Oxstones Investment Club™With all the good economic news that has been coming out in the past two weeks one may question why we at the Daily Capitalist are bucking the opinions of the claque of conventional-wisdom economists. But now it appears that we have good company: Bridgewater Associates, one of the world’s largest hedge funds at $125 billion run by the very unconventional Ray Dalio, has also taken a dim view of 2012 and has come to conclusions almost identical to ours. More on that in a moment.
First let’s recap the recent data. Jobless claims for unemployment insurance have been going down, and have been under the stubborn 400,000 weekly level for eight of the last nine weeks:
Being a big fan of trends, this is positive. Overall, the unemployment rate remains very high, at 8.6%, but is slowly improving. We’ll see the next report on unemployment on Friday.
Auto sales were also good, coming in at a 10.3 million unit sales YoY (same as November) and the Big Three US manufacturers reported good years. From May of 2011, when sales bottomed at about 8.8 million units (post-Cash for Clunkers), there has been a steady gain.
Retail sales, according to Redbook (+4.9% YoY) and ICSC-Goldman (+4.9% YoY) was good, but December sales were listed as weaker than anticipated. More on this on Thursday when the monthly data come out.
The ISM manufacturing index for December also reported positively, up 1.2 percentage points over November, with the Index in the positive at 53.9%. The important new 0rders index increased for the third consecutive month of growth, up 0.9 percentage point from November to 57.6%. This followed a three month negative trend.
This is an important index which we follow closely. (There is a question about these data [below].)
The Census Bureau reported that:
New orders for manufactured durable goods in November increased $7.5 billion or 3.8 percent to $207.0 billion … This increase, up four of the last five months, followed a slight October increase. Excluding transportation, new orders increased 0.3 percent. Excluding defense, new orders increased 3.7 percent.
Today, the Census Bureau reported:
New orders for manufactured goods in November, up following two consecutive monthly decreases, increased $8.2 billion or 1.8 percent to $459.2 billion … This followed a 0.2 percent October decrease. Excluding transportation, new orders increased 0.3 percent.
Not a very strong trend; it has been consistently flat for almost two years.
The report on real estate construction was up slightly.
With all this happiness-in-numbers, why would Ray Dalio’s company strike a negative note for 2012? Here is what they say (this is from an interview with Bridgewater Associates’ co-chief investment officer, Robert Prince—underlining emphasis added):
Robert Prince, co-chief investment officer at Bridgewater, and his managers at the world’s biggest hedge fund firm are preparing for at least a decade of slow growth and high unemployment for the big developed economies. Mr. Prince describes those economies—the U.S. and Europe, in particular—as “zombies” and says they will remain that way until they work through their mountains of debt.
“What you have is a picture of broken economic systems that are operating on life support,” Mr. Prince says. “We’re in a secular deleveraging that will probably take 15 to 20 years to work through and we’re just four years in.”
In Europe, “the debt crisis is [a] long ways from over,” he says. The economic and financial morass will mean interest rates in the U.S. and Europe will essentially be locked at zero for years. …
But for longer-term investors looking out over the next decade, he says, equities may be a good buy. There is even money to be made in U.S. Treasurys, despite interest rates near record lows, and gold is likely to resume its climb as central banks print money to bolster their economies. Mr. Prince says. …
Recent better-than-expected news on the U.S. economy is unlikely to be the start of a healthy expansion, he says. The uptick in economic growth has been fueled by a decline in the savings rate, which, without material income and employment gains, is unlikely to be sustainable as long-term credit growth also remains weak, he says.
The problem for the U.S, says Mr. Prince, is that it is on the wrong side of a long-term debt cycle.
This should not be a revelation of readers of the Daily Capitalist since we’ve been beating this same drum for quite a while now.
I find Ray Dalio, Bridgewater’s founder, to be an interesting guy and I’ve posted that I believe he may be somewhat “Austrian” in thinking and analysis, even if doesn’t know it. The above interview is so close to Austrian thinking on this business cycle, that he could have been quoting us (no, I’m not so big-headed to suggest that he did or does).
Why would they come to this conclusion? I don’t know exactly, but I will tell you why we think that way, and discuss some recent data reports that belie the likelihood of a sustained growth trend.
Real disposable income has been declining-to-flat since October 2010:
The personal savings rate has been declining, now down to 3.5%:
This would suggest that any strength in consumer spending cannot be a lasting trend. Interestingly, Dave Rosenberg just addressed this issue (a point that we also have been making) in his newsletter. His states that since we’ve not had wage/disposable personal income growth, recent spending has come from consumer savings and lower gasoline prices (already gone back up), and job growth has been mainly in lower paying jobs that don’t replace the higher paying jobs in the financial industry lost post-Crash. He is exactly correct in this.
I don’t need to remind you of the continued decline in home prices which have been dropping since the government’s ill-fated Cash for Condos program petered out in April, 2010 (down at a 20% annual rate in the past four months). I don’t need to remind you of the consistent high levels of debt carried by consumers. I don’t need to remind you of the problems with commercial real estate—flat-to-declining prices, except in apartments.
Manufacturing has been strong, but I question whether or not it is a trend. If you look at the regional Fed reports, manufacturing is still weak: Richmond, Dallas, Kansas City, Chicago (up, but flat from prior month), New York and Philly (up, but still trending down or flat). Also the Census data on durable goods and manufacturing, cited above, has been largely flat. The Chicago Fed’s National Activity Index declined in November, and except for the summer boost, it declined for most of 2011.
How can this manufacturing weakness be explained in light of the positive ISM data (above)? A post on FT Alphaville, a blog on the Financial Times site (thank you DoctoRx), may have an answer. Both Nomura and Goldman Sachs have noted the divergence between the ISM data and that of the Fed’s data:
The bottom line is that they believe the non-seasonally adjusted ISM numbers are less accurate than the Fed’s seasonally adjusted numbers. Also Goldman suspects that the Crash and subsequent recession/depression may have affected the data as well. Both were putting their faith in the Fed’s data which were far less rosy that the ISM data. Such a conclusion fits more squarely with our view of manufacturing as well.
Another factor is corporate earnings. S&P 500 EPS data show that corporate profits are contracting at a 3.8% annual rate for Q4. This is the first sequential decline since the fourth quarter of 2008.
The above chart is for Q3 2011, not Q4, but the trend is significant. The important factor is the blue line which shows the YoY percentage change. While the level of profits are impressive, after-tax profits have been declining. Much of earnings have been from efficiencies in operations rather than expanding sales. However, the big multinational exporters have been strong and have benefited from a cheap dollar.
I do not need to add much to the issues mentioned by Bridgewater’s Mr. Prince. The level of debt is still high among consumers. The problem real estate loans, commercial and residential, on the books of lenders, especially the local and regional banks, still need to be resolved. Commercial Mortgage-Backed Securities delinquencies are at a 22 year high. And 22.5% of all US homes are underwater.
All of the issues mentioned by Mr. Prince are still largely unresolved, and I agree with him that we are probably years away from a sufficient deleveraging of debt encumbering malinvested projects, mainly because of various government roadblocks.
Then there is monetary stimulation. The Fed’s attempt to create price inflation has worked to an extent, with the CPI index up 3.4% YoY as of November, 2011. While it appears that prices may be starting to decline, especially at the producer level, all the Fed’s quantitative easing has had the effect of causing the consumption of capital, the very thing that is needed for an eventual economic recovery.
While it is too soon to call this a trend, prices may be declining. There are two reasons. With Europe and much of the rest of the world heading into recession, demand for commodities appears to be slacking, and prices are declining.
The second reason may be the reason why all prices may be declining and that is that it appears that money supply (True [Austrian] Money Supply) may be declining as well. This is because the impacts of QE II may be petering out. While it is too soon to call it a trend, the data in interesting:
This may sound ridiculous to many as we can see the post-Crash explosion of liquidity from the Fed. But the issue is: how much of that expansion has been truly inflationary? Remember that money has to reach to economy to be inflationary, and the best way to do that is through banks creating credit on the back of Fed created reserves. Presently, bank credit has not been expanding at a rate that would be inflationary in the Austrian sense. The only monetary expansion that has really impacted the economy is QE I and II, which, according to Michael Pollaro, are about 77% of the size of money expansion that led to our current boom and bust. Please see my article, “The Economy Is In Jeopardy, Part II” for a detailed discussion of this.
This monetary expansion could also explain much of the positive data we have been seeing and why it now appears to be stagnating: the effects of monetary steroids wear off. It also may explain why the s0-called “recovery” has produced so few jobs because the growth we have seen may be mostly malinvestment, or growth that only lasts as long as the money lasts and which is eventually found to lack economic reality.
It may also be the reason why Bridgewater believes, as do we, that the Fed will be forced to do QE3, which will cause a further devaluation of the dollar, will keep inflation on the positive side of the charts, will cause more capital destruction, and will allow smart investors to direct investments to Treasurys (US and elsewhere) and gold.
It’s a complicated world. But we are not crying alone in the wilderness.
Tags: consumer deleveraging, hedge fund, ISM, macro hedge fund, macro investing, macroeconomic indicators, Ray Dalio of Bridgewater Associates, savings rate, secular themes, secular trends, unemployment