The Bellyache Brigade

Daily Reckoning Presents: a Wednesday Guest Essay in which the author explains why stock prices have predicted exactly “nine of the past two recessions.”

THE BELLYACHE BRIGADE

Much as some people want to believe otherwise, this slowdown is not so bad.

There are a lot of whiny, doom-and-gloom brats out there, and I want to grab them by the collar, get right in their teary red faces and tell them, “Quit crying – or I’ll give you something to cry about.” These crybabies are filling the air with desperate warnings that things are going down the tubes.

Consider: CNBC now flashes its terrifying jobless-claims chart more frequently than it does close-ups of Maria Bartiromo and Liz Claman. Not long ago, the mention of “Challenger” drew blank stares from analysts; now every good Street moron can cite the outplacement firm’s latest harrowing layoff statistics. There’s even a rumor going around that the manufacturing sector has lost a ton of jobs lately. Can anyone confirm this?

Quit it already. I don’t know how things got this way (I have in my head visions of overeager beavers combating contrarian thinking with more contrarian thinking, which lands us right back at conventional tripe), but this thinking’s all wrong, and it’s got to stop. If you think what’s gone on in labor markets lately is nasty, you either weren’t around for previous cycles, or you haven’t done your homework.

For the whiniest of the whiners, it’s both.

When economic growth peaked during the first quarter of last year, the unemployment rate was hovering at 4% and average hourly earnings were growing at a 3.7% year-over- year rate. Now, five quarters later, the unemployment rate sits at 4.5% and average hourly earnings are growing at a 4.2% year-over-year rate. Since the slowdown began, then, the jobless rate has climbed by a half-point and wage growth has accelerated by the same amount.

A brief look at other economic slumps reveals an altogether different scenario. Five quarters into the 1990 episode, the unemployment rate had risen by 1 1/2 percentage points – three times greater than the increase this time around – and average hourly earnings were growing at a rate half a point slower than when the deceleration began.

Five quarters into the 1981 episode, the results were more striking: The unemployment rate was up by 2 1/2 percentage points – to 9.9% from 7.4% – and wage growth was down by 3.7 percentage points – to 5.5% from 9.2%. The 1968 episode followed the same pattern, though on a lesser scale. A little more than a year after the slowdown began, the unemployment rate had risen by 0.8% and average hourly earnings growth had slowed by half a percentage point.

Clearly the latest episode is different in that (a) the unemployment rate hasn’t risen much at all, and (b) average hourly earnings are growing faster, not slower – as was the case in the three prior instances – than they were when the deceleration in overall growth began. One major difference is consumption, which has held up well. Why?

First, because jobs (and the income they produce) are far and away the most important determinant of consumption.

This isn’t intuitive to lots of people out there – not to the piggish popular press, not to the analysts who feed it corn and not to the public that happily imbibes from its teat. They all now believe that as share prices go, so goes spending.

So let’s emphasize this: Jobs are important – more important than the housing market, than who’s president, than the number of alcoholic and depressed Backstreet Boys – and, yes, even more important than stock prices.

If you’re paying an economist or a consultant who’s using a consumption equation in which jobs don’t carry the greatest weight, or in which stocks carry more weight than housing, or in which the Nascrack predicts retail sales or some such nonsense, then you’ve been pointed in the wrong direction the past few years – and you’re wasting your money.

There’s a reason that stock prices have predicted nine of the past two recessions, and it’s this: For completely opposite reasons, traders and investors (i.e., the people who move stock prices) can’t accurately predict such things any better than a coin toss can – traders trade no matter what’s going on, and investors are looking out over an obscenely long time horizon.

You can aggregate as many millions of these wise minds as you like, but the inescapable fact is that their predictive power is zero.

The second reason consumption has held up is because average hourly earnings have held up, and that poses a threat to the kind inflation outlook the Fed embraces (and encourages us to embrace, too). No, continued acceleration of wage growth does not guarantee an inflation problem to which the Fed would react by hiking rates, and yes, wage growth might well begin to decelerate presently.

Yet the fact that wage growth is proving so sticky this time around certainly isn’t helping the mild-inflation case. And the longer wage growth stays stubborn, the greater the chance the Fed’s tremendous easing to date will keep it high and exert further upward pressure. Given that wages and core inflation are both still cruising at faster clips than when the economic slowdown began five quarters ago, one wonders what they might do if the Fed’s first-half stimulus produces a meaningful growth rebound by the year’s end.

Finally, the reaction of the jobless rate and hourly earnings so far hints at how much longer the economic slowdown might last and the potential strength of the rebound once the deceleration has run its course. Income is still turning in quarterly increases north of 4% because wage growth has held up so well, and this will put an important floor under spending for as long as it continues.

That throws cold water on the notion that we’re in for a long, drawn-out, U-shaped recovery. With so much fuel for spending in the form of income growth, rebate checks, 275 basis points of easing in the pipeline and real interest rates that, in some cases, are the lowest in 10 years, the environment is not the kind in which slowdowns remain stuck in neutral.

For those who argue otherwise, the scanty half-point increase in the unemployment rate so far threatens their forecasts. Most doom scenarios seem bound to – and driven by – a jobless rate that rises all the way up to 5%.

Five percent? Stop with the crocodile tears, people.

That would mark a peak-to-trough increase in the unemployment rate of just one percentage point, whereas past economic slowdowns have delivered increases two to three times bigger than that. And how hard will it be to rebound from a drawn-out “recession” during which the jobless rate rises by only one percentage point? About as hard as it is for Tiger to score a new Buick.

So quit the whining. The employment situation has been much worse at this stage of previous economic slowdowns. The fact that it’s not so bad this time around makes the crybabies even harder to bear than usual.

James Padhina
For the Daily Reckoning
Baltimore, Maryland
July 18, 2001

James Padhina is a staff writer at grantsinvestor.com. As a reader of the Daily Reckoning, you are welcome to a 30-day free trial of grantsinvestor.com. Simply click here:

http://www.grantsinvestor.com/

Whoa! Industrial production fell again in June – for the 9th straight month. If this isn’t a recession, it is the worst non-recession in U.S. history. Among the longest- running periods of declining industrial production since WWII, our present slump now ties for 3rd place – equal to the 9-mo. setback in the year I was born – 1948 – and corresponding to the 13-mo. recession of that era.

What makes the picture look a little brighter today is that consumers continue to ‘hang in there.’ And the Fed continues giving them additional rope to hang themselves with. In the first half of this year MZM, or ‘cash’ as we used to call it, rose at an unheard-of rate of 23.7%.

But Barton Biggs, Morgan Stanley’s economic strategist, doesn’t think it’s believable that “the toxic combination of the wealth effect, record layoffs and higher energy prices won’t take its toll on an already leveraged, undersaved and overspent American consumer.”

“In the next couple of months,” predicts James Paulsen of Wells Capital Management, “there will be more job losses, and the consumer will capitulate.”

“I think the consumer is going down…” adds another Morgan Stanley economist, Stephen Roach.

But these are baby boomers we’re talking about. They won’t go down gracefully…or sensibly. Instead, they will have to be knocked down and carried out. Stay tuned.

Eric, what happened yesterday on Wall Street?

*****

– ‘Tis the season for earnings reports. And in the same way that Christmas has its jingle bells and Thanksgiving has its turkey dinners, the earnings season has its own peculiar trappings – namely, manic overreactions to “a penny shy of estimates” here or “a penny better than estimates” there.

– Let’s be serious, if investors really cared so much about earnings, would the Nasdaq be selling for more than 100 times its component companies’ annual profits?

– Center stage yesterday was heavy-machinery maker Caterpillar. The stock raced ahead about 6% after topping the consensus estimates by seven cents with earnings of 78 cents a share. “Continued strength in electric power and heavy construction and improved demand in coal mining and oil and gas sectors helped fuel second-quarter sales,” said Chairman & CEO, Glen A. Barton.

– Apparently, some parts of the old economy keep on chuggin’…even as the new economy sputters.

– The stock market celebrated Caterpillar’s strong report with the Dow gaining 134 points to 10,606 and the Nasdaq climbing almost 2% to 2,067.

– Maybe Wall Street is simply caught up in the global “feel-good” phenomenon that appears to be circling the globe at the moment. Consider that inside of one 24-hour period earlier this week, PLO leader Yasser Arafat had a face-to-face with Israel’s Shimon Peres; Pakastani President Pervez Musharrat engaged in a “frank and constructive” private chat with Indian Prime Minister Vajpayee; and Russian President Vladamir Putin embraced Chinese President Jiang Zemin.

– Will these centuries-long enemies suddenly become friends? Not likely. Nor has Wall Street suddenly become a welcoming investment destination for every rube who gets off a bus at Pennsylvania Station. For every one Caterpillar, there are numerous Intels and GMs.

– Intel on Tuesday reported a whopping 76% plunge in second-quarter profits. General Motors announced a similarly severe 73% drop in second-quarter earnings.

– What does a bubble look like? David Hale, Chief Global Strategist for Z?rich Financial Services: “1) 70% of all technology venture capital funding in the U.S. since 1980 occurred in [only] two years, 1999 and 2000; (2) the value of venture capital funding shot up to $114.6 billion in 2000 from $4.4 billion in 1995; and (3) the value of IPOs for the technology sector surged to $37.5 billion in 2000 from levels of $2 to $3 billion per annum during the early 1990s.”

– As Walter Bagehot, who lived and chronicled many 19th- century panics, once said, “[A]t particular times, a great deal of stupid people have a great deal of stupid money.”

– Does history repeat itself? In “100 Years of Land Values in Chicago,” written in 1933, Mr. Hoyt observed: “Real estate loans, not failed stockbrokers’ accounts, were the largest single element in the failure of 4,800 banks in the years from 1930 to 1933.”

*****

Bill asks:

*** Well, has it been worth it?

*** I pose the question on or about the 2nd anniversary of the Daily Reckoning. For two years, I have been writing these letters – with hardly even a pause. Was it worthwhile, after all, putting up with my gratuitous reflections on war, politics, love and poetry? You decide, dear reader.

*** I’ve mentioned dozens of investments…some positive, some negative. How did they do? Well…the investments on which I was bullish rose an average of 13%. Not great, but better than the Dow or the S&P – and far better than the Nasdaq. And the stocks on which I was negative fell an average of 43.21%.

*** So, maybe you won’t get rich quick by reading the Daily Reckoning. But you won’t go broke either.

*** Many thanks to you for reading. I enjoy writing; I hope you’ve enjoyed reading half as much. And tune in tomorrow…as a suspicion grows – that the Fed, like Lincoln’s war and all government programs, may be leading us to a “deadweight loss.”

Bill Bonner

p.s. Sometimes over the past two years, I’ve been accused of sounding like a broken record. In an effort to counter that perception, we offer a Wednesday Guest Essay, by grantsinvestor.com’s James Padhina below.