Three BIG Words: Revision, Recession, and Intervention

Three BIG Words: Revision, Recession, and Intervention
Three words can best describe today’s markets: revision, recession, and intervention. The morning began with the government’s report on GDP for Q2 and the revisions for years 1999-2001. First a look at the Q2 numbers which show the economy has weakened considerably from the first quarter. The rate of economic growth slowed down to only 1.2% versus economists’ estimates of 2.4%. In addition to the slump in economic growth, another report by the Chicago Purchasing Managers Index for July showed a sharp drop in manufacturing activity. The Chicago CPM Index fell to 51.5% from June’s 58.2%. A reading below 50 indicates the economy is contracting. Like the GDP numbers, which fell short of expectations, the CPM Index came in far lower than expected.

In addition to these numbers, the Fed’s periodic Beige Book report showed the economy expanding modestly and unevenly across the country. The Fed used words such as "stable," "steady," "modest," or "moderate" to describe economic conditions. Four of the Fed’s districts in New York, Boston, Atlanta and Dallas show that economic activity is tapering off. Six other districts reported marginal growth; while only two regions of the country, Cleveland and St. Louis, showed signs of growth. Retail sales are mixed, and in most regions of the country there are visible signs that consumers are starting to retrench on their spending plans. Labor markets are weak and real estate was mixed.

Back To The Past?
It appears from the above reports that the economy is likely heading back toward a recession. This is worrisome for most analysts and economists who have been consistently wrong in forecasting a second half recovery. They were predicting 3.5% to 4% economic growth along with Wall Street. The widely held view is that we get strong economic growth in the second half of the year and this strong economic growth will help fuel corporate profits. Wall Street has some very hefty earnings growth figures for the third and final quarter of the year. The prediction is that pro forma earnings will grow at a 30% rate in the third quarter and a 40% rate during the fourth quarter, even though these projections aren’t real numbers. There is nothing on the horizon, either, in the economy or in the business world that would indicate these projections are even close to becoming a reality. This could be a big shock for the financial markets this fall, which have been counting on a big boost to earnings. Those projections for economic growth and miraculous earnings are looking more like a fantasy at this point.

GDP Revisions Ominous
More ominous for the economy and the financial markets is today’s government revisions of the economic numbers for the years 1999-2001. The major revisions show an economy that was much weaker than originally reported. GDP growth for the first quarter was revised down from the original 6.1% growth rate to 5%. What is more telling is the revisions of 2001 GDP, which show only a rise of 0.3%. Instead of one quarter of negative economic growth, we actually had three consecutive quarters of economic decline. Economic growth actually peaked in the fourth quarter of 1999 and slowed substantially during all of 2000. During 2000, the economy was already heading toward recession with the first quarter of recession beginning in the first quarter of last year. Previous reports had shown the economy had been strong throughout 2000, when in fact it had been weakening all along. A summary of other revisions are listed below:

The Bureau of Economic Analysis (US Commerce Department) issued their GDP report today. A link to the report is listed here for those who want to delve into the statistical data and form your own conclusions. Suffice to say this report is one more nail in the coffin of the new paradigm economy of the 1990’s. Like so many of the corporate revisions we have witnessed -- with more to come in the future -- the 1990’s "New Era Economy" has turned out to be more fiction than reality. As corporations come clean with their books, the government is coming clean with its own revisions as well.

Pinpointing The Truth
What these economic restatements reveal, and what so many other corporate revisions show, is the economy and corporate profits have been much weaker than expected. They point to one of the worst profit recessions in decades and an economy that is plagued by many imbalances. It also points to a day of reckoning that will be ominous when it occurs. The economy is heavily dependent on foreign capital to finance burgeoning trade and current account deficits. The US is taking in and consuming about 75% of the world’s savings. Between US foreign investment outflows and trade and current account deficits, the US needs to take in capital inflows of around $900-$1,000 billion per year. The trade and current account deficits require about $450 billion. Add to it the outflows of US capital, and it isn’t too hard to conclude a dollar crisis of a magnitude never seen before lies directly in front of us.

What must be keeping Fed officials up at night is they are seeing their credit bubble turn into their own worst nightmare. The economic numbers show an economy that is once more heading back into recession and a credit crunch that is developing in the credit markets. The Fed however, is caught in a Catch-22 of its own making. If it lowers interest rates again to combat a weakening economy and flood the financial system with money to combat a credit crunch, it risks losing its credibility. Lower rates could send a signal to the markets that the Fed is losing control. On the other side is the plunging US dollar, which may require raising interest rates to keep foreign money invested, which in turn could damage the economy. Moreover, raising interest rates would pop the Fed’s latest bubble in the housing market. Rising interest rates would abruptly end the consumer-refinancing boom that is helping to prop up consumption as homeowners extract more equity out of their homes. Once the housing bubble bursts, there will be nothing left to prop up the economy besides deficit spending by the government, which has taken on a new dimension.

Cornered, With No Way Out
The 1990’s Clinton/Greenspan credit bubble leaves the Fed no attractive options. In every direction it looks, the Fed finds itself backed into a corner with "no way out." Once realization comes that the economy and the markets aren’t coming back, there is going to be a very severe reaction in the financial markets. The one area to watch is the dollar. Foreigners now own $9 trillion of US financial assets. Those assets are taking a beating with falling financial markets and a plunging US dollar. When some of that money decides to leave our shores, the day of reckoning will be upon us. The excesses of the 90’s will be dealt a severe retribution in the financial markets. There is also the $3 trillion in US equity funds. Up until this time, most investors have been in a state of denial, preferring not to look at their financial statements. At some point when the Fed can’t control the financial markets through intervention and spin, I suspect that John Q. Public and his neighbors are going to be heading for the exit gates at the same time. Trading curbs could be a daily feature of the financial markets if they don’t lock up.

I’m not sure that Fed indirect intervention in the markets will be able to contain the rush towards the exit gates. It is becoming more apparent by the day that intervention is holding up the markets. These miraculous last hour recoveries are becoming more obvious. The one-day wonders when the markets jump up by 4-6% defy rational explanation. Stories that the markets rallied on news of the Rigas family being taken off to jail on July 24^th, or the story for Monday’s rally due to investor optimism over the rescue of miners over this weekend are shallow and insulting to one's intellect. Intervention was able to turn the markets from the abyss to a minor gain in the Dow and the S&P 500, but they couldn’t save the Nasdaq.

A Brief Window of Opportunity
What investors may have to understand at this point is they have been afforded one more opportunity to get out of stocks. The predicted second half recovery, or the miraculous earnings recovery, will not take place for the third consecutive year. The cleansing process of the 90’s excess credit boom is about to take a turn for the worst. It could begin as soon as August or at least by this fall. The markets and the public are going to need something to distract them and perhaps a war will do just that. The miracle earnings predicted for the last three years are not going to appear. The economy is going back into recession. And if the dollar plunges, the Fed may be forced by foreigners to raise interest rates at a time it doesn’t want to with severe consequences for the housing market, the economy and the financial markets. If the Fed believes in miracles, it better hope that the $9 trillion of foreign money in our financial markets doesn’t decide to head for the exit gates. If it doesn’t, that will be a miracle worth praying for because there will be no miracle in earnings.

Heads Up Everyone
Watch the dollar and the US bond market -- they are the keys to what is going to happen going forward. Watch the gold market. It is currently reacting to the derivative markets as James Sinclair and Harry Schultz have explained in their essays on this site. Also watch the gold and silver equities markets reacting in a leveraged way to the price action of bullion. We are now in a corrective process that is taking some of the froth out of the gold markets from second quarter. Once these excesses have been taken out, and gold has been transferred from weak to stronger hands, the stage is set for the next advance of what I believe will be a decade-long bull market. At the moment, gold and silver are climbing a wall of disbelief by both bulls and bears. By fall, and finally by winter, much of this disbelief will turn to conviction. There is nothing like a strong price move to new highs to create new converts. A spike in prices is going to depend, to some extent, on what happens to the dollar and Treasuries. If they both plunge, which I suspect they will, then you are going to see some very large gaps in the price of gold and silver. When that happens, the precious metals stocks will go parabolic. The reason they rise so quickly and dramatically is because of their scarcity. It is similar to the Internet stocks. The floats are small -- even for some of the majors. So when demand hits these stocks, the prices fly.

If you are new to investing in gold, you must understand that this is a volatile sector. It moves on emotion and fear as well as fundamentals. You must also understand that like the metals themselves, it is scarce. Very strong hands also hold it. Those who are strong believers aren’t parting with it. So when it rises, it moves quickly because there isn’t enough supply. This is why you may want to consider adding to your position on weakness, buying at support levels for the metals or the equities. Finally, avoid the hedgers. They have done poorly when prices rise because they aren’t as leveraged to the price of gold and silver because they have sold their production forward. So when prices rise, they don’t benefit to the same extent as the unhedged companies. You can see this difference reflected in the price run up of the HUI versus the XAU.

Today's Markets
Volume was high coming in at 1.92 billion on the NYSE and 1.64 on the Nasdaq. Advancing issues outpaced declines by a narrow margin on the NYSE while losers beat out winners on the Nasdaq by 20-14. The only green light on the board occurred in oil, drug and bank stocks.

Overseas Market
European stocks climbed as companies including Unilever, Allied Irish Banks and Sanpaolo IMI said earnings will be better than forecast or topped estimates. The Dow Jones Stoxx 50 Index was 0.9% higher at 2744.83 at 5:45 p.m. London time. Five of the eight major European markets were up during today’s trading. Japanese stocks fell, led by exporters such as Kyocera Corp., after a drop in a U.S. consumer confidence index stoked concern that spending will slow in the nation's biggest trading partner. The Nikkei 225 stock average lost 1.3% to 9877.94 as of 3 p.m.

Treasury Market
Treasuries reacted positively to the day's weaker-than-anticipated data, which fully support the notion of a sidelined Fed for the foreseeable future. But Treasury investors also had to contend with a large refunding package. The government will auction $22 billion in five-year notes and $18 billion in 10-year notes next week. The 10-year Treasury note rallied 1 point to yield 4.46% while the 30-year government bond gained 1 10/32 to yield 5.305%.

The Fed's Beige Book report on economic conditions revealed that growth expanded moderately across sectors and regions. The Fed also indicted that retail sales were mixed and that manufacturing was improving while labor markets remained stable. Thursday will see the release of another slew of reports: weekly initial claims, June construction spending, expected to have risen 0.3%, and the July Institute of Supply Management Index, which is seen posting

I just found this. It pretty much says what I have been trying (unsuccessfully) to point out. It isn't supposed to happen this way -- but it is:

While economists have been complaining in recent months about the disconnect between the bear market and the improving economy, they didn't notice the disconnect building between their economic models and what's actually happening out there in the economy.

Here is the complete text of the article:

Jobs now the critical indicator

Richard W.

I seem to remember a little war called VIETNAM that totally screwed the economy---not just later, but AT THE TIME. It did nothing for the politicians then in office---Johnson, ultimately Nixon.

Moreover, the combination of an unneeded war, and a bad economy, is pure political death.

On the other hand, a NECESSARY WAR, which I think Iraq is, does wonders to stablize markets worried about the future. Nevertheless, I do NOT think that the "war on terror" is driving the current economic issues one way or another, except to say that the vast destruction caused by 9/11 was deeper than most have thought. Whatever is going on, it is being driving by 1) a total restructuring of corporate asset accounts based on stock options estimates; 2) public perceptions of corruption; and 3) both REAL and media-driven concerns about profitability. (I don't think #3 has the analysis of why these companies aren't profitable right, but it doesn't really matter for our discussion).

I think to try to link the war with this, one way or another, is a mistake.

the vast destruction caused by 9/11 was deeper than most have thought.

What vast destruction? We suffer through natural disasters 100 times worse than 9/11 (property loss, not life) and do just fine. Any economic problems that we are having now weren't caused by 9/11.

The war on terrorism or the upcoming one with Iraq is just a distraction. It will take the publics mind off the economy and provide political cover for the ruling class. Otherwise, someone just may try to hang them. You know how unfashionable and UNPATRIOTIC it is to criticise the government while the country is at war. As I have been saying, listen to the drumbeats of war. The louder the beat, the more bad economic news we can expect.

Richard W.

That "drumbeat" business certainly was not true in 1898---the economy was growing prior to the Sp-Am War; or 1914 (ditto); or the Civil War (which raised HELL with the economy, and it didn't recover for years; and as I said, the Vietnam war killed the economy, along with Ralph Nader, the environmental whacko movement, and stultified non-competitive business.

On he 9/11 destruction, you should go to the Milken Institute web site. Some months ago their economists did a study of the economic cost of 9/11. Go to www.milken-institute.org or www.milken_institute.org (I can't remember which) and look for an article called "The Butcher's Bill." It not only was INITIALLY staggering, but it pushed the already fragile (and admittedly badly-priced) airlines over the edge; that, in turn, further damaged tourism. Look at Disney---the THEME PARK division, which has always been a money maker, announced losses this year. This is almost directly due to 9/11. We were in Vegas a month or so ago---9/11 shut down the entire strip for days, and shut down NY NY hotel for a WEEK due to a similar bomb scare. The people there told me that just THEN (May) they were back to 80-90% of where they were Sept. 10. So you can't tell me that wasn't HUGE. Then throw in the addition burdens of the fed. deficit and all that that implies---I know, it was going to be in deficit anywhy, but nothing like that. So I think 9/11 hurt more than anyone knows.

It isn't right to blame 9/11 for as much as people are now doing. Yes, it did hurt the airlines and they sure didn't need any more problems than they already had. Yes, it hurt some tourism, but not as much as you might think. I live in Charleston and you can't fit another tourist in this town. Eisner was steering DIS onto the rocks before 9/11.

The only point that I'm trying to make here is that The Office of Propaganda and Information Management is going to point at a variety of causes for the weak economy. It will be 9/11 or it will be the war on terrorism or it will be Wall Street or it will be Iraq or this and that. The last place they want us looking is at the government. It's the old blame game and big business or terrorism are easy targets.

9/11 was tragic, make no mistake about it but you sure can't blame it for the unraveling of a bubble economy.

Richard W.

Okay, I finally found it and did read it.

a day at Disneyland may be worth $500, even though the price of admission and assorted souvenirs is just $100. We reiterate: the point of this admittedly rough exercise in social accounting is to put the losses in useful context.

A two-day partial work stoppage and attendant loss of productivity, as the nation adjusted to the shock, likely cost another $35 billion.

the value that people implicitly place on their own lives rises with income and included in how people value their own lives, the 6,000-plus death toll translates into an economic cost in the range of $40 billion.

Accordingly, we estimate the value of the 788 million hours lost to be some-where between $16 billion annually (valuing time at $20 an hour) and $32 billion annually (valuing time at $40 an hour).

Counting the value of lives lost as well as property damage and production of goods and services forgone, the United States has already suffered losses exceeding $100 billion. Including the loss in stock market wealth – the market’s own estimate arising from ex-pectations of lower corporate profits and higher discount rates for economic volatility – the price tag approaches $2 trillion.

If you are buying into this, I have nothing to say.

Richard W.

You must be joking. Assessing lost earnings via death has not only been a stock in trade of economists for 50 years, but for insurance companies and lawyers for 100 years. What in the world is wrong with measuring the value of the national work stoppage?

I already told you that Las Vegas was virtually shut down for three days, and New York New York casino completely shut down for a whole week. Las Vegas alone was off 50% from 9/11.

I don't see at ALL what you find mystifying about putting a dollar value on the 3000+ people killed. Any insurance company or economist (who do this routinely to calculate the impact of wars, military actions, or even environmental/safety laws) would have the slightest qualm about a $40 billion figure on human life loss. So where is YOUR evidence. As usual, Richard, you bash and dismiss, but don't provide anything except some guy's wierd internet gold report.

I don't know what the "revised" numbers will say. But here are a few little tidbits from today and yesterday's USA Today, buried again.

Manufacturing investment is up. Not a huge amount, and not across the board, but this is another KEY indicator. Gears, nets, bolts, machine tools---UP.

P&G, a great company, had better than expected earnings.

GM voluntarily today said it would "expense" options.

And, I see this as a good sign, a report yesterday said that several Venture Capital firms---which is where the REAL next explosion is going to come---returned money to investors. I see this as good because 1) they didn't waste it in "speculation" and 2) the money is "out there," just no opportunities right now.

That leads me to think that we are in for another 6 months (at least) of mediocrity and + or - 10,000. But as my broker (whom I trust) told me, "the money IS out there, and it isn't going anywhere." When the opportunities appear again---and they will, if mfg. investment is up and consumer spending is up---VC will soon again look for a home.

You have to remember that several groups have an interest in keeping the economy down: 1) Democrats, desperate for an election issue; 2) liberals and socialists, who hate capitalism, and ESPECIALLY a growing stock market which makes people less dependent on government; and 3) goldbugs who always want a depression to validate a position that has not proved right for 50 years. I also tend to think that there are a lot of Y2K "gloomsters" who are still pi**ed that their idiotic predictions about mass meltdown did not occur.

Now, are there REAL PROBLEMS? Of course. We are WAY overtaxed, still. The regulators are worse than ever. South America is not in good shape---but then, can ANYONE tell me a time when it was? (Remember the 1970s, when the big banks were lending in SA because the U.S. opportunities sucked---look what happened: in the 1980s, the big banks all quietly wrote off all those loans and you never heard a word about it). Also, there is this WAR business, which DESTABILIZES MARKETS. Capitalists do not like wars, and always see wars as unpredictable, contrary to popular belief. This is masked by the fact that usually in "big" wars the government takes over the economy and conceals price increases and "forces" productivity increases---in war goods only---by either controlling or operating the companies.

So there are wild cards. I'm ONLY optimistic about the evidence I see of productivity increases, manufacturing investment, consumer spending (which I think even Richard admits does not EQUATE with "inflation": everyone now agrees (I think) with the position I've held for five years that we are in DEFLATION. You cannot have massive consumer spending and productivity increases, absent huge infusions of money, and not have economic growth. It is purely impossible.

More good news today. Wholesale sales up last month .06%, even though inventories were only up .03%, meaning that companies are fast selling more than their inventory.

Market up again. Specualtion that the Fed may cut interest rates. Yep, that's a REAL SIGN of "inflation," right? No. It is a clear sign of deflation, despite the fact that consumer credit is still expanding.

Now, when you see consumer credit grow, you have a negative response ("Oh no, all those people getting deeper in debt means they are worried.") But I have seen studies that show just the opposite---that people take on more consumer debt when they have a POSITIVE outlook about the economic future.

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