Much ado about nothing
November 23, 2015

Untitled Document

One of the characteristics I like about economics is that it forces you to always think about the other side of the argument. There is always another side in any argument. President Truman, frustrated with so many options, allegedly asked to be presented with a “one hand economist”. He was tired of listening to a completely different argument that would always be preceded by on the other hand.

Excluding republicans, I don’t think there is an economist with “one hand”.

This preamble is necessary to understand my view about the state of the US economy. The latest indicators are mixed and the “threat” of an increase in interest rates is making the markets jittery, afraid of a recession and a bear market. The FED governors are not helping with their constant interviews. If they would just shut up, it would be great.

The US economy, amongst the developed economies, is the one doing well, still showing (tepid) but constant economic growth. On November 16th we learned that Japan is in recession again and that the GDP rate of growth for EU19 was 0.3% in the third quarter.

Since the end of the “great recession” in the third quarter of 2009, the USA has had positive growth every quarter except for the first quarter of 2014. On December 2009 unemployment was 9.9% and the last reading, in October, showed a rate of 5.0%. There is also no sign of inflation- as measured by the CPI. If anything, the year to year CPI has been actually declining (although that is not what I feel in my wallet).

In the past month, GDP only rose 1.5%, a weak result, but better than some very pessimistic projections. Interesting enough, consumer demand had a significant weight on the result, having increased 3.2%. On the other hand, business inventory had a negative contribution, -1.44%. The good news is that as inventories decrease, there will be a need for more investment.
Auto sales climbed to 18.2 million much more than the 16.6 million last year, which demonstrates that consumers are feeling good. This is also a good sign for the holiday season.
The ISM manufacturing report was weak and the past three months have showed this index declining, now standing at 50.1. Below 50 is considered recession. On the other hand, the Chicago PMI jumped to 56.3 from 48.7 in September, and new orders and production also increased.

The stock market is also sending mixed signals: after a horrible drop in August and September, October was the best month in 4 years and last week was the best week of the year. At this point we have heard from most of the companies in the earnings seasons and so far the results are again mixed, and, despite some good beats, underwhelming. Only 68.6% of companies’ of the S&P have beaten estimates, and less than 43% have beaten revenues. Moreover, earnings growth is expected to decline and so are revenues. Blame the strong dollar for that.

The Employment report announced on November 6 gave economists a reason to be ashamed: it came 100K above expectations, which demonstrates how bad forecasters’ economists are. That number, released last week, reinforced the expectation that the FED will raise rates in December.

So, with that many mixed results, can we say anything about the future of the US economy? Well, I personally feel very confident that, in the absence of any external shock, we will continue along the same path, meaning slowly but constantly. Let’s remember that a recession needs a cause, a reason. Sometimes it is lack of confidence, which leads to absence of investment- like we are experiencing in Brazil, amongst other factors. Sometimes is an external shock like the oil prices in the 70’s, and sometimes is a combination of internal and external factors like the increase in interest rates in the late 80’s plus an increase in oil prices with the Gulf War in the 90’s. People refer to the burst of the bubble as leading to a recession, which is technically wrong. We did not observe 2 consecutives quarters of economic activity retraction in 2000 or 2001. In the last 25 years there was a brief recession in the end of 1990 and beginning of 1991 and the great recession in 2008. People make a common mistake, which is to use bear market and recession as synonyms. A recession is followed by a bear market but you can have a decline in stocks without a recession, as has occurred in 2000-2001.

Some people want to argue that the strong dollar and weak oil prices and commodities could lead to a recession; the decline in oil prices and commodities affects a range of industries in the energy and mining sectors, which will lead to layoffs and smaller equipment and capital goods production (affecting the I in the aggregate demand equation); the strong dollar will result in less exports (affecting the X-M) in the same equation. An increase in interest rates would make the dollar even stronger and would weaken the economy even more.

On the other hand… the confluence of a low unemployment rate, no inflation, and less money spent on gas and energy related products should lead to a stronger consumer (which positively affects the C in that equation). In fact the Michigan Consumer index released on Friday the 13th showed an increase from 90.0 in October to 93.1 in November.

Intuitively I think anybody could say that if the interest rates would go from 0 to 5% or even 4% we could look at an “interest rate shock,” which could be the reason for a recession. Also, it would lead to an inversion of the yield curve (short term interest rates higher than long term interest rates), which historically precedes a recession. Does anyone believe that that is a possibility? I don’t think so, and in this past week MR market seems to agree with me. Therefore I guess the question is if a 0.25% increase on interest rate will have the same impact or it is much ado about nothing?

October 27, 2015
Brazil, we can only pray (or hope)
August 18, 2015
Looking back, looking forward
June 30, 2015
Lack of good news
April 14, 2015
What if...
February 24, 2015
What to expect in 2015
November 17, 2014
The American conundrum or just plain stupidity?
October 27, 2014
What is next?
September 09, 2014
Lessons we should have learned
August 12, 2014
US and Brazil: 2014, what to expect next
June 26, 2014
Headwinds ahead but still optimistic
April 26, 2014
Roller Coaster
March 14, 2014
Brazil in perspective
February 07, 2014
Stay the course. Change the course.
January 17, 2014
Diversification. Or not.
November 25, 2013
Who buys a US$ 500 pillow?
October 02, 2013
September 03, 2013
What a mess...
July 31, 2013
Of Protests and Stocks
June 19, 2013
Betting in the future
April 30, 2013
Nowhere else to go
March 26, 2013
Cyprus: not enough to stop the US market
February 25, 2013
The Sequester
January 23, 2013
2013: what is ahead for investments
December 07, 2012
Brazil: uncertainty and mixed signals
November 05, 2012
It is not about the economy!
September 20, 2012
The Country is better off
July 05, 2012
The New Normal
May 30, 2012
Half empty, half full
April 30, 2012
How to restore prosperity
April 21, 2012
Brazil became poorer
February 27, 2012
Romney, Obama and the American Imbroglio
January 25, 2012
On storms and calmness, waiting for next round
December 22, 2011
Happy Holidays!
November 23, 2011
Impasse and Paralysis
October 24, 2011
The rally has legs. Or not
September 23, 2011
Preparing for the crisis
August 24, 2011
Kicking the can down the road: is there an end in sight?
July 24, 2011
Can the politicians be rational?
June 24, 2011
Global Economy: where are the world leaders bringing us?