Kudlow: A Quarter Away?

A consensus of economic forecasters anticipate that economic recovery will occur in next year’s second half, and bolder forecasters believe evidence of a recovery could surface in next year’s second quarter. But the recent upturn in Treasury rates suggests that recovery could surface as early as the first quarter. That’s right, the first quarter.

Here's some evidence: After falling for over a year, Treasury rates have suddenly headed upwards, with both nominal and inflation-adjusted Treasury rates reversing direction in the past two weeks.

Changes in the direction of interest rates often signal turning points in the economy. When rates are falling, people tend to postpone spending and investing decisions in search of the interest-rate bottom. Holding back until financing costs have hit their low point, people have an incentive to defer economic activity, and this deferral effect coincides with economic slumps.

That’s pretty much been the story for the U.S. economy over the past eighteen months. When rates turn up, however, people frequently accelerate their economic activity. This acceleration effect comes from the incentive to beat higher financing costs that are likely to occur in the future. Right now, this acceleration effect could be starting to happen, and it may signal a turning point in the economy.

Real interest rates in the government securities market have suddenly jumped between 35 and 100 basis points, while market rates have increased roughly 65 basis points across-the-board. Interest rates are forward-looking indicators; much better forecasting guides than backward-looking GDP or other government statistical releases. Treasury rates in particular are especially sensitive to shifts in inflation, taxes, and economic growth.

A forecasting model using the five-year inflation-protected Treasury security (TIPS), which matures in July 2002, is actually predicting an annual rate of 3.8% economic growth in both the first and second quarters of next year, following a 2% decline in this year’s fourth quarter. This model uses the five-year TIP as a coincident indicator of real GDP growth.

Of course, the model may be irrationally exuberant, overstating the recovery case. But even if first-quarter growth comes in at 2%, that would be a surprise. Stronger-than-expected and sooner-than-expected economic growth implies an earlier-than-expected rebound in corporate profits.

That is exactly what the forward-looking stock market could be telling us. From the September 21 low, the S&P 500 is up nearly 20%. The leading sectors are classic cyclical recovery growth areas: technology (40%), consumer cyclicals (29%), capital goods (27%), transportations (26%), basic materials (23%), and financials (19%).

While Congress has not yet passed its so-called stimulus package, there’s a lot of stimulus emerging from our dynamic and resilient economy. Price-cutting is occurring all over the place: lower financing rates, cheaper autos, heavy discounting by retailers (clothing stores and various home furnishings), all manner of technology-related price drops, and energy price declines.

Gasoline price drops are a major stimulant. By some estimates, every $0.10 decline in pump prices increases consumer disposable income by $15 billion. Since May gas prices have fallen about $0.50. Do the math: it’s a $75 billion stimulus package. And don’t forget the big price drops in electricity and natural gas, which have contributed to positive profit margins over the past five months for goods-producing firms.

Add to that the efforts of the Federal Reserve, which has been a busy little beaver this year (especially since 9/11). The basic liquidity measure controlled by the Fed, the monetary base, has expanded by 9% year-to-date. Last year it deflated by 3%. Along with declining interest rates, that’s a big turnaround in monetary policy from excessive restraint to substantial stimulus. With the two-year Treasury now yielding 100 basis points above the fed funds rate, there is no need for additional central bank easing measures.

As yet, there is absolutely no evidence of recovery in the business sector. Industrial production and business equipment investment are still falling. That’s why accelerated depreciation and small business tax-cuts (nearly one-third of personal taxpayers are small businesses) are still necessary. You can’t consume what you don’t produce. True consumer purchasing power always stems from investment and production.

However, tax cuts are surely coming before year-end. And another tax-cut-like effect is developing from the good news on the war front in Afghanistan. As the noose tightens, the war-uncertainty tax declines. As people at home feel more comfortable about domestic security, the war-tax effect falls even more.

So, while business is still lagging, the interest-rate signal suggests that better times are coming. And they may be coming a lot sooner than folks think.

Prices did sink, but we are witnessing the cartel manipulating everything they can think of to cover their butts: 9/11/01 to shock the market into a 'bottom', and a hyper-extreme, massive expansion of credit.

But the cause (market manipulation through monetary inflation) of the economic downturn is not the cure (monetary inflation). For now, people think that is going to work. The boyz have this thing all juiced up in the 4th Q, and are suckering people in with false expectations for 2002.

But we lose either way, because even though we are witnessing a temporary rally off the lows, the price pressure created by the monetary inflation will continue to abort any economic recovery. It is just the nature of the game. Eventually the economic stalemate created by monetary inflation will cause productivity and prfitability do decline further, until finally we see a substantial asset price break.

Right now the cartel 'appears' to be doing everything they can to keep an asset meltdown from happening, but I really doubt they are dumb enough to fall for their own propaganda. At some point they'll slowly grind the market down until thet get what they want.

Banks have a lot to worry about because 65% of all residentail purchase money is based upon the hyper-inflated valuations of the last 2 years. When we throw in refinancing, we are close to 100%. If RE assets break by 40% - 50% that means a vast majority of RE loans will greatly exceed the value of the underlying asset, and will likely spark a massive amoun of foreclosures, and huge losses to the banks. This could lead to across he board bank failures. Which would lead to a complete economic disaster, which means the purported benefit of a fiat ponzi game run by the creeps at the cartel was no benefit at all.

So there is a motivation here by the cartel to do something to save their butts, even though even they must know eventually the cause (monetary inflation) is not the cure (monetary inflation), which means they have to work this thing into the hole so they do not lose their position.

We have a long way to go, down, but geez, after all this suffocating BS in the 4th Q, it could take at least 9 months to get past 9/01 lows. In the meantime the economy will be under seige, held hostage to the artificially created high prices the cartel inflation creates, prices that organic market forces are working their relentless, but painfully sloe process to breakdown. Not much one can do except wait, and sell rallies here and there.

Right now they are playing a technical game under 10K on the DOW, the 4th Q has pretty much been conceded and given to the buyers. heck, I was a buyer in Sep at the lows,but those trades are long gone now. It is a stubborn market, and people are not that bright. It looks like we have to wait an awfully long time for them to find out that whatever their expectations were for 2002, they just are not going to pan out. The pervasive denial as to the reality of what is going on is what creates this inordinate delay.

I thought, maybe, we'd get to the bottom of this process this year, but the global elite is still rigging, manipulating and playing games, 9/11/01 being the centerpiece of it all. So, here we go again.

Lastly, the attempt by the treasury to manipulate the bond market by killing the 30y T-Bond failed. I think that is a sign that all of this other manipulation will fail as well. It just takes a lot longer because the stock market and the stupid gullible public are much ewasier to manipulate than bond traders.

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