Market Talk

The ramifications of the Japan quake are impossible to know at this point, and the human toll will obviously be the most important, and devastating, aspect of the whole disaster.

In the cold math of the markets, the earthquake will spark economic activity. Lumber futures in the U.S. are higher this morning in anticipation of the rebuilding effort. There’s the thought that with the nation’s nuclear plants offline, crude oil demand will rise. But that’s cold comfort for all the bad things that are going to happen, both economically and from just a mere human standpoint.

Capital Economics’ Julian Jessop has started sketching out the ramifications:

The consequences of the major earthquake and tsunami that hit Miyagi Prefecture and other areas in north-eastern Japan today are not yet clear and the impact on local people is of course foremost in everyone’s minds. But the financial markets also need to consider the economic costs and the implications of the disaster for the public finances. These could be considerable.

While noting environmental disasters often have a smaller economic impact than initially feared, since the resulting reconstruction boosts demand, and that Japan is uniquely prepared for earthquakes. But considering the state of Japan’s economy, the timing is very bad.

The timing of the disaster could not have been much worse. The economy had already
contracted in the final quarter of last year. This shock may be too small and too late to have much impact on GDP in Q1, but does marginally increase the chance that output will decline in the current quarter as well. Moreover, a large part of the reconstruction costs will probably have to be met by local authorities and ultimately by central government, which is already struggling to bring public debt under control. Overall, it will be that much harder to deliver a credible long-term fiscal plan in the summer if the economy is stuck in recession, the public finances are in an even worse state, and many people are still suffering the after-effects of this disaster. At the very least, the scope for fiscal stimulus to mitigate the economic damage is much less than it was in 1995.

Japan is still the world’s third-largest economy, so what happens there is very likely to have some kind of impact overseas.

If you’re a trader, you can’t like what you saw today. In fact, if you’re just about anybody but a speculator in the oil market, you can’t like what you saw today.

US stocks essentially flat, as stock traders can’t push prices much higher while crude oil futures keep pushing new highs amid the swirl of revolt and history sweeping across North Africa and the Mideast. DJIA adds 9 to 12067, after rising as much as 57 during the day; S&P 500 rises 2 to 1308, Nasdaq Comp gains 11 to 2748.

ADP comes out with bullish take on jobs, but the market is fixated on crude. Nymex crude and Brent both hit 2011 record highs. There’s no doubt rising crude prices crimp the economy, and the higher they go, the bigger the crimp gets. This is a problem that’s getting more traction on the market’s radar.

We watched crude prices climb all day, and I just don’t like the direction they’re going. Nymex crude rose above $102/barrel, a fresh record for the year and the highest price since September 2008; Brent rose to a fresh high as well, $116.35/barrel. We’ve been watching for the $103-$104 level on Nymex; there’s technical resistance there that, if broken, will let the Vandals break through the walls and sack Rome. Or something like that. You get the picture.

If it crosses those levels, and I think somehow that’s inevitable, I see another sell-off in the stock market. The only question is how big a sell-off. A 10% correction wouldn’t surprise me at all, in fact corrections like that are often healthy. Is a 20% correction possible? It depends.

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Things are looking chaotic out there. Libya is being torn in half, there’s fighting in the streets in Greece – again. Crude oil prices are spiking, stocks are tanking. The fear underlying all the selling in the market, all the moves into safe havens, is that the crude oil spike eats into a weak global recovery and tips the economy back into recession.

It certainly could happen. There’s a disruption right now to oil flows, given what looks like a civil war in Libya. But the loss of Libyan production can be made up by other nations, primarily Saudi Arabia, which is sitting on the world’s biggest reserves under its sands.

For this moment, the crude-oil spike doesn’t appear to be sufficient to derail the economy. Painful, yes, annoying, without a doubt. But not enough to tank the economy. Much depends upon what happens from here on out, of course. If the revolutionary fervor reaches Saudi Arabia, for instance, and shuts down the oil fields there, well then all bets are off. You’d see a super-spike. So far, that doesn’t appear likely. But again, the Jasmine Revolution is moving with quite a bit of speed.

Capital Economics’ Julian Jessop puts it into some perspective:

The turmoil in the Middle East has prompted a chorus of warnings that the world economy could eventually be dragged back into recession if the price of oil continues to climb relentlessly (well yes it could, obviously). But while we continue to expect global growth to be slower this year than in 2010, and slower still in 2012, we do not expect the oil price to be pivotal.

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Here’s a headline that just crossed the Broadtape that should shock just about absolutely nobody:

Severe Winter Storm Hitting Much Of US – Reports

Doesn’t come as a surprise to me; I spent more than an hour this morning waiting outside for a bus. Already, you can hear the weather being used as an excuse for everything from jobless claims to retail sales. One thing it won’t be used to excuse is the stock market, which today is striking fresh multi-year highs, as apparently the market has now totally discounted the crisis in Egypt and any effects from it. If you watch the business news shows, in fact, Egypt is hardly an issue at all anymore. They’ve already moved on.

That would be a mistake. The ramifications of what’s happening in Egypt will be felt beyond the ruling palaces of Cairo. It will be felt, as well, beyond the oil pits. (Truth be told, we should give the boys on the NYSE floor a break. This crisis is going to be ongoing, the ramifications will move on a time-frame totally divorced from the second-by-second life of the U.S. stock exchanges, and, well, they’ve still got business to conduct.)

While the majority of the focus so far has been on the effects of the crisis on oil, you might want to pay attention to how it’s affecting food.

Capital Economics’ Julian Jessop has this thought:

For now, we are more concerned about the impact of the events in Egypt on food prices. Unlike the rise in the cost of oil, the recent increases in agricultural commodity prices mainly reflect supply shocks, which have been compounded by export bans and hoarding. Extreme weather conditions last year damaged crops in many parts of the world, notably harvests of wheat and sugar. The resulting increases in food prices have contributed to social unrest in many countries, including in Egypt. Governments in the rest of the Middle East and elsewhere, fearful of contagion, are responding by restricting exports of agricultural commodities and/or increasing imports to add to precautionary stockpiles. In the near-term however, these individual actions simply make the global problem worse.

This suggests that, even if the crisis in Egypt eases soon, the actions taken by governments elsewhere to prevent similar uprisings in their own countries will add to the upward pressure on global agricultural commodity prices. This will add to the upward pressure on food price inflation too, and is probably a better reason than higher oil prices to expect the global recovery to disappoint.

You, Mr. Average American Worker, may be more productive than your foreign counterparts, especially those in the developing world. But those workers in the developing world (who happen to be your competitors for a living wage) cost far, far, far less than you do, and management knows it, knows it all too well.

Capital Economics out with a report today saying that the relative bargain that overseas workers provide is at least one explanation for the so-called “jobless recovery” here in the states. Now, this isn’t exactly something new; the dynamic began decades ago. Ask anybody in the Rust Belt. But the difference now, I think, is that in the past the counter argument was well, those are low-skill jobs that we don’t want anymore anyway. We’re a knowledge-based economy (or whatever soothing pablum the speaker could think up.)

With 15 million unemployed Americans, I don’t see too many people making that argument anymore.

From the firm’s Paul Ashworth:

The continued weakness of US jobs growth can partly be explained by offshoring. Tempted by lower labour costs and lower corporate taxes overseas, multinational firms are expanding employment abroad rather than in America. Employment by US multinational firms in low cost developing countries, particularly China and India, has been growing very rapidly in recent years.

Overseas employment by US multinationals increased to 10.1 million in 2008, equivalent to 7.4% of domestic US employment. Between 2002 and 2008, US multinational employment abroad increased by a cumulative 1.9 million, or 22.6%. In contrast, over the same six-year period, US domestic employment expanded by 6.4 million, which represents an increase of only 4.9%. China and India were together responsible for a quarter of all foreign employment growth by US multinationals. Employment in China doubled from 338,000 in 2002 to 774,000 in 2008. Over the same six-year period, employment in India tripled from 101,000 to 313,000.

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Look, I’m excited about the holidays. I like the hope that a new year represents, and I hope that next year is better than this year, and the year before that, and the year before that. But it amazes me how willfully the Street is to suspend any disbelief, and go whole hog on this notion that the recovery, both here and overseas, has reached some kind of, what was the phrase Larry Summers used? Escape velocity.

It’s hard to reach escape velocity when there’s so much gravity all around you. The problems in the world’s four largest economies — the U.S., China, Japan and the European Union as a group — range from double-dip recession to full-blown meltdown. The fact that both Democrats and Republicans here in the U.S. agreed to that big tax-cut bill, which amounts quite essentially to another stimulus bill, shows how weak the recovery really is, despite the incessant chatter from the stock bulls.

On this topic, here’s a good, brief piece from Julian Jessop, the chief international economist over at Capital Economics. The thing I like about this firm is that they’re a very even keeled group; they’re not writing from an undisclosed underground location, but they’re not the giddy CNBC types, either. Jessop’s main point today is that the global recovery, due to the ongoing problems that are not being solved but merely papered over, is going to disappoint. That’s something that is not priced into stocks, I’ll tell you that.

The universal reaction from world governments to the financial crisis has been to kick the can down the road, to throw money at problems and hope they go away. But the problem with this strategy is no matter how far you kick it, the can doesn’t actually disappear. You will eventually catch up to it.

From Jessop:

The additional fiscal stimulus in the US and the ongoing credit boom in China have improved the near-term prospects for the global economy, but they do nothing to resolve the underlying imbalances that threaten the sustainability of the recovery. World GDP growth is still likely to be slower in 2011 as a whole than in 2010, and slower still in 2012.

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We got a lot of jobs-related data this morning, as the Wednesday before the monthly BLS report has become a sort of de-facto run-up to the queen mother of data points. The market took it all as very good, of course, since it was already in full-on rally-mode. The reports were generally positive, to be sure, but didn’t show the kind of strength necessary to spark expectations that the economy is going to stop scudding along and start growing strongly. That’s important to keep in mind.

We’re just spinning wheels here, folks. The reality is this: the unemployment rate isn’t going anywhere meaningful any time soon. The Fed knows this. Anybody who actually works for a living knows this. Sure, the big, massive, historic layoffs are over. But companies are now in the tweaking stage. Notice anybody getting laid off where you work? It comes in dribs and drabs now; a few jobs here, a few positions eliminated over there.

It’s more than drips or drabs if you’re, say, a Newark, N.J., police officer.

Companies in a number of industries (See table below) have boosted their profit per employee, according to data from the research firm Sageworks. This means companies are now making their profits using fewer employees, and unless demand rises such that they’re going to lose business by not having enough staffers around to produce enough widgets, companies aren’t going to start hiring, because to start hiring means to cut into their profit margins. Sageworks’ Melinda Crump wrote this:

Industries have right sized and adjusted for slowed sales by cutting expenses that include employee costs. Fewer employees now mean that these industries have increased efficiency over slowed sales and may not be looking to hire quickly if the economy sees only modest growth. Companies have been adjusting to slower sales for a while now, and strong growth is the only push that would call for a scaling of economies and increases in payroll back to 2006 levels…some industries such as manufacturing and construction may be evaporating, shrinking the total work force for years to come.

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Perhaps nothing so well illustrated the fact the Europe still has a boatload of problems than the reaction to the “agreement” on the Irish bailout. Announced Sunday, the markets took it under advisement for a couple hours, then began selling. It’s one thing when it was one country, Greece, that needed a bailout. But now, you have the reality of a second, and while the common refrain was that Ireland’s bailout was being done to help stanch contagion, once you go from the singular one to the plural two, you’ve already got contagion.

The folks at Capital Economics put it into perspective:

The significance of the crisis in Ireland and the problems in other economies on the fringes of Europe is potentially far wider than their small size would suggest. The exposure of global financial institutions to the likes of Ireland is relatively well-known and manageable, at least compared to the fall-out from the collapse of the mortgage-backed securities market in 2008. However, uncertainty about the future of the euro itself will remain high, undermining business confidence and risk appetite generally. Renewed safe haven demand for the dollar could also accelerate any correction in global commodity prices.

That bit about the future of the euro is getting some attention today. Germany’s finance minister, Wolfgang Schaeuble, put it there. Given everything going on in Europe, he said, “I want to say very clearly that our common currency is at risk.” (I saw this first at Zero Hedge.) “If we can’t defend our currency effectively as a stable currency, the economic and social consequences for our country and the people in our country would be incalculable,” he said.

As if one German official making dire pronouncements isn’t enough, Angela Merkel was out today with much the same message. “We’re in an extraordinarily serious situation, as far as the situation of the euro is concerned,” she said in a speech.

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Capital Economics out today with a thorough, frank and reasoned report on the US economic outlook, taking a look at a host of areas like consumption, investment, external demand, labor market, prices and monetary & fiscal policy. The upshot? Recovery is “likely to remain muted for years to come.”

Let that sink in for a minute. For years to come. Doesn’t seem as if investors have really wrapped their heads around that concept, but the firm builds a pretty compelling case, in straight-forward terms. For example, this simple point:

The fundamental obstacle preventing a return to stronger economic growth is the damage done to the balance sheets of households and financial institutions by the housing bust and
the related financial crisis.

Household deleveraging is “still in its infancy,” the firm says, noting that since the start of 2008, household debt has fallen $470 billion, but half that decline has come because of defaults, not from folks paying off their debt. “Overall, the downward pressures on real incomes and the structural problems caused by high debt and lower asset prices mean that households will not be able to spend freely for at least the next two years.” Continue reading…

In my previous post, on the Fed and deflation, I didn’t get into the nuts and bolts of where things stand on the inflation/deflation front, for brevity’s sake. Given the Fed’s almost Ahabesque determination to create inflation, there is already mounting criticism that the Fed is in fact blowing a dangerous inflationary bubble. But two notes landed in my inbox this morning that make the exact opposite argument, and illustrate again why the Fed is doing what it’s doing.

The first comes from Capital Economics. “Fears that the Fed has put the economy on the path towards rampant inflation looked even more misguided last week when it was announced that core CPI inflation fell to a record low of just 0.6% in October,” the firm writes (the note is dated Nov. 22, so the reference to last week is actually about this week.) “The real danger is that the economy is heading towards deflation.” They continue:

Although housing costs are no longer falling, the high unemployment rate means that landlords will not be able to make rent rises stick. Core services inflation is therefore unlikely to rise back. Meanwhile, core goods inflation will continue to fall, not least as auto prices drop further.

Nominal rigidities have so far prevented core inflation from falling further. But with the economy set to remain saddled with a lot of spare capacity, the downward pressure on prices will eventually become overwhelming. It might not be long before the US is flirting with deflation.

The second comes via UBS’ Art Cashin, who clips part of a speech from John Williams, director of research at the San Fran Fed. Here’s what Mr. Williams had to say about deflation, excuse me, here’s what Mr. Williams had to say on the lack of inflation:

I’d like to turn now to inflation, or, I should say, the lack of inflation.  The measure of inflation we follow most closely is the core personal consumption expenditures price index.  These prices have been rising at a 0.9 percent rate so far this year.  This is the lowest nine-month inflation rate recorded in the over 50 years that this statistic has been compiled.  Our forecast is that inflation will come in about 1 percent for the year as a whole and stay at that rate next year.  That’s about 1½ percentage points below where it was at the start of the recession and well below the level of around 2 percent that most Fed policymakers have said is consistent with stable prices.

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