Financial Sight

Friday, January 11, 2008

What a difference a year can make:

A year ago...

BofA is in talks to acquire Countrywide at a cost of about $30 billion. Countrywide shares soared 11 per cent after FT.com disclosed a possible alliance and closed up 4.2 per cent at $42.00. BofA shares fell slightly to $52.04.

- January 26 2007 FT.com

and now...

Bank of America confirmed on Friday it is buying Countrywide Financial in an all share deal that values the struggling home mortgage lender at $4 billion.

- January 11, 2008 FT.com

In the news:

The trade gap widened 9.3% to $63.1 billion in November, the largest deficit since September 2006. Economists surveyed by MarketWatch expected the trade deficit to widen in November to $59.5 billion.

Merrill Lynch is expected to report a $15 billion writedown when it reports quarterly results next week; the hit is bigger than the $12 billion writedown many Wall Street analysts are expecting.

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Thursday, January 10, 2008

TED Spread

Here is an updated chart on the TED Spread. Here was the original post on the TED Spread. The TED spread is one of the warning signals of the possible upcoming recession.

The 3 month LIBOR has dropped over the last few weeks by nearly .50% from where it was at in December to 4.44% yesterday. The spread has narrowed to 1.4 which is still quite high. It spiked up for little over .5 to 1.49 in August of 2007.

The recent drop in the TED Spread indicates a small improvement in the credit environment, but we are still at very elevated levels.

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Thursday, January 10, 2008

photo by Mozzer502

Quote for the day:

What has become clear to you since we last met?

- Benjamin Franklin

In the news:

BofA in talks to buy Countrywide.

U.S. retailers reported disappointing holiday sales in December. Walmart and Costco were bright spots.

Ben Bernanke says lower rates may be needed: "We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.''

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Recessions

Now that some of the major Wall Street firms are predicting we have entered into a recession, I thought I would take a closer look at recessions. Per Wikipedia, a recession is defined as ”a decline in any country's gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year.”

In the U.S., the National Bureau of Economic Research(NBER) officially dates the recessions. Here is their definition: A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough.

The NBER typically declares that a recession has started 6 to 18 months after the beginning of a recession. At the time, it is often tough to tell if the economy has tipped into a recession. We won’t see the advance GDP numbers for 4th quarter 2007, until January 30, 2008. The numbers for January through March wont be announced until the end of April.

Calculated Risk had dug up these classic quotes on the 1990 recession.

“In the very near term there’s little evidence that I can see to suggest the economy is tilting over [into recession].” Greenspan, July 1990

“...those who argue that we are already in a recession I think are reasonably certain to be wrong.” Greenspan, August 1990

“... the economy has not yet slipped into recession.” Greenspan, October 1990

The recession was declared by the NBER to have started in July 1990. By October 1990, the S & P 500 was close to the bottom. By the time it was obvious we were in a recession, the bottom had already been reached.

Despite the inherit murkiness of recessions, I will take the liberty of creating these graphs with the clarity of hindsight vision. You can click on the graphs for a larger view.

>We have had 10 recessions going back to 1948. The average recession has lasted 10.4 months. The average return on the S & P 500 from the start of the recession to the end of the recession has been -0.57%. In 6 out of the 10 recessions, the S & P 500 was higher at the end of the recession rather than the beginning of the recession. However, during the last 10 recessions, the S & P 500 did decline 13.6% from the beginning of the recession to the low reached during the recession. Note that the S & P 500 figures do not reflect the highs and lows that the S & P 500 traded at on a daily basis during the month; my figures just reflect the closing price for the month. The low was reached on average 6.8 months after the start of the recession. From the low during the recession to the subsequent high, the S & P 500 has gained an average of 35.1%.
There have been 3 instances of what I have termed false bottoms in the first or second month of a recession. In the last 10 recessioins ,there was never a real bottom that early. There have been 2 recessions in the last 10 years where the low was reached at the third month, the rest have been later. This is partly due to the fact that recessions are normally thought of as lasting at least 2 quarters. If the economy recovers in a few months (bottom is reached in the first or second month), then the period most likely would not be defined as a recession.

Finally, for a different perspective, I am also including the charts for the Great Depression, the recessions of 1937 and 1945, and finally the most sobering of all: the Japanese bubble.

I plan to revisit this topic from time to time.

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Wednesday, January 9, 2008

Wednesday, 1/9/08

photo by Tony~M

Quote for the day:

"I thought if I was glued to the bed, they couldn't make me go to school. I didn't want to go, the holidays were so much fun."

- a 10 year old boy in Mexico

In the news:

Goldman Sachs says recession "has now arrived, or will very shortly." They say the recession shouldn’t last more than three quarters and should be relatively mild.

St. Louis Fed president William Poole said that it is too early to tell if the problems in the housing market will push the economy into recession.

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Tuesday, January 8, 2008

Merrill Lynch declares we have entered in recession.

David Rosenberg, chief North American economist for Merrill Lynch, announced: "According to our analysis, this [recession] isn't even a forecast any more but is a present day reality."

Marketwatch reports:

"Friday's employment report strongly suggests that an official recession has arrived," Rosenberg wrote in a note to clients on Monday.

"The key question now is how deep the recession will be and how long it will last," wrote Richard Berner and David Greenlaw, economists for Morgan Stanley, in a note to clients on Monday.

According to the Telegraph:

Mr Rosenberg points to a whole batch of negative data to support his analysis, including the four key barometers used by the National Bureau of Economic Research (NEBR) - employment, real personal income, industrial production, and real sales activity in retail and manufacturing.

Mr Rosenberg notes that although the NEBR will be the final arbiter of any recession, such confirmation may be two years away as it typically waits for conclusive evidence including benchmark revisions.

However, he believes that all four of these barometers "seem to have peaked around the November-December period, strongly suggesting that we are actually into the first month of a recession."

The Big Picture posted this graph:

Here are some Rosenberg quotes from the Jay Hancock's blog at the Baltimore Sun:

At no time in the past sixty years has the unemployment rate risen 60 basis points (50 bps is the actual cutoff) from the cycle low without the economy slipping into recession, and here we now have the jobless rate hitting 5% in December versus the March/07 trough of 4.4%.
Aggregate hours worked in the economy contracted at a 0.4% annual rate in 4Q, and this comes on the heels of a 0.6% decline in 3Q. Back-to-back declines in total hours worked have always been associated with recession.

The level of unemployment is up 13% YoY, again a development that has always been consistent with past recessions. The YoY rate of change in the level of the unemployed who have been idle for at least 15 weeks is particularly ominous - +20%, which is a pace that prevailed in the early stages of prior economic downturns (hitting this trend in April/01 and in Aug/90 when the recessions were one-month old).
And we have Household Employment contracting 49,000 in 4Q and the YoY trend lowing to +0.2% in December from +2.2% a year ago, another classic recession signal. Consider for a second that in March of 2001 that trend was running at +0.8%, and in July of 1990 the pace was +1.1% - those two months represented the onset of a technical recession and yet the trend in Household jobs is weaker now than it was then.

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Tuesday, January 8, 2008

photo by powderruns

"I am concerned that developments on the inflation front will make the Fed’s policy decisions more difficult in 2008. Recent data suggest that inflation is becoming more broad-based. Recent increases do not appear to be solely related to the rise in energy prices. Consequently I see more worrisome signs of underlying price pressures…"

-Philadelphia Fed President Charles Plosser in a speech today

In the news:

The National Association of Realtors' Pending Home Sales Index, fell 2.6% percent in November, after two months of improvement from a record low hit in August. Economists surveyed by Briefing.com had forecast a 0.8% decline.

James Cayne to step down as Bear Stearns CEO. Yesterday, its shares were at $76.25, below their 52-week high a year ago of $172.61.

Moody's Investors Service downgraded the ratings of 46 tranches from eight Alt-A deals issued by Bear Stearns (BSC) in 2007.

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Monday, January 7, 2008

Residential Investment and Recessions

Calculated Risk has a great post on some of the components of GDP and their relation to recessions.

His first chart looks at Private Fixed Investment. You can click on it for a larger image.

He notes that “Private fixed investment has fallen 13 times since 1948 (14 including the current slump), with only 10 recessions.” He comments that in the dips in 1951, 1967, and the minor slump in 1986, private investment fell, but the economy didn't slide into recession. However, each time was accompanied with a surge in defense spending with the Korean war, the Vietnam war, and the general defense build-up with the Cold War.

Here is a chart with Defense Spending.

The Defense Spending in the first quarter of 1951 through the second quarter of 1952 was off the chart (65% in the first quarter, 98%, 118%, 111%, 75%, and 47% in the 2nd quarter of 1952).
Calculated Risk points out that “the year-over-year change in private fixed investment appeared to have bottomed in early 2007, suggesting the economy might have avoided a recession”. Currently our Defense spending is up helping to cushion the drop in fixed investment. But Defense spending is not up at the high levels it was at during the previous wars.

Calculated Risk created a second graph separating private fixed investment into residential and nonresidential components.

Residential and Non-Residential Investment

He illustrates that in general “residential investment leads nonresidential investment.” If residential investment continues to fall, it suggests that nonresidential fixed investment would also fall.

Calculated Risk also has good charts on residential investment compared to equipment and software investment and also compared to structures. Both those components of GDP tend to lag residential investment.

Edward Leamer, a Professor at UCLA, presented “Housing is the Business Cycle” at the Housing, Housing Finance, and Monetary Policy Symposium sponsored by the Fed in August 2007. In his presentation, he noted some of the same dynamics.

“Residential investment consistently and substantially contributes to weakness
before the recessions, but business investment in equipment and software does
not. And the recovery for residences begins earlier and is complete earlier than
the recovery for equipment and software.”

Residential investment “contributes most to weakness before recessions. In 6 of
the 10 recessions, residential investment was the greatest contributor to
weakness prior to the recession. Only twice of 10 did residential investment not
contribute significantly to weakness prior to the recession: the 1953 and 2001
oddballs. “

Consumer durables, consumer services, and then consumer non-durables were the next significant contributers.

"Equipment and software ranks as the number one source of weakness during the
recessions compared to a rank of six prior to the recessions. In terms of their
impacts during recessions, after business spending on equipment and software
came consumer spending on durable and nondurables."

Leamer said that after residential investment, the next best predictor of recessions is consumer durables and consumer services. Here are graphs of each.

Neither consumer durables or consumer services dipped in the 3rd quarter of 2007. The 4th quarter 2007 GDP figures are due to be released on January 30, 2008.

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Nice graphic on volatility

2007 may have felt volatile, but it was an average year at most. The New York Times looked at volatility over the last 100+ years. If you want to see what volatility looks like, look at the chart on the Shanghai composite. You can click on the picture to go to the NY Times Article.