Mish's Global Economic Trend Analysis

Recession is On the Way: Questioning One's Sanity; Beat the Crowd, Panic Now!
Ukraine Rations Food; Interbank Rate New Record Low; Monetization of Bonds; "Devaluation Kerosene"; Electronics a Store of Value
Right-to-Work Sweeps Midwest, Heads for Passage in Wisconsin

Recession is On the Way: Questioning One's Sanity; Beat the Crowd, Panic Now!

Posted: 26 Feb 2015 09:55 PM PST

In 2006-2007 I called for a recession. We got a big one. I called for another one in 2011, as did the ECRI. That recession never happened.

50% is not a very good recession predicting track record except in comparison to consensus economic opinions that have never once in history predicted a recession. Consensus opinion is batting a perfect 0.00%

Investigating the Record

By the way, the ECRI was late in calling the recession of 2007. They still deny it. And questions regarding the 2001 recession and ECRI have still not been answered.

I have talked about all of this before, and it's worth a recap, if for no other reason than to note the difficulty of calling recessions in real time.

February 24, 2012: ECRI Sticks with Recession Call on CNBC; More than a Bit of an Exaggeration by Achuthan to Make His Call?

November 29, 2012: ECRI Sticks With Recession Call

October 13, 2009: A Look at ECRI's Recession Predicting Track Record

That third link above seriously calls into question the ECRI's recession calling capabilities.

I am not calling out just the ECRI. Open up the middle link and you will find this statement by me:

"The ECRI is sticking with its 'US is already in recession' call based on four coincident indicators. Very few agree, but for what it's worth (perhaps nothing) I am one of those in agreement."

I have already admitted my error. It's been silence from the ECRI, which has been my biggest objection to them over the years.

The moral of this story is: "If you cannot admit your mistakes, someone else is sure to admit them for you."

Word About Predictions

Yogi Berra said it best: "It's tough to make predictions, especially about the future."

Nonetheless, and throwing caution to the wind, on January 31, I stated Canada in Recession, US Will Follow in 2015.

Also on January 31, I went Diving Into the GDP Report and noticed "Some Ominous Trends" on imports and exports.

This was my call...

US Recession

The US won't decouple, just as China did not decouple from the global economy in 2008-2009 (a widely-held thesis I also knocked at the time).

Indeed, now that virtually no economist expects a US recession, I believe we are finally on the cusp of one, just as the Fed seems committed to hike.

Contemplating My Own Insanity - Again

With the above backdrop, Albert Edwards at Society General had me laughing at his own personal assessment in his Global Strategy Weekly Email Update (no link available).

He titled his research "Contemplating My Own Insanity - Again". Here are a few snips.

With equity markets galore hitting record high s clearly I must be missing something big! We are at that stage in the cycle where I begin to doubt my own sanity. I've been here before though and know full well how this story ends and it doesn't involve me being detained in a mental health establishment (usually). The downturn in US profits is accelerating and it is not just an energy or US dollar phenomenon – a broad swathe of US economic data has disappointed in February. One of the positive surprises, payrolls, is a lagging indicator. The $64,000 question is not if, but rather when will investors realize what is going on?

My colleague Kit Juke summed it up nicely in his morning note "Whatever the Fed does, they will not risk the economic recovery. That bias is why rates won't get anywhere near 'neutral' before they peak. The economic cycle will be brought down by asset bubbles bursting long before 'tight' policy has any effect. Lessons were learned from the Global Financial Crisis, but not that one."

Investors are transfixed instead by the Fed and when it will tighten rates and can't see the wood for the trees. The Fed's focus on payrolls, a lagging indicator, is most perplexing but not unusual at this stage in the cycle. The reality is that the vast bulk of economic, as well as earnings, data (even outside the energy sector), has been simply dreadful.

Current Rate of Profit Deterioration

click on any chart for sharper image

February US Data Above and Below Expectations

If you believe profit deterioration is a solely or even mostly related to the collapse in oil prices you are mistaken.

Fed Study Shows "Persistent Fed Overoptimism"

The Society General report is all the more amusing because nearly every Fed economic forecast has been on the optimistic side since 2007.

I commented on this phenomenon on February 2 in Fed Study Shows "Persistent Fed Overoptimism about Economic Growth"; What Will They Do About It?

US GDP Slow-Down

File this one in the "If I am wrong, I am at least in good company category".

Via email on Thursday, Steen Jakobsen pinged me with his thoughts.

US Q4 GDP revisions are out tomorrow and will most likely show a slow-down from 2.6% to 2.0%: (Source: Bloomberg – WECO US)

This makes Q3(2014) the peak in this cycle and I expect QoQ growth in the US will hit ZERO by Q3 or Q4 – there are several factors for this including rising real rates, malinvestment into energy but most importantly is the falling earnings in the US.

[Also referring to the society general chart] ... The point however is US data been worsening for a long time – I personally think we are in period where we yet again hand-over the growth engine from the US to emerging market but via a significant new low in growth which will make Europe looks good.

The expected path for me is: Slow down confirmation in the US over the next two months – that will kill the improvement in Europe by end of Q2 and leave it stable - not growing for the year.

Meanwhile emerging market will come back as market realize the FOMC is years away from 'talking up' rates. The June or September initial hike (if it comes) still leaves the FOMC 100 bps above Wall Street on its projected long-term path for growth – a Wall Street who on their own is also too optimistic about future growth. The Fed sees 3.0-3.5% growth while Wall Street sees 2.5-3.0% on average. In other words there is room for a +100 bps correction to the sustainable long-term growth which will render 10-year rates a 1.0-1.5% before we over with this part of the cycle. I label this: Restarting the business cycle.

QE and targeted "help" for banks is running out of time if not out time. The inequality and low salary to GDP base simply can't produce enough domestic consumption anywhere for the middle class to be able to afford the products the stock market listed companies produce.

Macro Conclusion

We are in an "in between period" where the US will slow down and ultimately hand over the growth engine to emerging market by the earliest Q4-2015 but firmly in 2016.

The problem is emerging market are not ready due to high US dollar debt, waning commodity prices, and Europe is still too weak to contribute net to world growth leaving a growth vacuum for new growth.

Europe will show one more month of improving data, then global slowdown of EM and US will drag down the data to flat performance.

Fixed Income

I still only have one very strong view and that's 10 YR fixed income will trade at 1.5%, possibly even potentially 1.0% this year. Everything else will lag this move by 9 month or so. In other words, if the low in yields comes in Q3 (as I expect) then the summer of 2016 will be the lift-off we all have talked about.

The US Dollar will peak this quarter and probably has peaked for this cycle. The weaker US Dollar will stabilize commodities and emerging markets, creating the conditions for a hand-over at the end of this year. The US dollar should be very sensitive to this relative slow-down in the US, especially as Europe is anachronistically improving.

Gold remains top of my list for new investment. I'm long and adding. I have also re-sold Brent/Crude as the marginal cost of producing oil is still rising, meaning global impact still is negative net-net.

Jeremy Grantham excellently argues that for world to benefit from falling energy prices, it has to come with falling marginal cost. The opposite is the case now: lower prices and higher production/extraction costs.

Stock Market

It's not time yet to call the top, but preparing special report on valuations and models, or the lack of it. Conclusion will be: There is potential for a 5-10% gain this year but also for a 25% correction.

The problem of course being that the market is very expensive by traditional standards, but these are hardly normal times.

The expected return for reference over 1, 3 and 10 years can be seen above – the upside is the first year still can carry market higher. The downside is a possible drop for the next 9-10 years!

CAPE Notes

CAPE stands for "cyclically adjusted price earnings ratio".

CAPE started the year over 25.

Business Insider writer Sam Ro commented on CAPE yesterday in Robert Shiller's Revered Stock Market Valuation Ratio is Crappy at Predicting 12-Month Returns.

I laughed at that headline because CAPE was never meant to be a timing signal. Rather it's a medium-to-long term warning signal.

"In other words, don't dump stocks and hide in cash because the CAPE is at 26. Rather, just be prepared [for] lower average returns for years to come," said Ro.

Lower or Negative?

Ro totally misses the boat. The warning is not about "lower" returns; it's about likely "negative" returns.

A Word About "Panic"

It's fitting to see such articles at this time, especially with earnings plummeting and everyone latching on to lagging indicators like jobs.

Yes, I have said this for a couple years. But CAPE has been stretched for a couple years.

CAPE was stretched in 1998 too. Yet, one could have had big gains through March 2000, if one held on, then cashed out at the top.

With that in mind, I have three questions for those who think like Ro.

How many held on, then cashed out at the right time?
How many panicked and cashed out at or near the bottom?
How many held stocks that never recovered at all?

Here's a bonus question: Did anyone buy a basket of stock in 1999, ride them up and down for 15 years, only to find themselves once again at the break even point?

I ask that bonus question because the Nasdaq 100 Index is just below the March 24, 2000 peak.

In spite of the above, we see the same perennial advice today that we saw in January of 2000 "don't dump stocks".

If one has a dedicated, no-panic investment commitment with a time horizon of 15 years or longer, such advice, coupled with dollar cost averaging, may make sense.

Four Evaluation Metrics

Doug Short at Advisors perspectives has an even more interesting chart of valuations in his post Equity Valuations, Recessions and Stock Market Declines.

click on any chart for sharper image

Using an average of four popular valuations metrics, the only higher blowoff tops in history were 1929 and the dotcom bust in 2000.

However, ahead of and during the dotcom bust, many market segments were very attractively priced. The same cannot be said now.

Panic Now!

If one doesn't have a dedicated, no-panic investment commitment (that they will realistically stick with), "Don't dump stocks and hide in cash because the CAPE is at 26", is not a good philosophy.

"Panic before everyone else does" is far more appropriate.

Given massive baby boomer retirements, coupled with strong doubts that people can and will have a dedicated time horizon long enough to matter, I offer simple advice: Beat the Crowd, Panic Now!

Outside the Box

For those willing to think outside the box, I echo this sentiment of Steen Jakobsen "Gold remains top of my list for new investment. I'm long and adding."

I also like "perennially despised" US treasuries along with Steen, and I am a big proponent of yen-hedged Japanese equities (a position I believe different than his).

Finally, and also of a contrarian nature, Russia looks quite attractive to me at this time. It's beaten up, off everyone's investment radar, and will do well if the ruble or oil rallies. Typically stocks turn before currencies.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Ukraine Rations Food; Interbank Rate New Record Low; Monetization of Bonds; "Devaluation Kerosene"; Electronics a Store of Value

Posted: 26 Feb 2015 02:30 PM PST

A chart of Ukraine's currency is nonsensical once again today.

Supposedly the hryvnia rallied again today, if only by a miniscule amount 0.15%. Yet, once again the chart is complete nonsense.

Black Market Rate

The Black Market Rate today is a bit improved, with a bid/ask spread of 29.45 to 34.55. How long that rally lasts is questionable. I presume not long.

If one could exchange at the official rate, one would immediately have an arbitrage on the black market.

Translation: The alleged official rate is "for show". No one can get it, except perhaps favored politicians and bankers taking advantage of their position of authority.

Reader John, whose father was a key figure in the Ukrainian Resistance in WWII, and whose sister currently lives in Lviv in Western Ukraine sent the following link that shows what's really happening.

Interbank Rate Fell Sharply to New Record Low

Dateline February 26, ZN-UA reports Interbank Hryvnia Fell Sharply to New Low.

Interbank Hryvnia, despite yesterday's statement heads the National Bank and the Finance Ministry to take measures to stabilize the currency as of February 26, the hryvnia plunged to a new record low, reaching a figure of 34.5 per US dollar.

Thursday morning the interbank rate opened at 22-27 UAH per US dollar.

The collapse of the hryvnia this afternoon was associated with the cancellation of the February 25 ban on bank's ability to buy foreign currency on behalf of customers.

Central Bank Reversals

In the past week, the Ukrainian National Bank (UNB) suspended foreign currency trading, cancelled the suspension, then resumed the suspension, then cancelled the suspension.

Wording and back-references are so confusing, I am not precisely sure of the current state of affairs. Do they know either?

Today's Wall Street Journal reports Ukraine Dials Back on Latest Attempt to Halt Currency Free Fall.

Yesterday, the Journal reported, Ukraine's Central Bank Limits Access to Foreign Currency.

I believe the Journal missed one intraday flip-flop that I caught, or perhaps I caught an announced reversal that never happened.

It's all meaningless anyway. The black market is where it's at.

Monetization of Ukraine Bonds Fueling Currency Crash

Let's get to the heart of the matter. Ukraine is bankrupt. Please consider National Bank Adds Fuel to the Devaluation Fire.

The NBU continues to give the banks billions of dollars of loans, increasing devaluation of the hryvnia with one hand while imposing administrative restrictions on the other, adding fuel to the devaluation fire.

The refinancing is one of the catalysts of the present fall of the hryvnia:

Direct (speculation by banks, including fictitious imports)
Indirect (in which bank customers can use deposits in hryvnia to buy foreign currency)

It should be noted there are other factors:

1. There is also unsecured NBU monetization of government bonds to cover the state budget deficit. (The NBU dare not cutoff the government - editor) [Mish comment - if that editor lives in Ukraine, he will soon be charged with treason]

2. Quasi-fiscal payments of the Central Bank in the state Treasury (article an excess of income over expenditure in the previous year)

3. The decline of the economy on the background of the war in the Donbass

4. Reduction of inflow of foreign currency earnings of exporters; previously generated demand importers for currency; a withdrawal of currency abroad by using fictitious import contracts

5. Panic in the market and so on

Thus, with one hand imposing administrative restrictions on the market, another national Bank adds fuel to the fire devaluation.

It is also worth noting that since the beginning of the year up to February 24, the portfolio of internal government bonds (t-bills) in the NBU increased by 20.2 billion UAH for the period 2014 - 14.5 billion USD). In January, the figure was 9.6 billion UAH.

For more, see Devaluation Kerosene

Devaluation Kerosene

I have to say "Devaluation Kerosene" is an interesting title so I looked it up. The above article is a synopsis with a few more details, so there is no need to dive in further.

Ukraine Rations Cooking Oil, Flour, Sugar, Buckwheat

Let's conclude our Ukraine roundup of the day with this report in English: Kiev Introduces Rationing, as Falling Hryvnia Causes Shopping Binge.

Ukrainian supermarkets have imposed rationing of basic products after the drastic fall in the value of the hryvnia. The currency has lost 70 percent of its value causing people to stockpile food and buy electronics as a hedge.

Restrictions apply for goods such as cooking oil, flour and sugar, Ukraine's news agency UNN reports Wednesday. Retailers may sell no more than two bottles of sunflower oil, and two packs of buckwheat per customer and, depending on the store, from 3 to 5 kilograms of flour and sugar.

Bread, rice, potatoes, meat and milk are not yet rationed, but are not so plentiful on supermarket shelves.

Stores have also see higher demand for household appliances, as people consider consumer electronics an investment as prices increase on a daily basis, RIA reports. Inflation in Ukraine is expected to reach 27 percent by the end of 2015.

27% Percent? How about 50 Percent, Already

This article is a couple days behind my report from "Ellen" who said "People buy anything just to get rid of hryvnias" (See Emails From Kiev: Free Speech Vanishes, Total Media Thought Control; US Radar System Falls Into Rebel Hands?).

Inflation is easily up 50% this year. And it's rather telling that people consider consumer electronics as a store of value.

We are not talking about inflation here, we are talking about hyperinflation as noted yesterday in
Ukraine Hyperinflation; Currency Plunges 44% in One Week! Actual Black Market Rates; Poroshenko Gives "Ultimatum" to Central Bank to Fix Exchange Rate.

Panic is in the air. And rightfully so.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Right-to-Work Sweeps Midwest, Heads for Passage in Wisconsin

Posted: 26 Feb 2015 11:03 AM PST

Right-to-Work legislation is sweeping the Midwest. It's one of many reforms needed to makes states more competitive, reduce cost pressures on infrastructure projects, and hold down the necessity of tax hikes.

Today the Wisconsin Senate Passed 'Right to Work' Legislation.

The proposal would let workers opt out of paying mandatory dues. Many would do just that, preferring to keep money for themselves rather than for the priorities of union officials, including corruption, graft, and various political goals that workers may not at all agree with.

The Wisconsin House of representatives is expected to approve the legislation making passage all but certain.

His staff issued this statement "Governor Walker continues to focus on budget priorities to grow our economy and to streamline state government. Governor Walker co-sponsored right-to-work legislation as a lawmaker and supports the policy. If this bill makes it to his desk, Governor Walker will sign it into law."

Illinois Again Lags Neighboring States

Unfortunately, and as typical, Illinois lags other Midwest states in passing much-needed legislation.

I wrote about that on Febuary 11, in my first article for the Illinois Policy Institute. Let's recap Missing the Boat on Right-to-Work.

Illinois Chamber Misses the Boat on Right-to-Work

The Illinois Chamber of Commerce recently took interesting, as well as contradictory, positions regarding the minimum wage and Right-to-Work legislation.

On one hand, the chamber is not in favor of minimum-wage hikes for Illinois. On the other, the chamber says "Illinois doesn't need right to work (laws) to compete with its neighbors."

At the root of both of these policy issues is the state's ability to compete and attract job creators. If the chamber acknowledges that a minimum-wage increase is a jobs killer, how can it oppose Right to Work, which is proven to attract new businesses?

Contradictory Positions

Illinois Chamber of Commerce Chief Executive Todd Maisch says that minimum-wage increases put employers at a competitive disadvantage. Maisch also contended "Illinois doesn't need right to work (laws) to compete with its neighbors."

Those positions are contradictory. To understand why, one must investigate the tie between "prevailing wage" laws, Right-to-Work laws and collective bargaining.

Prevailing Wage

Illinois' Prevailing Wage Act governs the wages a contractor or subcontractor is required to pay to all "laborers, workers and mechanics" who perform work on public projects. This wage is to be "no less than the general prevailing hourly rate as paid for work of a similar character in the locality in which the work is performed."

As the Illinois Policy Institute noted in Unions take advantage of Illinois' prevailing wage law, "This almost always is taken to mean the union rate, even though union workers make up less than 40 percent of the construction workforce and union wages are often 50 percent higher than those of nonunion workers."

Want to repair roads? Add another wing onto a public school? Fund a bond for any public project? Cities have to pay the "prevailing rate." Those prevailing rates apply to every imaginable public project, spilling over into many private projects as well.

Prevailing rates are in direct opposition to the idea behind Right-to-Work laws. Under properly formed Right-to-Work legislation, any contractor should be able to bid on any project, regardless of a government-mandated prevailing wage.

Preferably, the needed legislation on these two issues should be accomplished in one fell swoop. If it takes two acts, one for Right to Work and another to repeal prevailing wages, so be it.

The third piece of the puzzle is collective bargaining.

Wisconsin Offers Example on Collective Bargaining

Wisconsin Gov. Scott Walker passed legislation in 2011 to eliminate collective bargaining for most public workers in the Badger State.

Then a curious thing happened, as reported by the Washington Examiner:

"The Kaukauna School District, in the Fox River Valley of Wisconsin near Appleton, has about 4,200 students and about 400 employees. It has struggled in recent times and this year faced a deficit of $400,000. But after the law went into effect, at 12:01 a.m. Wednesday, school officials put in place new policies they estimate will turn that $400,000 deficit into a $1.5 million surplus. And it's all because of the very provisions that union leaders predicted would be disastrous.

Some of the most important improvements in Kaukauna's outlook are because of the new limits on collective bargaining.

Overnight, the Kaukauna, Wisconsin, school district turned a $400,000 deficit into a $1.5 million surplus. In essence, Illinois needs to do the same.

Specifically, Illinois desperately needs to do three things, all of them related:

Eliminate collective bargaining of public unions
Pass Right-to-Work legislation
Scrap prevailing-wage legislation

Whether this is done in one fell swoop or in three separate acts does not matter except in terms of time, and Illinoisans have little time to spare.

Businesses and private citizens are fleeing the state at record rates in search of a healthier business climate and to avoid enormous property taxes. Illinois cannot afford for these losses to continue much longer, especially if another national recession should occur. Illinois fared poorly in the last recovery, and another recession may very well do in the state – especially state pension plans – unless appropriate measures are enacted soon.

See The Light

The Illinois Chamber of Commerce, and others coming out against Right to Work in the Land of Lincoln, would be wise to reconsider their position.

One by one, neighboring states have seen the light. Illinois needs to join the right-to-work party or be left behind, lagging in job growth, while paying more in taxes for infrastructure improvements.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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26.2.15

Mish's Global Economic Trend Analysis

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