Here is a link to our Credit Crisis teleconference replay. It’s approximately 20 minutes long, with slides, and there’s a further 10 minutes of Q&A afterwards. We cover the problems in the global money markets, the falling US housing market, and the prospects for corporate bonds and high yield if there is a recession or significant global slowdown.
Here’s a bit of proof of our assertion that the bond market is better at forecasting recessions than the Wall Street economists. Apparently in March 2001, the first month of the last US recession, 95% of US economists were predicting that there wouldn’t be one, and the average forecast growth rates for Q2 and Q3 were 2.2% and 2.3%. This New York Times article suggests that because recessions are relatively rare "it’s like asking people who spend their time in Alaska to start forecasting tropical storms". I prefer Merrill Lynch’s chief economist David Rosenberg’s comment in today’s FT when he states that telling a client that there’s going to be a recession "is like looking a client in the eye and telling them that their child is ugly. It’s not what people want to hear". For the record, Rosenberg, along with Richard Iley of BNP Paribas have been rare contrarians for the last year or so, and have been predicting tough times ahead.
Those of you listening in to our Credit Crisis conference call on Friday will have heard me suggest that the unemployment numbers would have to catch up with our expectations of an already softening American economy. We didn’t expect it to be such a rapid turnaround. Payrolls shrank by 4000 jobs in August, and back revisions meant that the economy has 200,000 fewer workers than the market expected. The "R" word is coming out thick and fast now. We will be putting link to the conference call on this site tomorrow if you missed it first time round – for those who did listen in, thanks, and apologies for the web freezing in the last minute of the Q&A. The World Wide Web is designed only to cope with the aftermath of a nuclear strike, not a fully blown credit crisis.
We’ve mentioned the crystal ball-like qualities of the US yield curve a couple of times on this blog. In May Jim showed that it can be a good predictor of recession (read article here), and the San Francisco Fed has recently published this interesting piece that adds weight to the argument.
There is some statistical analysis within the article, but in short it concludes that the yield curve is a better predictor of recessions than the professionals. There’s the old joke about the bond market predicting 9 out of the last 5 recessions – but the fact is that the economists employed by the investment banks predicted none of them. Nobody on Wall Street likes a bearer of bad tidings – just unleash the Rally Monkey and everything might be alright.
We have just 17 days to wait till the publication of Alan Greenspan’s autobiography, "The Age of Turbulence: Adventures in a New World". It’s 544 pages long, so hopefully nobody will buy it for me for Christmas, but from the synopsis that’s been released we learn what a great job he did of saving the world:
The most remarkable thing that happened to the world economy after 9/11 was …nothing. What would have once meant a crippling shock to the system was absorbed astonishingly quickly, partly due to the efforts of the then Chairman of the Federal Reserve Board, Alan Greenspan. The post 9/11 global economy is a new and turbulent system – vastly more flexible, resilient, open, self-directing, and fast-changing than it was even twenty years ago.
Events of the last couple of months show that the economy is a little less flexible and resilient than claimed – and many would argue that the huge imbalances in the western economies have resulted from Greenspan’s actions at the Fed. Whilst rates needed to come down post 9/11 and the bursting of the tech bubble, they were then kept at emergency levels for far too long. The Fed Funds rate was kept at 2% or below from September 2001 all the way through to November 2004, yet US growth had recovered significantly by the third quarter of 2003 and was probably well above trend by early 2004. This mispricing of the cost of money simply created another bubble, this time in residential property, as well as increasing the attractiveness of leverage in the financial sector. The unwind has only just begun. Bernanke got the hospital pass, Greenspan got the book deal.
It was announced yesterday that US house prices fell by 3.2% in the year to the end of June, according to the S&P/Case-Shiller house price index. As the chart to the left shows (click to enlarge), this is the most severe slide since the index began in 1988. It is worth emphasising that this data does not include the turbulence of the past couple of months – things may have deteriorated much further.
We now have a simultaneous attack on economic growth in the US from both the real economy (ie the stalling consumer) and from the financial sector crisis (ie no more cheap money). It looks like the US housing disaster will probably get worse before it gets better, and a US recession is looking more and more probable (50/50 for 2008?).
I am giving a teleconference on Friday 7 September at 10am to talk through what’s going on in bond markets and the global economy at the moment. If you are interested in our views and have any questions about recent events then please click here to register for the teleconference.
Angelo Mozilo, the chief executive of Countrywide (the largest US mortgage lender) seems to think so. His answer to the above question was that "I can’t believe…that this doesn’t have a material effect…on the psyches of the American people and eventually on their wallet".
He certainly has a case. This chart (click to enlarge) plots US economic growth since the mid 1980s, and I have annotated the various financial crises over this period. What is striking is that when a financial crises occurs during times of rapid growth, the economy dips a little but quickly bounces back. In fact the US economy didn’t waver at all following the stock market crash of 1987, probably because US growth was booming at an annualised rate of 7.2% in Q4 1987. The financial crises of the mid-late 1990s only caused the US economy to dip briefly.
But a financial crisis combined with already-weak economic growth has traditionally caused a severe dip. The real estate boom of the late 1980s turned to bust, and helped contribute to a sharp recession in 1991. The equity market collapse of 2000-02 occurred when the economy was already on its knees, and only some aggressive intervention from the Fed and the US government prevented the US economy experiencing negative growth.
This time around, the US economy has already had a year of sub trend growth, and a credit crunch has come at a bad time. I think the Fed will have to act fast to prevent a slide towards recession.
Unemployment in the US has remained remarkably low in the face of the recent economic slowdown, partly because unemployment has traditionally been a lagging indicator. Labour market rigidity means it’s not possible to immediately make workers redundant when there’s a slump in demand (even in the hire & fire US economy).
But the unemployment rate looks finally set to turn. US initial jobless claims moved higher for the third consecutive week last week, and this chart (click to enlarge) suggests that a jump in the unemployment rate is imminent. There is a close correlation between the US delinquency rate and the US unemployment rate, where delinquencies tend to lead unemployment by about two years. Most worryingly, the delinquency data here is only for Q1 this year – Q2 figures aren’t due to be released for a few weeks yet, and will surely be significantly higher.
In fact you can plot the delinquency rate against a number of other variables, and all make fairly grim reading. This chart (click to enlarge) shows the correlation between delinquencies and corporate bond spreads. The corporate bond sell off that’s taken place over the past couple of months should have been of no surprise given the recent spike in delinquencies, and if you assume that the Q2 delinquency figure will be in the region of 5%, then the spread on the average US BBB rated should be over 200 basis points, not the 177 basis points at friday’s close.
Last week saw some dire statistics released on US housing starts, permits and completions. US builder sentiment is close to all-time lows, and the housing market debacle is far from reaching the bottom.