Warning signs

The Fed cut rates yesterday, although not as much as 'expected' (read: 'hoped') by the ever hopeful stock selling industry. Nonetheless stocks rocketed higher by a huge amount. Did this make sense? Not if these data mean anything.

Lots of items are clearly pointing towards recession, which, if true, *should* be very stock unfriendly. In each case below I am providing some commentary, a link, and then a snippet from that link (in the quote box).

Exhibit A:

Tax receipts by the government are one set of data that I trust because they are not "seasonally adjusted", hedonically adjusted or in any other way manipulated. They simply are what they are. And taxes are very sensitive to economic conditions, so they are pretty reliable indicators of how things are going. In February the government reported that tax receipts were down by 12.1% over the prior year. That's a very significant decline and it clearly signals some pretty profound economic weakness if not a recession.

TRIBUNE NEWS SERVICES March 13, WASHINGTON - The federal government budget deficit widened to a monthly record $175.6 billion in February, as a weakening economy reduced tax revenue for the second consecutive month.

Revenue last month fell 12.1 percent, while spending increased 17.1 percent, the Treasury said Wednesday. The shortfall was bigger than the $170 billion deficit economists had forecast and compares with the previous record of $120 billion in February of last year.

Exhibit B:

I know we don't manufacture nearly as much as we used to but our manufacturing base still gives us some indication of how things are going. Last week the Empire State Index which measures manufacturing throughout a fairly large region in the NY/PA/NJ area reported a huge decline, much larger than expectations, to a new all time record low.

WASHINGTON (MarketWatch) -- Manufacturing activity in the New York area plunged for the second straight month in March, the New York Federal Reserve Bank said Monday. The bank's Empire State Manufacturing index fell to negative 22.2 in March, a record low reading. The index had fallen to negative 11.7 in February from 9.0 in January. Readings below zero indicate contraction. Economists were expecting the index to improve slightly to -5.0 in March.

Exhibit C:

Job losses. A net loss of 63,000 jobs was reported for February. This was the combination of a terrible 89,000 jobs lost in construction and manufacturing but offset largely by addition of 50,000+ jobs in two areas; Leisure & Hospitality and Government Hiring. So we're producing a lot less but that's apparently offset by the fact that we're taking more vacations and working for the government in ever larger numbers.

Actually, it's even worse than that. The government uses a variety of methods to estimate the rate of job creation and one of the more suspect items in their repertoire goes by the ear-catching name of "the Birth-Death model". What this model does is either add or subtract jobs from the actual data that is sampled from establishments (businesses). For the past five years the B-D model has only added jobs for 10 out every twelve months and February is always an "add" month. How many jobs did the B-D model add? 135,000. Without these 135,000 modeled jobs the reported employment number would have been closer to negative 200,000 jobs. To help you understand why I am deeply suspicious of the output from this model is illustrated by the fact that it calculated that 9,000 construction jobs were added to the economy in February. This brings us to...

Exhibit D:

Housing. There has never been a big downturn in housing that was NOT associated with a recession. In fact, history is quite a burden for anybody who wants to claim that this time will be different and that we won't have a recession even though housing activity is falling off by the largest amounts ever recorded. The most recent data?

WASHINGTON (AP) - In another sign of troubles in housing, construction of new homes fell by a larger-than-expected 0.6 percent in February to an annual rate of 1.065 million units.

So, taken all together, we have weak tax receipts, declining employment, slumping manufacturing, and housing in a free fall but, thankfully, a buoyant stock market. Don't fall for it. Something has broken down. Once the stock market used to be called 'the great discounting machine' because of its ability to rise and fall in advance of news, either good or bad. Now? It's so far behind the news that we can only speculate as to why, or for how long, but we can be sure that the risks of holding stocks right now are extremely asymmetrical; that is, the chance of losing 30% is probably equal to the chance of gaining 10%.

But the real cause for concern is not in the fundamental economic data listed above, but the extremely troubling signs that remain in the financial arena. The ones that give me the most pause are:

  1. The TED spread measures how willing banks are to lend to each other and, when things are healthy, is usually within 30 'ticks' (30/100 of a percent) of T-bills. Today it started out at 165 ticks away (yikes!) and shot straight up to finish the day at 203 (gulp). This tells us that banks are refusing to lend to each other, that their confidence is at an unusually low ebb, and that the valiant efforts of the Fed may have reinflated stocks but their actual target, system liquidity, is not responding as hoped. In times past, such as in 1987, the TED spread has had an uncanny ability to blow out (like we saw today) right before a big market crash. I'm not saying we're definitely going to have a market crash, but this sign alone makes me very nervous for anybody holding a lot of their assets in stocks.
  2. Treasury bonds continue to get bought, bought, bought. This too is usually a reliable sign that economic weakness is on the way and is a very strong indicator that a recession is either here or will be soon. Again it's not a 100% certainty, but we can state that either stocks or bonds are making a colossal mistake here because they are signaling very different things.
  3. Rumors, rumors, rumors. Besides the vast number of articles indicating that Lehman may be next in line, I am hearing lots of grumbling about the prospects of a great many banks and brokerages. Where there's smoke there's usually fire. Is it possible that the problems began and ended with Bear Sterns? Yes, but it's not probable.

My bottom line? I consider the mysterious stock buying spree of Monday and Tuesday to be a gift for those seeking to lighten their stock positions. My concerns about the viability of the banking system remain fully in effect and nothing I have seen over the past three days has done anything but confirm my beliefs about the seriousness of the underlying situation.

More to come...


This is a companion discussion topic for the original entry at https://peakprosperity.com/warning-signs-2/