The Trend is Your Friend? Hardly
The following is an excerpt from our 07 August Weekly Outlook #32
We show these housing trend statistics on the US as they are more or less indicative of the Anglo-Saxon countries and partially to places in the EU (Spain, France). This has implications for the world economy in our view.
• Sales of new single family home sales fell 3.0% during June to 1.131M (SAAR) and the prior month's increase was revised down sharply to just 0.5%. Consensus expectations had been for June sales of 1.17M.
• New home sales during the first six months of this year fell 10.9% from the first six months of 2005 and during June were 17.3% below the monthly peak last July.
• Sales in the Northeast were the weakest last month showing an 11.3% (-33.7% y/y) decline. Sales in the Midwest also fell, by 7.9% (-24.5% y/y) and sales in the South declined 6.0% (-5.2% y/y). Sales out West posted the only regional gain with an 8.2% increase but nevertheless were off 7.0% y/y.
• The number of new homes for sale advanced 0.7% m/m in June and rose 24.4% y/y.
• The median sales price of a new single family home fell for the third month in the last four. The 1.6% decline to $231,300 followed a 7.4% drop during May.
The reason it has implications is because the US consumer is and has been the consumer of last resort for the world's manufacturers and exporters in Asia and Europe. The talk of global imbalances is still correct. Europe is a continent in angst - people save, cut back, fear of losing their jobs and incredibly high energy prices. Both Europe and Asia have been reluctant to make the structural changes to their social systems and economies just as the USA politicians have not even begun to address the trillions in debt to their corporate and social systems - nobody is budging. They probably never will as long as foreigners continue to buy their debt via US Treasuries. But getting back to the story: all the talk of central banks raising rates and cutting off liquidity is only partially true, if at all. Sure, they are raising rates, but from negative territory of the past , i.e. if inflation is running at 2-3% officially in the Eurozone and 4-5% in the USA and the ECB and Fed are at 3% and 5.25% respectively, then who is kidding whom? The real interest rates are just about zero - i.e. not nearly so restrictive as the media keeps hashing out. But this may have its reasons. Bernanke and Trichet know that falling asset prices and restrictive monetary policy would likely have dire consequences for an interlinked and highly US-top-down world economy. So, even while central bank interest rates are rising worldwide and thus liquidity tightening, in retrospect, the tightening is not nearly so bad as many make it out to be, especially on the back of money supply figures which show the US and EU growing near 5% and 8% respectively → they are "tightening" on one end while throwing the switch on the printing presses to create more money. This is not really surprising as it has become simply a game of perception and illusion. The consumer and media perception is that CBs are tightening and that liquidity is drying up while in the background money supply figures are soaring. Trichet's "vigilance" is a good show just as is Bernanke's, but they know the real game and that game is to keep the inflationary tendencies running.
Via OEF: Despite the prospect of inflation remaining well above target for many months to come, the ECB appears - by its standards - to be remarkably relaxed on this issue. But inflation is set to remain above 2% until at least end-2007 and growth is at its highest since 2000. Should the ECB not be more aggressive? After all, real interest rates are barely positive, credit growth is accelerating and pipeline inflation pressures are building. Interest rates are heading higher, starting with the meeting on August 3, but with only two more 25 bp rises expected after that during the rest of 2006, the level of rates at the end of the year would be 3.5% - still accommodative. Just as its critics argued in the past that the ECB kept interest rates too high for too long, and suppressed activity in the process, is there a possibility that the ECB is too relaxed about prospects for inflation?
Real and historic interest rate tightening looks and feels different. We do not contend that the world economy may be slowing down but it may have less to do with purely interest rates than people think. Real wages (graphic on page 1) have been falling for 15 years in the Eurozone just as wages in the US lower end sectors have been. That is, we're all feeling poorer. On top of that is and was the dot.home euphoric bubble - ie. I'm richer via real-estate. No you're not, you may now be poorer because in this case buying something with money you did not have in the first place will not make you richer just because value perception changes. As is now happening, perception has changed against homeowners as witnessed by the US housing statistics above. Unfortunately real mortgages and ARMs don't disappear on value perception.
As to whether the world is headed for a recessionary or stagflationary outcome, we believe that is the case. How drastic that downturn could get, we don't know yet nor does anybody else. But the fear is rising. We do not at this point believe in a regional decoupling from the US economy for other parts of the world. The trade and interlinkage of economies has never been balanced and will not suddenly become balanced. This list below is what we surmise will bring down a global economy built on malinvestment and unwillingness to address structural economic issues :
whether restrictive or not, in the historical sense, rising interest rates withdraws spending power from consumers as mortgages rise and debt must be serviced in NOW dollars or euros
Wage rises do not look inflationary as offshore production can replace local production, if anything, wages are decelerating on the manufacturing end.
rising energy prices across the board not only withdraws spending power for obvious personal transportation and heating costs, but is inherent in everything built, processed or transported in getting to the consumer. Likewise, a "demand grab" for more energy resources will likely spiral prices higher as supply cannot keep up with the fear of losing out
Regions or countries like Asia and Europe which export large percentages to the US cannot smooth out export contraction amongst themselves. Structurally and consumer-wise these regions have not undertaken or undergone any measures to improve their local economies.
Likewise, appreciating currencies in Japan, Euroland and even China will result in higher costs to US consumers and strangle off trade as the Wal-Mart mentality of "cheaper is better" just when many US consumers may be financially strapped between stagnant wages and higher debt servicing costs.
Inversion of short and long term bonds : short @ 5.25% while the 10 yr bond @ 4.90% Historically this points to recession
ALL of THIS leads to contracting investment liquidity for the markets and releases a waterfall type perception of falling business and consumer confidence
Likewise, the ongoing geopolitical hotspots around the world look to grow only worse and this threatens commodity / resources as oil and energy tend to be in such geographic and politically unstable regions.
A proviso to the above is that should the USD weaken substantially further against other major currencies the Fed may be forced to step in and up rates to bolster the USD which of course has the adverse follow-on of making its own economy weaker from the consumption and debt-servicing sides.
To conclude, the Central Banks around the world are in a very ill-fitting predicament. Raise rates further and the consumer (a GDP driver) will suffer even more as debt servicing becomes untenable and withdraws liquidity. Keep pumping money into the system and risk the currency becoming unwanted by the markets or that foreign investors will durther diversify away from the "funny money" or bite the bullet and get set for a global recession. We believe that human psychology within the ruling political / elite class of taking the path of least resistance is likely -- Create more money and hold the interest rates to an acceptable, albeit justifiable, minimum; take no structural economic reform action, make no harmful fiscal policy reforms to sour voters, and finally, wait for the blow out. If ever there was a scenario to hold gold and other "stuff" then this seems to be it. The reason is simple : in a highly geared and intercoupled world economy, the first country or region to flinch and make such reforms loses because investment capital will exit and seek "better" fiscal environments - in essence, the world economy has nearly become an All or Nothing bet. The world has been on a "high" since the mid-1980s in terms of growth. The outlook for continued unabated world growth looks stretched at best and in our view, highly susceptible to a forthcoming contraction. We will continue to monitor key indicators.