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Get Used To Disappointment


The data recently has had the curious characteristic that it has disappointed both economy bulls and economy bears. The economy bears are disappointed that the numbers haven’t fallen off the cliff yet as Initial Claims several weeks ago seemed to promise was imminent. Yes, Initial Claims rose to 465k, but that’s merely in the middle of the year’s range and a far cry from the 504k high in August.

But economy bulls are disappointed too, because the improvement isn’t happening. While the NBER says we are in an expansion now and no longer in a recession, most of the economic data doesn’t seem to realize that. Existing Home Sales logged their second-worst month ever, at 4.13mm, which was right about on expectations (by the way, the Houses Available For Sale number stayed right around 4mm units. The regression I showed in yesterday’s comment suggests that home price growth over the next 12 months will be around -3% again/still. Economy bulls can’t cheer very loudly for either of these two numbers, and neither did equity investors who watched the S&P shed 0.8% and fall right back through the breakout levels from Tuesday. Even the clean technical breakout has disappointed.

Now, some people will look at today’s 0.3% rise in Leading Economic Indicators (LEI), which was a bit stronger-than-expected, as being good news and auguring further growth. I should first say that I almost never spend as much as five minutes looking at LEI, because it is just an aggregation of individual data releases most of which we have already seen. There is much more information in the individual pieces of data than in the coarse aggregation of them.

For example, for this month the following components added the following amounts to the index:

Average Workweek 0.07%
Jobless Claims -0.19%
Consumer Goods Orders (*) -0.01%
Pace of Deliveries -0.12%
Orders Nondefense Capital Goods (*) 0.01%
Building Permits 0.05%
Stock Prices 0.03%
M2 Money Supply (*) 0.11%
Interest Rate Spread 0.27%
Consumer Expectations 0.02%

(*) indicates the component was estimated by the Conference Board.

So, the biggest contribution to the rise in Leaders was the Interest Rate Spread. In fact, the 0.27% was the lowest contribution from this component in well over a year. This contribution comes from the historical observation that when the curve is very steep, it usually indicates that the Fed is adding lots of liquidity and the market is expecting growth (and rates) to rise in the future.

The problem is that in this circumstance, the extraordinarily steep yield curve is a result of panic and the fact that the Fed lowered rates and did things that led people to expect inflation. But it did little to help growth. This “leading indicator” was adding to LEI in early 2008 (yes, early 2008) and was adding more than 0.1% per month as early as April 2008. By June 2008 it was adding 0.2% per month and by mid-2009 it was 0.3% per month. Now that’s a leading indicator. It’s really leading by a loooong time.

Now, money supply is finally beginning to re-accelerate, slowly. The growth rate over the last 26 weeks, a 4.2% annualized pace, is the fastest pace in over a year although still anemic. But perhaps, finally, the Fed’s actions are starting to gain a little traction, so that the yield-curve-as-leader might be improving. But I am not very confident in that possibility.

We are now being warned that an extension of the Bush tax rates will probably not be passed before the November elections. We are also told that at least some of the rates will be extended post-election, but there is certainly no guarantee that a Republican or partly-Republican Congress will be able to break bread with the Democrat Administration on this issue. I was looking to the Fed meeting right after the election as being the most-likely time for an announcement of some kind indicating that QE2 is beginning. But it may be too uncertain for the Fed to do anything in early November; it may behoove them to wait until December when they may be armed with better information about the likelihood of a fiscal shock and possibly have a lower core CPI to give them cover for such a move. I continue to think that only if there is a threat of a significant fiscal crunch will the Fed pursue a meaningful QE2, but I am less confident than many about the likelihood that Congressmen put in office on a platform of fiscal responsibility will vote to increase the deficit especially if doing so will give the other party cover on that issue. When it comes to politicians, it is usually wise to expect to be disappointed.

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A reminder/re-announcement for regular readers of this column: I’ve been asked to speak at the New York Investing Meetup scheduled for next Tuesday. My talk will begin at around 7pm. If you’d like to see me wear a tie, and especially if you are interested in my topic “Why I Don’t Worry About Deflation And You Shouldn’t Either,” go to http://investing.meetup.com/21 for details. You don’t have to be a member of the group to attend; attendance is only $10 to cover the group’s expenses.

I’d love to meet you. Please consider coming to the meeting. I will have copies of my book on-hand.

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