<<What recession>> ... the one that is down the street and around the corner and is waiting to jump on all of us <g> ...
... I can only copy the text ... but you will get the picture ...
ContraryInvestor.com - 04/10/01
Market Observations
The Train Kept A Rollin'...The "little engine that could" of consumer credit growth continues to chug ever higher up the hill. Neither a setback in financial asset price growth nor the now current reality of actual job losses seems to slow the progress. With slow and steady determination, consumer households continue to leverage personal balance sheets in almost rote fashion.
Consumer credit outstanding grew at an 11% annualized growth rate in February. After a brief cooling off in the holiday season of December of all months, consumer credit growth is firmly back to its double digit annualized ways in the first two months of 2001.
It's On The Wrong Track And It's Headed For You...As you know, most market participants have virtually grown numb to excessive consumer credit growth over the last few years. As the good times rolled on during the mania stage of the bull market, the focus on consumer credit was not related to absolute or relative dollar amounts outstanding, but rather how effectively consumer credit could be employed to maximize individual consumer common stock exposure. Maintaining portfolio holdings while financing lifestyle needs at a cost of capital lower than annual rates of return on equities. Financial arbitrage for the common man/woman.
We now live in a world of contracting financial asset values, low single digit year over year retail sales growth, and declining auto sales growth. It begs the question as to why consumer credit growth is still expanding at double digit annualized rates. Something seems amiss. Very amiss. One look at the above chart suggests as much. The internal components of the consumer credit number tell a disturbing story. In February, revolving credit grew at an almost 22% annualized rate while non-revolving credit grew at 3.4%. Non-revolving credit usually finances bigger ticket items like autos. It seems a natural that this type of credit growth would be slowing as the economy weakens. What does not seem natural is that revolving credit is spiking during a period where annualized growth in personal consumption expenditures is falling.
Clearly consumers are not ransacking retail sales shelves. The Redbook and Mitsubishi retail sales reports today showed March sales below plan for retailers on average. The big retail report lies ahead and we clearly are not expecting fireworks. Likewise, consumers are not piling gobs of money into stocks. Equity mutual funds have experienced what we would characterize as modest redemptions over the past few months. Why the need for what was an additional $11 billion increase in revolving consumer credit during February? A number 75-100% higher than any monthly total in recent memory. Our answer is the initial signs of consumer distress. The need to tap the card for emergency credit. Is it energy costs, layoffs, etc.? You bet. Given that consumption numbers do not reflect strength, we surmise revolving credit is being used to fund household income shortfalls or weakness. In just a minute, we'll be looking at the labor market as of late. In light of what is happening with jobs, the revolving credit spike in February begins to make a lot more sense. As you know, one month does not a trend make. We'll clearly be focused on these monthly numbers as we move ahead.
What is also quite telling about the unspoken current condition of the consumer is that alongside what seems abnormally high revolving credit growth, where interest is non-deductible for tax purposes, refi activity has boomed over the past six months or so.
Countrywide credit said yesterday that they lent almost $10 billion in March alone. Loan funding up 89% over March of 2000. Refi activity for Countrywide was 57% of total funding. The data also show that the bulk of refi activity is "take out" financing. You know, increasing loan values above current balances to leave the refi borrower with new (borrowed) cash. Interestingly, the chart shows that in just the last quarter, refi activity, although strong on an absolute basis, has leveled off. Although the mortgage industry is beefing up staff and watching heavy hitters like Washington Mutual bulk up, it appears to us that mortgage rates are going to have to take a quantum leap downward to really juice activity ahead.
The fact is that the bulk of public mortgage paper outstanding in this country is priced between 6.5% and 7.5%. From where we are now, the pool of new refi candidates is diminishing unless rates drop significantly (plus or minus 100bp's).
Refi activity makes academic sense in terms of lowering cost of personal capital. Also from an academic vantage point, shifting non tax deductible debt balances such as revolving credit to real estate leverage is tax efficient (to a point). Unfortunately, current numbers do not suggest there is a shift occurring. Quite the opposite. Mortgage debt and revolving debt are growing concurrently. Set against the backdrop of a declining growth rate in household consumption and rising layoffs, this confluence of events suggests to us that we are seeing the initial signs of a US consumer who has hit the proverbial wall. The spike in current borrowing relative to rising current job stress tells us that our favorite current coincident economic indicator, the battle ship US consumer spending, is headed directly for the rocks. Full steam ahead? Current borrowing patterns are not being borne in the warm waters of consumer confidence. Quite the opposite.
Labor Pains...The notion that the current domestic economic softness is nothing but a pregnant pause is losing new age converts by the day, despite what have been and will continue to be sharp bear market rallies in the equity markets. Was the employment number that hit the Street last Friday really that big a surprise? Well, apparently to the analytical community expecting an up number, it was. We don't want to turn this into an in depth economics only discussion, but we believe the messages being delivered by the employment numbers are serious and reflect directly on investing opportunities ahead.
After what has been the greatest three month period for announced layoffs in US history, it's a natural that the employment numbers start to reflect the reality of the situation. As we have discussed with you in the past, we firmly believed that the early 1990's passage of the Warn act would delay the realities of announced job losses as the Act requires 60 days lead time notice to laid off employees. Those receiving pink slips late last year and in early 2001 are now showing up in the employment numbers. Don't worry, there's a lot more to come. Other concepts we have mentioned to you in the past include speed - e-time decision making causing quick cost cutting response to faltering demand. Likewise the fact that the variable cost that is an employee would be an easy target for quick cost reduction after the largest fixed asset capital spending boom in history. Unfortunately, depreciation never sleeps. These factors led us to believe that employment across all sectors of the economy was, and still is, in a period of stress.
No Tears And No Hearts Breaking, No Remorse...There have been declines in monthly employment before during the last ten years. But, in many cases, rationales such as weather, completion of the census, etc. have been the cause. This one looks real. This is corporate America cutting back on payrolls. The March number of 86,000 in job losses is the first such negative number since 1995 and the worst monthly loss since 1991.
As you know, watching stock prices fall is one thing. Losing your paycheck is something else altogether. Especially in terms of future confidence. We, as well as many others, have wondered aloud recently just how investors have been able to remain so complacent in the face of a 60%+ implosion in the NASDAQ over a twelve month run, to say nothing of losses in the S&P and the Dow. One of the real reasons had to be that during this entire period paychecks were not perceived to be at risk. That perception will change. We're not saying this to be bearish at any cost, it's the facts that point us in that direction.
It's certainly no surprise that the manufacturing sector bore the brunt of job losses in March. YTD, the absolute number of losses in manufacturing is 270,000. For the entire second half of 2000, the losses were only 180,000 in manufacturing. Acceleration is upon us. The following chart simply says it all for the manufacturing sector.
The level of absolute manufacturing employment seen at the current time is as low as anything we have experienced in the last thirty years. Yes, we know we have become more of a service based economy over time. The succession of lower highs in absolute levels of manufacturing employment over the last two decades demonstrate that. But, do you think manufacturing employees don't have 401(k)'s? Think again. We are clearly on track to set new absolute number record lows in the current environment. Oh yeah, we're not even officially in a recession yet.
Spread Out, Ya Knuckleheads...We only wish this was a Three Stooges short. The fact is that service jobs declined more than at any time in the last 9 1/2 years.
You saw the recent Disney announcement. In March, food and drink employment lost 25,000 jobs. In a recent survey by Travel and Leisure magazine, only 41% of households are planning to take a vacation in the next six months. That's the lowest survey number in over 20 years according to the magazine. Not good news for travel and leisure services employment. The current downturn is not being limited to manufacturing by any means. It's spreading out sector by sector.
Lastly, the easiest group of all to eliminate has been and continues to be washed out with the economic tide - temp workers.
Year over year growth in unemployment for this group is as high as anything we have seen during this entire economic cycle. The tech industry is taking a hatchet to temp employees, but it does not stop there.
Growth in weekly hours worked has been trending down for a number of years now. As you know, layoffs are usually the final action in cutting employment costs. First, hours are cut back. The recent report still showed a positive gain in hours worked, but just barely. Good for the employee, at least for the moment.
Lastly, a final negative in the picture is that hourly compensation continues in a positive growth mode. Good for the employee, but bad for corporate profits. It suggests that if there is no turn upward in corporate profits anytime soon, further layoffs seem assured. In the recent report, average hourly earnings vaulted higher by and annualized 4.3%. As you know, many a CEO would kill right now to show bottom line growth of that magnitude.
So, now that we have made you wade through the macro details of the current employment situation, here's our real concern. As you know, the employment situation in this country has been tight as a drum over the last few years up until the recent economic cliff diving contest sponsored by the Fortune 500. Macro unemployment hit a multi-decade low only recently. Hard dollar costs of attracting and retaining employees mushroomed for corporate America in the last few years, in spite of the stock option blitzkrieg. Do you really believe that corporate America would be conducting significant employee layoffs if management truly believed this was to be a one to two quarter inventory correction? Especially with the recent last few years experience of extreme difficulty in attracting quality
employees in the first place? Also with the cost of training new employees? Of course you don't. The management of corporate America is sending a direct signal to all who care to listen that what they believe to come is anything but a short lived inventory correction. It makes no sense at all to dismiss the numbers of employees they are dismissing...unless they were scared silly that this corporate profits recession will be longer and deeper than the current consensus believes. Much deeper, in fact. The Fed may believe it's just an inventory correction. Wall Street strategists may believe it's just an inventory correction. Our money is squarely bet on insiders, corporate management, who obviously aren't listening to either the Fed or the talking heads as they now hand out pink slips like they used to hand out stock options. Next.
Listen to what is being said in upcoming quarterly earnings releases and how stock prices react. Watch the layoff announcements. Watch the revolving consumer credit picture. Watch the consumption numbers. As you know, we'll be commenting on the whole shooting match ahead. The real stress in the system is readily apparent. It just seems a shame that so many are still devoting so much time to trying to call "the bottom" or every squiggle in stock prices, as opposed to objectively assessing the facts that will ultimately determine those same stock prices over a reasonable period of time.
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