Winding Down The Year

We have had a flurry of news this week causing the stock market to bounce around in near frenetic glee. If you to believe that the markets are even vaguely rational, which hopefully you are highly skeptical of, then have cause for optimism. If you’re like me and regard markets as deeply flawed and easily misled, then you end the year with more of a yawn.

The news, you see, adds up to more of the same.

Earlier in the week we heard that housing starts had risen from an annual rate of 628,000 in October to 685,000 in November. This set off a market rally presumably because the perennial optimists there wanted something to offset the gloom and despondency settling in from Europe. But a cursory look at those starts numbers tells a story of continued drift: they are weak, albeit not quite so weak as before. Yes, its true that recoveries sometimes start with small steps. And it’s also true that we have to pass through 685,000 on the road to the kind of numbers we associate with a healthy economy. So this week’s very modest uptick is, indeed, a good move. But it isn’t the end of the crisis. Far from it. Housing has a very long and painful road to haul before it reaches the safety of normal growth.

So why did the markets react so strongly?

Because there are other small signs that real estate has touched bottom and has started its climb out of the hole.

On Monday we read the monthly index of home builder confidence. It too was up from the prior month. In this case the most recent reading is for the beginning of December: the index now stands at 21, up from 19 in November. This is, of course, an almost derisory reading. This is one of those indices where a reading of over 50 is considered strong because at that pint over half of all respondents state they are experiencing better business conditions. So 21 is still pretty pathetic. But, yes, it’s better than 19. This is hardly the stuff of legendary growth though, so we are all entitled to look on the market’s reaction as one of clinging to even the slenderest of slender straws of hope, rather than as a sign of a great turn about in our fortunes. Still, we should note that the index has registered three straight improvements so there are signs of stirring.

Adding to the signs of life was the sales of existing homes release on Wednesday. It too rose, from an annual rate of 4.25 million homes in October to 4.42 million in November. Once again the cautionary note holds: this is still a lousy performance. Just not as lousy as before. The problem with this news report was hidden in the details. The National Association of Realtors, not exactly an objective source in the best of times, is the group compiling this report, and they used this month to alter their numbers going back to 2007. The adjustment knocked about 14% of the accumulated number of sales between 2007 and 2010. So the decline was more severe than we first were led to believe. This downward adjustment is in line with similar moves in other indices – recall that GDP itself was significantly reduced a few months back, meaning that the recession was much worse than we thought it was as we went through it. Since housing, and the ridiculous overvaluation of our property, was at the heart of the crisis, it was inevitable that housing sales were also over-reported during that same period.

The week’s real estate news ended this morning with the data on new home sales. Again there was a very slight uptick, from an annual rate of 310,000 in October to 315,000 in November. I won’t bore you by adding my well worn caveat. Just be aware that this, too, is pretty lousy.

Amidst all this real estate news we also heard that third quarter GDP was revised downward, from 2.0% to 1.8%. This seems not to have set off a negative move in the markets. Although it ought to have done. The main reason for the revision down was that consumer spending was 0.4% less than first estimated. Given that our hopes for a solid recovery hang, by and large, on consumer spending, this is not good news. Couple it with today’s report that personal spending and incomes were essentially unchanged – both grew 0.1%, weaker results than the prior month – and it is very difficult to articulate a credible argument that we about to spring to life and see GDP growing at the oft forecast rate of 3.0% next year. There just isn’t any momentum carrying us to those kinds of heights.

But the optimists keep on forecasting that way. Sooner or later I suppose they will be correct. Not yet.

Two other reports give the optimists support: weekly claims for unemployment assistance, and consumer confidence.

The claims data has shown a steady improvement in recent weeks. They are now down at 364,000, well below the rotten readings of 400,000+ we saw all summer long. And nowhere near the awful numbers we saw at the height of the crisis. This is an indication that the labor market is firming up a little. Before we get too far ahead of ourselves, though, we need to remind ourselves that claims should be a further level down before we can think of the labor market being healed. Typically we see claims below 325,000, sometimes much lower, in better times. So there is work yet to be done. Although we have clearly made a start.

That things are improving a little is also reflected in the modest upturn in consumer sentiment, which according to the monthly University of Michigan survey, rose to 69.9 in December, from 64.1 in November. More interestingly is the fact that each successive revision of the December figure has edged the total upward, implying that a trend is developing that might carry over into next year. Once more I warn you to be careful getting carried away with this news: in a good year this index regular scores above 90, so we have a long way to go. But, as with all this week’s figures, an improvement is welcome however modest it is.

So.

What does all this mean?

Well, not a great deal.

The economy is clearly improving. After all this time it darned well ought to. The debate now centers on the rate of growth that this improvement will lead to next year, and to the political ramifications that such growth may have.

This is where I remain on the cautious side. My view is that the economy is set for a very modest year. That means, in my mind, GDP growth between 2.0% and 2.5% for most of 2012. This contrasts with the more optimistic forecasts being produced on Wall Street where 3.0%+ is frequently mentioned. The key will lie in how consumption fares. With unemployment down, but still way too high; with wages flat; with debts still to be reduced; and with no sign of a burst of business investment around the corner, I just cannot see a source of strong consumption growth. If we throw in the plight of Europe, where recession surely beckons, and the possibility of slower growth in China, the outlook for trade to provide an acceleration is also reduced. Indeed, the international outlook provides a strong chance of damage rather than help to our growth prospects. Throw in the contraction in Federal and State spending we are most likely going to see next year, and nothing appears to provide a justification for anything other than a forecast more sideways than upwards.

Anyone, like me, who thinks that recoveries from crises centered in finance – as this was – are much more difficult to recover from, has to look at next year as another year of relative stagnation. Our banking system still is unwieldy and dangerous – our banks remain way too big, too powerful, and too subsidized for our economy to grow strongly without igniting another collapse. Our debt levels are still way too high. And households are still too fearful of the future to impel us forward. We, most likely, have another two or three years of adjustment to go before we arrive back in calm waters. Between now and then the risks are all on the downside.

Then there is the endless political farce being played out in Washington. This week’s ridiculous Republican attempt to raise payroll taxes back to there pre-stimulus levels is an example of the immense damage we could sustain from the radicals in Congress. So hell bent are they in overthrowing the last seventy years of settled policy that they nearly drove our economy over the cliff once again. We live in a time of absurdist politics, where a small group of extreme radicals can sustain an attack on our economy and use the chaos of the crisis as cover for their enormously regressive agenda. In many ways the uncertainty added to our outlook from this attack hangs as the darkest risk on the horizon. Political risk is something we are used to ascribing to minor economies the world over as unbalanced regimes extract a toll on their nations. We are not used to describing the US in those terms. Yet we ought to. In my view the greatest weakness we have, and a potential source of the greatest damage to our prospects, is the radical wing of the Republican party and its attempt to double down on Reagan era mistakes. That the GOP presidential candidates all have to bend to the radical’s will – no one has the courage to stare them down and lead the Republicans back to the center – tells me that, were one of them to emerge as president, we should expect more extreme policies and a period of greater instability.

Romney’s preposterous statement that Obama is undermining free enterprise demonstrates this problem. Romney is allegedly a centrist. His claim is an overt pandering to the radicals who seem not to realize that corporate profits are at all time highs right now. We will not solve our problems by giving more away to big business, and, more particularly, to managers of big business – especially the banks. As I have said many times before: these are great times to be a corporate CEO or shareholder. The economic game is rigged already in their favor. Change will almost inevitably have to be away from business towards the people if we are to improve our economy. So the radicals want to go in exactly the wrong direction. That Romney cannot resist them does not augur well for the country.

Which is a shame, because Obama surely needs a firm kick in the pants to get him to act decisively. An opposition based upon obstruction is neither loyal nor productive. We need sensible alternative policies for the nation to debate. We do not need the radical libertarian anti-social and deeply divisive policies that currently pass for the GOP platform.

So, as the year winds down the economic news is modestly on the upside. But the political risks are mounting. Hence our need for continued caution when we try to predict the economy’s performance over the next few years.

More of the same, in other words.