A lot of people are pondering the next shoe to drop in the global economy. Most that I read are concerned primarily with the US economy, but that’s simple selection bias. There are many contenders, of course: residential real estate, commercial real estate, consumer spending, pensions, state governments, (US or European) banks, oil, private equity, a currency crisis, or some sort of problems with China. Let’s take an updated look at some of these.
Residential Real Estate
Residential Real Estate, aside from being one of the last shoes to drop, has two interesting votes for being the next shoe to drop. The first comes from an interesting post by Mark Hanson about the Mid to High (MTH) End Mortgage & Housing Market — A Slower Moving Train Wreck
One market segment that will not catch fire from anything being done is the mid-to-high end (MTH). This is where the next crisis is building right now. Only significant house price depreciation and sustained low rates can spur sustained sales in this market segment.
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[T]he MTH is a slower moving train wreck, which in the macro may be worse than the way Subprime imploded. Subprime borrowers who got wiped out a couple of years after getting their 2/28 are way down the de-levering road — renting a property and living within their means, which is when spending can begin again if they chose. At the end of the day, defaults and foreclosures across the MTH will be in the double digits with a respectable number in front, but stretched out over a longer period of time pressuring this housing and borrower segment for the duration.
Meridith Whitney also chimed in on this today. Watch the video. She predicts increased mortgage costs and another leg down in housing. She also hits on consumer credit, banks, state governments, and even the overvaluation of equities.
I haven’t been this bearish in a year… I look at the board and every single stock from Tiffany to Bank of America to Caterpillar is up, but there’s no fundamental rooting behind why these names are up, particularly in the consumer space… You haven’t seen this much consumer credit contraction ever… You didn’t see this amount of consumer credit contraction even in the Great Depression… All this said, I don’t know what’s going on in the market right now because it makes no sense to me… There’s no root in fundamentals.
On the plus side, she doesn’t think that commercial real estate is as big a problem as residential real estate.
Commercial Real Estate
Bernanke gave a speech at the Economic Club of New York On the Outlook for the Economy and Policy
While I am on the topic of bank lending, I would like to add a few words about commercial real estate (CRE). Demand for commercial property has dropped as the economy has weakened, leading to significant declines in property values, increased vacancy rates, and falling rents. These poor fundamentals have caused a sharp deterioration in the credit quality of CRE loans on banks’ books and of the loans that back commercial mortgage-backed securities (CMBS). Pressures may be particularly acute at smaller regional and community banks that entered the crisis with high concentrations of CRE loans. In response, banks have been reducing their exposure to these loans quite rapidly in recent months. Meanwhile, the market for securitizations backed by these loans remains all but closed. With nearly $500 billion of CRE loans scheduled to mature annually over the next few years, the performance of this sector depends critically on the ability of borrowers to refinance many of those loans. Especially if CMBS financing remains unavailable, banks will face the tough decision of whether to roll over maturing debt or to foreclose.
His speech also hit on the unemployment outlook (not very good, and hope rests upon productivity improvements reversing).
Pensions
The problems with pensions are just starting to be addressed. Some have noted that the pension problem may end up costing another $1 trillion. The post office just declared a $3.8 billion loss. Last year’s loss of $2.8 billion was largely attributed to their attempts to make up for their pension shortfalls ($5.6 billion). This year, it only amounted to $1.4 billion. The fact that the post office is probably the most fiscally responsible government establishment should give some idea how bad problems are elsewhere. Social Security still has rather optimistic forecasts built into its projections. For those keeping track, France is way ahead of the US on this. See France Shows Us Our Future: Longer Work, Shorter Retirement.
Private Equity
I actually haven’t heard a lot of people talking about this as the next shoe to drop, but a short article was linked to by Naked Capitalism today. The Coming Private Equity Default Crisis. The problem is roughly the same size as the sub-prime meltdown. About $1 trillion in debt must be rolled over by the companies owned by private equity. How long the refinancing window will stay open is anybody’s guess.
China
Ambrose Evans-Pritchard jumps on the Blame China bandwagon in China has now become the biggest risk to the world economy. For a slightly different take, see William L. Anderson’s post.
US Banks
FAS 166/167 both passed their activation date without another delay. I thought there would be more headlines about them, but I forgot the fact that the earliest they would have an impact would be January. That’s when banks will report their Q4 status. The accounting rules will force banks to bring previously off-balance sheet assets onto their balance sheets. This will involve roughly $450 billion in assets. That could force some banks (Citi) to recognize some big losses.
Conclusion
It’s not news that the economic recovery is rather fragile. Q3 GDP numbers will likely be revised down due to poor estimates on business inventories and the trade deficit. It’s unrealistic to assume that there won’t be stumbles on the path to recovery. Some of these stumbles will prevent a worse fall, but others may involve more than scraped knees. Further bailouts are guaranteed. A second large stimulus package is starting to be discussed in earnest. Unemployment will not fall back to 5% until after 2020 (though there’s a good chance a large fraction of the unemployed will no longer be counted in the official U-3 headlining rate by then).
If I had to guess at a precipitating event, I would look at either the junk bond yields or the dollar carry trade. Either the financing window will close and cause stocks to follow, causing credit to tighten and a time warp back to last year to occur, or something will reverse the dollar carry trade, and all other asset classes will collapse at the same time, ending with a similar feedback cycle. If I am right—and both the magic 8 ball and the Ouija board indicate I am—I will likely change my opinions toward inflation being the biggest threat to economic health. This would be fortunate, as inflation is a solvable problem.
So close. I know I said that because of the lack of hiring the celebration point for the new claims number should be dropped from 500k to 400k. The truth is that I would celebrate just a little when we drop below the 500k mark. I’ll also celebrate a little when the numbers improve year over year, even if we’re comparing to a time when the economy was hemorrhaging jobs. It is true, though, that the two biggest celebrations should be reserved for the weekly number coming in below 400k and the monthly number coming in positive (net job creation, now that’s worth celebrating). I suspect the two will be closely related.
This week’s Unemployment Insurance Weekly Claims Report has been released. Initial claims dropped to 502,000. This was toward the low end of the Bloomberg consensus range of 495k to 525k. Last week’s number was revised up 2,000 to 514,000. From the report:
In the week ending Nov. 7, the advance figure for seasonally adjusted initial claims was 502,000, a decrease of 12,000 from the previous week’s revised figure of 514,000. The 4-week moving average was 519,750, a decrease of 4,500 from the previous week’s revised average of 524,250.
The advance seasonally adjusted insured unemployment rate was 4.3 percent for the week ending Oct. 31, unchanged from the prior week’s unrevised rate of 4.4 percent.
The advance number for seasonally adjusted insured unemployment during the week ending Oct. 31 was 5,631,000, a decrease of 139,000 from the preceding week’s revised level of 5,770,000. The 4-week moving average was 5,790,750, a decrease of 100,750 from the preceding week’s revised average of 5,891,500.
The seasonally adjusted initial claims number is the important number for those tracking trends. The continuing claims number (insured unemployment number) hasn’t been very useful for either the adjusted or unadjusted version; the expiration of benefits is indistinguishable from new hires. The unadjusted initial claims number is also important because it tells us the number of actual people losing their jobs. This week, the number moved in the wrong direction:
The advance number of actual initial claims under state programs, unadjusted, totaled 529,446 in the week ending Nov. 7, an increase of 46,904 from the previous week. There were 539,787 initial claims in the comparable week in 2008.
The advance unadjusted insured unemployment rate was 3.8 percent during the week ending Oct. 31, an increase of 0.1 percentage point from the prior week. The advance unadjusted number for persons claiming UI benefits in state programs totaled 4,944,307, an increase of 10,863 from the preceding week. A year earlier, the rate was 2.6 percent and the volume was 3,460,633.
We’re now back at the point where the seasonal adjustment makes the new claims number look better than reality. This should be kept in mind when looking at reports. However, this doesn’t diminish the value of the seasonally adjusted number for helping to identify turning points.
The good / bad lists are looking a little better this week, but this might be because CA jumped from one extreme to the other. We needed the breather.
The good list (-1000 or more): CA, FL, GA, NY, NC, SC, KS
The bad list (+1000 or more): PR, MI, IL, WI
WI (the worst) was +1,501 vs CA (the best) at -6,752. Construction and manufacturing are responsible for both the respite in the good states and the renewed bleeding in the bad states. Construction, manufacturing, trade, and service will likely remain the most volatile industries for a while. They also are responsible for a significant chunk of total employment.
There was big news last week. The unemployment benefits extension was signed into law. Extended benefits trumps anything in this report. In about 4 months, expiring benefits will probably be another headlining issue. Until then, there really isn’t an issue that dominates the short term outlook for the unemployed. The truth is that there’s unlikely to be a major source of jobs before then, so an engine for jobs growth remains the most significant issue for the long term.
Fans of natural justice may have been cheered this week by a hedge fund performance snapshot from Lipper confirming that managers specialising in shorting have been suffering. Last year’s panto villains are this year’s charity cases, underperforming a dozen other strategies by a whopping 32 per cent in the first ten months.
I am continually amused at shorting being considered such a taboo. Sure the strategy generally relies on negativity, but if things are going into the shitter, wouldn’t you like the chance to profit from it instead of watching your retirement account erode to zero?
The E.U.’s statistics agency, Eurostat, reported that G.D.P. growth in the 16-member euro zone improved by 0.4 percent from the second quarter, following five consecutive quarters of contraction. Growth was still 4.1 percent lower than a year earlier.
The biggest problem with GDP as the main indicator of a recessionary period (and the emergence therefore) is that the trickle down effect neglects the job numbers. Which in my opinion is a far more interesting and indicative indicator: if companies are hiring, the effect on the economy is far stronger than simple GDP growth.
Analysts said the outlook for the major economies of the region remained patchy going into 2010, particularly because unemployment is still climbing and wages are stagnant.
Ah, see? The rub. If unemployment is continuing to climb and wages are stagnant, is the GDP growth a simple blip? Will GDP decrease as the unemployment numbers look bleaker and bleaker?
The other problem with looking at the Euro Zone is that, yes it is a basket of countries and that knife cuts both ways. A few strong economies can skew the numbers in one direction or another. While the net may be up, it may simply be localized to a handful of countries while the majority suffer economic stagflation/recession.
Our Chairman,
Who Art At Goldman,
Blankfein Be Thy Name.
The Rally’s Come. God’s Work Be Done
On Earth As There’s No Fear Of Correction.Give Us This Day Our Daily Gains,
And Bankrupt Our Competitors
As You Taught Lehman and Bear Their Lessons.
And Bring Us Not Under Indictment.
For Thine Is The Treasury,
The House And The Senate
Forever and Ever.Goldman.
