After a series of relatively positive economic releases this month, and an as yet non-disastrous earnings season, a new consensus has begun to materialise. The new wisdom insists that the Q1 GDP and last week’s jobs report proved that recession fears were overblown, that the Fed is done cutting rates, that the credit crunch is over, and that the housing market is set for a recovery.
Wrong, wrong, wrong, wrong, and wrong again says Merrill Lynch. Merrill debunks these 5 economic “myths” and offers some of the most bearish commentary on the macro picture we’ve read in a while.
Myth No. 1: The GDP report shows no recession… Just because the economy technically “grew” in Q1 doesn’t mean that we’re out of the woods. Remember that a lot of this “growth” came from an expansion in inventories:
In our view, the folks that are relying on the “plus” sign in front of that first quarter 0.6% GDP number as a sign that we dodged the recession bullet, we believe, are not correctly interpreting the data. First, the really important attribute in the GDP data was the fact that for the first time in 17 years, real final domestic demand contracted (-0.4% at an annual rate). Such a decline happens basically 10% of the time – a 1-in-10 economic event that the markets are whistling by right now. Large swaths of GDP are contracting – consumer spending on durables and semi-durables, housing, nonresidential construction and capex. Not everything is going down – selected services such as health care and dollar-plays like exports are still hanging in.
Myth #2: The employment report was great, which means no recession… While it’s true that companies shed fewer jobs than economists had expected, much of this was offset by a reduction in working hours:
While companies did not cut as many positions as we expected, they cut the hours instead. The average work week plunged 0.3% (and, aggregate hours worked were down at an annual rate of 1% in the past three months), which, by the way, would be the equivalent of 400,000 job cuts. This is a sign that labour market conditions and domestic demand are far softer than the headline suggests. What drives consumer spending inevitably is income growth. Average weekly earnings fell 0.2% sequentially in April in what was the largest decline in two years. This dragged the year-on-year rate down to 3.1% from 3.3% in March, 3.7% in February and the nearby peak of 3.8% posted last November in what is clear disinflationary trend in wages.
Myth #3: The Fed is ready to raise rates again… While the fed is certainly ready to stop cutting, there is absolutely no indication that we’re anywhere near the point at which the Fed could even consider raising rates:
While the Fed did strongly hint that it will very likely go on hold for the next few months, the notion that the central bank is anywhere close to where the Fed futures contracts are in terms of making its next move a hike – not just one, but almost four tightenings through 2009 – should be laid to rest as the overall tilt was still toward providing monetary accommodation if there is to be next move at all.
Myth #4: The credit crunch is over… Not if you’re watching some of the anticipatory moves the Fed has been making with regard credit card ABS:
The real kicker is the Fed accepting credit card ABS – seemingly in response to the difficulty the banks are experiencing in terms of securitizing their card loans – and because of the nature of credit card ABS, old deals “return” to the balance sheet unless the related loans can be re-securitized. None of these banks can afford the capital hit (both balance and loan loss reserve related) of additional balance sheet loans – especially credit cards with 4%+ provisions.
Myth #5: The housing market is ready to recover… Not if you’re keeping track of housing inventories, which have gone from bad to worse:
The Census Bureau’s allinclusive inventory data were released for the first quarter and showed that the total number of single-family and condominium units that are vacant and for sale rose 4.5% or at a near-20% annual rate – for the second quarter in a row – to a record 2.277 million units. The ‘frictional’ or normalized level is closer to 1.2 million, so this represents a 1.3 million deviation from what is normal. At current sales rates, it would take almost two years to absorb that excess inventory backlog. Alternatively, single-family housing starts will have to slide a further 25% from their alreadydepressed levels and test their all-time lows of around 500,000 and stay there for a good four years. Either way, we are probably much further away from the bottom in starts and prices than is generally perceived – judging by the intractable unsold inventory backlog, the downturn could well last through to 2010.
So best leave that bottle of Dom Perignon in the fridge. While we’re not quite as pessimistic as Merrill is, we think the softness won’t be over for quite some time. Until then, be ready to grit your teeth and bear some pretty depressing news