Monday, December 3, 2012 - Still in the Woods and Other Economic News

Still in the Woods and Other Economic News

by Sinclair Noe

DOW – 59 = 12,965
SPX – 6 = 1409
NAS – 8 = 3002
10 YR YLD + .02 = 1.63%
OIL +.01 = 88.92
GOLD + .80 = 1717.00
SILV + .22 = 33.76

Let's start with the economic news. Business among manufacturers contracted in November and fell to the lowest level in more than three years. The Institute for Supply Management's index of purchasing managers dropped to 49.5% from 51.7% in October. Any reading below 50 indicates contraction in the manufacturing sector. The decline in the overall ISM index largely reflected a steep drop in new orders but companies remained active fulfilling prior orders. Only six of the 18 U.S. manufacturing industries surveyed by ISM said they expanded somewhat faster in November. Nearly twice as many said their industries contracted.

In the euro zone, manufacturers contracted for the 16th straight month, according to Markit. China’s manufacturing sector expanded slightly.

In a separate report, the Commerce Department said spending on construction projects advanced 1.4% in October to the highest level since September 2009.

The big economic news will come on Friday with the monthly jobs report. The best guess is that the economy added about 75,000 jobs in November, but that is just a guess; Hurricane Sandy has distorted some of the economic numbers. The fourth quarter of 2012 has clearly gotten off to a slow start. Consumer spending, by far the biggest source of economic growth, fell in October for the first time in five months. And orders for expensive, long-lasting goods, or durable goods, were flat in October. Sandy disrupted economic life in the Northeast in late October and contributed to the decline in spending, but consumers were reluctant shoppers last month even when the effects of the storm are discounted; the reason is simple – lack of money. And that brings us back round to jobs; more jobs means more income and more spending.

Last week we saw the revision to the estimate that U.S. real GDP grew at a 2.7% annual rate in the third quarter, up from the initial estimate of 2%. Sounds good, but deeper analysis shows it's far from good.

The revised figures do show an improvement of 0.4 percentage points in the contribution of exports, which are now claimed to have added about 0.2 percentage points to the 2.7% growth figure instead of subtracting 0.2% as originally reported. But this was erased by a 0.4 percentage point reduction in the contribution of consumption spending. More than all of the reported improvement from 2% to 2.7% GDP growth could be attributed to a higher rate of inventory accumulation than previously estimated. To put it another way, real final sales for the third quarter were originally reported to have grown at a 2.1% annual rate, whereas the new numbers have the figure at only 1.9%. The bottom line is that growth in demand for U.S. goods and services overall remains weak, even weaker than originally reported.

The new report also gives us the first look at an alternative estimate of third-quarter GDP that is built up from separate data on the income people are earning rather than goods and services being produced. Conceptually, an estimate of GDP constructed using either method should produce the identical number. But in practice, one arrives at different numbers using different data sources. The bad news is that if you strip out the GDI, or Gross Domestic Income, the economy only grew at a 1.7% rate in the third quarter and actually fell 0.7% in the second quarter. Not so great but probably not enough to say we are headed for a significant downturn, unless.

Last week, Treasury Secretary Tim Geithner presented the White House plan to avert the fiscal bluff, or fiscal cliff, or whatever. In the ongoing battle of the budget, President Obama has done something very cruel. Declaring that this time he won’t negotiate with himself, he has refused to lay out a proposal reflecting what he thinks Republicans want. Instead, he has demanded that Republicans themselves say, explicitly, what they want. Republican leadership didn't like it, but they didn't offer an alternative, until today; when they kind of mumbled through a reply.. The alternative remains a little light on specifics, but it calls for $800 billion in new revenue achieved through closing loopholes and capping deductions; $900 billion in health care and other mandatory spending cuts; $300 billion in spending cuts for discretionary spending, which includes social programs such as food stamps; and $200 billion gained by changing the way the government calculates cost-of-living adjustments for Social Security and Medicare; and raising the eligibility age for Medicare benefits.

Where does that leave us?

The woods are lovely, dark, and deep,
But I have promises to keep,
And miles to go before I sleep,
And miles to go before I sleep.

The stock market was essentially flat in November but the S&P 500 has chalked up some decent gains - over 12%, year to date. That's only partially accurate. A new report from Morgan Stanley chief equity strategist says that 90% of the profit growth has come from just 10 stocks in the S&P500. Those 10 stocks are: Apple, Bank of America, AIG, Goldman Sachs, Wells Fargo, JPMorgan, Citigroup, IBM, General Electric, and Western Digital. Striking that the profit growth is concentrated among banks and insurers. It helps to have friends in the Fed. Also, make note that this report referred to profit growth, not stock price.

The banks should be making money, the yields on agency mortgage-backed securities are really low, which leaves some wiggle room for the banks to build in some profits. And the banks have been wiggling. Which is not a really good thing for a couple of reasons. First, if the primary desire of Fed policy is to get people to buy houses, be rich, etc., and if its primary mechanism for doing so is buying MBS, then the inefficiency in transforming that mechanism into that desire is rather macroeconomically important and bad. Second, if money is coming out of the Fed and not ending up in homeowners’ pockets, that leaves only so many pockets it could be ending up in, and it is easy enough to observe that big banks (1) sit between the Fed and the homeowners and (2) have lots of pockets.

So the Fed held a conference on the matter today, and they produced a research report that basically said the banks make profit from charging more for a mortgage, than they are charged with Mortgage-backed securities; the banks pocket the difference, or the spread. The spread was 30-50bps in the ’90s and early 2000s, but rose to 150bps in September and is around 120bps now. So where banks used to make $10,000 on a $500,000 mortgage, now they make $25,000. Of course most of the loans are a better quality than years back, and most are refi's, with federal guarantees, but it seems the banks are making up for lost..? Maybe making up for the lost ability to rig rates elsewhere.

Swiss Bank UBS is reportedly near a settlement with American and British regulators for its role in the Libor rate rigging scandal. UBS is expected to pay $450 million and admit that some employees reported false rates to increase profit; if so, it would match the settlement and fine Barclays agreed to pay earlier this year. When the scandal broke at Barclays, it led to the CEO’s resignation and a shakeup in the company’s highest offices. So far, there have been no shakeups at UBS. The fine amounts to a blip on the $32 billion in annual revenue at UBS. Even though there were actual individuals scamming the Libor, there have been zero prosecutions. Nine figures sounds like a big amount but it is a pittance for the bank, especially because it will be passed on to shareholders, who can't be very happy. Shares of UBS are off nearly 70% since the financial crisis, the result of several scandals that included accusations that UBS helped wealthy clients dodge taxes and a $2.3 billion loss from the actions of a rogue trader.

Meanwhile, British lawmakers have announced plans to crackdown on tax dodgers; part of a campaign against “offshore evasion and avoidance by wealthy individuals and multinationals.” The push, the Treasury said in a statement, was expected to yield £2 billion in additional annual revenue. The drive comes amid growing criticism in Britain and elsewhere in Europe of the fiscal policies of several American companies that pay little tax on the billions of pounds and euros in sales that they generate in the region. The report focused on the tax practices of Starbucks, Amazon and Google, criticizing their policy of using lower-tax jurisdictions within Europe, like Ireland, Luxembourg and Switzerland, to record much of the revenue they generate in higher-tax countries like Britain, France and Germany. Companies like Google then transfer money they earn in Europe to Bermuda or other locations, thereby deferring or avoiding U.S. taxes as well. The companies say it's all perfectly legal

Ships are backing up, a kind of traffic jam off the coast from the ports of Los Angeles and Long Beach; freighters with no place to unload their cargo are line up at anchorages. The 800-member clerical workers unit of the International Longshore and Warehouse Union walked off the job last Tuesday, with some 10,000 longshoremen and other union members refusing to cross picket lines, forcing a shutdown at 10 of the twin ports' 14 container terminals. Four other container terminals remained open, along with facilities for handling shipments of automobiles, liquid fuels and cargo such as raw steel. The overall economic impact of the strike has been estimated to run at more than $1 billion a day, including lost wages of dock workers, truckers and others idled by the walkout, and the value of cargo rerouted by shippers.

The ports of Los Angeles and Long Beach together handled more than $400 billion in goods arriving or leaving the West Coast by ship last year. The strike  marks the largest disruption of cargo traffic through the two southern California facilities since a 10-day lockout at West Coast ports in 2002.