Tuesday, June 29, 2010

Is The Economy Really Chugging Along?

There has been an awful lot of attention concerning the chances for a double dip, and even a third depression, the latter heavily promoted by Princeton University economist Dr. Paul Krugman. However, each theory relies heavily on differing stances of policies and deficits, all of which are difficult to quantify and examine. So in this article, we aim to break down a few simple indicators in an attempt to grasp the future prospects of slowing growth in the United States. We will start with rail loads, a statistic that is published weekly by the American Association of Railroads. The graph below depicts GDP and a quarterly average of rail loads. It is noticeable how strong this past quarter's average of rail loads (ending on June 30) was compared to other recent quarters.

A rebuttal here could be that I was using a quarterly average. Okay, so I'll use the sum of rail loads by quarter, which shows an even bleaker picture of growth.

Comparing this year's rail traffic thus far to the past 4 years, we are able to see how much weaker this year has been. The only bright spot is traffic is up from last year.

I've outlined in previous articles my strong opinions of how housing and employment contribute strongly to the growth of an economy. Well, currently in the US, we have neither. As you can see from the graph below new home sales and the monthly average for lumber in rail cars have a pretty strong correlation. Lets take this past months decline of 32% in new home sales, for example. The consensus was for new home sales to fall, but instead dropped off the face of the Earth. Were the monthly rail numbers telling us this all along? In May, the average amount of lumber being transported dropped almost 6%, the largest decline since October of 2009. During the period from September through the end of December, new home sales dropped by 12.10% and lumber loads dropped by 12.12%. (I do realize that the correlation between the two is nowhere near this strong, but you have to admit it's eerie). So lets take a stab at predicting new home sales from the month of June. Well so far, lumber loads have been horrendous and will mostly likely finish with one of the worst month over month declines in some time (further back that I care to calculate). So, I'm going to project we see a slight uptick, and I stress slight, however there is still downside risk.

If that graph wasn't enough to convince you, maybe the one below might. Right now, lumber inventories held by wholesalers, a number from the BLS site, are at 1 year high (they are subject to a 2 month lag, so that peak your seeing is April's number). Coincidently, lumber loads were at their highest levels since 2008 in April. Basically we are looking for a drop in lumber inventories to further solidify our case that the housing market continues to remain weak.

Looking at lumber prices and the generic 1st contract for lumber, LB1 for you Bloomberg users, we can see the huge decline in prices. Since the year began, prices are down 12%, but from the 2010 high, they are down over 40%. This is certainly disturbing. Comparing the price of lumber with rail loads of lumber, we can see the correlation has been pretty strong over the past year or so. Going by this assumption, we are likely to see a decline in lumber loads and subsequently a drop in new home sales, thus dragging GDP around the 2.0-2.6% range.

If we use lumber as an indicator for possible future growth, well, its pretty bleak. It is clear we are out of a recession, but will strong growth follow? Probably not. Lumber loads haven’t been rising enough for us to say that future looks good.

But enough with the talk of wood and trains, lets move on to employment. This Friday we get a monstrously crucial number, nonfarm payrolls. This will give an indication of job creation and growth for the month of June. Lately, census workers have artificially inflated job growth. This reading will drive the market either up or down. A sour reading would certainly help build the case for a slowdown in growth and maybe even the next stages of a bear market. As unemployment remains high, housing is also impacted. With banks imposing tight lending standards, it is tough for anyone to get credit to purchase a home, or even refinance to get out of a high rate. Once again, housing will suffer. The recent increase in home prices from Case Shiller was met with a drop in mortgage applications. The home price numbers are lagged from April so the increase in prices can, once again, be related to the homebuyer tax credit.

So where does one put their money? Well shorting Toll Brothers might be a nice place to start. Although the stock is at a recent low, and may be relatively cheap, its EPS is -4.1, according to Google finance.


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