Rosenberg: "Statistical Illusion Of Recovery"

Chief economist David Rosenberg at Gluskin Sheff comments on Friday’s economic numbers. According to Rosenberg they make up an statistical illusion of a recovery. In fact, adjusted for the highest amount of artificial stimulus from the government ever, the U.S. economy is in an ongoing depression.

“If there is a bright spot, it is in the industrial sector.”

David Rosenberg

“The University of Michigan consumer sentiment index, while improving in May, to 73.3 from 72.2 in April, is actually still in recession terrain as in downturns, it averages 73.9; and during expansions it averages 90.9. So, we have the statistical illusion of a recovery, but in reality, organic growth is still hard to find,” Mr. Rosenberg writes in today’s market commentary.

While most analysts and commentators use the latest job report as an explanation for the stock markets drop, Rosenberg barely mention the slower than expected job growth.

Probably because he have already said what is to say about the situation in the American labor market in earlier commentaries.

“The ADP private payroll survey is showing marginal employment growth with none in the small business sector at all. And jobless claims, as we saw yesterday, have basically stopped falling; however, at still around the 440k level, they are not consistent at all with sustainable job creation. After plunging from 600k in June 2009, to 440k, as of January 2010, claims have basically stopped declining. That is a problem.”

Instead, Rosenberg focus on the U.S. consumers and consumer spending.

The Depression Is Ongoing

“The big deal in the April retail sales report was the “core control” segment (excludes autos, gasoline and building materials), which feeds directly into the consumer spending component of the GDP accounts,” he writes.

“The metric fell 0.2% MoM in the first meaningful decline since last July and the largest drop since the depths of despair in March 2009; a huge miss, vis-à-vis the consensus estimate of -0.3%. So this was the big downside surprise beneath the surface.”

“In addition, the University of Michigan consumer sentiment index, while improving in May, to 73.3 from 72.2 in April, is actually still in recession terrain as in downturns, it averages 73.9; and during expansions it averages 90.9.”

“So, we have the statistical illusion of a recovery, but in reality, organic growth is still hard to find.”

“The headline (inflation) did come in above expected, at +0.4% MoM, but that was due to a spurious 0.5% increase in the automotive segment (even though the U.S. Commerce Department already told us two weeks ago that unit vehicle sales showed a near 5% slide) and a 6.9% bounce in building materials, which may be part and parcel of the flurry of housing activity ahead of the expiry of the federal tax credits,” he adds.

Both industy output and retail sales are classic signs that the recession in the U.S. ended last summer.

David Rosenberg agrees with that, but says the depression is ongoing and the reason is that real personal income, excluding handouts from the government, has barely budged.

“In fact, real organic personal income is nearly $500 billion lower now than it was at the peak 16 months ago and this has never occurred before coming out of any technical recession. It is a depression, as the chart below attests — that is the trend-line for real household incomes, until the government comes in to top them off with handouts, subsidies and extended jobless benefits. The share of U.S. personal income being derived from Uncle Sam’s generosity has risen above 18% for the first time ever.”

“Real consumer spending is up $200 billion over the past 16 months and everyone believes we have a sustainable recovery even though organic income is down almost $500 billion. Think about that for a second because once the stimulus wears off, and with a 10% deficit-to-GDP ratio and concerns surfacing everywhere about sovereign credit risks, there is little out there to support future growth in consumption.”

“Some are clinging to the notion that employment growth will accelerate. From our lens, once you remove all the assumptions the Bureau of Labor Statistics uses in its monthly data, there is little growth in the nonfarm payroll data. And, the Household survey is much too volatile and too small a sample size to rely on.”

Global Deflation

“Spain’s underlying inflation rate just turned negative in April for the first time since at least a quarter century and this is likely the thin edge of the wedge as we have yet to see the full brunt of fiscal austerity hit aggregate demand. Core consumer prices, which exclude energy and food, fell 0.1% from a year earlier from the miniscule +0.2% trend in March. All the deficit-challenged countries in the Eurozone, which technically means all of them since none come close to meeting the Maastricht budgetary targets, could be facing severe deflation pressure in the future based on the amount of slack in their economies,” the Gluskin Sheff chief economist writes.

Adding: “Ireland is already experiencing deflation, with nominal GDP falling faster than real GDP (both are down for two years straight but nominal is falling faster — nominal GDP was down by 11% in 2009, real down 7.5%). Not surprisingly, there is a lot of slack in the economy and the output gap stands at -7.1%, which suggests more deflationary pressures over the medium term. This problem is now widespread: Spain has an output gap of -5.3%, Portugal -3.6%, Italy -5.7% and Greece -4.6%.”

“Even with the recently announced austerity measures for Spain and Portugal, these countries may have trouble improving their fiscal ratios, if deflation sets in and GDP falls (as it has in Ireland). It’s otherwise known as the ‘catch 22’ — and the future of the Eurozone project, as it currently stands, is more in doubt than many are willing to believe at the current time. Either the Euro plunges or several of the EMU members will inevitably opt for their own currency of yesteryear to ease the deflationary pressure on their economies,” he concludes.

The Good News

If there is a bright spot, it is in the industrial sector, Rosenberg points out, and lists the following:

• The just-released U.S. industrial production data was strong, rising 0.8% MoM in April beating analysts’ expectations of a 0.6% increase. On a year-over-year basis, production is running at 5.2%, the strongest pace since mid-1997. Manufacturing is a bright spot with production jumping 1% MoM, matching the gain in March and is also up 6% YoY.

• Steel production is up 74% year-on-year.

• Lumber production has risen 29%.

• Automotive by 67%.

• Truck tonnage has risen 7.5% and container traffic out of Long Beach has surged 19%.

• Railway carloadings are up 14% over the past year. Some of this is related to global growth, some it to the lagged impact of U.S. dollar depreciation, and some of it related to the improved productivity position of U.S. manufacturers, which indeed seem to be enjoying somewhat of a renaissance (something we wrote about three years and should be on archive back at the old shop).

• The latest foreign trade data showed that U.S. exports of goods and services have exploded 20% YoY, as of March.

“So you see, the news is not all bad. The 20% of the economy related to exports and capital spending — the latter will benefit from the fact that capacity actually fell a record amount over the past two years and some of that surely has to be rebuilt and most pronounced in areas like transportation equipment, chemicals, plastics, industrial machinery — are certainly bright spots,” David Rosenberg writes.

Here’s a copy of today’s commentary: “Lunch With Dave”

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Why Optimists Are Wrong About The Euro Zone

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Albert Edwards: Europe On The Edge Of A Deflationary Precipice

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Why Optimists Are Wrong About The Euro Zone

I don’t there’s much disagreement on that the euro zone needs is a consolidation strategy based on growth, a credible fiscal adjustment plan and and a new and functioning system of economic governance. In face of the worst economic crisis in Europe since WW II, the most optimistic politicians believe that austerity programmes coupled with a weak euro will solve the problems. Well, they’re wrong.

“The Europeans are choking off the recovery before it has even started.“

Wolfgang Münchau

The consensus argument among European leaders at the moment is that fiscal indiscipline has caused the crisis. Austerity must therefore solve it. A weak euro and a global recovery would cushion the impact of austerity. In addition, the financial guarantees and the bans on short sales would see off the speculators. Voila! End of crisis.

Sounds pretty straight forward, right? Almost too good to be true.

And it probably is.

The optimists have not had a good crisis so far. According to Financial Times commentator, Wolfgang Münchau, this will not change.

Here’s why:

“First, fiscal adjustment programmes will be necessary eventually but European governments are currently repeating their age-old mistake of cutting spending and raising taxes well before the economy has recovered. In the US there is a debate about another stimulus package to ensure the recovery does not prematurely run of out steam. The Europeans are choking off the recovery before it has even started. The premature austerity programmes will ultimately impede debt reduction, as nominal growth remains very weak,” Münchau points out.

Furthermore, Italy and Spain will both need to accompany fiscal adjustment with structural reforms.

There are no such reforms on the horizon in Italy. Spain is about to decide a labor reform package.

But it will almost certainly not deal with the fundamental problem of a divided and extremely inflexible labor market.

Even in Germany, where domestic spending remains anemic, the government coalition is discussing a tax increase.

How Low Can You Go?

“Second, the euro’s exchange rate has indeed weakened, and may weaken further. But it will probably not do so sufficiently to solve southern Europe’s competitiveness problems. In Greece, for example, tourism is the main export industry. A slump of the euro against the dollar is not going to change the country’s relative competitive position against the euro zone nations of the Mediterranean Sea. It could improve competitiveness against Turkey and Croatia, for example, but only to the extent that the lira and kuna also revalue. For the euro exchange rate alone to do the heavy lifting in restoring southern European competitiveness, it would take a massive further depreciation – to about 60 or 80 US cents to the euro,” the FT Deutschland commentator writes.

Assume this were to happen, and then consider the overall effects:

The Organisation for Economic Co-operation and Development last week forecast that Germany’s current account surplus, which fell to 5 per cent of gross domestic product in 2009, would rise again to 7.2 per cent in 2011.

That forecast is based on current exchange rates. An extreme further fall in the euro would have two effects: it would increase Germany’s surplus even further, probably to well over 10 per cent of GDP, and thus increase internal imbalances within the euro zone.

It would also contribute to a deterioration of global imbalances, as the euro zone as a whole would turn a small current account deficit into a large surplus. Relying on the exchange rate would be the ultimate beggar-thy-neighbor policy.

Rescue Package Might Be Illegal

“Third, lingering doubts remain about the €750bn financial rescue package to help weaker euro zone countries. The German constitutional court has still to rule on the package and, while its rulings are difficult to predict, there are some legitimate reasons for concern,” Münchau says.

The Council invoked Article 122 of the treaty on the functioning of the European Union, under which financial assistance is allowed “where a Member State is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control.”

But it is not sure the court will accept the force majeure argument invoked by the European Council in deciding to permit the rescue package.

“I think there are legitimate doubts about whether the multiple policy failures that led to this crisis constitute an event beyond one’s control. I also fear the German justices will express misgivings about the European Central Bank’s decision this month to buy bonds,” Münchau writes.

Chasing Ghosts

“Fourth, the assumption that the crisis was caused, or triggered, by speculation, is not just legally dubious. It may also deflect from the overriding need to reform the euro zone governance framework. If you blame speculators, it may be an obvious policy response to ban short sales and penalize hedge funds rather than reform the framework. I therefore expect little substantive reform. At most there will be a souped-up stability pact, to be announced in another pompous press conference at the next European summit in June. Governments are already watering down the European Commission’s sensible, though not very ambitious, proposals. This means European governments are very likely to miss the opportunity to fix the problems in the long run,” Wolfgang Münchau concludes.

What the euro zone really needs is a consolidation strategy based on growth and a credible fiscal adjustment plan.

It needs to encourage domestic demand in northern Europe to facilitate the adjustment in the south. And it needs a new and functioning system of economic governance.

But instead, governments have chosen to chase speculators and to impress each other with austerity packages. They are thus contributing further to the euro zone’s increasingly probable though still distant disintegration.

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Spain Loses AAA Rating – Here's The Full Report

Fitch Ratings strips Spain of one its A’s by downgrading the country’s long term credit rating to AA+, from AAA.  Fitch anticipates that the economic adjustment process in Spain will be more difficult and prolonged than for other economies. Here’s the full rating report from Fitch.

“Fitch believes the Spanish government could find it hard to implement some of the expenditure cuts. In particular, the agency has some doubts over the feasibility of the cuts that need to be made by Spain’s autonomous communities.”

Fitch Ratings

“The downgrade reflects Fitch’s assessment that the process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium term,” the rating agency writes in its special report on the Spanish economy.

Fitch Ratings downgraded Spain’s Long‐Term Foreign‐ and Local‐Currency Issuer Default Ratings (IDRs) to ‘AA+’ from ‘AAA’ on 28 May 2010.

Despite these expectations, the Stable Outlook on Spain’s sovereign rating reflects Fitch’s view that the country’s credit profile will remain very strong and consistent with its ‘AA+’ rating, even in the event of some slippage relative to official fiscal targets, Fitch analysts says.

The Spanish government has announced an ambitious fiscal consolidation plan to ensure a return to sustainable public finances after the global financial crisis.

Fitch believes the Spanish government could find it hard to implement some of the expenditure cuts. In particular, the agency has some doubts over the feasibility of the cuts that need to be made by Spain’s autonomous communities, who may also see a reduction in the transfers they will receive from the state budget.

“Nevertheless, Fitch believes the risk that economic growth will fall short of the government’s projections is a more important consideration. The Spanish government is forecasting a sharp recovery in private consumption and investment. Fitch believes that Spain’s unemployment rate, the legacy of its construction boom, and its high level of indebtedness will weigh on private consumption and investment in the medium term.”

Consequently, Fitch is forecasting weaker growth for the Spanish economy in the medium term than the government is, although the agency’s projections on the contribution of net trade to growth in the medium term are slightly more optimistic than those of the government, the report says.

“Slightly” More Pessimistic

Anyway – the rating agency have trouble seeing how the Spanish government will be able to meet its growth projections for the next decade.

I’m not sure if I would call a difference in the  GDP projections of 1,2 – 1,3 percentage points (about 35%) for “slightly” lower, but that not the biggest issue here.

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Here’s a copy of the full rating report from Fitch.

Latest: U.S. stock market takes another beating after the news about the downgrade of Spain. Stocks currently down between 2,5 and 3,8 percent.

Check the U.S. markets live indicators at high5finance.

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