Jul 31th

“Advance” 2Q09 Gross Domestic Product

Author: Kenn Lamson

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The Commerce Department reported that the “advance” estimate of second quarter real Gross Domestic Product fell 1.0%, on an annualized basis, from the first quarter of 2009. Today’ reading was marked by a continued downturn in business investment and housing construction, consumer spending and exports.  Economic growth in the first quarter of 2009 was even weaker than originally reported, with real GDP revised downward from -5.5% to -6.4%.

GDP has now fallen for four consecutive quarters, the longest streak on record. 

While today’s figure was better than economist’s consensus estimate of -1.5% and a substantial rebound from first quarter, the disappointment of the release was that consumer spending, which represents about 70% of US economic activity, resumed its decline for the third out of the last four quarters.   

The decline in investment in housing was smaller than last quarter, falling 29% annualized basis in 2Q09 versus 38% in 1Q09.  

The drop in business investment in inventories was also less pronounced than in 1Q09, which suggests that the period of inventory “de-stocking” may be coming to an end.  While de-stocking hampers the economy in the short run, it allows companies to resume a more normal pace of production in coming periods.

These declines were partially offset by international trade, which was a positive contributor to growth as exports declined less than imports. 

As noted, today’s release was the “advance” figure that is based in part on incomplete and estimated data.  As with each Commerce Department GDP estimate, today’s release is subject to two additional revisions, which are labeled as “revised” and “final”.

With today’s downward revision, 1Q09 appears to mark the bottom of this economic cycle. As noted in earlier commentaries Harmonic Investment Advisors recently revised its forecast higher to indicate that US economic growth will become positive by 4Q09, although economic growth for the full-year 2009 will be negative.  Consequently our tactical asset allocation, sector weights and security selection remain skewed towards defensive and high quality equities and fixed income investments, although we began earlier this year to tilt our models towards a more neutral position to take advantage of attractive valuations and an economic recovery, albeit one that will likely be slow and fitful.

Real GDP (quarterly data, annualized), white, left scale (%); Consumer Spending (quarterly data, annualized), red, right scale (%)

Real GDP (quarterly data, annualized), white, left scale (%); Consumer Spending (quarterly data, annualized), red, right scale (%)

Jul 30th

“Not Exactly the Picture of Health, but Recovering”

Author: Kenn Lamson

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One can literally get a picture of the global scope of the current recession with the help of a graph from Moody’s Economy.com.  Perhaps it comes as no surprise that most of the world for which data is available either fully in recession or at risk of becoming so. 

  

A few countries and regions are growing, including China, India and emerging Asia, but given the export-driven nature of their economies (not to mention the questionable sustainability of China’s nearly $600B stimulus) and relatively small portion of the global economy they represent, one must wonder whether they can be the engine that pulls the global economy back to positive growth.

 

On a more positive note, however, the consensus of economists surveyed by Bloomberg Finance LP expects the US economy to grow by around 2.0% in 2010, faster than almost any of the other G10 nations and regions such as the Euro area (+0.6%), Japan (+0.9%), and the UK (+0.8%).  Canada (+2.5%) is the only G10 country forecast to have higher growth in 2010.

 

 China is expected by these economists to enjoy 8.5% growth, but this seems ambitious (see below a link to an excellent article from “Foreign Policy” outlining concerns).

 

 http://www.foreignpolicy.com/articles/2009/07/23/the_china_bubbles_coming_but_not_the_one_you_think?page=full

 

Harmonic Investment Advisors expects a slow, fitful recovery of both the US and global economies as the accumulated leverage of the past 25 years is wound down and we adjust to a lower secular growth rate.  A primary driver of our expectation, as outlined in a recent letter to clients, is that we believe that consumers across the globe, particularly in developed countries like the US, are being forced to adjust to lower levels of consumption as they reduce their debt load in the face of falling home prices and rising unemployment.  There’s evidence that consumers are saving, rather than spending, their tax refunds and “savings” from the recent lower gasoline prices and otherwise adopting a frugality that we believe represents a paradigm shift in the main driver of the global economy.

 

global-recession1

 

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Jul 28th

Case-Shiller Home Price Index – May 2009

Author: Kenn Lamson

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Although house prices continued their slide in the May, as reported in today’s release of the S&P / Case-Shiller Home Price Index, the annual rate of decline has improved for the fourth straight month. The 20-city Index fell 17.1% from a year earlier, bringing national home prices back to levels seen in mid-2003. Average home prices are down 32.3% from their mid-2006 peak.
As noted, today’s release is the fourth consecutive monthly improvement in year-over-year levels, after 16 months straight months of declines that began in October 2007. Prices actually rose from April, by 0.5%. Also, seventeen of the 20 cities surveyed saw a deceleration in the year-over-year rate of decline which June suggest an inflection point in the housing market was reached earlier this year.
Harmonic Investment Advisors is pleased to note the recent deceleration in the rate of home price declines, but believes home prices are likely to continue to fall as the overhang of unsold homes appears to far outweigh the number of potential buyers. Reports indicate financial institutions may be hoarding properties or forestalling foreclosure to prevent an even larger glut of homes on the market. Further, the pool of potential buyers is negatively impacted by the increased tightening of credit available to fund purchases and by discomfort caused by declining investment market values and rising unemployment. Given that the home is the most valuable asset on most Americans’ personal balance sheet, declines in home prices reinforce the negative sentiment and increase the financial pressure that has contributed to this consumer-led recession.
However, HIA notes that falling home prices have begun to attract some buyers, as suggested by the recently reported increase in sales of existing and new homes. The upside of falling house prices is, of course, greater affordability for buyers, which ultimately will be a factor in slowing and reversing the economic downturn.

S&P / Case-Shiller 20-City Home Price Index - May 2009

S&P / Case-Shiller 20-city Home Price Index (January 2001 – May 2009)

Jul 23th

Harmonic Investment Advisors Change Growth Forecast

Author: Kenn Lamson

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Harmonic Investment Advisors is revising its forecast higher to indicate that US economic growth will become positive by 4Q09 (and possibly as early as this quarter).  While economic growth for the full-year 2009 will be negative, several respected sources suggest growth has rebounded faster than we expected and will be slightly positive later this year.

·         As noted in previous communications, the Index of Leading Economic Indicators has risen for three consecutive months. In the most recent survey, seven of 10 components rose, putting the year-over-year decline at 1.18%. The Index, which apparently bottomed in December 2008, has historically lead the trough in economic activity by an median of 7 months.

·         The Economic Cycles Research Institute, an independent organization known for its forecasting acumen, states that each of its three leading indices have turned higher and have satisfied the ECRI’s criteria for arguing that the recession will end this summer.

·         NYU-based economist Nouriel Roubini, a well-known “bear” and, like the ECRI, one of the few to identify ahead of time the current economic downturn, recently repeated his assertion that the recession will likely conclude by the end of this year.

 

Harmonic continues to believe that, despite the faster-than-expected rebound, growth will remain anemic as unemployment continues to rise and private leverage is flushed from the economy. Further, there is a substantial possibility that the US economy will relapse into a W-shaped recession as the impact of the bursts of fiscal and monetary stimulus fade and the pressure from budget deficits increases.

In light of the above forecast, Harmonic Investment Advisors believes US stock prices to be fairly valued to slightly expensive at present. We continue to expect that, while they may continue their recent surge on the back of the government stimulus, stock prices will at some point correct lower as market participants absorb the likelihood of the aforementioned W-shaped recession and long, tepid recovery. Harmonic has recently shifted the asset allocations of its clients’ portfolios incrementally towards a more “risk averse” stance, but is vigilant for the opportunity to become more aggressive when the economic forecast and valuations warrant.

 

Jul 22th

“Taking Away the Punchbowl”

Author: Kenn Lamson

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The most famous quote attributed to William McChesney Martin, Jr., the ninth and longest serving Federal Reserve Chairman, is that  the Fed’s job is to “take away the punchbowl just as the party gets going.” While the current round of economic stimulus might be more fairly characterized as life support for an ailing patient rather than a source of conviviality, its removal is of more than a little interest to observers and participants in the global economy.

 

Ben Bernanke’s Congressional testimony yesterday, and his Wall Street Journal op-ed piece, published the same day, outlined in some detail the strategies the FOMC may use to remove the stimulus it’s applied in hopes of avoiding a depressionary deflation.  Concern now among Keynesian economists like Bernanke (and most others who’ve taken an economics class since WW2) is that the massive monetary stimulus will cause a spike in inflation when economic recovery begins unless the stimulus is removed in an effective and timely manner.

 

Chairman Bernanke listed several tools in the Fed’s kit for removing unnecessary stimulus, including paying interest on reserve balances at the Fed, repurchase agreements, and selling of longer-term securities. In short, he seemed to be telling observers “don’t worry about it, we’ve got this covered.”

 

The Chairman did not, however, illuminate the timeline associated with those actions. While he stated that rates would stay low “for an extended period” (which accounted for yesterday’s bond market rally), it remains anybody’s guess when the Fed may begin to raise the Fed Funds rate and remove other “policy accommodations”.  

 

Asha Bangalore, economist at Northern Trust, notes two historical occurrences that will guide the Fed’s behavior: 1937, when rates were raised too soon and the US economy slipped back into recession, and 2003, when the Fed Funds rate was held at 1% for 12 months, putatively inflating the housing bubble that’s now catastrophically exploded.

 

Unfortunately, observers may have been reassured that Bernanke and his colleagues at the Fed (and ostensibly at other of the world’s central banks, many of which have enacted similar stimulative strategies) are on the lookout, but remain without specifics of how they’ll avoid the inflation “iceberg” before the economy crashes into it.

 

Additional commentary:

Financial Times: http://www.ft.com/cms/s/0/ffecdb42-7635-11de-9e59-00144feabdc0.html

NY Times: http://economix.blogs.nytimes.com/2009/07/21/looking-for-the-when-not-the-how-in-bernankes-exit-strategy/

Jul 20th

Index of Leading Economic Indicators – June 2009

Author: Kenn Lamson

Comments: 0

The Conference Board its Index of Leading Economic Indicators (LEI) rose 0.7% in June, somewhat better than a consensus expectation for a +0.5% reading and following a 1.3% increase in May.  Ken Goldstein, Economist at the Conference Board, stated “The recession has been losing steam since the spring, although very large job losses continue.  Nevertheless, confidence is slowly rebuilding.  Financial markets are less volatile.  Even the housing market is stabilizing.  If these trends continue, expect a slow recovery this autumn.”

Seven components rose, led by the interest rate spread (10-year Treasury yield less the Federal Funds rate), building permits and stock prices. These items were somewhat offset by negative readings from the other three components, led by money supply (M2).

Harmonic Investment Advisors believes that the LEI, which seeks to evaluate the economy’s likely performance 6 months in advance, has historically been a useful tool for forecasting US economic growth.  HIA’s principal’s skepticism regarding the pace of acceleration shown in the June LEI data proved to be well founded, but positively today’s release continued the upward trend of the past two months.

Harmonic integrates the information provided in this release into the macroeconomic models that drive its tactical asset allocation and economic sector weightings and will continue the shift to an incrementally more cyclical stance as the year progresses and when market valuations appear attractive.

 

Conference Board Index of Leading Economic Indicators

Conference Board Index of Leading Economic Indicators, June 04 - June 09; (vertical line indicates approximate official start of recession)

 

 

Jul 15th

Consumer Price Index – June 2009

Author: Kenn Lamson

Comments: 0

The U.S. Bureau of Labor Statistics reported this morning that the consumer price index (CPI) fell -1.4% from June 2008.  Today’s reading is the largest 12-month decline since January 1950. “Core” CPI, which excludes food and energy costs, climbed by 1.7% over the past year. The data indicates that while overall prices have fallen, when volatile food and energy costs are excluded the rate is comfortably within the range the Federal Reserve apparently prefers.  This fact reinforces the idea that the ongoing fiscal and monetary stimulus hasn’t yet ignited inflation.  It also suggests that severe deflation appears unlikely.

Month-over-month, the seasonally-adjusted “headline” CPI rose 0.7% in June and the monthly “core” rate of consumer inflation also rose 0.2%.  

As has frequently been the case in recent periods, the price of fuel was the primary cause of index fluctuation, with gasoline rising 17.3% during the month.  Housing costs, which comprise 40% of the Index, were unchanged in June.  Food and beverage costs rose by 0.1%, led higher by fruits and vegetables (+1.1%).  The costs of personal computers continued to decline during June (-1.1%).   

Harmonic Investment Advisors sees significant benefits resulting from the decline in consumer prices.  As suggested by the difference in “headline” and “core” inflation statistics, the overall decline in prices has primarily been due to falling energy and food costs, two of the least discretionary purchases that consumers make.  Reduced pressure on consumers’ budgets supports Harmonic’s stance that while the economy will remain sluggish over the coming months, the strengthening consumer balance sheet, in the form of higher savings, is key to stabilization in the economy and stock markets.

In its Large-cap Core, Smid-cap Core and All-cap Core US stock strategies, Harmonic stands at “neutral” in comparison to benchmarks with regard to the weight of stocks in the consumer discretionary sector.  HIA remains overweight energy stocks on the belief that the rising price of commodities will spur exploration for natural resources as economic weakness moderates.

 

Month-over-month (red) and year-over-year (white) “core” CPI

Month-over-month (red) and year-over-year (white) “core” CPI

 

 

 

Jul 11th

Economic Impact of Stimulus Spending

Author: Kenn Lamson

Comments: 0

Several periodicals, The Wall Street Journal and the Financial Times prominently among them, have featured recent op-ed pieces arguing for or against a follow-on stimulus package (the third in less than 12 months, by our count.) At the risk of becoming embroiled in the politically charged rhetoric, Harmonic would simply like to point out what we consider to be a salient fact: As of 22 May 09, only 10% of the stimulus funds authorized for 2009 ($36.7 billion of $379 billion) have been disbursed1. This figure represents a whopping 0.26% of the US economy, according to economist Paul Kasriel of Northern Trust.

Further, since much of the stimulus spending will take some amount of time to flow through the economy, and because the economic statistics we use to “take the temperature” of the economy are by definition backward-looking, an accurate assessment of the success or failure of the plan approved early this year may be months or even years away.

For the same reason an athlete doesn’t typically take more ibuprofen if the ache or pain isn’t alleviated a few minutes after the first dose, an “overdose” of fiscal and/or monetary stimulus could be a catastrophic thing; the US economy already faces high levels of potential inflation, and enormous deficits, in coming years.

Bottom line: There is simply not enough definitive evidence to evaluate the stimulus plans already in place. While a difficult prescription for those looking for work or financially stressed, patience is counseled.

1 Doug Elmendorf, Director, Congressional Budget Office

Author’s note: Additional information is available at Recovery.org and Recovery.gov.

Jul 02th

Humor from comedian Steven Wright

Author: Kenn Lamson

Comments: 0

Towards the end of what’s a Friday afternoon for many we’d like to share a few droll observations from one of our favorite comedians, Steven Wright.  Best wishes to everyone for a safe and enjoyable Independence Day weekend.

Here are some of Steven’s gems:

• Borrow money from pessimists – they don’t expect it back.

• Half the people you know are below average.

• 99% of lawyers give the rest a bad name.

• 82.7% of all statistics are made up on the spot.

• A clear conscience is usually the sign of a bad memory.

• If you want the rainbow, you got to put up with the rain.

• The early bird may get the worm, but the second mouse gets the cheese.

• I almost had a psychic girlfriend, … but she left me before we met.

• If everything seems to be going well, you have obviously overlooked something.

• When everything is coming your way, you’re in the wrong lane.

• Hard work pays off in the future; laziness pays off now.

• Eagles may soar, but weasels don’t get sucked into jet engines.

• If at first you don’t succeed, destroy all evidence that you tried.

• A conclusion is the place where you got tired of thinking.

• Experience is something you don’t get until just after you need it.

• To steal ideas from one person is plagiarism; to steal from many is research.

• Everyone has a photographic memory; some just don’t have film.

Jul 02th

Forced Real Estate Sales and House Prices

Author: Kenn Lamson

Comments: 0

The June issue of The NBER Digest, published by the National Bureau of Economic Research, contained an interesting article entitled Forced Sales and House Prices.  Given the relevance to the current real estate market, I thought it was worthy of passing along.

As most recognize, forced sales, particularly those caused by foreclosure, weigh on house prices for two reasons: First, these sales can create excess supply of houses in a given area. Second, there may be direct physical impacts such as property destruction prior to foreclosure.  Further, since home appraisals are in part based on comparable properties, and homeowners are typically more likely to default when they’re “underwater” on the value of their home, rising foreclosures can stimulate a negative spiral of home price declines and foreclosures.

The article’s authors calculate that, based on their survey of about 20 years of transactions in Massachusetts, houses sold after foreclosure sell for an average discount of 28%. Other categories of forced sales – death and bankruptcy – also generate discounts, 5% to 7% and 3% respectively.  Foreclosure discounts were found to be most pronounced for lower priced properties in lower priced zip codes, probably because lenders were willing to accept steeper discounts to reduce possible vandalism.

Finally, the authors attempted to quantify the spillover effect foreclosures have on the value of surrounding homes.  Their research suggests that foreclosures predict lower house prices for homes located <0.25 mile away, and particularly <0.1 mile.  They estimate that each foreclosure that occurs within 0.05 mile lowers the price of a given house by 1%.

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