Thursday, November 18, 2010

Société Générale's Albert Edwards Upbeat, Almost Chipper: See's Humanity Approaching Broad Sunlit Uplands (Nov. 17, 2010)

Okay, the "broad sunlit uplands" bit was Churchill.
And the rest of the headline?
You know that's not the Mr. Edwards we love.
Let's go a bit further into that June 18, 1940 speech, delivered first before the House of Commons and then broadcast to the Nation:
"... then the whole world, including the United States, including all that we have known and cared for, will sink into the abyss of a new Dark Age, made more sinister, and perhaps more protracted, by the lights of perverted science..."
That's more like it but still doesn't capture L'essence Albert.
Here he is in his own words:
...Many clients we have spoken to do not believe that the US economy can drop into recession because most of the key cyclical elements of the economy, such as housing and consumer durables, remain depressed. In addition, with profit levels so high and corporates flush with cash, clients remain confident that deep falls in the cyclical elements of the economy cannot now occur. They have forgotten the mathematics of inventories.

Remember, this is an economy that has enjoyed the biggest ever peacetime stimulus, yet has seen the weakest ever rebound in final sales (see left-hand chart below). With final sales so weak, it will not take much in the way of a negative contribution from inventories to send the economy into decline- even without further weakness in the moribund cyclical sectors.

Inventories have surged in recent quarters (see right-hand chart above), and their contribution to GDP growth has been considerable (see left-hand chart below). But wait! As my good friend James Ferguson from Arbuthnot pointed out to me the other day, it is already clear from the ISM data that a slowdown in the inventory build is imminent (see right-hand chart below).

All those who discount the impact of inventories: pay attention.
Now you won't need reminding that it is the change in growth in inventories that counts towards GDP growth. So even if inventories rise another $110bn in Q4, as they did in Q3, the contribution to GDP growth is zero. If inventories rise a still strong $60bn in Q4, for example, inventories will deduct 1.5% from annualised GDP growth. With final sales rising a sickly 0.75% annualised (!!) over the last two quarters, you don't have to be a genius at maths to realise a recession is entirely possible, even without sharp declines in housing or consumer durables.

Over the last quarter, production has exceeded new orders in the ISM survey by the most in 20 years. Hence the mismatch between new orders and inventories is such that the headline ISM falling into the recessionary sub-44 range is likely (see chart below). I feel very confident that the markets have a big growth shock to the downside coming down the tracks. I am confident because I can now hear the toot of the train's whistle above the roar of the engines.
If Edwards is correct, and he is, that the ISM will plunge by almost 10 points shortly, another important observation is that inflation expectations will likely tumble (although that assumes that inflation is still measured in traditional metrics, and not under the post-QE2 regime in which every action by the Fed is solely to weaken the dollar and generate a stock surge). The good thing is that it would validate QE2, and likely lead to QE3 and so forth, further accelerating the endgame to the painful muddle through process. 
That last bit was ZeroHedge, here's Albert quoting his protoge:
...Finally I leave you with a thought from Dylan from his brilliant work on the unfolding structural rise in grain prices. “Hunger eats civilization” says Marjane Saatrapi, author of the beautiful book Persepolis.
Food inflation has a dark history. It has been said that the 70s food crisis contributed to the Iranian revolution.
We know the Russian Revolution started with starving workers protesting high bread prices. The Parisian riots of 1789 following the devastated crop of 1788 snowballed into the French Revolution and the revolutionary fervour which swept Europe in 1848 followed a sequence of bad harvests”. No wonder the Chinese authorities have leapt into action. The Fed may have opened a can of very toxic worms. What price for emerging markets in this brave, but very hungry new world?
...MUCH MORE, every syllable worth the read.

And the Churchill?
That was his "Their Finest Hour" speech. Here's the whole thing via The Churchill Centre and Museum.