Monday, December 11, 2006

As China Weeps...

I've been busy these past ten weeks in the mysterious and wonderful world of "off-line", preparing my family for the 2007 - 2008 recession, since most of our income comes from transporting freight by truck, and naturally less consumer demand = fewer goods to be moved = ouch for us.
We've moved to a less-expensive living situation, and I've decided to re-enter the full-time workforce. (Que world's smallest violin).

Anyway, I'm taking a week off from that, before going "dark" for another six weeks or so, hoping to be completely transitioned to the new paradigm by the beginning of Feb. '07.

One thing that leaps out at me, when catching up on the archives, is that this blog has some major intellectual firepower. No person here is always right, but golly can you guys write, and the positions taken and cases made are usually high-level & top-notch. Like the way the 9/11 conspiracy nut had all of the underpinnings of his vapid argument knocked out from under him in something like four posts. (Not that he noticed).

The following are a few essays of the sort that convinced me that the U.S. economy will continue to slow into recession in '07, and I'm also convinced that the recession will last longer then the past two shallow and swift ones, which were far shorter than the typical post-WW II recession. If this one lasts a more "normal" eighteen months, then it'll stretch into '08 - a boost for Hillary, methinks, or whomever it is that's the eventual Dem nominee. The Clinton luck holds. (Possibly).

To add a personal anecdote in support of the conclusions of these pieces: The trucking business normally picks up considerably from Oct. to the end of the year, as Christmas retail goods make their way from port or factory to warehouse and store. Often we're booked for weeks ahead, and drivers get paid bonuses to delay taking normal time off, to stay on the road for a few more runs - to "work weekends", so to speak.

This year: Zilch. It was busier this summer than it is now.

[Except for the one sub-heading, all emphasis is added].

The Recession of 2007

by John Mauldin
December 1, 2006

[W]hile the economic data is not a total disaster, it has not been good this week. Yet the response of investors everywhere is defiance, or at the very least serious nonchalance.

Recession possibilities? "What recession? I spit on your talk of recession." They continue to assume that things will turn out much better than merely OK. All manner of investments are priced for perfection, perfection being defined as growth slowing enough to take out inflation risk yet not enough to hurt the ever upward rise of corporate profits. Goldilocks is the name of the game.

[...] This week we had the housing data for October. Permits and actual starts were down 28% and 27.4% (respectively) from one year ago. New home sales fell for the first time in three months, down 3.2% from the previous month.

[...] We are seeing inventories of homes for sale rise. And it could get worse, as foreclosures in sub-prime loans are rising. The mortgage bond market is showing some signs of strain. About 3.3% of sub-prime mortgages made THIS YEAR are now delinquent by more then two months. Think about that for a second. Borrowers or lenders could not see (or did not care about) problems coming even a few months in advance.

While traditional mortgage defaults are not a problem as yet, delinquencies in ARMs (adjustable rate mortgages) are becoming an issue. [...]
Late payments are accelerating, after lenders began to require less documentation for loans and financed more homes without down payments, New York-based Bear Stearns & Co. analyst Gyan Sinha said in a Nov. 14 report.

About 38% of the most common sub-prime mortgages this year were for the full value of the home, up from 31% in 2005 and 21 percent in 2004, according to Bear Stearns. Sinha said 45.5% of the loans this year required "low documentation" of borrower income and net worth, up from 44.5% in 2005 and 40.1% in 2004. The data reflect "common methods of allowing first-time homebuyers to borrow more than they can afford," Sinha said.

[...] Look at the rise in total homes for sale. The trend is not good. Paul Kasriel of Northern Trust tells us that "Total construction outlays fell 1.0% in October, after a downwardly revised 0.8% drop in the prior month. The 1.9% drop in residential construction spending in October is the seventh consecutive monthly decline. The main message is that the housing market recession's bottom is not here yet."

When residential fixed investment drops 10%, we have had a recession in the US. [...] RFI is [now] down by more than 10%.

Housing market recessions generally take years to work out, not months. This one is going to get worse before it gets better, with a bottom probably not coming until the middle of 2007. And as housing construction slows down, the 15% of the growth in the US economy that has been related to housing is going to disappear. While many market commentators, looking for good news a few months ago, cited nonresidential construction as performing well and adding to growth, we have seen that sector drop for the last two consecutive months by over 1%. Things will not grind to a halt, but they are going to slow down even more.

[...] This week we were also told that the third quarter was not as bad as the first GDP data released last month suggested. GDP was revised upwards to 2.2% from 1.6%. This was mainly due to inventory buildup and rising imports being revised higher. But higher inventories mean that manufacturers will slow production in the future.

[...] Wal-Mart sales were down by 1%, with the company downgrading forecasts for December. Tiffany sales and profits were up 23%. Barry Ritholtz [of Big Picture Blog] did a 30-store survey of discounting and sales and found that sales prices and promotions are quite high. He tells us, "The most recent review of price cutting is that they are both deep and broad. Our quick survey of both brick and mortar coupons and online savings codes shows that discounting is ramping up dramatically."

[...] This week, while staying at the Helmsley in New York [...], I walked into the bar on Sunday night to get a drink before going to bed. Looking around, I noted there were 34 mostly middle-aged ladies in the bar and no men. Thinking this was somewhat odd, I asked one of them if there was some sort of convention. The pleasant accent that came back was from Ireland. It turns out that much of the hotel was occupied by ladies from Great Britain and Ireland on a shopping holiday.

They were positively giddy about the prices. "Everything is half what we would pay in London or Dublin." They were hiring limos to go shopping so they would have enough room for their packages on the way back. [...] The pound is back to where it was when George Soros famously decided to break the Bank of England back in 1992. It is almost to $2. [...]

The Inverted Yield Curve Gets Steeper

The yield on the 10-year bond dropped to 4.43% as of the close of the markets today. [...] The bond market is clearly expecting a slowdown, and the yield curve is signaling an increasing chance of a recession. [...] 3-month T-bills are 23 basis points lower than the Fed fund rate.

[...] An inverted yield curve is the best indicator of a recession coming within at least four quarters. When we saw the yield curve invert in September of 2000, we had a recession about 7 months later. [...] If we had the same timing [now], that would suggest a recession beginning in the second quarter of 2007. If the data is all that bad, I can hear you asking, why will it take so long?

Because it takes time for things to slow down enough to actually put the US economy into a recession. For instance, new home construction is slowing, but builders must finish what they started. Real estate construction employment is down but is nowhere near the bottom.

As I think this is a housing-led recession, we should realize that homeowners are initially reluctant to drop prices. That takes some time. Further, it will take some time for lower home prices to really register on consumers and thus on consumer spending. [...] Consumer spending takes a while to actually slow.

But that is why I think the recession will be relatively shallow, as much of the economy is now in services, which are more resilient than manufacturing or housing...

When Will the Housing Market Bottom?

by John Mauldin
December 8, 2006

"When," I am asked frequently, "will we see a bottom in the housing market?" This week we look back at what past housing recessions have looked like to see if we can find a bottom anywhere soon. And could things be different this time? (Maybe.) We look at the government statistic on the number of houses for sale and find that it doesn't count all homes that are for sale. (I know it will shock most readers that government statistics might not be 100% accurate.)

[...] Lennar, the #3 homebuilding firm, said the cancellation rates for home sales were running about 30% last quarter. KB Homes said the number was 43%. A lot of anecdotal stories suggest the numbers could get worse. So that would add homes back into the Homes for Sale statistics that the Commerce Department (Census Bureau) tracks, wouldn't it?

The simple answer is no. The Census Bureau surveys home builders and specific housing starts. If a home is built and at some point put under contract for sale, it is then considered sold. The Census Bureau does not go back a few months later and ask, "Did you really sell that house?"

Because of the way they do the survey, they do not double count if the home sells at some later point to another person. One house, one vote. In the long run, cancellations do not cause the system to either overestimate or underestimate the number of houses sold.

But in the short run? As their web site explains: "As a result of our methodology, if conditions are worsening in the marketplace and cancellations are high, sales would be temporarily overestimated."

So the recent data that shows new home sales as possibly, maybe, getting to a bottom of the cycle? With north of 30% cancellations, the number of actual sales is certainly less than the data is showing.

[...] Lately, after every bit of data on the housing market, there is at least one analyst who will proclaim the end of the housing recession. How long, I wondered, did it take for past housing market recessions to bottom, and how severe were they?

Thus I was delighted to get a recent letter from Hugh Moore of Guerite Advisors in South Carolina full of the answers to my questions. I always appreciate it when someone else does my homework for me. (A guerite, by the way, is a type of sentry box projecting out from a castle or fortress).

First of all, what we are really asking when we wonder about a housing bottom is, when is housing construction likely to turn back up? [...] The construction industry has lost 53,000 jobs in just the last two months. That suggests it is not likely to bottom this year.

[...] Hugh tells us that "In the previous seven cycles since 1959, housing starts (seasonally adjusted) have fallen, on average, 50.7% from peak-to-trough. Each time housing starts have fallen more than 25% from their most recent peak, a recession has followed (except during the 'credit crunch' of 1966-67 that ended in an economic contraction, but not an 'official' recession)." [...] Housing starts have dropped 34% so far since their peak in January of 2006. Just to get to the average drop we have another 20% or so drop in starts to go.

[...] "In the seven cycles since 1959, both Housing Starts and the [ratio of residential fixed construction to GDP, a measure of how much housing construction is contributing to GDP] have taken roughly 27 months, on average, to fall from peak-to-trough. As of November 2006, both indicators are 11 months (or so) past their most recent peaks...or roughly halfway to bottom." [writes Hugh].

I asked Hugh to give me an estimate for this quarter for the RFI/GDP ratio. He thinks it will fall to 13.5 or so and then fall by 27% from its peak in the fourth quarter of next year. He expects residential fixed investment to drop by 20% (at least) from its peak last year, and to bottom sometime in the fourth quarter of 2007.

But Hugh may be an optimist. [Professor Robert Shiller of Yale has constructed an index that] tracks housing prices, adjusted for inflation, since 1890. This is on existing houses and not new construction. It is easy to see that the recent boom is a bubble. Since 1997, the index has risen 83%. Shiller talks about housing regressing to the mean over time. That could mean a lot more than a 20% drop in housing prices and another 12 months to the bottom. A drop to the mean could be over 40%.

[...] Housing sales and prices are the weakest on the coasts, where they went up the most. I got a letter from a rather well-off reader who has invested in rental real estate for some time and has a number of properties doing well, both from appreciation and cash flow. It is the two homes he is currently building in Florida that are giving him some problems. He has one coming to completion in a month, and he has $240,000 in it. His realtor told him there are 100 homes in the local area like his, and they are listed for $220,000. He has another one that will be finished in 6 months.

He has the option of renting and dealing with the negative cash flow. Not a fun thing; but for him it is an option, and that market should come back at some point, as more and more boomers will find Florida a great place to retire.

But what about all the weak hands in that market who can't deal with negative cash flow for a few months, let alone a few years? 28% of new homes started within the last year were for investment purposes. Those homes are now coming on the market. You can bet a few (at least) of those 100 homes in his neighborhood are going to be foreclosed. That means they are going to sell for less than the $220,000 they are listed for today.

David Leonhardt, writing in the New York Times this week, highlights an auction for homes in Naples, Florida. On average, the homes sold for 25% less than their value in 2005. Leonhardt listed several homes that sold in 2005 and now are down 28-35% when sold at the auction. (Thanks to Barry Ritholtz for sending this to me.)

Yet the official numbers tell us that housing prices are only off by 3.1% nationwide. This just goes to show that all real estate is local. There will be areas where home prices rise next year and a lot of regions where home prices will fall very little. The national average will not reflect the real problems of areas like Naples.

"The truth is," Leonhardt writes, "that the official numbers on house prices -the last refuge of soothing information about the real estate market on the coasts -are deeply misleading. Depending on which set you look at, you'll see that prices have either continued to rise, albeit modestly, or have fallen slightly over the last year. But the statistics have a number of flaws, perhaps the biggest being that they are based only on homes that have actually sold. The numbers overlook all those homes that have been languishing on the market for months, getting only offers that their owners have not been willing to accept.

"In reality, homes across much of Florida, California and the Northeast are worth a lot less than they were a year ago. The auction in Naples may have exaggerated the downturn in the market there, but not by much. Tom Doyle, a Naples real estate agent, estimated that a typical house there, sold in the normal way, would go for about 20 percent less than it did the previous fall. Right now, all these [OFHEO statistical] flaws seem to be making house values look much stronger than they really are. According to the latest index, for example, the average house in Miami would have sold for 22 percent more this summer than a year earlier. You won't find many house sellers in Miami who would agree that's true."

[...] Now, let me make the argument that it may not be as bad as in past housing recessions. When you look at the periods of serious housing declines, they are usually accompanied by serious unemployment or high interest rates. While unemployment will rise next year if we have a recession, as I think we will, we must remember that 80% of the US economy is in the service sector. It is not as in the past when the unemployment rate shot up because of lay-offs in manufacturing...

Well. One thing that didn't get mentioned above is that employment statistics are a lagging indicator. Almost always there will continue to be slow job growth into the beginning of a recession, and unemployment will continue to expand even after economic growth resumes. This is because companies can't know for sure whether slowing or growing demand will last, until the trend continues for awhile, and so they either hang onto their trained workers for a time at the start of a recession, or ask their workers to put in some overtime at the beginning of the recovery, delaying new hiring.

Some good places to get more information are at Calculated Risk - simple, straightforward, and excellent, and the comments are equally smart; - the most entertaining, and there's a lot of good stuff in the comments there too, but ignore the doomsday posters who think that the Great Depression will seem like a day at Disneyland compared to what they think is coming; and Nouriel Roubini's Global Economics Blog - very information-dense, but perhaps a little dry.


Blogger Brit said...

Where have you been hiding, Oro?

December 11, 2006 6:29 AM  
Blogger Peter Burnet said...

Good to have you back, but what happened to Mr. Optimistic? Oro, isn't there some kind of gadget we can invent to make this all go away?

December 11, 2006 6:34 AM  
Blogger Duck said...

Great to hear from you, Oro! I need to settle up for the oil bet, so send be an e-mail with your address when you get a chance. Or if you have an Amazon account that I can credit, send me the details.

I've read stuff from Maudlin in the past, he is in the perma-bear camp. I was much more bearish going into the last presidential election, but the dire forecasts failed to materialize. I'm not sure what camp to be in anymore.

December 11, 2006 9:45 AM  
Blogger Harry Eagar said...

I've no idea what the national economy is going to do -- assuming there is no flu epidemic or something that interferes with cross-border commerce -- but for years I have been thinking about medical costs, and again recently.

Sometime about 15 or 20 years ago, it occurred to me that cost-cutting by the feds in Medicare (etc.) could throw the economy into recession. At the time I noticed this, health was around 13-14% of all spending, and policy experts were talking about wringing 10% out of it.

Growth at the time was calculated at around 1.4%/yr.


I have been thinking about this again because a bunch of local doctors came to me complaining about how cost-cutting was driving them out of business.

It's an uneven situation, but I'm more or less agreeing with them.

Therefore, I see medical reimbursements going back up. With effect on the overall economy of . . . no idea, but something.

December 11, 2006 11:29 AM  
Blogger Hey Skipper said...


We've missed you, welcome back.

I have recently returned to a previous life, meaning I am in essentially the same profession you are.

That also means I very much want you to be wrong. By the way, my employer disagrees with you, if the hiring pace is anything to go on.

So here's the bet: a book that no quarter in 2007 has GDP growth less than or equal to 0%. Outcome to be decided at the beginning of 08Q2, to allow for reconsidered statistics.

December 11, 2006 11:36 AM  
Blogger Bret said...

I wouldn't be surprised to see a bit of a slowdown in 2007. Housing has something to do with it. I also think the Fed has miscalculated which is also hurting the economy. Also, unemployment is very low and increasing unemployment pretty much directly subtracts from GDP at this point.

But profits are robust, technology is galloping forward, crude has gotten somewhat cheaper, the dollar is weakening (boosting exports), and consumer confidence is pretty good. So if there's a recession, I think it will either be very shallow or it won't deepen till well into 2008. Assuming no catastrophic events (like Iran nuking Israel).

It's always fun to predict. Let's see how I do.

I would neither bet with hey skipper nor against him. I'd give it 50-50.

December 11, 2006 12:16 PM  
Blogger Hey Skipper said...


I've had all the layoffs I prefer for a lifetime.

Work with me, man!

December 11, 2006 7:18 PM  
Blogger Oroborous said...


I've been thinking, packing, and travelling, with more to come. As I wrote in the main post, I expect (hope) to have everything settled in seven weeks or so.


Thank you. I'm extremely optimistic, in the long run and in the broadest sense, but in the short-term and specific, I recognize that bad things happen to good people, and that life is usually two steps forward and one step back. It's time for the step back.

There is in fact something that society could do to even out economic cycles and reduce the impact of other negative phenomena: They could simply do as I instruct them to do. If they were to do that, we could have avoided the last year's worth of inflation in the Tech Bubble, and the rapid deflation of same; the last two year's worth of inflation of the Housing Bubble, and the multi-year deflation of same; the coming collapse of America's Social Security programme, and most of the pain that'll follow; and of course the rates of heart disease, cancer, and diabetes could be cut in half.

But differing opinions are what make markets, and so I'll content myself with winning another free book in Q2 '08.


Thanks! Let me find a book that I like, and you can have Amazon ship it to me.

Yeah, the trouble with being a Perma-anything is that you're wrong most of the time, so that when you are right, everyone sees you as "the boy who cried 'Wolf !'"

I read a lot of economic analysis and stockmarket chatter, and while I may not agree with him 100%, I find Mauldin's newsletters (half of which feature various other people's opinions and writing), to be extremely informative and contain valuable insight, and I'd pay hundreds of dollars a year to receive them.
Fortunately, he gives them away for free, which is one of the best bargains going.


With the effect of bankrupting Medicare, among other things.

But everyone's expecting the healthcare sector to grow to be at least 20% of the economy, with the Boomers retiring and all.

The wildcard there is automation. It's possible, but by no means certain, that advances in technology will make long-term care and medical treatment more efficient, which could drive down costs, even as many more people require greater per-capita care.


Thank you. Remember that any individual company might thrive, even as the broader economy fails a bit. And in any case, a U.S. recession should mean falling oil prices, which would be a wind beneath your company's wings. (Bad pun intended).

It's a bet. I'll give you the same two-to-one odds that I gave Duck, 'cause I think that Bret's being a bit optimistic at 50/50. As far as I'm concerned, an '07 recession is a done deal; if we avoid such, it'll be ahistoric.


If only one historically-pretty-accurate recession predictor went red, such as an inverted yield curve, then I might agree with you.

However, we have a whole board full of blinking red lights and warning tones.

Housing starts are way down; home sales are way down; housing inventories are very high, with more being added - it's not a stretch to find a scenario in which inventories double in '07; home prices are falling, with a long way yet to go to hit the historic trend line; there's a mild but long-lived yield curve; manufacturing activity is contracting; Ford is permanently cutting HALF of their work force, and GM a third; business inventories are very high; by the end of '07 there will have been a million people let go by the construction industry and related industries; '06 Christmas sales are (so far) very disappointing...

I'm going to do a main-page post about all of that before I take off again.

December 12, 2006 9:51 AM  
Blogger Bret said...


2-1 odds? That's almost interesting.

Today's retail report was quite unexpectedly strong. We'll see if xmas sales really end up being all that disappointing (don't worry, my kids won't be disappointed).

A million people? That shaves less than a percent off of GDP growth and there's 3% to 4% to play with.

I think it will be pretty close making it an exciting bet. What would we do without such entertainment from the daily duck?

December 13, 2006 10:39 AM  
Blogger M Ali said...

I'm not really keen on the prediction business. Duck sent me some articles a long while back from Bill Gross of PIMCO - a very smart guy - who predicted a big downturn in 2003/4. Similarly everyone here was saying that the bill for Gordon Brown's spending would have major impact on economic performance in 2006. Hasn't happened.

Personally I think it's best if you ignore and all that and just keep to sensible financial habits through good times and bad.

December 14, 2006 3:58 AM  
Blogger Oroborous said...


Yeah, Bill Gross is now predicting 3% long bonds in America within the next eighteen months.

Good financial habits through thick and thin are indeed a good way for the average person to get through life without too much worry or damage, but if one wishes to play "market casino", predicting is necessary.

And I like to play.

December 14, 2006 8:32 AM  
Blogger Harry Eagar said...

Well, I think we should recruit a MUCH bigger army, and the only way we could do that is to have a recession.

How's that for a tradeoff?

December 14, 2006 10:44 AM  
Blogger Oroborous said...

I've seen people seriously arguing a varient of that, or close enough.

Or if the U.S. economy were growing at 5% a year, we could just keep raising military salaries and benefits until another million people can't resist joining, and then borrow a few hundred billion more dollars to pay for it all.

December 15, 2006 1:12 AM  
Blogger Harry Eagar said...

We are facing a variety of the problem that faced France in 1970-1914.

In order to match Germany's army+reserves, France had to conscript for 3 years to Germany's 2. Which damaged France's economic growth, which weakened its relative strength v. Germany, which required a bigger army . . .

Since we are a seriously labor-short country -- always have been except 1930-40 -- anything we do to drain labor (exclude immigration, expand army, fund college scholorships) erodes growth.

If your business strategy includes growth (and Wall St. demands that if you need to borrow), then you are in trouble.

That's why my business is in such trouble. Newspapers are extremely profitable and include the psychic rewards of being the community's mouthpiece. But Wall St. hates them because they are not growing. So it is destroying them.

Which is why I am a skeptic about markets.

December 15, 2006 11:23 AM  
Blogger Oroborous said...


While I accept that many people who attend college aren't notably improved by doing so, for society at large having people attend college is more of a capital investment, rather than a drain on resources, IMO.

As for the plight of the newspaper business, I lay the blame for that squarely at the feet of management. Apparently many of them thought that the internet was a passing fad.
There are newspapers that do the 'net well, and that are prospering thereby. The rest should take notes, and action.

Besides, a lowered share price doesn't directly affect a healthy underlying business, unless it causes management to run around like decapitated chickens.

December 15, 2006 4:08 PM  
Blogger Harry Eagar said...

Sure, it does. Newsrooms are being gutted by managers doing the bidding, of their readers, but of Wall St.

Going back over a century, newspapers have regularly failed. Generally, the ones that didn't have solid reporting.

The New York Mirror had a circulation of over a million when it folded.

I understand that greater levels of education, if the education is more or less functional, is an investment that pays off in the long run. It doesn't in the short run, and as Keynes didn't say, right now we are in danger of being all dead in the short run.

It's certainly true that when my father's college was interrupted to fight the Japanese, it had a negative economic impact on the rest of his life. But it was important to take care of business.

December 15, 2006 7:36 PM  

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