Sometimes we wonder if we live in the same universe as other financial commentators. We turn on Bloomberg and there’s some talking head spouting off about the US economy being in “very good shape”. Then we check the latest data, and the discrepancy between the spin and reality almost makes us wonder if it’s all some big joke at our expense.
The end of last week was a bearish bonanza, since it saw the release of both housing and third quarter GDP numbers. Both were bad. Both show signs that things could get a lot worse.
Let’s start with housing. The financial headlines picked up on a professed bounce in new home sales, up 5.3% to 1.075m. The real estate lobby hailed this as the evidence that the market is bottoming. Well, they would, wouldn’t they? Except that there’s a few problems with that story…
One is that these slightly-rising sales were accompanied by a 9.3% month-on-month drop in the median price. In other words, builders are holding a firesale – slashing price tags to try to clear their inventories. That’s not generally the sign of a market that’s about to turn around.
Year-on-year, prices were down 9.7%, the biggest drop since December 1970. (Sales were down 14.2% year-on-year). From what we read, that probably understates the extent of the price cuts, as some builder incentives aren’t counted as cuts.
It’s also worth noting that the sales numbers are subject to heavy revision in subsequent months, partly as a result of buyers backing out of contracts. July first came in at 1.075m; the latest revision put it at 0.984m. August was initially estimated at 1.05m, now it’s down to 1.021m. So even the bounce reported may be optimistic.
Existing home sales weren’t any better either, as we reported on Thursday. Sales were down 14.2% year-on-year, while median prices fell 2.5%, the largest decline ever recorded.
And there’s every prospect that this rout that has barely started. Historically, the aftermath of a housing boom in the US sees the share of housing in GDP drop to around 3.5%-4% of GDP. Presently it’s 5.7% from a peak of 6.3% last year, so if the pattern holds true we’re only around one-quarter of the way through this bust.
Meanwhile, the first estimate of third quarter GDP growth came in at 1.6% annualised, below consensus estimates of 2%. Unsurprisingly, the main weakness was in the housing market; residential investment dropped 17.4% in the third quarter, knocking 1.1% off growth.
There were positives. Business investment was up strongly, while the doughty US consumer is still shopping until (s)he drops, with consumption growth up 3.1% in Q3 from 2.6% in Q2. These two sectors will be crucial to the economy going forward, because many leading indicators are now pointing towards recession in mid-late 2007. If that’s to be averted, consumption will have to stay strong and business investment will have to pick up the slack left by the housing slump.
That’s not impossible, but things will have to get better from here. Consumers benefited from lower fuel prices last quarter; unless oil rockets again that should help them this quarter as well. But the US shopper is heavily dependent on the rising value of their houses, both because they use their houses as cash machines via mortgage equity withdrawal and because simply having a valuable asset makes them feel more secure and more ready to spend.
With the housing market slumping, it’s hard to see how consumption will continue to strengthen unless wages pick up very strongly. As yet that doesn’t seem to be happening – the big gains in wages have been due to stock options at the top end of the income scale. Joe Worker in manufacturing has been seeing his wages fall in real terms.
The collapse of American consumers has been prophesied many times before. Each time, they’ve surprised with their strength. But one day this debt-driven consumption cycle will unravel and now seems as likely a time as ever.
Meanwhile, business investment may not be strong enough to take the strain. Optimists hope that the commercial construction market will take over from the residential one, but the 14% gain in commercial construction in the third quarter was down from 20.3% in the second quarter. On the fact on it, commercial, while still strong, is slowing even as residential worsens.
And spending on equipment and software – a healthy 6.8% gain this time – may not be sustained. A good deal of investment in information technology is likely to be deferred until late 2007 as buyers wait for the release of Microsoft’s new Vista operating system (the replacement for Windows).
One of the few analysts forecasting an outright recession is Nouriel Roubini of New York University. He makes a good point about business spending’s failure to take off: “The corporate sector may be flush with liquidity and profits like never before but, instead of investing, it is giving back to shareholders this cash in the biggest share buyback bonanza in US history ($400bn in 2005 and $600bn in 2006).”
“No corporation would give back to shareholders its profits at this unprecedented rate if it had good investment or M&A prospect; the share buyback bonanza is the strongest signal of the pessimistic expectations of the corporate sector.”
Is recession a certainty? Not necessarily. As mentioned already, the US economy has often proven more resilient than expected in the past. And if a severe downturn begins to look like a real risk, the Fed will cut rates aggressively in a bid to keep things afloat on a sea of cheap money.
But it’s more than a possibility. Take no comfort from the fact that almost no analysts are predicting it; they have a lousy record when it comes to spotting tipping points. For now, we feel safer in our unfashionable, bearish universe.
Turning to the stock markets…
The FTSE 100 slipped back, shedding 32 points to end the day at 6,160. Hanson was the main faller, down 4% to 711p as weak US housing data hit the building materials group, while AstraZeneca and GlaxoSmithKline both extended Thursday’s falls. For a full market report, see: London market close
Elsewhere in Europe, the Paris CAC-40 closed 37 points lower, at 5,396, while the Frankfurt DAX-30 fell 21 points to 6,262.
Across the Atlantic, stocks ended the week on a low note, as the weaker-than-expected quarterly US growth figures hit sentiment. The Dow Jones closed 73 points lower, ending the day at 12,090. The Nasdaq was 28 points down, at 2,350, and the S&P 500 shed 11 points, falling to 1,377.
In Asia, the Nikkei 225 fell sharply, down 317 points to 16,351 as worries about US growth and consumer spending hurt shares, particularly in the technology sector. A fall in industrial production during September compounded the tech sector’s woes.
Oil was higher in New York, with a barrel of crude trading at around $60.80, while Brent spot was also higher, at $58.50.
Spot gold moved back above $600 an ounce, trading at around $602 an ounce as the weak US GDP growth figure sent the dollar lower.
And in London this morning, Financial Times publisher Pearson reports it saw underlying profits rise 15% during the first nine months of the year. It is set to make record profits for the year as a whole.
And our two recommended articles for today…
Could you win in the hedge fund casino?
– The hedge fund industry is larger than ever, and managers also seem more willing to embrace risk than ever before, as demonstrated by the recent Amaranth debacle. Could the system of generous incentives be to blame? asks Brian Durrant. To find out, click here: Could you win in the hedge fund casino?
How you can profit from climate change
– The European Union has a big chance in the next few months to make a difference to climate change – and possibly allow a few canny investors to turn a profit. Merryn Somerset Webb looks at which companies stand to benefit from carbon trading – if the EU can just do the right thing. For more, see: How you can profit from climate change