It's over, it's over, it's over?
By Daniel M. Ryan
I spent Friday morning wafting between CNBC's "Squawk Box" and BNN's early morning roundup, with TV primarily tuned to the former. After all, Larry Kudlow was guest-hosting; it was interesting watching him preach the optimism gospel as if he were Bill O'Reilly. The big event for Wall Street that day was the wait for the latest employment figures, and the consensus of the gathered stats-watchers was that the consensus estimate would be 50,000 jobs lost plus an unemployment rate of 5.0%. The only pessimist of the bunch was Mark Zandi, of economy.com, who concurred with the consensus. This concurrence made him the odd man out of the five stats-watchers (including Mr. Kudlow) gathered to await the news. Because he was in the odd-fellow slot, he expanded on his relative pessimism by stating that the hair's-thin 0.6% GDP growth for 4Q '07 USA would be revised downwards to a negative figure. He further stated that 1Q '08 would either be reported as negative or would be revised as such later. To state his position simply, the U.S. is already in the middle-tail of a mild recession, not a mere slowdown.
Mr. Kudlow, being the professional optimist, did note that the current recession (or near-recession) still looked better than 1990's slowdown, which in its time was remarkably mild given the then-current expectations floating around. I remember that the approximately 6.5% peak in the unemployment rate was interpreted as a sign that the U.S. economy had gotten off easy. Nowadays, a 6.5% unemployment rate – 1.4% above Friday's unexpectedly high announcement of 5.1% for March – would be greeted with alarums on the Hill.
It wasn't just the experts, as well as me, that were confounded in early Friday by the reported figure of 80,000 jobs lost. Just before the release time of 8:30 AM Eastern, the Dow Jones Industrial Average futures shot up about 50 points. That blip-up didn't last, needless to say: by about 8:35, the 50-odd point blip-up had turned into a blip-down of about equal change. It was a fascinating moment, like being at a horse race where one of the riders jumps the gun through bolting out of the wrong end of the box and then hurriedly reversing course to get moving in the right direction.
And yet, at the end of the day, the Dow closed almost unchanged. Both the NASDAQ and the S & P 500 were up slightly on the day. Further, a little digging shows the yield curve flattening a little, with short rates on government paper rising more than those on the long end. When it comes in the midst of trouble, with a previous plummet in short rates and a contemporaneous non-decline in the equity averages, rates rising in this way make for a light at the end of the tunnel. The post-credit-crunch phase of the business cycle, a flight to top-quality debt instruments, is beginning to ebb, implying that a less jaundiced look at the economy's prospects is taking root. The "TED spread," or the difference between the yield on three-month Treasuries and the London Interbank Offer Rate, has been narrowing for at least the past two weeks. Although still abnormally high, it's well off its mid-March peak. That peak was slightly lower than September's or December's. (Data courtesy of Bloomberg.)
The only financial indicator that's still at worrisome levels is the spread between junk bonds and investment-grades. This more sobering statistic can, though, be chalked up to the corporate-bond-market participants' flight from their previous ratings-driven overoptimism. An investment advisor known among the goldbugs cautiously suggested that the worst may be over, credit-wise; a recent upturn in the S&P500/T-Note ratio formed the base of his claim. (I got this page through a goldbug hangout, "the Daily Reckoning Forum.") Some may find significance in the fact that some of the regulars at the DRF have turned to "denial" as an explanation for last month's bad times for the financial sector beginning to evaporate.
And, of course, the markets closed at about even on Friday…implying that they more than held on to their gains from last Tuesday. Despite the recent panic drop in the prices of gold and silver – which (I should add) did not spill over into the buying of physical metals, if anecdotal reports combined with Ebay watching make for an accurate guide – the commodities markets show no signs of contraction in the nosebleed section of the economy. This despite the fact that both Martin Feldstein and Ben Bernanke have described the current contraction as a recession for the public eye.
I have to admit to being doubly confounded. Back in early-mid February, I had said that there would be no recession but that there would be a mild bear market. The accumulating evidence suggests that I was overoptimistic myself, although not by much, regarding the former call. And yet, the current equity market performance suggests that I was too pessimistic about the fates of the U.S. stock market in the latter call. To use market jargon, I seem to have been somewhat whipsawed. All three major U.S. averages are slightly above the level they were at as of Feb. 11th, although their near-term bottoms were not reached until around early March.
We've seen quite a demonstration of the Bernanke technique in the last two months. Put simply, it's "keep your powder dry" (in terms of overall credit expansion) and "step in immediately, as would a forest ranger in the case of a fire" during a crisis. Layered onto this basic technique is the use of balance-sheet operations instead of open-market ones. The latter is the main engine of inflation, while the former doesn't seem to affect the overall monetary base that much. Back in the old days, the Fed would have boldly bought Treasury securities and gamely hoped that the CPI wouldn't catch up with their reflation efforts. The current Fed is more subtle than that.
For the record's sake, Chairman Bernanke had to describe the Bear Sterns bailout as a response to liquidity pressures faced by a basically solvent institution. He doing so was largely for form's sake as well: it's been an open secret for some time that the Fed is tackling solvency squeezes. In a sense, it's a good thing that they do because solvency matters don't require that much "reliquification" (alternately spelled with the word-stem f-l-a-t-i-o-n with either an r-e or i-n in front) and thus can be unwound without putting that much inflationary pressure on the general economy.
There is, however, a cloud on the horizon which might have an anvil formation rising up from it - not enough time has passed to tell. If Friday's lack of drop turns into a relief rally that takes, then the recently doomy prognosticators all over the mainstream are going to look, and feel, foolish. They about-faceing would obscure the fact that the financial sector in the U.S. keeps pushing the envelope in terms of moral hazard. It's oddly similar to the growth of the hippie movement in the 1960s: at first comes the long hair, then the questioning of "society," then the bumming around, then the easygoingness turning into widespread anger, and then the cultural chaos. Long forgotten by the beginning of the ‘70s was the fact that the (male) beatniks managed to be outré while still dressed in suits/jackets and ties, or at worst turtlenecks.
If we see a relief turnaround that changes bear into bull, and contraction into continued expansion, it'll probably be "back to the party" for most. The Fed's use of balance-sheet measures so as to minimize general reflation will be seen as something akin to a magic wand, which does successfully what credit controls tried to do futilely. Suffice it to say that Mr. Bernanke's confident-academic mode was ridden by real fear in his speech to Congress last Wednesday – and he doesn't strike me as the type of man who would be nervous in front of elected politicians.