Saturday, April 4, 2009

The economy is bottoming

The U.S. and world economy were in free-fall in the latter months of 2008. Panic reigned. Investors and speculators were selling anything and everything in order to raise cash and/or pay down debt; yields on cash and Treasury bonds collapsed as a result of intense demand for risk-free assets. All the things that had shot up in price in the past several years (e.g., gold, commodities, energy prices, real estate) suffered sudden and massive price declines as investors and speculators scrambled to reverse the trades that had been so profitable up until mid-2008. Equities collapsed as well, as everyone feared that massive wealth losses would result in equally massive unemployment, a depression of epic proportions, and widespread price deflation.

Equities experienced another vertiginous drop in January and February of this year as investors were blindsided by the Obama administration's rush to implement an unprecedented expansion of government spending, a radical increase in the price of carbon-based fuels, a significant increase in overall tax burdens and in the tax on capital, and a major push to advance universal healthcare. All of this on top of what looked like complete disregard for federal deficits that could be measured in the trillions of dollars for many years to come. Not surprisingly, many thought that we were experiencing the end of the world as we knew it.

Over the past month, however, the doom and gloom has faded somewhat. Equities have recovered most of this year's losses. Obama's plans have been dealt several blows: the Senate has rejected his proposal to limit the charitable deductions of the rich; cap and trade will not be imposed on the country without a thorough debate. Obama's popularity has taken a hit, and many of his formerly ardent supporters now question the wisdom of his decisions (e.g., allowing Nancy Pelosi and Harry Reid to design his stimulus plan, firing the CEO of GM and dictating which car models the company should focus on). Mark-to-market rules have been relaxed. As the first chart shows, interest rates on Treasury bonds have risen almost one percentage point from their year-end lows. As the second chart shows, oil prices are up 50% from their December lows; most commodity prices are higher today than they were at the end of the year. Both charts provide strong evidence that the economy is not collapsing as many had feared, and may even be finding a bottom.

This is not to say that the economy is now off to the races. The good news that has driven stocks higher is that the bad news that had been expected has failed to materialize; things aren't as bad as the market had feared.


Rob said...

It's been fascinating to read you increasingly "light at the end of the tunnel" posts, Scott. Particularly since the other blog pundits I read, such as Mish Shedlock, seem to use charts to reinforce their more gloomy views. Eg today, Mish has a post about US home sales and how they could be only part of the way down in their fall from the peak. I'd love to know what you make of Mish and posts like this:
Thanks as always Scott.

Scott Grannis said...

Mish is a perma bear so it is going to be hard for him to see anything good out there. I've been following (and posting re) the Case Shiller prices, and arguing that we should be nearing the end of the price declines. I think the best thing to look at is inflation adjusted prices, and those have fallen (I'm extrapolating from the lags in the index, etc.) by about 40%. That seems like plenty to me considering that mortgage rates are at generational lows.

Anonymous said...

Great, very well put. I am anxious to see how interest rates are going to respond to some of these indicators. Most would say they will go up, with inflation on the rise and all. That will have another effect onn the economy.

Scott Grannis said...

Interest rates will rise when the economy is stronger. Higher rates won't hurt the economy, they will be a sign of a stronger economy.

Also: the household sector has more floating rate assets than floating rate debt, so higher interest rates are a net plus for households. Think retired people with bank CDs, and most mortgages with fixed rates.

Mark A. Sadowski said...

I've been trying to reverse derive
e-forecasting's monthly real GDP changes (based on what little I hear as I'm unwilling to subscribe). Here's what the numbers look like to me (all at annual rates):

July 08 0.9%
August 08 1.3%
September 08 -11.6%
October 08 -1.5%
November 08 -8.2%
December 08 -12.7%
January 09 -11.8%
February 09 -12.0%
March 09 -6.8%

So it does appear that the rate of decline fell in March. But it also implies that the first quarter GDP report by the BEA will be brutal (-10.0% or so).

As for the stock market I remind everyone of Rogoff and Reinhart's research. In a financial crisis stock market indices are a lagging indicator.There are probably six more bear market rallies before we hit bottom.

P.S. If anyone has a subscription or has other info please let me know.

Scott Grannis said...

Mark: Don't forget that GDP is a lagging indicator as well. It is frequently revised significantly up to two years after the fact. You've got to instead focus on the true leading indicators, which are market-driven prices that trade in real-time: gold, the dollar, commodities, spreads, etc.