Supply Side Economics

The questions of the day are:

1. Are the supply side tax cuts responsible for this expansion since 2003?
2. Is the job market humming along nicely?

If one wants to credit supply side tax cuts for creating jobs and stimulating the economy it is a back handed compliment at best. We are currently in 6 years of expansion and job growth has been anemic at least as far as expansions go.



The above chart is from Jobs Picture with thanks to the EPI. The chart puts into perspective just how weak this recovery has been from the jobs side. Wages sure have not followed suit either as corporate profits soared.

The current boom is really more the result of an unwarranted slashing of interest rates to 1% in a panic move by Greenspan in the wake of a dotcom bubble bust followed by 911 but certainly tax cuts did not hurt.

For such massive stimulus we have little to show for it. Outsourcing continues unabated with losses of jobs to India and China, and gold and metals have been soaring as a result of our "spend and spend" implicit weak dollar policy. In aggregate all both really accomplished was a massive housing bubble with consumers going ever deeper in debt.

It is now payback time. The question is not whether we will have a recession but how severe that recession will be. For all this huge boom the supply siders are bragging about, many states are in a trouble with unfunded pension plans and falling tax revenues in the wake of a housing bust.

In Housing Slump Pinches States in Pocketbook The New York Times is reporting on tax shortfalls.

• In Florida tax revenue is projected to drop this year for the first time since the energy crisis of the 1970s.
• New Jersey could face a $2.5 billion shortfall by mid-2008, according to Governor Jon S. Corzine, and may lease its turnpike or its lottery to a private company to raise money.
• In California income tax receipts in January were $1 billion less than forecast.
• Maryland’s real estate transfer tax revenue has tumbled by 22 percent this fiscal year.
• Connecticut’s real estate transfer tax revenue, which state budget analysts predicted would fall by 3.6 percent, is down by 13.3 percent so far.
  

“It’s the year of the housing hangover,” said Sean M. Snaith, director of the Institute for Economic Competitiveness at the University of Central Florida.

So what's, the solution? More tax cuts? And that will stimulate exactly what? What is it that we need that will create more jobs? Houses? Home Depots? Nail Salons? Pizza Huts? Anything? Overcapacity is rampant everywhere. And to top it off outside of construction which is now waning, most of the jobs we did create were at the low end of the wage scale.

The two most telling indicators of the economy are the inverted yield curve and falling money supply as measured by an annual rate of change on the CPI adjusted monetary base. That combination has called 7 of 7 recessions since 1960 with no misses and no false positive as noted in Foolproof Recession Indicators.

According to research at the Northern Trust, close to 50% of the jobs in this recovery came directly or indirectly from housing. As residential construction expanded, retail stores of all sorts followed. But we are in the waning moments of that expansion with a dramatic drop in capital spending as noted in Capital Spending Myth and Reality.

While everyone says there will be no spillover there are signs of spillover everywhere including 2.1 million people who missed a housing payment last year. And we have not yet seen the full effect of mortgage rate ARMS resets that will occur later this year.

In retrospect it should be clear to everyone that what happened was a drunk induced orgy of unsustainable spending fueled by a massive carry trade and panic by the Greenspan Fed as opposed to some sort of supply side tax cut miracle. And sad to say we have so little to show for that boom except a massive hangover that is destined to get worse.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Waiting for the Blood to Rise

I have an unexpected email update this holiday weekend from Mike Morgan. This one is called "Waiting For The Blood To Continue To Rise”. Here goes from Mike Morgan:

!?

Mish Note:
Post removed. The reason it was unexpected is because it well not meant for publication. There was a misunderstanding. When I received that post I thought it was OK to post it. But Mike only wants me to post them if he specifically say so in his email to me because of paying clients.

Post removed and apologies offered to Mike Morgan and his clients
And a happy Easter to everyone.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

March Employment Numbers & Leading Indicators

The March 2007 Employment Numbers are in. Following are the results from the establishment survey.

In March, nonfarm payroll employment rose by 180,000 to 137.6 million, after seasonal adjustment. This increase followed gains of 162,000 in January and 113,000 in February (as revised). Over the year, total nonfarm employment rose by about 2.0 million. In March, construction employment rose sharply, following a large decline in the prior month. A sizable job gain also occurred in general merchandise stores in March, and job growth continued in health care and in food services. Manufacturing employment continued to trend down over the month.

Construction employment increased by 56,000 in March, mostly offsetting a decline of 61,000 in February. Unusually adverse weather likely contributed to February’s decline. Overall, the construction industry has shown no net growth since employment peaked in September 2006. Over this span, job gains in the nonresidential components of construction have been more than offset by losses in the residential components.

Within retail trade, employment in general merchandise stores rose by 36,000 in March and by 81,000 in the first quarter of this year. Despite the recent growth, employment in general merchandise stores was little changed over the year.

Elsewhere in retail trade, employment in building material and garden supply stores
has declined by 15,000 since reaching its peak in October 2006. Employment in health care continued to increase in March with a gain of 30,000; over the year, the
industry added 348,000 jobs. In March, offices of physicians and hospitals added 9,000 jobs each, while nursing and residential care facilities added 7,000. Food services and drinking places also continued to add jobs in March (+19,000). Over the year, employment in the industry grew by 335,000.

Professional and business services employment was essentially unchanged in March and over the first quarter of 2007. The industry added half a million jobs in 2006. In March, employment continued to expand in computer systems design and in management and technical consulting services, but those job gains were offset by small job losses in accounting and bookkeeping and in employment services.

Manufacturing employment continued to trend down over the month (-16,000), with declines in furniture and related products (-4,000), computer and electronic products (-4,000), textile mills (-2,000), and paper and paper products (-2,000).

This is actually a pretty good set of numbers. Yes construction rebounded mightily but the birth death/model added 128,000 jobs as shown in the following table.



As shown above the Leisure and Hospitality birth/death adjustment added 39,000 jobs and construction added 27,000 jobs (together over half the total). If one is looking for negatives in this report in isolation it would be the Leisure and Hospitality adjustment. Those are low paying jobs in general.

If one accepts the BLS's report in aggregate, with the construction numbers swinging wildly based based on the weather, then I suppose one should average the last two months of data. The revised February total of 113,000 added to the March total of 180,000 yields a two month total of 293,000 (a monthly average of 146,500). January came in at 162,000. Given that we need to create 150,000 jobs a month to keep up with population growth and immigration we are right on the break even mark.

That is probably a realistic way of looking at it, and to be fair I am willing to assume those 128,000 jobs added by the birth/death model do indeed exist, but I am also smoothing to a 3 month average so to speak because of the weather (again doing nothing more than accepting the report in total). On that basis here is the bottom line: The jobs numbers are not fantastic but they certainly are not weak.

If instead one wishes to look at this month in isolation this was a good, but by no means excessively strong set of numbers.

The Bear Case

I was asked earlier on my blog "What does this do to the bear case?" My answer is not much. As stated above, this was a good but not fantastic set of numbers. But remember that 2.1 million households missed a mortgage payment in the last quarter of 2006. People are clearly struggling in spite of low unemployment rates.

Look at the jobs we are creating. Yes construction (higher paying jobs) rebounded but much of the real growth is in leisure and hospitality, which are very low paying jobs. But that is just the jobs picture. One must also look at jobs data in context of other data, not in isolation.

Capital Spending

For the proper context one must consider Capital Spending Myth and Reality.

Business outlays for new equipment and facilities have slowed sharply over the past year. That's important because when businesses expand their operations they also add to their payrolls. Job growth over the past couple of years has been the primary support under consumer spending, so any sharp slowdown in capital spending would most likely have an even broader impact on consumers than the weakness in housing.

That was the lead paragraph on my recent blog on Capital Spending. One needs to look ahead to where the job growth will be coming from not only today but in the future. In context, those leisure and hospitality jobs added in March are likely the tail end of previous buildouts.

I have talked about this before but will bring it up again. There is simply no reason for businesses to expand in this environment. We do not need more cars, boats, nail salons, Pizza Huts, Walmarts, strip malls, Home Depots, etc etc etc. But given the lag between the slowdown in residential construction and commercial construction, in the context of falling capital spending, this is likely the last hurrah of hiring. Yes I have said this before but timing of this is next to impossible to call this on the nose. You either buy the theory or you do not.

The data in context says a slowdown is coming, even though jobs (a lagging indicator) in isolation may appear to indicate otherwise. In this case I would suggest paying attention to valid leading economic indicators. And as I have proven before in that link, the stock market is simply not a leading economic indicator in spite of what anyone says.

OECD Composite Indicators

The OECD released report on Composite Leading Indicators for Major OECD member countries on April 6, 2007.

The latest composite leading indicators (CLIs) suggest that some moderation in economic expansion lies ahead in the OECD area. February 2007 data show weakening performance in the CLI’s six month rate of change in most of the Major Seven economies. The spreads between short and long-term interest rates are contributing negatively to the performance of the CLIs in all the Major Seven economies, while business confidence is contributing positively in these same countries except Germany. The latest data for major OECD non-member economies point to strong expansion in China, moderating expansion in India and Brazil, but a weakening outlook for Russia.

The CLI for the OECD area was unchanged in February 2007 at 109.5, but its six-month rate of change shows a downward trend since March 2006.

The CLI for the United States decreased by 0.3 point in February with its six-month rate of change showing a downward trend since March 2006. The Euro area’s CLI was unchanged in February and its six-month rate of change has fallen since June 2006. In February 2007, the CLI for Japan fell by 0.1 point and its six-month rate of change has a downward trend since March 2006.

The CLI for the United Kingdom decreased by 0.1 point in February and its six-month rate of change shows a downward trend since May 2006. The CLI for Canada decreased by 0.3 point in February, and its six-month rate of change is also down over the last two months. For France the CLI rose by 0.2 point in February, but its six-month rate of change has a downward trend since December 2005. The CLI for Germany fell by 0.3 point in February and its six-month rate of change shows a downward trend since May 2006. For Italy the CLI decreased by 0.1 point in February and its six-month rate of change shows a downward trend since July 2006.

The CLI for China showed a strong 5.6 points rise in February 2007 and its six-month rate of change increased for the fifth consecutive month. The CLI for India remained unchanged in January 2007. Its six-month rate of change was down for the second month in a row. The CLI for Russia decreased by 0.1 point in February 2007, and its six-month rate of change shows a downward trend since April 2006. In February 2007, the CLI for Brazil decreased by 0.1 point and its six-month rate of change is also down over the last two months.

(click on chart for a better view)

Outside of Asia the leading indicators are anemic. That ties in well with the capital spending slowdown in the US. Here is the key question: Can Asia/Emerging Markets alone carry growth forward?

Short term the answer is no. Long term we are all dead. So what happens in between? In between I am still sticking to the theory that while the influence of the US is waning, it is still the most important economic powerhouse in the world although China/India growth is arguably the most important factor at the margin. Right now the US is still the dog, and China is still the tail. That role may change in the future but much of what China/India produces now still depends on the US consumer.

With US consumers are struggling to pay the bills in an economic expansion , with capital spending is on the wane, with services and manufacturing ISM numbers weakening, with leading economic indicators slowing worldwide, and given that jobs are a lagging indicator, there is a huge disconnect between the stock market an reality. How long that disconnect lasts is anyone's guess but those playing for stock market advances in the face of this reality are playing the Greater Fool's Game just as they did with with housing in the summer of 2005. All I can say to that is Good Luck.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

The Changing Business of Real Estate (Part 1)

Like it or not (and the NAR doesn't like it one bit) the business of buying and selling a home is changing. While a slowdown in home sales may be cyclical, changes in the nature of how people buy and sell homes is going to be permanent. These changes will dramatically affect the current real estate commission structure and who benefits.

I had the pleasure of talking to Joseph Fox, CEO of both BuySide Realty and its sister company IggysHouse about the nature of these changes. Let's take a look at each side of the transaction.

The Buy Side

In the typical relationship at present, a person finds a home with or without the help of a Realtor, makes an offer, and commissions on the sale are split between the buyer's agent and seller's agent.

Those commissions are usually in the 5-6% range. Historically the split has been 50-50 between the buyer's agent and seller's agent but given the current slowdown the buyer's agent now gets as much as 4% of 6% commission.

The question is "for what?"

Joe Fox said the percentages in Iggy's Facts come straight from the NAR. So if 64% of home buyers find a home without the help of an agent (24% online and the rest driving around neighborhoods or by other means), exactly why should a substantial commission be paid to some lucky real estate agent for essentially doing nothing but presenting an offer?

It is that very question that was the foundation for BuySide Realty. The idea came about when Mr. Fox and his brother Avi flew to California a couple years ago to look for a house. On arrival, a Realtor had them look through a bunch of online listings to see if they liked anything. "Why fly to California to look at images on a computer?" asked Fox. "Our trip was symptomatic of a totally broken business model". Joe Fox and his brother scrapped the idea of buying a house and spent the entire rest of the trip formulating the basis of BuySide Realty.

BuySide Realty operates on the principle that people who find the home they want to buy should get paid for their effort. So BuySide actually shares with the buyer 75% of the commission it receives. This commission sharing can be substantial. On a $500,000 home with a 6% commission spit equally, BuySide Realty would return $11,250 to the buyer of the house. If the commission was split 4% to the buyer's agent (not uncommon in this market) BuySide Realty would return $15,000 to the new home buyer. The largest rebate so far was $40,000.

In 2006, the average BuySide customer received over $11,000 that they otherwise would never see. BuySide keeps the other 25% for providing expert advice from the offer through the closing.

The current perception that BuySide is attempting to change, is that one needs substantial help from a Realtor to buy a house. Mr. Fox offered the following comment about those perceptions: "The NAR has done an excellent job of convincing the consumer they are too stupid to buy a house on their own accord even when their own facts show otherwise".

Just to see how the process works, I registered online and there are plenty of homes right in my own neighborhood to see. Unlike classified ads in places like CraigsList, the homes on BuySide Realty are the same ones you would see in any Realtor's office. BuySide Realty pays fees to the MLS for access to those lists.

Once you register you can print out a business card to hand to the agent at any open house you attend. BuySide will also arrange appointments on your behalf. That is the way to assure you that 75% of the seller's agent commission benefits you rather than unnecessarily padding the pockets of some random agent. Here is an image of the card for Illinois.



Another interesting fact about BuySide Realty's business model is that BuySide agents are paid a regular salary as opposed to the commission based structure in the NAR model. Furthermore the BuySide bonus structure is based entirely on customer satisfaction goals as opposed to sales price. Thus BuySide agents have no vested interest if someone buys a house for $200,000 or $750,000. Instead they have a vested interest in making sure their customer is completely satisfied. "We have had incredibly good feedback from customers" said Fox.

Contrast the BuySide model with the average real estate agent whose primary goal is to get you to buy his listing, listings with the highest commissions, and/or listings with the highest prices.

In the NAR model, given the enormous housing inventory glut, some sellers have resorted to upping already absurd commission rates. I have even seen this advice offered as a tip by Realtors in many articles. Of course those agents are then all too happy to show higher commission generating houses first. "This is just another symptom of a business model broken beyond repair." said Fox. "In contrast, our model is based on service, customer satisfaction, and trust".

The key word in that sentence is trust. How can there be any trust in a model where someone can hop to the front of the showing line simply because they are willing to offer the listing agent a higher commission? A home buyer in the existing NAR model always needs keep this fact in the back of their head at all times.

Another distinguishing feature of the BuySide model is pre-approval not just pre-qualification. Before scheduling a private showing on any listing in their system, a buyers must be pre-approved. If someone can not afford a house they want to look at, it simply will not be shown.

Currently BuySide is doing business in 5 states: Illinois, California, Florida, Virginia, and Georgia. A person in one of those states can save a lot of money by finding a house oneself. BuySide will be rolling out additional states soon and eventually plans to be in all 50 states.

For at least 64% of the population buying a home, there is simply no reason to fork over huge commissions to a real estate agent when that person can instead pocket those commissions himself. When Buyside expands to all 50 states, that is going to result in a big dent in the pockets of real estate agents as buyers flock to take advantage of BuySide's significant improvement over the current business model.

Consider the situation from the point of view of the NAR. Many real estate agents are already stressed over declining sales and falling prices. The rollout of BuySide Realty in all 50 states is going to significantly compound the problems those commission based agents are facing. In California alone one out of every 55 working age adults in California who is a real estate agent. Where are those next commission checks going to come from?

But the problems with the NAR model do not stop there. Tomorrow we will take a look at the sell side of the equation from BuySide's sister organization known as Iggys. I will have some final thoughts at that time as well. Stay tuned.

Note: This post originally appeared in Minyanville along with this announcement.

Minyanville is proud to introduce the newest professor to the mix, Mike Shedlock. Mike Shedlock, or Mish, is a registered investment advisor representative for SitkaPacific Capital Management, an asset management firm. Mish has his own blog called Mish’s Global Economic Trend Analysis, currently the 4th top rated economic blog in the country.

It's a distinct pleasure to be able to join Todd Harrison, the rest of the professors, and all of the critters (especially Sammy and Snapper) at Minyanville. The professors at Minyanville have helped me both personally and professionally. I hope to return that favor to others.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Spillover Scorecard

Bloomberg is reporting Services ISM Unexpectedly Slows.

U.S. service industries grew at the slowest pace in almost four years in March, leaving the economy more exposed to slumps in manufacturing and housing.

The Institute for Supply Management's index of non-manufacturing businesses including banks, builders and retailers slid to 52.4, lower than economists anticipated. Orders placed with American factories rose 1 percent in February, the Commerce Department said in Washington, also less than analysts predicted.

Services, which account for 90 percent of the economy and have propped up growth for the past year, are now being hurt by rising fuel costs and slowing sales.

FedEx Corp., the world's largest air-cargo carrier, is among service providers getting pinched. On March 21, the Memphis, Tennessee-based company reported its first quarterly profit decline in three years and cut its earnings forecast for this quarter citing slowing economic growth. The slowdown is hurting its Express parcel delivery and Freight trucking units.

The ISM index was forecast to rise to 55, according to the median estimate in a Bloomberg News survey of economists. Factory orders were forecast to increase 1.8 percent. Excluding transportation equipment, bookings fell 0.4 percent after a 2.5 decline the prior month.

Orders Slow, Prices Rise

The ISM's report showed the index of new orders fell to a seven-month low of 53.8 and a measure of prices paid rose to 63.3, the highest since August. The report also showed hiring cooled to an almost three-year low.

"Business sentiment is weakening," said Kevin Logan, senior market economist at Dresdner Kleinwort in New York. "Sales are slowing, and businesses are looking out and seeing that it's going to be harder to make money."

Monster Worldwide Inc., owner of the world's largest Internet job-listing site, said today first-quarter sales rose less than forecast as demand slowed in the U.S.

The slowdown in services last month confirmed a similar weakening in manufacturing. ISM's factory index, out earlier this week, showed activity slowed while raw-materials costs jumped, adding to concerns that a cooling economy is failing to damp inflation.

Once again we see the word "unexpected" and once again I can not figure out why. The better question is how is it holding up as good as it is?

German Industrial Production Declines

In Germany we see Industrial Production Probably Declined in February.

German industrial production probably declined in February for the first time in four months after export orders sagged early in the year, a survey of economists shows.

Production may have fallen a seasonally adjusted 0.5 percent from January, when it rose 1.9 percent, according to the median of 39 forecasts in a Bloomberg News survey. The Economy and Technology Ministry will release the figures at noon today.

Dyckerhoff AG, Germany's second-biggest cement maker, said March 28 it expects earnings this year to stagnate. Vossloh AG, Germany's largest supplier of concrete rail-track ties, aims to cut annual spending on production, purchasing and logistics by 25 million euros ($33 million) by next year.

Used car prices plummet in Canada

In Canada a Flood of used cars pours in from U.S.

Peter Pauls runs a small used-car dealership northeast of Winnipeg and rarely has his lot been more jammed with metal than in the past several months.

Cars and trucks have been piling into Canada's pre-owned market and into the hands of dealers like Mr. Pauls. And their prices have plunged as supply exceeds demand.

Mr. Pauls said he sold a handful of Pontiac Grand Am and Oldsmobile Alero cars before Christmas for between $12,900 and $14,100. That's half of their manufacturer's suggested retail price. All the cars were one year old.

"I'm still up to the rafters in inventory," he said yesterday. "I'm over-filled. Unless I've got a vehicle sold, I am still not buying anything."

Used-vehicle prices are a key leading indicator of overall vehicle demand and also a good proxy for the health of the overall economy, according to Bank of Nova Scotia. And their accelerated drop in recent months signals potential pain ahead.

The price drop began in Canada last summer and has worsened in recent months, Scotiabank said. It has spread to the United States, as slowing economic growth begins to dampen household purchasing power, the bank said.

Lower used-car prices hurt sales of new cars because consumers have less equity when they trade in their vehicles. That in turn means they're more likely to keep driving the vehicles they have instead of buying a new one.

"We think that this means new-vehicle sales should start coming under additional pressure in coming months," said Carlos Gomes, senior Scotiabank economist. Scotiabank forecasts automakers will sell 1.55 million new light vehicles in Canada in 2007, down from 1.61 million last year. The unexpectedly strong Canadian sales automakers have seen in the past four months are not sustainable, the bank said.

Building permits in Canada plunge

The big story in Canada is a plunge in building permits.

The value of Canadian building permits plunged from record highs to their lowest level in a year in February, but analysts were quick to caution against doomsday predictions of a sudden real estate collapse.

Statistics Canada reported on Wednesday a 22.4 percent tumble in permits due to a sharp decline in both residential and nonresidential permits.

The decline was more than three times the 6.5-percent drop forecast by analysts in a Reuters poll. The total value of permits was C$4.9 billion ($4.2 billion), 12 percent below the monthly average in 2006.

Building intentions in the residential sector fell 17.8 percent to C$3.0 billion, pulled down by a 34.4 percent plunge in permits for multifamily units. The biggest decline was in the province of Ontario but western Canadian provinces of Alberta and British Columbia, as well as Quebec in the central region also saw significant setbacks.

Analysts noted extremely cold temperatures in February, which might have impacted construction.

When things go bad blame the weather. I suggest this is the beginning of the end of the housing boom in Canada. Canada seems to be about 18 months or so behind the US and has a lot of catching up to do. It will be a painful process especially for recent buyers and trapped sellers, just as it played out in the US.

The Current Scorecard

1. Non-manufacturing ISM unexpectedly slows.
2. Capital spending is weak.
3. Sales of new single-family homes plunged to the lowest level in more than six years.
4. U.S. corporate profits fell in the fourth quarter of 2006.
5. Durable goods orders except transportation unexpectedly drop.
6. Monster job listing rose less than forecast.
7. Housing permits plunge in Canada.
8. Used car prices in Canada plunge.
9. Germany Industrial production declines.
10. The yield curve is inverted.
11. Base money supply and M' annual rate of growth is negative.
12. That combination of money supply and yield curve inversion has accurately predicted every single recession with no misses and no false positives since 1960.
13. 2.1 million homeowners missed a mortgage payment in the 4th quarter of 2006.
14. Foreclosures are rising.
15. Bankruptcies are rising.
16. Home prices are falling.
    
17. Jobs growth is anemic.
    
18. There will be no housing spillover.

All this talk of no spillover is rather interesting given that many items on that list might be considered proof of a spillover.

Nonetheless the International Monetary Fund headline du jour is World 'unlikely' to catch America's cold.

The economic slowdown in the United States is unlikely to spill over into the rest of the world as long as America's problems remain confined to its troubled housing market, the International Monetary Fund has concluded.

It said in its World Economic Outlook, published ahead of its annual meeting in Washington next week, that the rest of the world was well placed to "de-couple" from the US economy and sustain strong growth.

The IMF studied five recessions and two mid-cycle slowdowns since the 1970s. It found that synchronised slumps were associated with full-blown recessions like those in 1974-75, 1980-82 and 1991, rather than with intermediate growth pauses like those in 1986, 1995 and the current phase.

It also concluded that worldwide downturns were rarely caused by "spillovers" from US-specific problems like the sub-prime mortgage crisis but reflected global shocks like the quadrupling of the oil price in the 1970s or the bursting of the tech bubble in 2000.

So the IMF has concluded this is an "intermediate growth pause". I have news for the IMF. The spillover from housing is going to be far bigger than the spillover from the tech wreck. We are currently in the greatest monetary experiment in history with worldwide housing bubbles, derivative bubbles, stock market bubbles, and empire building bubbles (the US in Iraq). In fact we have bubbles within bubbles with the all encompassing bubble being the credit/debt bubble partially fueled by a mammoth YEN carry trade. The question is not whether or not there will be a mammoth spillover (there will be) but rather how fast and furious it will be once it gains some traction.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Capital Spending Myth and Reality

In what should be no surprise to readers of this column, BusinessWeek is talking about The real economic threat: Weak capital spending.

Business outlays for new equipment and facilities have slowed sharply over the past year. That's important because when businesses expand their operations they also add to their payrolls. Job growth over the past couple of years has been the primary support under consumer spending, so any sharp slowdown in capital spending would most likely have an even broader impact on consumers than the weakness in housing.

The odd feature of this weaker spending pattern is that it has occurred during a period when the fundamental drivers of business investment have been generally strong. Based on robust earnings and record profit margins, the prospective returns on new plants and equipment have been high, even as investment costs have been low. The cost of borrowing in the credit markets remains relatively cheap, and banks, on balance, have not tightened their lending standards for their corporate customers. Companies also sport exceptionally high levels of corporate cash and solid balance sheets.

THIS DISCONNECT between the ability and desire of companies to spend appears to reflect a sharp turn toward caution in the boardroom. Companies have been rocked by one uncertainty after another since 2000, including recession, corporate scandals, terrorist attacks, war, and a tripling of oil prices.

As for corporate confidence, one of the best indicators is businesses' willingness to plunk down money for new equipment, a trend that has gone south in recent months. Orders for capital goods, such as machinery and high-tech hardware (outside of defense items and commercial aircraft), fell 1.2% in February, the fourth decline in the past five months. The three-month moving average of orders, which gives a good reading of the trend, has dropped sharply after heading almost straight up for about two years. The longer companies keep their capital-spending plans on hold, the more vulnerable the economy will be to other downdrafts, such as any new surprises from the housing market.

THE CURRENT SLOWDOWN in capital spending is actually part of a longer-term hesitancy on the part of businesses to expand their plants and equipment. Throughout this five-year expansion, the growth in outlays has failed to match the pace of the 1990s expansion, even prior to the boom late in the decade.

For the past four years, the real, or inflation-adjusted, stock of equipment and software in place at nonfinancial corporations has generally not grown any faster than that sector's real gross domestic product, based on Federal Reserve data. That suggests the 4.4% growth rate in equipment outlays in 2006, the slowest in three years, has been insufficient to keep up with the rate at which old computers and machines are wearing out.

Companies aren't wary only about spending. They also seem unwilling to borrow for anything other than financing stock buybacks and taking their businesses private. Recent Fed data show that nonfinancial corporations last year, on net, retired a record $602.1 billion in equity. In the fourth quarter alone, they set aside $701.2 billion, measured at an annual rate, far more than the additional $604.6 billion they borrowed in the credit markets. Companies seem interested in cutting their overall cost of capital, but they don't seem very hot on taking advantage of cheaper capital to invest in expanding their operations.

THE ANSWER TO THIS PARADOX goes back to corporate prudence, and the heavy demands investors have placed on companies to perform. Capital-spending decisions depend most crucially on prospects for demand, which has slowed in recent quarters, with little to suggest a pickup. Recent news that sales of new single-family homes plunged to the lowest level in more than six years, along with new evidence of falling house prices, only reinforces the perception that demand is softening.

There is no paradox about falling capital spending nor is there a disconnect except in the minds of proponents of the Goldilocks theory. It is and remains complete silliness to expect businesses to expand in the face of rising defaults, rising bankruptcies, and decreased needs for all kinds of durable goods associated with home purchases. Nonetheless that is what nearly everyone seemed to believe.

Lower earnings, Less Capital Spending, Less Hiring

MarketWatch is reporting Lower earnings could cut into capital spending, hiring.

U.S. corporate profits fell in the fourth quarter of 2006, signaling the end of one of the greatest profit cycles in post-war era, economists say. Economic growth is slowing, hurting corporations' top line. Meanwhile, costs are rising, squeezing profit margins.

"Profits growth has turned decisively down, and the end is not yet in sight," wrote Gabriel Stein, an economist for Lombard Street Research.

"As the expansion matures and unit labor costs rise, profit margins will be under pressure," said Stephen Stanley, chief economist for RBS Greenwich Capital.

"The deceleration of profits may be dramatic," wrote Mickey Levy, chief economist for Bank of America, in a research note. "If so, weaker profit growth may affect business hiring and capital spending decisions, and will likely influence financial markets." "Weaker profits may undercut any rebound in capital spending," Levy said.

Although corporations are sitting on a mountain of undistributed profits, their spending plans are based on future returns compared with the cost of capital. Money doesn't burn a hole in a chief financial officer's pocket as it can with a consumer. Corporations have been returning much of their profits to shareholders through dividends and share buybacks, rather than investing in expanding production.

Awful Data

The grim reality is that excluding transportation durable goods orders fell 0.1% in February.

"Awful data," concluded Ian Shepherdson, chief U.S. economist for High Frequency Economics, in an email.

The outlook for capital spending and economic growth "is at risk," wrote Drew Matus, an economist for Lehman Bros.

The figures "inflicted a sharp blow" on the outlook for U.S. gross domestic product growth, wrote Mike Englund, chief economist for Action Economics, in an email. He now expects growth of 1.6% in the first quarter and 2.8% in the second quarter.

The rise in orders for durable goods was mostly powered by an 88.4% increase in orders for non-defense aircraft, eclipsing a big drop of 60.4% in January. Economists surveyed by MarketWatch had been expecting durable-goods orders to rise by 3.8% in February after falling by a revised 9.3% in January.

Shipments of durable goods overall fell by 0.8% in February.
Inventories rose 0.2% in February. The inventory-to-shipments ratio rose to 1.44, the highest since August 2003.

While not addressing February's report specifically, Federal Reserve Chairman Ben Bernanke noted a greater softening in the demand for capital goods than would be expected at this stage of the business cycle.

In testimony on Capitol Hill, he expressed optimism that business investment would "grow at a moderate pace this year."

Bernanke's Testimony

Picking up on the Capital Hill testimony theme let's tune in to Bernanke's economic outlook before the Joint Economic Committee, U.S. Congress March 28, 2007. Here are some highlights from that testimony:

• Economic growth in the United States has slowed in recent quarters.
• The inventory of unsold homes has risen to levels well above recent historical norms
• Weakness in residential construction is likely to remain a drag on economic growth for a time as homebuilders try to reduce their inventories of unsold homes to more normal levels.
• Business spending has also slowed recently. Expenditures on capital equipment declined in the fourth quarter of 2006 and early this year.
• The magnitude of the slowdown has been somewhat greater than would be expected given the normal evolution of the business cycle.
• Despite the recent weak readings, we expect business investment in equipment and software to grow at a moderate pace this year, supported by high rates of profitability, strong business balance sheets, relatively low interest rates and credit spreads, and continued expansion of output and sales.
• Investment in nonresidential structures (such as office buildings, factories, and retail space) should also continue to expand, although not at the unusually rapid pace of 2006.
• Thus far, the weakness in housing and in some parts of manufacturing does not appear to have spilled over to any significant extent to other sectors of the economy.
• The continuing increases in employment, together with some pickup in real wages, have helped sustain consumer spending, which increased at a brisk pace during the second half of last year and has continued to be well maintained so far this year. Growth in consumer spending should continue to support the economic expansion in coming quarters.
• Overall, the economy appears likely to continue to expand at a moderate pace over coming quarters. As the inventory of unsold new homes is worked off, the drag from residential investment should wane. Consumer spending appears solid, and business investment seems likely to post moderate gains.
• Core inflation, which is a better measure of the underlying inflation trend than overall inflation, seems likely to moderate gradually over time.
• Although core inflation seems likely to moderate gradually over time, the risks to this forecast are to the upside.
• The rate of resource utilization is high, as can be seen most clearly in the tightness of the labor market.
  
• Anecdotal reports suggest that businesses are having difficulty recruiting well-qualified workers in a range of occupations.

Those interested can click here for a video of Bernanke's Testimony.

If inflation risks are to the upside then why did he remove the statement about additional firming being required from the latest FOMC statement? Answer: He is spooked more than he is letting on about the risks of a continued housing implosion.

When it comes to jobs are we now down to "anecdotal reports that businesses are having difficulty recruiting well-qualified workers in a range of occupations"? What about anecdotal reports about The Disposable Workforce? That last jobs report was anemic, with fewer than 100,000 jobs created and 39% of those were government jobs.

With so many homeowners missing payments exactly why should "Growth in consumer spending should continue to support the economic expansion in coming quarters."? What about Hot Lines for Hard Times and 2.1 million homeowners who are struggling so much that they missed a home payment in the 4th quarter?

It is pretty tough to swallow the idea of strong consumer spending line in the face of 2.1 million homeowner delinquencies. And what about those rising inventories in both housing and durable goods? What about the effect of interest rate resets the bulk of which have not yet hit?

If someone is looking for a major disconnect here it is: Bernanke is expecting growth in consumer spending in the face of a housing bust, a slowdown in capital spending, rising defaults and massive interest rate resets that will culminate in later this year.

Unlike Greenspan's typical Congressional testimony, one can actually understand every single word Bernanke said. Unfortunately we have traded Greenspan's incomprehensible gibberish for Bernanke's comprehensible doublespeak. That doublespeak allows Bernanke to sit in his ever tightening box pretending that these economic problems will go away, there will not be a housing spillover, capital spending will rise, and consumers will not throw in the towel. He is wrong on all accounts.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

No Spillover - No Contagion - Not

The following post is an update from Mike Morgan. Since he has now has paid clients, updates from Mike will be somewhat more sporadic. I am not able not post everything he sends me. There are also a few details from our conversation today that I can not release. But here goes with his latest weekly update that he calls No Spillover - No Contagion - Not.

Quote of the Week – “The Homebuilders are Toxic – Boo Yaa” – Jim Cramer - I wonder if he hurt his back on this flip-flop. Maybe he sprained his jaw. This is the only scary news on housing for the shorts. When the mouth goes south, the stocks might just go the other way. This is the same guy that not only told me I was NUTS, but then went on his show and read parts of one of my emails to him, and ridiculed my comments. Needless to say he’s on my email block list now.

Back-Up Quote of the Week from Someone That Matters – “This is just horrific.” Ian Shepherdson, chief U.S. economist at High Frequency Economics in response to the numbers this week.

Market Conditions – Easter comes early this year, so the snowbirds in Florida are leaving early . . . cutting our “selling season” short. I’m still not sure I saw the selling season. I guess I blinked. I’m hearing the same things from California, Arizona, Nevada, Northern Virginia, and unlikely spots like New Jersey, Pennsylvania, and South Carolina

Beazer – The law firm that filed this lawsuit was one of the four firms on my original legal team representing me against Lennar. The Jackson Law Group also has a 6000 home class action moving forward against Ryland. Very sharp guy, and he spent the last few days in Nevada speaking with attorneys to form a national coalition of attorneys to address construction defects and predatory lending practices.

I have been in touch with several of these firms, and I am now gathering information for mortgage problems regarding Lennar’s UAMC mortgage division. We have Sponsored Links up on Google. You can see them by doing a Google search for UAMC or any combination of UAMC, Lennar etc.

I spoke with a law firm on Friday that has been investigating Lennar for RESPA violations. I will be meeting with them this coming week. The most interesting response we have received to date, is from a former UAMC employee that basically spelled out exactly what the problems are. Consider Beazer built about 18,000 homes at its peak, and Lennar built 49,000. It’s easy to see which direction the sharks will be swimming. And Beazer did not own a mortgage division like Lennar’s UAMC. Stay tuned.

WCI – Still the most frequently asked question I receive. NO, there is no hidden value. YES, there are problems with the closings of Singer Island and Lesina. Not as much at Singer Island, because buyers think Startwood’s Luxury Collection hotel is going to make them as wealthy as Barry Sternlicht. I worked for Starwood. I can tell you, you don’t get rich owning condo/hotels or vacation ownership interests. After the fees and the fees and the fees, and the short season at Singer Island, the owners will be scrambling for the door in a year. But WCI should have a decent closing rate there. The only question will be the flippers that bought other units in Mosaic, etc. and they are still stuck. So they will not be able to close at Singer Island. Moreover, mortgage requirements are getting tougher, so some of those buyers will not be able to close.

Still no word on hard numbers at Singer Island or Lesina. Not sure why anyone would close at Lesina, when you can buy a comparable unit for significantly less on the resale market. But there is a sucker born every minute, and some people have no idea what they have bought. They are relying on brokers trying to protect their commission when it comes to closing advice. As for Icahn, all I have heard are rumors that he is looking for the back door. In full disclosure, I own some short term puts on WCI.

TOA – Rumors again, but the word is they cannot continue as a going concern and they are going to sell what’s left. Unfortunately, I don’t think all of the damage control has been made public. We visited one local Engle office and it was closed. Another Engle office is struggling to control cans by selling the cans. Not working very well, and they are not making any new sales.

California – The poster child here is BHS. 65% entrenched in California. My advice to them is sell it all and put it on red. Much better odds. But the wild card is whether Ian’s brother bails him out. Ian’s brother is Brookfield Asset Management.

I’ve seen some of the high priced research reports from the guys that claim to have hundreds of people driving around counting lock boxes, for sale signs and watching traffic in and out of offices. These same guys rely on a lot of data direct from the builders. Well, NAR had David Liar (Lereah) and the mortgage industry has LIAR loans (no docs) and if you think we can trust the builders to tell us what is really going on, you need to move your business to Kim and Oppenheim, then drink some of Bob’s Kool-Aid.

With that said, here are some numbers. Inland Empire sales down 50%+ with a 15%+ increase in the number of projects. San Diego sales down almost 40% with a staggering 45% increase in the number of projects. These are horrible numbers, but ground zero reports are much worse.
On the ground, from speaking with real estate agents and brokers, I am hearing a different story than the bedtime stories Kim is reading.

1 – Too much inventory.
2 – Not enough buyers.
3 – Buyers that can’t qualify.
4 – Desperate sellers dropping prices.
5 - #4 adds to #1
6 – Sellers that can’t sell existing homes.
7 - #6 adds to #3
8 – Did I already say, too much inventory.
9 – Buyers waiting for the bottom.
10 – Rising foreclosures hitting the market.
11 - #10 adds to #1
12 – Flipper inventory coming on the market.
13 - #12 adds to #1

That’s the Baker’s Dozen, although some of the expensive research reports I have seen paint a rosy picture. Since that data comes from builders and is purchased by builders, I’m not sure it is the kind of color you want.

Mortgage Financing – One word – Ugly.

I hope you all know how ugly the residential end is, and how ugly it is going to get. But maybe a few of you have not seen this FDCI graphic for construction and development loans.

“And that’s all I have to say about that.” Forrest Gump

Well, maybe one more comment. The FDIC does not break out residential and commercial. So the numbers you are looking at are much worse for the residential guys, because the commercial guys are not in trouble yet.



I love graphics. Maybe someone made a mistake with the tail on this one. NOT. It’s from the Fed and as you can see, even when all of us at ground zero knew we were in trouble, the Fed loosened lending standards in late 05. It was not until these issues hit the media, that the Fed decided to do something. Better late than never? In this case . . . way too late.

So now we are overdoing it and people that should qualify, can no longer qualify. The FED is not done. Last week we had a residential client that qualified. This week they don’t.

Liar Loans – These are no doc loans with stated income. That means you can tell them anything you want. Case on point from The Economist: “In 2006 the 24 year old web designer from Sacremento bought seven (not a misprint – 7) houses in five months. He lied about his income on “no document” loans and was not asked for anything so old fashioned as a deposit. Today Mr. Serin has debts of $2.2M (that’s million). Three of his houses have been repossessed; others could (read – will) share the same fate.” Parenthetical (pathetic) commentary added.

If you think this is isolated, call me. I’ll put you in touch with as many people you want to talk to that are in the same boat. Not Ara Hovnanian’s boat with a slow rising keel, but one of those boats you see fishing for crab in the Bering Sea being crushed by ice as it sinks and all hands die.

ARMS Resetting – 60% of all adjustable rate loans made since 2004 will reset this year with payments 25% higher. So the guy paying $1,800 a month for his mortgage will now be paying $2,250+. And 20% of these loans will reset at payments 50% higher - $1,800 becomes $2,700+. I’m not an economist, but that tells me a lot of money is going to be sucked out of the general economy. The sucking sound from Mexico will sound like a whisper a year from now.

Inventory and Sales – Inventory UP – Sales DOWN – I’m trying to keep this report tuned into simple colors – Black and White. I know you all want lots of color, but trust me, you don’t need it.

Okay, so this graph is in color. Once again, forget about the 7 months number. There are some new dynamics today. One, many builders and MLS boards have decided NOT to report numbers because the numbers are so bad. Example – Naples, Florida. Two, we have a ton of flipper inventory that is NEW but either not on the market or is rented out in hopes of things “turning on a dime.”

This NEW home inventory that was simply moved from the builders book to the flippers. Future Color – Add to these numbers the huge inventory of spec homes the builders are NOT building.

Inventory of unsold homes rose to 8.1 months, the largest number in 16 years . . . at the tail end of the recession. Are you still with me? We’re just entering out recession. Here’s another tidbit from Rex Nutting at MarketWatch – “Inventories are probably understated, however, because they don’t include homes thrown back on the market due to buyer cancellations.”
Backlogs (Supply Side) are up almost 50% from a year ago to more than 180,000 homes, while sales (Demand Side) were just revised down to an 848,000 annual rate. Moreover, January and February were “revised” downward. Liar Loans, David Liar and Liar Liar – Alan Greenspan, who cut down the cherry tree and didn’t tell Ben.

Foreclosures – Forget about the “S” word. The “F” word will be far worse. I’ve heard all the same numbers you have, like 2.2M homes facing foreclosure, and the Princess of Housing forecasting a 20% increase in the inventory numbers NAR reports attributable to foreclosures. Personally, from what I am seeing and hearing at ground zero, 20% will be a soft number. I think it will be North of 30% . . . as the housing industry slows and the job loss contagion reaches epidemic proportions. Don’t think this is just limited to the guys that build the houses. It hits the guys that work in the kitchens of restaurants. Clarence Otis, the CEO of Darden Restaurants said he already sees a slow down in traffic that he attributes to housing issues from loss of jobs to empty ATMs. How about the guys selling jet skis and other toys to the knuckleheads that used their homes as ATMS.

By the way, the top 5 states for foreclosures have a few surprises. California and Florida are no surprise, but how about Ohio, Michigan and Texas. But wait, I know you need more color. Here are the states with 20%+ changes YOY in foreclosures: Louisiana, Minnesota, Nevada, Missouri, Tennessee, Idaho, North Carolina, Oregon and New Mexico. Idaho? Oregon? New Mexico? = Spillover, Contagion or whatever you want to call it . . . but it is bad.
And take a look at just a few of the new websites popping up:

• The Colorado Foreclosure Prevention Hotline is 877-601-HOPE (4673).
• The homeownership preservation foundation has a national homeownership hotline at 1-888-995-HOPE (4673).
• The Florida Foreclosure Prevention Hotline is 1-877-532-HELP (4357).
• The New York City Foreclosure Prevention Hotline is 718-246-3279.
• The Boston Foreclosure Prevention Initiative phone number is 617-635-HOME (4663).

Inventory II – More on inventory. After reviewing a number of reports dating back to the October issue of Barrons, as well as analyst projections and liar numbers from the builders, here are a few interesting notes. The average inventory if 5+ years with an average of 40% optioned. At the top of the pile, is Toll Brother with 8 years. What makes matter worse, is that many of these projects have been started . . . roads are in, utilities are in and some spec homes have been built. Oops, strike that. They don’t build spec homes.

Jobs – We heard this month that builders have slashed jobs by 20%. Centex just issued pink slips to 120 people yesterday, and from what we are hearing, this includes some people above the administration level. I’ve talked about the spillover effect into other industries far too much, but here is a local piece from Port St. Lucie, FL, one of the hotbeds of construction for the last few years. They are seeing a 10% reduction in employment attributable to reductions at construction companies. Linda Cox, the executive director of the St. Lucie Chamber of Commerce said, “All the builders I’m talking with say there is nothing going on.”

Lawsuits – More and more and more. The sharks smell the blood. We are seeing more lawsuits against builders for failure to meet construction deadlines, failure to deliver what was promised in brochures and sales material, and a host of other menu items, only lawyers can dream up.

Bonus Quote – "This forecast is subject to a number of risks. To the downside, the correction in the housing market could turn out to be more severe than we currently expect, perhaps exacerbated by problems in the subprime sector. Moreover, we could yet see greater spillover from the weakness in housing to employment and consumer spending than has occurred thus far. "– Big Ben Bernanke speaking to Congress this week.

Noticeably Absent: I did not comment on the Lennar conference call because, as most of you know, I am in the middle of a lawsuit with them. I can tell you, Stuart and Bruce provided a lot of information. Read between the lines. Listen to what they said about what they were doing and what they will be doing. Think about Even-Flow and Everything Included. If you would like to discuss the call, feel free to call me.

Disclosure: I own puts on WCI, KBH, SSD, CORS and one share of LEN.

Note: I am moving over to a new machine with Vista. Here is a word of warning. Do not even begin to think about running early versions of Outlook on Vista. Anything other than Outlook 2007 is likely to be nothing but grief. I have some real horror stories over the last 4-5 days and that has cut down a bit on my blogging and posting in various places. I hope to be back up an stable on a new Vista box by Tuesday.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/