which peaked in nominal terms in June, has declined every month since and is down at a 5.2% annual rate. This goes down as the sharpest retrenchment in consumption on record.

During that time, discretionary spending has collapsed at nearly a 15% average annual rate: motor vehicles (-38.7%), movies (-36.6%), air travel (-32.7%), sporting goods (-12.7%), hotels (-12.5%), casinos (-11.7%), jewelry (-10.3%), furniture (-9.8%), home improvement (-8.2%), appliances (-7.3%), clothing (-6.6%), computers (-6.5%), electronics (-6.5%), toys (-3.3%) and books (-2.3%).

Even recession proof items are being cut back on

Even so-called recession-proof items like food (-3.6% SAAR) are being cut back on as households shift from veal marsala to pot roast, and from brand name to private label (in real or unit terms, food consumption has declined for six months in a row, so this is not just about lower prices, but also about shifting spending patterns even when it comes to grocery shopping). Utilities have also declined at a 4.9% annual rate, though some of this is clearly price related. There are also widespread anecdotal reports of households falling behind on the monthly gas and electricity bills.

The areas where consumers are spending their money

The only areas where consumers have allocated more of their budget toward since the spending peak in June are sundries/drugs (+6.3% SAAR), medical services (+4.4%), telecom services (+4.8%; the cell phone, we are finding out, is a staple in this cycle), cable (+7.3%; clearly a substitute for movies, as movie attendance during the holiday season was off 5% YoY) and education services (+4.7%).
Rosenberg is no gourmand, suggesting that Americans are downshifting culinarily ("as households shift from veal marsala to pot roast"). Veal marsala isn't much of a step up from pot roast. Giving up two-inch thick dry-aged porterhouse for pot roast, or potted meat for that matter, is a punchier comparison. Only in my house is porterhouse a recession-proof food. Still, for an economic report, it ain't a bad line.

Finally, Rosenberg contemplates the fear that rising protectionism will sustain recession and exacerbate economic hardship, just like what Hoover did in the early 30's:
If you read the papers over the holiday period, rampant fiscal stimulus, auto bailouts and other rescue packages are occurring all over the world. There is a growing risk of protectionism, which has a historical pattern of following periods of deep global recessions (ie, this is all about self-preservation). For example, since that ballyhooed G-20 meeting in Washington in November, five of those countries – Russia, India, Indonesia, Brazil and Argentina – have announced their intentions to raise import tariffs or otherwise restrict trade. Russia has announced plans to raise tariffs on autos. India has already lifted duties on iron, steel and soy. Brazil and Argentina are putting together a case within Mercosur for boosting external tariffs.
That reminds me to finish up my latest reading on the Depression in the next week.

All in all, a report rich with compelling data, arguments, and insight.

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