Sunday, 5 September 2010


Round and around and around we go
Where the world's headed nobody knows

(Fans, marvel at the a capella vocals here)

social degradation, 
inner-city decay, 
police brutality, 
political corruption... 

Considering the catalogue of injustice The Temptations had to sing about when this classic was released in 1970, the use of an iconic protest song to illustrate the economic problems in our altogether more bountiful age might seem a little flip.  

But if that year represented a turning point between the youth-inspired creativity, hope and idealism of the 1960s and the late-century age of cynicism, materialism and greed which ultimately followed, I'm wondering if a different kind of tipping point may have been reached right here, in the dog-days of 2010.

Sept.2010: We're going down
In the first part of this two-month examination, starting with a brief close-up of the current confused economic picture, I'll try to pull back the focus until we end up with a shot wide enough to put the recent jagged and conflicting fragments in their true perspective.

Sept. 2010: We're going up

I want show why discussion of a 'double-dip' might actually be redundant, why our leaders' attempts to restart sustained growth are doomed to fail and how, when the dust has settled,  you and I may be able to take advantage of the truly historic opportunities which should then be presented to us


This summer has seen a wild see-saw ride between competing visions of economic recovery and collapse. We begin with the story of the late '09 - early '10 growth boom, which almost gave the economy escape velocity only to fail as it reached the edge of space, directly followed by the story of the 'double-dip' recession which, right at the lip of the dip, refused to drop.  


No need to worry, everything's 
been sorted
Heading into April the stock market recovery - as opposed to the economic recovery - had proved a stunner.  70%+ gains since March 2009 were a global commonplace as data came in which suggested that, if not yet going gang-busters, the world's economic powerhouse was merely dusting itself off in preparation for the kind of full-scale growth boom we'd seen so many times before.  

In common with many pundits, my conviction that all was not well under the hood was to be tested to the extreme. Any forecaster foolish enough to stick his head above the parapet and raise the prospect of another downturn was likely to have it handed to him, such was the fervent belief that happy days were here again. 

Then came Greece, the 'flash-crash' of May 6th, and a slew of new data suggesting the 'V'-shaped recovery might resemble something more like a U-bend.


Having warned that a serious decline was imminent prior to the top in April, I posted a major market alert in late June as the stock market plunged 15% and into dangerous technical territory.  

It bounced in early July but, come August, fear of the dreaded 'double-dip' began to grip investors once again after Ben (he-who-sporteth-a-white-beard-so-must-be-wise) Bernanke, the man with his hands on the world's biggest monetary levers, announced that the outlook had become "unusually uncertain".  This is as close as a man presumed to be all-knowing can come to an admission he hasn't got the foggiest.  The markets didn't warm to his candour.

By the end of the month stocks had sagged back into the danger zoneencouraged by a steady drip-drip of bad US economic news...

Rally for job-creation at California's City Hall

500,000 weekly claims for benefits when a genuinely recovering economy should at this stage have slashed that number by half...

Source: NY Times
...-27.2%, the biggest drop on record. Another leg down in housing seems to have begun in earnest with the ending of US government sweeteners for first-time buyers...

A slew of data pointed towards a major slowdown in economic activity between April and June and so it proved.  The above figure will surely be revised even lower in coming months...

Not only did the direction of the trend (ie. into the toilet) seem clear using traditional measures but leading indicators were also hinting strongly that another recession - assuming of course we exited the first one - is baked into our future.

The ECRI's Weekly Leading Index, a proprietary 'black box' composite of various hyper-sensitive measures of economic activity 6 - 9 months in advance of GDP has, once its growth rate falls to the current level, a blemish-free record of predicting recessions stretching back 40 years.  Last time we were at -10% was in early 2008, when the overwhelming majority of forecasters and politicians were flatly denying a recession was possible.  In fact by that stage it had already begun.

Mid-August, technical signs of imminent breakdown began to pop up everywhere, including the dreaded (and absurdly hyped / mocked) Hindenburg Omen; it appeared the market collapse I'd anticipated had arrived at last, as stocks sank into the end of the month. Everything pointed downwards.  This, it seemed, was it.

Then, right at the fag-end of August, Uncle Ben pulled the big fat rabbit markets had been praying for right out of his felt fedora.

QE2 sails triumphantly to the rescue
(of Wall St)

At an annual Fed chin-stroking junket in the unfortunately-named Jackson Hole, Wyoming, The Beard gave an implicit assurance to markets that, while he expects things to improve, he will certainly restart the printing presses if they deteriorate.  Quantitative Easing mk2 was nailed on.  Once investors had digested the implications of his comments, they realized that they essentially had been given a risk-free pass to buy stocks - so they did.  

Why?  Any bad news would now automatically be good news - because it meant the Fed would assuredly step in and funnel new-minted cash into the markets.  Good news would by itself boost risky assets yet investors could count on a Fed cushion if the economy weakened, just as they could in the bubblicious good ol' days.  Helped by a dollop of slightly-less-bad-than-expected news on the unemployment front, stocks soared.  And so, just as the bears thought they had the bulls cornered...


'QE2' would once again fill the trough at the banks and allow them to trade their way to profits even as they starved the overall economy of loans, putting a floor under most asset prices and goosing the stock market just as we saw in 2009.  

Main St might have to limp along with little sustenance but, hey, that's what governments are for, right?  Throw the little guy a sweetener - another homebuyer tax-credit, another cash-for-a-pile-of-old-crap programme, while the big boys on Wall St keep the real show on the road.

Prof. Niall Ferguson (of Ascent of Money fame) reckons that, with the mid-term elections imminent and President Obama's Democrats on the verge of ritual slaughter, he'll have no choice but to offer, within days, some juicy bribes to the electorate.  I think you can take that to the bank.

So that, dear reader, is where the US economy - for where it leadeth so shall we followstands as we ride into September 2010.  Where to next?  Have the bears been skewered?  Is it up, up and away for the stock market? Can we sing Happy Days are Here Again for the economy at long, long last?  

The answer, my friend, is blowin' in the wind, the answer is blowin' in the wind...



The Central Bank?  The Government?  Goldman Sachs? Nay, nay and thrice nay.  These well-manicured actors and their cohorts in the financial power structures regulate the money supply, grease the wheels and allocate the capital, but they're still parasites: adjunct to, feeder of, servant to and leech upon the true boss of the world economy - the western consumer.

Without final demand kicking in from Joe & Jane Schmo (with stout backup from Jack, Jill, Gerd & Gerda Schmo) the best efforts of all the above amount to a hill of barbecue beans in this crazy world.

Clocking in at 70% of US GDP, the 250+ million strong army of American consumers remains king, determining the fate of businesses from Cleveland to Canton.  And what the US government's latest figures are telling us, after hundreds of billions of dollars in stimulus and a two trillion dollar monetary flood from the Federal Reserve is that, stripping out the one-time effects of inventory rebuilding*, demand in the economy between April and June measured by real final sales increased at an annualized rate of... 1%.  

*Businesses stop producing and slash their inventories of goods during a recession when demand is at its weakest.  Once demand recovers sufficiently they restart the production lines and  re-stock, and that temporary surge of activity shows up in the GDP figures as the economy emerges from recession.


Here, in comparison with the nine other recessions since the war, is the rate of recovery of US final sales to mid-2010.

100 on the vertical axis represents the peak before each recession, with the timeline in quarters below.  The current recovery (red) shows sales growth comatose

Not good.  You'd also expect retail sales to be a big factor if the consumer is struggling, so here is a comparison of Main St recoveries going back to the 1970s:

Previous retail recoveries raced away (though interestingly, considering consumers' gradually rising debt burdens, the last two were more sluggish). The current state of affairs (red)  is not encouraging

Many of the reasons why American consumers have been so slow to regroup are well-known and well-disseminated.  We all know, bluntly, that many took on a massive over-burden of debt.

In fact consumers embarked on an historic feeding frenzy, which was enabled, fuelled and eventually rocket-propelled by the biggest credit expansion in world history.  Businesses and retailers fed on this spending like algae and the entire economy expanded at an accelerated clip.  Unfortunately the outstanding debt accelerated exponentially faster.  According to Australian economist Steve Keen, one of the tiny handful of economists who saw this whole thing coming, total US GDP expanded by $9trillion since 1987 at the same time as total private sector debt rose $34trillion.

We now sit atop these outstanding debts with a substantial proportion of the assets they were lent on declining in value and an economy barely growing enough to keep many of those in hock from default.  


Central banks slammed interest rates into the floor to prevent a meltdown and now, desperate to keep the game going, are attempting through QE to force-feed the economy even more credit.  This kind of monetary sluicing worked successfully in tempting consumers and business to borrow and spend for 25 years. But this time, something remarkable is happening.  

People are saying, "enough".

Yes, banks have tightened their sphincters ever since their near-death experience in 2008 and from the P.O.V of supply less is being lent.  But there's a potentially more worrying trend - less is being demanded.


A recent Fed senior loan officer survey shows a continued steady decline over recent years in consumers' demand for credit (above) while - don't tell anyone - but banks themselves have in recent months become a bit more willing to lend:

Banks a bit less stingy now, but demand is down

Businesses have been hoarding cash like never before even while they remain indebted, which illuminates this intriguing picture from the Fed survey of commercial and industrial loans:

Banks are reporting significantly weaker demand for loans from
businesses, even at record low interest rates

So if, even when banks decide to lend more, consumers and business are reluctant to borrow - since their priority is now saving and paying down debt - spending from all sources fades and we have a downward spiral on our hands.


This picture of suddenly renewed frugality is reflected in the consumer savings rate, which has lifted off a crater low since the crisis began.  Most would agree this is a fine thing in the long run, but that's cash not feeding the tills at Macy's or Marks & Spencer, not encouraging them to hire, not feeding up in taxes to Uncle Sam or Nosferatu George and therefore not going towards cutting our stupendous deficits.

The previous trend towards saving lasted a generation -
have we just seen another long-term turning point?

One might say a consistent pattern of consumer behaviour is beginning to emerge, especially when you consider the otherwise inexplicable charge of investors out of stocks and into bonds.  Look at this extraordinary graphic courtesy of Traders Narrative blog, illustrating the latest flows between US stock and bond mutual funds:


Since March '09, during one of the greatest rallies in the history of the stock market, investors drew down their US equity holdings.  In fact, since 2007, they have withdrawn $248 billion from stocks and ploughed $729 billion into (supposedly safer) bond funds, in a great migration to rival any convoy seen since the Civil War.

What I believe we're witnessing here is the great American public firmly shunning - and at the same time unwittingly pulling the rug out from underneath - their own stock market recovery.  

US S&P500 
October 1998:  1100 
September 2010:
Think about the major bind so many investors are in: an executive in his early fifties, say, who began piling his savings into stocks during the tech bubble in 1998 has made precisely zero capital return over 12 years.  He may feel that, in terms of building a secure foundation for his retirement, he has wasted the most productive years of his life.  

Now he heads into a murky future, facing an employment situation which seems less and less certain, with time to build a decent pension running out and precious little to show his family for the saving he's already done.  

If he thought there was a safer alternative, why on earth would he stay in the stock market? 

The reason this is surely important is that it may be flashing a big fat red light for stocks as an asset class for years to come - if, that is, we're seeing a profound change in the risk-appetite of this indispensible class of US investors.  What makes it more likely than you might imagine is something blindingly obvious.  

The median age of the US baby-boom generation is now 53.  These folks, vast in number, are not spring chicks any more and as time creeps on those who haven't made their fortune yet can't afford to be quite as reckless with their spending - nor with their investing - as they once were.  Thoughts gradually, inevitably, turn to security and away from risk.  

How vulnerable is the stock market?  Well, unless they suddenly turn tail and start buying equities again, Joe & Jane Schmo will not be providing the fuel in terms of their 401k and IRA stock allocations that all bull markets need to push higher once their initial surge is spent - a surge which, in our case, appears to have ended in April.   

And if that is true, this stock market recovery is now dead in the water - it just doesn't know it yet.




Next month, Sunday October 2nd, I'll be focusing on the even bigger story of which I take this unusual consumer behaviour to be a compelling early chapter - the ageing of the western world's population, an event I believe has been the major driving force behind both our great boom and its spectacular bust.  

The picture it reveals of our economic future, both near and long-term, ain't pretty and for pension investors as well as governments it throws up some huge challenges - but from an investment perspective it is also set to dish up some truly stupendous opportunities.

So I'll be looking at how we can reliably keep ourselves safe from the ongoing storm, resisting temptation, keeping our powder dry, getting ready to finally capitalize on those once-in-a-lifetime opportunities which will be waiting for us when we do, at last, emerge blinking into the sunlight.

Have a great month!