CEO Economic Update

Can GM catch a break?

GM is faced with the lowest auto sales since the Great Depression, can't resell the vehicles getting pushed back to them via off-leases, is getting killed because of its exposure to housing in its 49% ownership of GMAC, and now the retail sector is hurting GM via GMAC.

As I wrote recently 5,000 stores are closing and the fallout touches companies as far flung as GM.  Here is the trail.  Boscov's Department Stores and their 50 or so stores just entered Ch. 11 and is closing 10 stores.  They owe GMAC $1.2 million. (see page 11) 

Now a million dollars isn't going to break GMAC or GM, but who knew GMAC had loans out to retail department stores?  How many other GMAC retail loans are out there?  We know 5,000 stores are failing, how many of them owe GMAC?

 

A recession can start with 2 positive quarters of GDP

Big Picture today and Merrill Lynch both remind us that this week will report GDP at a positive number, which sets up the question, can we really be in a recession with 2 quarters of GDP.

It is an important question because nearly everyone is expecting GDP to be about 2%, this is on top of the 1% for the first quarter.  So can we have a recession with 2 good quarters?

The answer is a resounding yes.

Not only can we have a recession with 2 back to back positive quarters, but for those with short memories, WE JUST HAD ONE.    In late July of 2001, the 2nd quarter data was released and it showed the following chart.  The first quarter of the recession had been 2% growth, it was revised to 1.3% by the time the 2nd quarter GDP was released.  But there you have it.  Just a mere 7 years ago we were in a recession and had 2 positive quarters of GDP.

And this data was persistent.  For another full year until July of 2002 these 2 quarters remained positive, yet NBER had announced the country was in recession.  

But why would we have positive growth during a recession?  Especially a recession that most likely started in December of 2007 or at latest January 2008.   So many possible ways to answer this but a fun analogy springs to mind.

An 18 year old named John is walking thru the mall with several bags in tow.  John has purchased $200 in merchandise, you the car dealer would like to sell John a car.  Do you use his obvious ability to purchase as your fundamental credit check?  That's one option.  The other is to ask him if he has a job or whether he just cashed his Christmas check from Aunt Millie.

Our current 2nd quarter is full of shopping bags (mostly food and gas) but it will go down labeled the Uncle Sam and Aunt Millie quarter.

Without Aunt Millie (or in this case Uncle Sam) the 2nd quarter would have been negative.  That still leaves us with one positive quarter.  But as we've already discussed the 2001 recession, the 1990 recession, the 1980 recession, and the 1973 recession all started with positive quarters. 

So although the stock market will swoon on Thursday, this is NORMAL behavior during a recession.   

U.S. Output rises by 0.5% in June

Right away I though "Wow, a good industrial output report, must have been a great month for exports".  Had that been true this news would have been solidly good news, end of story.  So I dug into the details of the report, and alas it's a headscratcher.

The basis of the strong output for June was made on a huge 0.7% gain in the consumer goods sector, and that soared as automotive products rose by 6.2% in June.  There was a resolution to the UAW strike at the end of May, so we should assume some pop in the auto sector.  But let's remember the larger picture.  Autos and Trucks are not selling and inventory is pilling up at historic rates.  In fact domestic production of trucks needs to be radically cut, not expanded.

Further into the details we get even more distressing news.  Auto production increased by 3% in June and Truck production increased by 9.8%.  This is madness.  Truck sales are down 35% from a few years ago, and truck inventory is sitting around GM, Ford, and Chrysler's neck like an anchor.

Just how bad is the inventory situation on a national scale.  From August of 2007 until May 2008 we have some startling data.  Retailers on the front lines haven't taken any additional inventory from wholesalers and manufacturers.  And why should they?  Their sales are slumping.

 

Wholesalers and Manufacturers continue to order away, and build up inventory waiting for some massive surge in final demand.  It's full steam ahead.  I've got news for them, it isn't coming, we are in a recession.  Regardless, wholesalers inventory is up over 7% in that timeframe, and manufacturers inventory is up 6%.  And with today's news it looks like June will provide another massive inventory add.  Paging Captain Smith... icebergs ahead.

63% of economists believe we are in a recession or about to enter one

The WSJ's excellent survey of economists just came out and more economists worry about a recession compared to a month ago.

I will have to track down which economists changed their minds, I certainly hope I don't have to add anyone to my hall of shame.

The big problem is in forecasting the 2q GDP growth rate.  Economists have been all over the map on this quarter and they are allowing wild forecasting swings in their predictions (a very bad thing), likely due to wild stock market changes. This vacillation is seeping into their judgment, and when that happens they violate the 4 rules of forecasting.  My Hall of Shame class has violated rules 1-3, and several are on track to break rule #4.

How bad has the forecasting gotten?  Take a look at a typical forecast quarter.  The 4th quarter of 2007.

Typically the consensus remains tightly bound until we get closer to having actual data, then consensus moves up or down.  In this example consensus moved 2% from 3% to 1%, a big move but not all that unusual.

Compare that to the current quarter, the 2nd quarter of 2008.  It breaks from normal in 3 ways.

1) No real consensus in the early forecasting.  Consensus quickly moves from 3% to 2%.

2) Very large change in the prediction.  From a high of 3% to a low of 0%.  I can't find another 3% change in consensus forecasting, it is very unusual.

3) Consensus changes direction !   This simply doesn't happen.  We start high, go low and then start moving higher.  A U shaped forecast for one quarter.  Consensus simply doesn't know where to place it's forecast.

Hard to see that chart, so here it is again.

This sort of whipsawing around is very upsetting for any economist.  It indicates the experts don't even have a solid opinion as to what is occurring.  It's one thing not to know, it's quite another not to have a consistent story.

 

 

Apparel store sales drop by 3% where's the stimulus checks?

For the 19 Apparel and teen apparel stores in today's same store sale report, their average sales dropped by 3.2% from a year ago.  That equaled a total drop of $342 million from a year ago. So much for the stimulus checks helping them out in June. 

So where did the stimulus checks go?

Primarily to gas stations and grocery stores, but also to discount stores as they focus on low prices and more importantly because they sell food.  The six discount stores in the report had sales increase by 4.9%, but even that is misleading.  Target saw an increase of 0.4% because they don't sell food, and the remaining 5 discounters all had sales increase by an average 5.5%.

Is that 5.5% average increase or the 5.8% increase at Wal-Mart something to get excited about?  I don't think so for several reasons. 

First, we know the spending is transitory.  Wages are barely increasing and not keeping up with inflation. The big income pop we saw in June was entirely due to the stimulus checks.  Once that goes away, spending will be tied to wage increases.

Second, consumers aren't actually purchasing more.  Food prices are up 5% over the last year, so the 5.5% gain we see at the (food selling) discount stores is merely reflecting the price difference, not additional units moving out the door.

Third, gas spending is up $5 billion a month over that of a year ago, that dwarfs the $2.7 billion increase in the discount stores and helps explain why the stimulus checks aren't making a bigger difference.

Some tough news for the economy today

I'm not sure what's worse, the employment report which was worse than expected, or prospects for the dollar.

Employment was bad news today with jobs falling by 62,000 (consensus was expecting 55,000) and with unemployment at 5.5% (consensus had penciled in 5.4%).  In retrospect the ADP survey failed us again.  ADP had employment dropping by -79,000.  BLS showed private employment fell by -91,000 and if that was the end of the story I'd say ADP did well, but BLS also lowered the 2 past months by -76,000.  So overall ADP was off by nearly 100,000.

The dollar might be worse. The European Central Bank decided that inflation was more of a concern and they lifted interest rates by 0.25% to 4.25%.  This puts additional pressure on the dollar as capital is expected to chase the higher ECB rate, and that in turn raises the price of oil and all our other imported goods.

Some good news in the employment report

Today's employment report was about as bad as it could have been. For one thing, unemployment hasn't jumped by a half percent in over 30 years. However, there were some indications the recession's end may be in sight.

This chart shows the percent of companies filling out the government's employment survey. The arrows perfectly chart the economies' growth spurts and periods of cooling off into recessions. Only one time in the last 17 years did this chart give a false reading, it suggested the cooling off in 1999 might be over and we'd be back to the races.  2000 was a good year but partially an anomaly as Y2K had companies rushing to purchase computers and equipment and once that was over the  economy continued it's slowdown and actually entered into a recession.  Right now we are seeing a pickup in 2008 survey responses as compared to 2007 and 2006 response rates. It's really good news and may indicate conditions are improving.  Out of the woods?  No, but heading in the right direction.

 

The second indicator showing a welcome development was two different private job surveys.  Both the ADP survey and the government's CES (payroll) survey showed upticks in the 3 month moving average. To be sure the more comprehensive government survey is still negative but less so than recently.

Unfortunately this immediate bit of good news was tempered as I looked back to prior recession periods. It does appear an uptick is a normal recession event as both the 2001 and 1990 recessions had initial job losses followed by a brief respit then followed by another leg down.  This could be happening yet again. 

 

 

The third bit of good news is from yet another employment survey the government's household or CPS survey.  The three month survey shows an uptick from 0.06% year over year growth in March to 0.12% in May.  The uptick is due to the monthly data which was negative in March for one month but has now been followed with two positive months of job additions.

Note the CES survey in this chart is slightly different from the one above as it includes government workers. 

 

 

 

 

 

The 4th data with a positive trend is the labor force participation rate.  In recessions as more are unemployed fewer are in the workforce, so typically this chart falls as conditions worsen.  Right now it is slightly up for the past few months.

 

 

 

 

I wasn't looking for good news as this months' report was so negative (stocks are down over 200 points) but was very surprised to find more than a couple of charts that showed an uptick.  We will most likely still get job losses in the months to follow, but perhaps the economy is finally heading in the right direction. 

Manufacturing finally cracks

On April 9th I said too much inventory will lead " eventually (to) bigger cuts in production

And on May 13 I wrote: (too much inventory means). There will have to be a sudden and sharp correction in imports and manufacturing, the only question is when .

It appears that when is today.

Two news stories show the manufacturing sector is finally realizing they've got too much inventory and retail sales are not turning around to bail them out. Both GM and Winnebago are shutting down production.

" GM said it will close four truck plants , make more small cars and consider selling its Hummer brand of large sport-utility vehicles. "

" Winnebago Industries Inc. will idle production at its Charles City, Iowa , manufacturing facility effective Aug. 1, citing a decrease in motor-home demand because of a weak U.S. economy, and rising fuel prices...

The $15 billion RV industry has been among the less-heralded casualties of the mortgage and housing crises, according to manufacturers and dealers. RV sales peaked in 2006 at about 390,000 vehicles, (dropped) 12% in 2007 (to 343,000, and) , the trade group expects sales to tumble 14% to about 305,000 vehicles this year, the lowest level since 2001."

GDP revised higher

GDP was revised up to 0.9%, not that much of a surprise as I thought back in late April that GDP would be first reported at 1%.  The reason for the higher GDP number was better news on business construction and much lower imports than first estimated.

There is some good news out of this new revision.

Inventory build did not occur, in fact inventory shrank in the first quarter, as I highlighted on May 13 noting that wholesale and retail inventory was shrinking. We still need manufacturing inventory to shrink as well, but there shouldn't be a big inventory swing in the 2nd quarter that would signficantly contribute to a negative GDP number.

Now for the bad news.

US imports were up 6% in both 2005 and 2006 helping to power GDP growth around the world as the American consumer snapped up foreign output. Increased foreign output and income (combined with a weak dollar) led to massive US exports, as they purchased our stuff in the following years in 2006 and 2007. Exports accelerated to 8% in both years. 

But now this cycle is working in reverse. The US only purchased 1.9% more in 2007, this sharp drop in demand means foreign output suffered a large decline. In 2008 its only gotten worse US import growth shrank in the last quarter of 2007 by 1%, and contracted by 3% in the first quarter.

The world is unable to sell to us, and thus they aren’t buying as much either.

US exports are slowing. Exports were up 19% in the middle of 2007, but had slowed to 6.5% by the end of 2007 and in the beginning of 2008 were only 2.8%.  The rest of the world is slowing down in lock step with the US, and our once hot export sector can no longer to be depended on. Exports in 2008 will likely be half what they were in 2007.   

5 years without computers

According to the BEA the entire U.S. did not purchase a single computer for 5 years during 1990 to early 1995.

Even more amazing, during those 5 years we destroyed $300 billion worth of computers. That's the entire amount we purchased from 1988 to 1989. So apparently by mid 1995 we were using some really old computers.  And if the average computer cost about $2,000 real purchases did not total the required $200 billion that it would have taken to outfit every employee with a new computer until 1998.

American businesses on the other hand don't agree. Their books show a $1.2 trillion discrepancy.  (That's $10,000 for every employed person in America) According to businesses, they spend over $900 billion in computer purchases during those 5 years.

So what's the government up to anyway?