Struggling Small Businesses Suggest A False Recovery

From Bloomberg, No Job Growth For Small Businesses Spurs Recovery Doubt:

Small businesses are becoming the Achilles heel of the U.S. recovery by limiting growth and job creation.

Companies with fewer than 500 employees, such as Phoenix Technologies Ltd. and Sonic Corp., helped lead the economy out of the four recessions since 1980. This time, they continue to cut capital spending and dismiss workers, eliminating 3,000 jobs in January, according to Roseland, New Jersey-based Automatic Data Processing Inc., the world’s largest payroll processor.

“Will you have a sustainable recovery a few years down the road without getting some small-business spending? No,” Cary Leahey, senior managing director at Decision Economics Inc. in New York and a former White House economist, said in an interview. “Wall Street gets it.”

There will be no economic recovery without the participation of small businesses, which account for over half of the workforce in the United States. While larger companies can weather economic downturns, especially with direct government assistance, smaller firms are more vulnerable to economic weakness.

Small Business Confidence Declining

The U.S. economy expanded at a 5.7 percent annual rate in the fourth quarter, the fastest pace in six years, after a 2.2 percent increase in the third quarter, buoyed partly by capital expenditures for equipment and software by large companies such as Dallas-based Texas Instruments Inc. Growth may be difficult to sustain if smaller firms continue to pare spending and staff.

“It suggests that a V-shaped economic rebound is even more unlikely than suggested by many standard economic indicators,” said Andrew Tilton, an economist at Goldman Sachs Group Inc. in New York, which sees gross domestic product growing 2.3 percent this year.

The National Federation of Independent Business’s index of small-business optimism has been near historic lows for 15 consecutive months, declining to 88 in December from 88.3 in November, the federation reported Jan. 12. During the four prior recessions, it dipped below 90 only once.

Forget all the hoopla surrounding an economic recovery- small business owners still view this as a recessionary environment. Don't expect an upturn in real economic activity without an uptick in small business confidence.

Phantom Jobs

The economy still needs a contribution from small companies, or growth and employment gains won’t be as fast as they could be, Rupkey said. “ISM and leading indicators are probably overestimating the recovery speed.”

The nation’s monthly payroll figures are inflated because the Labor Department model that estimates small-business hiring has overstated the number of jobs added during the recession, Shepherdson says.

According to the model, small companies created an average of 113,000 jobs a month from February through December -- a period when total employment fell by a nonseasonally adjusted 3.7 million, Labor Department statistics show.

The model “is creating jobs out of thin air that are not actually being generated,” Joshua Shapiro, chief U.S. economist at MFR Inc., an economic-consulting firm in New York, said in a Feb. 4 note to clients.

Leave it to the government to magically create phantom jobs using the birth/death model. While everyone focuses on the drop in the unemployment rate from 10% to 9.7%, the government massively revises previous unemployment estimates by over 900,000. Government statistics have, quite frankly, turned into one big joke.

Where's the Credit?

Lack of access to credit is also affecting small businesses disproportionately. The Federal Reserve reported Feb. 1 that banks were continuing to tighten standards for loans to small firms, while standards for large companies were unchanged.

This is still a weak credit environment, which is very detrimental to small businesses. The Fed is obviously pushing on a string here, as massive stimulatory measures have failed to benefit the broader economy.

If this is really an economic recovery, then we are experiencing perhaps the most unusual economic recovery in history. Never before have we seen such a disconnect between (supposed) GDP growth and rising unemployment. The prolonged weakness in the credit markets is also unusual in a supposed economic recovery. While it may not be clear to most now, this is truly an economic recovery the government has conjured up out of thin air.

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Unemployment Rate Falls to 9.7%: Internals Still Weak

From the Bureau of Labor Statistics:

The unemployment rate fell from 10.0 to 9.7 percent in January, and nonfarm payroll employment was essentially unchanged (-20,000), the U.S. Bureau of Labor Statistics reported today. Employment fell in construction and in transportation and warehousing, while temporary help services and retail trade added jobs.

This is a somewhat positive report, although many of the internals continue to deteriorate. Let's first take a look at some of the positive points in this report.

Civilian Labor Force Participation Rate

The Civilian Labor Force Participation Rate ticked up slightly to 64.7% in January from 64.6% in December. Note that at the beginning of the recession, the labor participation rate was 66%. As marginally attached employees, who are not included in the labor force, start to reenter the labor force in future months, there will likely be upward pressure to the unemployment rate.

Part-Time Workers

The number of part-time workers for economic reasons dropped by 849,000 to 8.3 million, which is a positive sign for our economy. This suggests more part-time workers are finding full-time employment.

Now for some of the weaker internals of this latest unemployment report.

Long-Term Unemployed

The number of long-term unemployed (those jobless for 27 weeks and over) continued to trend up in January, reaching 6.3 million. Since the start of the recession in December 2007, the number of long-term unemployed has risen by 5.0 million.

This is still a weak labor environment for those who have been out of a job for an extended period of time. These are the individuals who will continue to find it difficult to reenter the market as their skills become outdated.

Marginally Attached Workers

Marginally attached workers, or workers who have given up on their job search, increased by 53,000 in January to 2,539,000, which is nearly double the amount of marginally attached workers since the onset of this recession.

As you can see, this is a somewhat mixed report. We all know that these reports from the government are subject to massive revisions, so the drop in the unemployment rate should be taken with a grain of salt.

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Are Gold Bugs Capitulating Yet?

After a 15% correction in gold and a 40% correction in many miners, most latecomers to the gold bull market now know that investing in gold is not easy! These are the kind of corrections that really test the conviction of gold bugs; I wonder how many will still be around when the next leg up in this bull market begins.

In any bull market, corrections of this kind are the norm, yet investors get so caught up in the daily swings that they end up selling at precisely the point that would have yielded them maximum profits. In other words, they sell at the bottom. The healthy correction in gold stocks should have long-term gold bulls celebrating on the streets, yet many are at maximum levels of despair. I suspect many latecomers to the gold party have finally capitulated and are swearing off investing in gold forever- that is, until we put in the next intermediate term top, at which point, they will be buyers again. The increasing bearish sentiment gold is a bullish sign and very conducive to the next leg up.

Be patient- this bull market has years to go.

Technical levels of interest

Now that gold has broken down below the multi-month consolidation zone, I would be looking for gold to consolidate between $1,040 and $1,050 dollars. Look for a possible retest of the breakout level of $1,025 dollars. The 200- day moving average is still firmly moving up, and this will serve as another level of support moving forward.

Fundamentals, Fundamentals, Fundamentals

What in the fundamental picture of gold has changed in the past 2 months? Has our government decided to rein in their spending? Has Helicopter Ben Bernanke stepped down yet? Have central banks become net sellers of gold? Has mine production risen substantively, altering the supply/demand dynamic?

The answer to all these questions is no. The fundamentals in gold are still in place, and are in fact, stronger than they were months ago. With rising volatility and threats of sovereign defaults looming everywhere, there will be a mass flight to quality, which means gold. Right now, gold is selling off along with every other asset class besides bonds. This is a miscalculation by the market. However, it usually takes the market some time to sort out short-terms mistakes caused by the raw human emotion of investors. Do you remember the massive rally in gold shares that followed the broad sell-off in stocks in the Fall of '08? Well these are the kind of severe oversold conditions we are starting to see now in the gold space.

That being said, I am still very bullish on gold in the long run. All corrections should be used as buying opportunities.

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Initial Claims Unexpectedly Rise to 480,000

From the Department of Labor:

In the week ending Jan. 30, the advance figure for seasonally adjusted initial claims was 480,000, an increase of 8,000 from the previous week's revised figure of 472,000. The 4-week moving average was 468,750, an increase of 11,750 from the previous week's revised average of 457,000.

Forecasts were for initial claims to decline to 455,000. While continuing claims were flat, extended unemployment claims rose by 242,000 to 5.86 million. The nature of this economic downturn is different from previous downturns since those who are unemployed are staying unemployed. The conditions seem to be ripe for the long-awaited double dip.

The 4-week moving average rose to 468,750, and has now risen for a third straight week, reversing a multi-month downward trend. Look for weakness in the labor market to be reflected in continued weakness in consumer spending and broadly in our economy.

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Negative-Equity Homeowners Strategically Walk Away

From the New York Times, No Relief in Sight, More Homeowners Walk Away:

New research suggests that when a home’s value falls below 75 percent of the amount owed on the mortgage, the owner starts to think hard about walking away, even if he or she has the money to keep paying.

In a situation without precedent in the modern era, millions of Americans are in this bleak position. Whether, or how, to help them is one of the biggest questions the Obama administration confronts as it seeks a housing policy that would contribute to the economic recovery.

The number of Americans who owed more than their homes were worth was virtually nil when the real estate collapse began in mid-2006, but by the third quarter of 2009, an estimated 4.5 million homeowners had reached the critical threshold, with their home’s value dropping below 75 percent of the mortgage balance.

They are stretched, aggrieved and restless. With figures released last week showing that the real estate market was stalling again, their numbers are now projected to climb to a peak of 5.1 million by June — about 10 percent of all Americans with mortgages

Introducing the strategic default- yet another factor that will weigh down on housing. The only thing that can prevent a trickle of foreclosures turning into a flood is an immediate V-shaped rally in home prices, since time is the enemy of underwater homeowners, especially with rising carrying costs. However, even if consumers are willing to step in and buy homes, banks are still wary of extending credit.

The estimated 5.1 million homeowners with home values below 75% of mortgage values, or 1 in 8 homeowners, will eventually capitulate. With over 15 million Americans (and rising) currently unemployed how will housing recover? Watch for mortgage resets in upcoming months to provide the knockout punch for many homeowners and effectively negate the influence of tax-credits on home prices.

"We’re now at the point of maximum vulnerability,” said Sam Khater, a senior economist with First American CoreLogic, the firm that conducted the recent research. “People’s emotional attachment to their property is melting into the air.”

The difference between letting your house go to foreclosure because you are out of money and purposefully defaulting on a mortgage to save money can be murky. But a growing body of research indicates that significant numbers of borrowers are declining to live under what some waggishly call “house arrest.”

Using credit bureau data, consultants at Oliver Wyman calculated how many borrowers went straight from being current on their mortgage to default, rather than making spotty payments. They also weeded out owners having trouble paying other bills. Their estimate was that about 17 percent of owners defaulting in 2008, or 588,000 people, chose that option as a strategic calculation.

Evidence continues to mount that national home prices will fall in 2010. Too many people are jumping directly into the fire and buying homes, not realizing the tenuous state many homeowners are in, while ignoring tremendous overhang of shadow inventory- which will put a lid on any housing recovery.

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FHA Loans Gone Bad: Foreclosures Rising

From the Washington Post, Rising FHA default rate foreshadows a crush of foreclosures:

The share of borrowers who are falling seriously behind on loans backed by the Federal Housing Administration jumped by more than a third in the past year, foreshadowing a crush of foreclosures that could further buffet an agency vital to the housing market's recovery.

About 9.1 percent of FHA borrowers had missed at least three payments as of December, up from 6.5 percent a year ago, the agency's figures show.

Although the FHA's default rate has been climbing for months and eating into the agency's cash, the latest figures show that the FHA's woes are getting worse even as the housing market shows signs of improvement. The problems are rooted in FHA mortgages made in 2007 and 2008. Those loans are now maturing into their worst years because failures most often occur two to three years after a mortgage is made.

If the trend continues and the FHA's cash reserves are exhausted, the federal government would automatically use taxpayer money to cover the losses -- a first for the agency, which has always used the fees it charges borrowers to pay for its losses.

There is little doubt in my mind that foreclosure will rise in 2010. FHA backed loans are just one of the mechanisms by which the government is artificially supporting the housing market. While government-sponsored stimulus temporarily creates an artificial boom, sooner or later the free market dictates where prices will go. Watch for asset prices to tanks as stimulus programs expire one by one.

Souring FHA-Sponsored Loans

For now, just about every major measure of the agency's financial health is worsening.

The FHA does not make loans but insures lenders against losses. And claims have already spiked. The agency had to pay out on 47 percent more loans in October and November than in the corresponding period a year earlier, according to an FHA report.

The number of loans in foreclosure, including those that have not yet been billed to the agency, has also increased. They were up 26 percent in the last quarter from a year earlier.

FHA Commissioner David H. Stevens, who joined the agency in July, flagged his agency's troubles with the 2007 and 2008 loans in October, when he told a House panel that "rogue players on the margin" immediately migrated to the world of FHA lending after the subprime mortgage market collapsed.

Although lending standard for FHA-backed loans have improved recently. there is no question that the FHA has served as the "lender of last resort" for a multitude of potential homeowners. The effect of these irresponsible loans are just starting to be felt. 2010 will be the beginning of a slow grind down in housing that will be measured in years.

Projections of brighter economic conditions are based on presumptions and blind hopes of a recovery in housing that are unlikely. Remember, foreclosures aren't isolated events, as they negatively effect surrounding home prices. To put it simply, rising foreclosures and rising unemployment are not what recoveries are founded on. There is no recovery.

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John Embry: Gold to Rise 30% in 2010

John Embry sees increasing gold premiums in the midst of a declining gold price as a sign of robust demand. Further, he considers the budget condition of states and the federal government as being supportive of gold prices. You can read the report here.

"When inflation rears its ugly head, and I suspect that will be sooner rather than later, the market will force interest rates higher in the U.S., and it is within the realm of possibility that an annual increase in U.S. debt-service costs, at some point in the not-too-distant future, might end up exceeding any total U.S. budget deficit prior to fiscal 2009."

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Obama Proposes Record $1.6 Trillion Budget Deficit

Now that's the kind of change I can believe in. I guess the austerity program Obama so often talks about will have to wait another year. From Bloomberg, Obama Offers $3.8 Trillion Dollar Budget With Focus on Jobs:

President Barack Obama proposes a $3.8 trillion fiscal 2011 budget today that calls for $100 billion in additional stimulus spending and projects this year’s deficit will hit a record $1.6 trillion.

The plan would reduce the shortfall in part by imposing more than $800 billion in higher taxes and fees on those earning more than $250,000, banks that benefited from the financial industry bailout and the oil, gas and coal industries.

The spending blueprint being sent to Congress for the fiscal year that begins Oct. 1 reflects the administration’s struggle to boost the economy and job growth -- both top concerns of voters -- while tightening the government’s belt to reduce deficits in the years ahead.

The $1.6 trillion deficit forecast for the current year represents 10.6 percent of the U.S. gross domestic product, making it the biggest by that measure since World War II, according to administration figures. The deficit in 2009 was $1.4 trillion.

Get used to following: higher taxes, spending cuts, and record budget deficits. If you think this is a formula for sustainable growth, you are kidding yourself. There will be no recovery until the government allows free-market forces to work out imbalances caused by an accommodating Federal Reserve.

Deficit to Explode

The administration’s deficit projections for 2011 and beyond are higher than the White House previously forecast because “the economic conditions were much worse” than predicted when Obama first took office, Orszag said in a Bloomberg Television interview this morning.

The increase totals 17 percent once the stimulus package is included, according to CBO estimates. The administration’s plan also calls for 120 program terminations, reductions and other savings it estimates would save $20 billion.

It would provide $33 billion in “emergency” funding this year to help pay for the administration’s troop buildup in Afghanistan. Next year, war costs would amount to $159.3 billion. The basic defense budget would amount to $549 billion, which represents a 1.8 increase adjusted for inflation. The Department of Homeland Security would get a 2 percent increase.

The budget has more than doubled from $1.9 trillion in 2001, according the OMB’s historical data.

I think you can conservatively add 20% to government budget projections, as the government is consistently wrong in forecasting future economic conditions. Future deficit projections are based on growth scenarios that are utterly detached from reality for a number of reasons, not the least of which being worsening demographic trends.

It's interesting that at a time of draconian spending cuts, President Obama is proposing increases in defense spending. How fitting of a Nobel Peace Prize winner. With the recent conflict with China in relation to U.S. arms sales to Taiwan, don't expect military spending to decline anytime soon.

It's deeply saddening that with record numbers in America living on government assistance, we are still ratcheting up war efforts abroad. With repeated policy errors of this kind, you can be sure that there will be no economic recovery, and that the people will show their displeasure in upcoming elections.

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The Next Housing Bubble?

The ongoing economic crisis has brought about massive government intervention in the free markets- intervention which, if history is any guide, will cause more harm than good.

There is a prevailing view that the housing bubble has popped for good, and that clearer skies lie ahead. The thought that housing can once again reach bubble valuations after such a steep decline seems laughable. However, bubbles are formed on the foundation of low interest rates and excessive credit, which promotes an unrealistic illusion of prosperity. These are the conditions the government is currently actively supporting.

Government support of the housing market, if left uncontained, will eventually lead to bubble-like conditions. From Marketwatch, Mortgage Bubble Warning:

The government's $700 billion bank bailout bill has met its goal of helping bring the financial markets back from the brink, but has so far failed to increase lending from the banks who received the taxpayer assistance, a key government overseer reported Sunday in a generally critical review of the program.

The report, which was authored by TARP's Special Inspector General, Neil Barofsky, also warned that the Obama administration's and the Federal Reserve's policies to support the mortgage market could in fact be creating another dangerous housing bubble.

"Stated another way, even if TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car," said the report.

Bubbles aren't necessarily characterized by prices way above historical norms, but merely valuations that are significantly above what they would be in a purely free-market system. Without the direct purchase of MBS debt, which effectively lowers interest rates, many more homeowners would be out of a home. As is, the government is simply delaying the inevitable readjustment in home prices that will come as a result of the lack of employment.

The report charges that high prices for homes between 2004 and 2007 were the result of unrealistic expectations for house values, low interest rates, in-accurate high ratings for mortgage securities, lax standards by lenders for mortgages.

It argues that that the Federal Reserve could be creating another housing bubble with its response to the crisis by keeping short-term and long-term interest rates low, setting up programs to support the mortgage market that also keep rates low, as well as a first-time homebuyer tax credit and a program near completion to purchase $1.25 trillion in mortgage-backed securities.

"Because increasing access to credit increases the pool of potential home buyers, increasing access to credit boosts home prices," the report wrote. "The Federal Reserve can thus boost home prices by either lowering general interest rates or purchasing mortgages and mortgage-backed securities."

"Both actions, which the Federal Reserve is pursuing, have the effect of lowering interest rates, which increases demand by permitting borrowers to afford a higher home price on a given income. Similarly, the administration is boosting home prices by encouraging bank lending and by instituting purchase incentives such as the First-Time Homebuyer Tax Credit. All of these actions increase the demand for homes, which increases home prices," said the report.

I would argue that many of the same conditions that led to the housing bubble are currently present, albeit on a smaller scale. It is quite amazing that we are not seeing a more powerful snap back rally in home prices given interest rates at 0%, sub-5% mortgage rates, and tax incentives.

The Inevitable Hangover

However, critics argue that long-term interest rates could increase in response to the Fed's decision to wrap up its $1.25 trillion mortgage-backed securities purchase program by March 31, along with other federal actions, could result in higher interest rates at a time where many regions continue to experience a depressed housing market and record foreclosures.

The coming double-dip in our economy will likely be led by a resumed decline in national home prices. Home prices still have a ways to fall, as price to rent ratios and price to income ratios have not adjusted to a point where one would be comfortable calling a bottom in housing.

I sense we are very close to a key inflection point in our economy. Sentiment will likely nosedive and hopes of a quick recovery will disappear. Keep an eye on housing, bond rates, gold and the dollar.

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GDP Surges 5.7%: Inventory-Led False Recovery Intact

4th quarter GDP came in much stronger than expected- for now. The only question I have is how much this initial GDP report will be revised down in the future. From the BEA:

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 5.7 percent in the fourth quarter of 2009, (that is, from the third quarter to the fourth quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 2.2 percent.

The increase in real GDP in the fourth quarter primarily reflected positive contributions from private inventory investment, exports, and personal consumption expenditures (PCE). Imports, which are a subtraction in the calculation of GDP, increased.

The acceleration in real GDP in the fourth quarter primarily reflected an acceleration in private inventory investment, a deceleration in imports, and an upturn in nonresidential fixed investment that were partly offset by decelerations in federal government spending and in PCE.

We are currently in the middle of a technical recovery. When economies hit rock bottom, they tend to bounce, only to fall into the abyss again.

Private Inventory Recovery

The change in real private inventories added 3.39 percentage points to the fourth-quarter change in real GDP after adding 0.69 percentage point to the third-quarter change. Private businesses decreased inventories $33.5 billion in the fourth quarter, following decreases of $139.2 billion in the third quarter and $160.2 billion in the second.

Companies are still decreasing inventories, albeit at a slower pace. The 3.39% contribution to real GDP from changes in private inventories is the most in 20 years. The is a substantially higher portion of growth due to private inventories than we see in normal recoveries, which makes me question the sustainability of this recovery.

It is slightly concerning that inventories fell at a slower rate, which implies unmet expectations for holiday demand. I would be keeping an eye on production moving forward.

Disposable Personal income

Current-dollar personal income increased $119.2 billion (4.0 percent) in the fourth quarter, compared with an increase of $35.1 billion (1.2 percent) in the third.

Personal current taxes decreased $11.7 billion in the fourth quarter, in contrast to an increase of $3.5 billion in the third.

Disposable personal income increased $130.8 billion (4.8 percent) in the fourth quarter, compared with an increase of $31.6 billion (1.2 percent) in the third. Real disposable personal income increased 2.1 percent, in contrast to a decrease of 1.4 percent.

Personal outlays increased $109.0 billion (4.2 percent) in the fourth quarter, compared with an increase of $132.3 billion (5.2 percent) in the third. Personal saving -- disposable personal income less personal outlays -- was $516.9 billion in the fourth quarter, compared with $495.0 billion in the third. The personal saving rate -- saving as a percentage of disposable personal income -- was 4.6 percent in the fourth quarter, compared with 4.5 percent in the third.

The disconnect between falling individual tax receipts and higher disposable personal income is curious to say the least, especially given the current state of unemployment. I'm still trying to figure out how disposable personal income can rise when wages are flat and unemployment is rising.

Rising personal outlays are a little easier to explain, since energy and food costs are rising. However, growth in personal consumption is not so robust once we account for inflation.

Bogus Government Statistics

It's getting rather difficult to believe the statistical nonsense that comes from the government these days. If our economy really grew at an annualized 5.7% in the 4th quarter, it begs the question: where are the jobs? Until we start seeing job growth, there is every reason to be skeptical of this "recovery".

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