Rocky Road

The Lehmann Letter ©

Today the Census Bureau released two reports that illustrate how rough this recovery will be.

August new home sales (http://www.census.gov/const/newressales.pdf) of 429,000 were about one-third greater than their January trough of 329,000. But look at the following chart for perspective. We remain two-thirds below the peak of several years ago. It will be a long, hard slog back to robust growth.

Chart 5.9 New Home Sales

(Click on image to enlarge)



Recessions shaded

New orders for nondefense capital goods tell essentially the same story (http://www.census.gov/indicator/www/m3/adv/pdf/durgd.pdf). August’s $52.7 billion remains in the trough. And the following chart makes clear that this trough is as bad as the 2001 dot-com bust and that today’s report is hardly better than readings from 15 years earlier.

Chart 4.1 New Orders for Nondefense Capital Goods

(Click on image to enlarge)



Recessions shaded

Finally, yesterday the National Association of Realtors reported August home sales of 5.1 million. A glance at the chart below only reinforces the impression created by today’s data releases. We have a long ways to go.

Chart 5.8 Existing Home Sales

(Click on image to enlarge)



Recessions shaded

(The charts were taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2009 Michael B. Lehmann

Five in a Row

The Lehmann Letter ©

Today The Conference Board released its Leading Economic Index (LEI): http://www.conference-board.org/economics/bci/pressRelease_output.cfm?cid=1

The index gained in August, the fifth consecutive monthly improvement following a 20-month losing streak. Ken Goldstein, a Conference Board economist said, “These numbers are consistent with the view that after a very severe downturn, a recovery is very near. But, the intensity and pattern of that recovery is more uncertain."

That says it all. The recession is over, but we can’t gauge the strength of the recovery. Keep in mind: Just because we’re no longer going south doesn’t mean we’re speeding north. This could take a while.

© 2009 Michael B. Lehmann

Profits & Profit Margins

The Lehmann Letter ©

The stock market has done well over the past half year despite a limited recovery in corporate profits.

Chart 2.1 Profits

(Click on image to enlarge)



Recessions shaded

Perhaps investors’ enthusiasm has something to do with a much stronger performance by profit margins.

Chart 2.3 Profit Margins

(Click on image to enlarge)



Recessions shaded

You can see that profit margins continued to grow throughout the recession even as total profits fell. Recall that total profits = Profit margins X sales volume. If sales volume plunges by more than margins improve, total profits will fall. That’s what happened in 2008 – 2009.

It’s easy to understand why sales volume fell. But why did margins improve? The chart measures profit margins by dividing the change in prices business receives (numerator) by the labor cost per unit of output that business sells (denominator). Remember: Price = Revenue per unit of output sold. Examining the chart once more, it’s clear that revenue per unit of output sold (numerator) grew more rapidly than cost per unit of output sold (denominator). That is, margins (price/cost) rose.

But let’s not beg the question. Why did costs rise less than prices? Credit the New Economy. Business continues to improve its productivity (efficiency) by mobilizing technology to raise output per worker. More output per hour of work = Less time required to produce a unit of output. If it takes less time to produce a unit of output, that unit of output will cost less provided wages have risen slowly.

That’s key. If wages rise less rapidly than output per worker (productivity), unit labor costs (the cost of producing an additional unit of output) will fall. And, since wages have risen slowly lately, unit labor costs have indeed risen less rapidly than prices. The bottom Line = Profit margins (prices/costs) have grown.

Improved profit margins will be very good for earnings when sales volume recovers. It appears that investors have bid up stock prices in anticipation of this event.

(The charts were taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2009 Michael B. Lehmann

Federal Deficit

The Lehmann Letter ©

In a September 10 posting this blog said:

“Demand will grow sharply when – and only when – buyers begin borrowing freely once more in order to finance their purchases. As long as they scrimp and save, guarding their balance sheets, demand will remain in the doldrums.”

If that’s true for private borrowing and spending, what about public borrowing and spending? Can it take up the slack? Better Yet: Has federal borrowing and spending compensated for the shortfall in private borrowing and spending?

See for yourself.

Chart 7.1 Federal Deficit

(Click on image to enlarge.)



Recessions shaded

Federal expenditures are growing swiftly despite the drop in federal tax collections. That is, the federal government is putting more into the expenditure stream than it is removing from the revenue stream. Consequently the federal deficit has grown rapidly and now stands at a record $1.5 trillion ($1,500 billion) at an annual rate. This is a recent increase of around $1 trillion and is definitely expansionary.

Compare this with the private borrowing chart below.

Chart 6.3 Private Borrowing

(Click on image to enlarge.)



Recessions shaded

Private borrowing has recently fallen by $2 trillion, i.e. more rapidly than federal borrowing has grown. No wonder that federal fiscal policy (the stimulus package) has not yet rescued the economy from recession’s grip. The federal stimulus represents only half the private shortfall.

On the other hand, imagine how much worse conditions would be without the federal deficit. It has replaced private borrowing as the economy’s principal driver.

(The charts were taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2009 Michael B. Lehmann

Private Borrowing

The Lehmann Letter ©


The rest of the economy stalled when home prices and home sales began falling in 2006. The financial crisis, for instance, began with the debacle in mortgage-backed securities.

Mortgage borrowing is an important component of total borrowing and the following chart illustrates their demise. The economy can’t recover strongly unless this line heads sharply upward.

Chart 6.3 Private Borrowing

(Click on image to enlarge.)



Recessions shaded

Purchasers put fewer dollars into the spending stream when borrowing contracts. Total spending falls even more if borrowers repay their debts, as they recently have.

Demand will grow sharply when – and only when – buyers begin borrowing freely once more in order to finance their purchases. As long as they scrimp and save, guarding their balance sheets, demand will remain in the doldrums.

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2009 Michael B. Lehmann

Good News… Bad News

The Lehmann Letter ©

Today the Federal Reserve released its Beige Book summary of economic conditions (http://www.federalreserve.gov/fomc/beigebook/2009/20090909/default.htm) . The report began, “Reports from the 12 Federal Reserve Districts indicate that economic activity continued to stabilize in July and August.”

That’s good news: Stability is better than decline. Soon the recession will be over because a sufficient number of indicators are no longer falling.

But that’s not the same as robust recovery. Yesterday, for instance, the Fed reported that consumer credit fell by $21.5 billion or 10.4% (http://www.federalreserve.gov/releases/g19/Current/ ). That’s a $258 billion drop at an annual rate. Households are repaying their debts at a furious pace.

Compare this with the trends in the chart below.

Chart 5.6 Consumer Credit

(Click on image to enlarge.)



Recessions shaded

$258 billion is larger than any negative number recorded in past recessions. This is a measure of the dire straits we’re in. Households have reduced their expenditures to repay their debts to strengthen their balance sheets. There will be little evidence of improvement in the economy until households complete this project and begin borrowing and spending again.

Households go into debt when they feel good. They repay when they feel bad. Right now households are repaying their debts in order to bolster their balance sheets. Financial security has become more important than consumption.

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2009 Michael B. Lehmann

Definitions

The Lehmann Letter ©


It’s become clear over the summer that everyone expects the recession to end shortly. But what does that mean?

Recession over = Economy no longer headed south.

That could signify a sharp recovery or it could signify no growth at all. Keep in mind: The economy only has to stop shrinking for the recession to be over. The recovery could be halting, shallow and disappointing and still count as a recovery.

So it’s worth repeating this blog’s earlier analysis of past recessions and recoveries.

Before the 1990-91 recession the Federal Reserve let interest rates fall whenever inflation subsided. Building activity immediately expanded, stimulating the entire economy. But escalating inflation soon prompted the Fed to raise interest rates and constrict residential construction. That depressed the economy and instigated recession. Inflation soon shrank, leading to a new round of rate cuts and building activity.

Think of that economy the way you’d think of a frisky horse. The economy broke into a gallop (boom) as soon as the rider (the Fed) let the reins dangle (low interest rates). But the economy came to a halt (recession) when the Fed pulled back on the reins (high interest rates), only to shoot forward again when the Fed relaxed its grip. Consequently those recessions were V-shaped, with sharp downturns and equally sharp recoveries.

The 1990-91 and 2001 recessions departed from this stereotype. The 1990-91 recession is associated with the first Persian Gulf War. That downturn came to an end when soaring computer and software expenditures led to the 1990s dot-com boom. The late-1990s dot.com boom collapsed when full employment boosted wages and salaries, thereby constricting profit margins and business capital expenditures and leading to the 2001 recession.

The Fed, in a traditional response, depressed interest rates from 2000 through 2003. The consequent real-estate bubble, and that bubble’s demise, led to the current recession. Once again the Fed dangled the reins, hoping the horse would gallop forward. But this horse remains exhausted from its 2002 – 2006 run. It’s barn sour and requires rest. It won’t break into another run for quite a while.

That means we can’t expect another V-shaped recovery. Right now we’re on the horizontal bar of an L, hoping at some point it will turn into a U.

© 2009 Michael B. Lehmann

Vacation’s Over

The Lehmann Letter ©

Hope you had a good summer.

The blogger is back

© 2009 Michael B. Lehmann