For those of you who were market watchers in the 1990s, Goldman Sachs’ investment strategist Abby Joseph Cohen always made to case to buy stocks. She was so well regarded that a bullish pronouncement would move the market. And since the market for the most part appreciated handsomely, she looked brilliant, until, of course, she didn’t.
She was also given the unenviable task of talking up stock prices in the wake of the LTCM collapse, when the securities of all sorts were on shaky ground, because Goldman had filed for its IPO and it would have been hugely embarrassing for them to withdraw it in the face of adverse conditions. But Cohen looked like she was being used, as she may well have been.
She has never regained the stature she enjoyed in the 1990s, so it was curious to see her as the author of a comment in the Financial Times, “Making the bullish case for a decelerating US economy.”
It is truly a remarkable piece of journalism, or one might say fiction. I have seldom seen a story so disconnected from the facts. Let’s start from the top:
Last week, Jeremy Siegel, professor of finance at the Wharton School, made the bullish case for equity valuations in this column. No less important is the current state of the US economy, including corporate performance. Simply put, the economy is displaying an improved balance between sectors, ongoing productivity gains, and mild-mannered inflation. Recession seems unlikely and a long period of moderate profit expansion would benefit equities.
An “improving balance between sectors?” Pray, what does that mean? I’d like to know what sectors are doing well. Retail sales are off, autos had a terrible April, and housing continues to deteriorate. Is Cohen trying to argue somehow that the economy being less dependent on housing is a good thing? If so, let me give you Bloomberg columnist Caroline Baum’s response:
To say that ex-housing the economy is doing just fine is tantamount to claiming that, ex-Iraq, Bush’s Middle-East policy is a rousing success.
How valid is the claim that outside of housing everything is hunky dory? Let’s go to the videotape to see how housing-centric the U.S. economy’s weakness really is.
The Commerce Department reported Friday that real gross domestic product rose 1.3 percent in the first quarter, the slowest pace in four years. The year-over-year growth rate slipped to 2.1 percent, also a four-year low.
Investment in housing, the purported culprit, fell 17 percent, less than in the fourth quarter. Residential investment, as it’s known in the GDP accounts, subtracted from growth for the sixth consecutive quarter, something that hasn’t happened since 1980.
The first quarter’s sluggish growth wasn’t confined to housing, however. Exports declined, inventories were a small drag, and capital spending (investment in equipment and software) rebounded 1.9 percent — better than expected based on monthly data on shipments but nothing to write home about after declines in the second and fourth quarters of last year.
“The initial weakness was in housing, but the weakness in capital spending is not a cross-infection from housing,” says Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York.
One year ago, capital spending was growing at a 9 percent year-over-year rate, he points out. Now it’s zero…
Note that there are plenty of other people singing from Baum’s hymnbook; she just happens to be the most colorful.
Let’s go to Cohen’s next claim, “ongoing productivity gains.” That’s a stretch, or one might say distortion. Dean Baker has pointed out for some time that productivity growth has been exaggerated. Productivity growth was higher from 1947 to 1973 than thereafter, and Baker (confirmed by research cited in the Wall Street Journal) has also stressed that productivity growth has slowed since the late 1990s. Baker’s take on the latest data release:
The articles reporting on first quarter productivity told us that it was better than it expected, coming in at a 1.7 percent annual rate. Count me among the surprised. I was expecting a number close to 0.5 percent based on 1.4 percent growth in output and a 1.0 percent increase in hours worked.
The Bureau of Labor Statistics now reports that hours worked fell at a 0.3 percent annual rate in the first quarter. This is possible given their methodology, because BLS takes hours for the self-employed from the Current Population Survey, and this data is extremely erratic. As a practical matter, it is not likely that hours actually fell at a 0.3 percent rate in the quarter, and it would not be good news if they did. Look for a sharp jump in reported hours in the second quarter and a very weak productivity number.
Her third assertion was “mild-mannered inflation.” The Fed doesn’t think it’s mild-mannered. Otherwise, it would be cutting rates to staunch the housing market implosion and economic slowdown. The Nattering Naybob (despite the blog title, he is an economist with a nose for data) also found a “gotcha” in Thursday’s statistical release:
The implicit price deflator for the business sector, which reflects changes in both unit labor costs and unit nonlabor payments… Q406 +1%… smoking hot in Q107 +3.7%…
The price deflator is one of the broadest measures of inflation, and the increase from quarter to quarter is striking given the weakening housing sector.
To continue with Cohen: “recession seems unlikely.” “Unlikely” in the sense that the odds of recession, according to Greenspan, are less than 50% (he put the probability at 1/3). But that was before the latest, generally weaker, set of economic releases. And if you take first quarter GDP growth of 1.3%, and use either the business deflator (3.7% per above) or a even a core-CPI-ish 2+% (to which Barry Ritholtz objects vociferously, calling the efforts to exclude goods like food and energy that are a big portion of household budgets and just happen to be rising fast as “inflation ex inflation“), we already have an economy with one quarter of negative growth. Two quarters of negative growth is a recession (although the label is usually based on negative nominal growth, not negative real growth).
Her last comment, “long period of moderate profit expansion would benefit equities,” is certainly true, but where does she expect continued profit growth to come from? We are already beyond the normal duration of a growth cycle. Profits tend to peak towards the end of a cycle. And as various commentators, starting with Paul Krugman, have noted, business investment has been particularly weak. That doesn’t bode well for continued growth.
Her article goes on, citing non-residential construction as a big offset to the housing construction slowdown (ahem, collapse). Has anyone told her that non-residential real estate shows signs of exactly the same sort of profligate lending we’ve seen in subprimes? And since borrowers are often in corporate form, they have more reason to defraud than residential buyers. So expect commercial real estate shortly to be on the same trajectory as residential. Similarly, she describes consumers as a “ballast” to the economy. Yes, 1Q consumer spending wasn’t bad, but the trend line is down, and likely to accelerate given that they have been negative savers for over two years. That isn’t sustainable, and their increasing disinclination to try to tap into home equity likely signals the end of that party.
Now having said that, Cohen may be right for all the wrong reasons. She is trying to justify continued stock market appreciation based on fundamentals, and that argument just doesn’t hold water. But the market is rallying strongly based on momentum trading, aka greater fool theory. Jeremy Grantham pointed to the likelihood of what he called an “exponential phase” before a market break. Barry Ritholtz sees the possibility of a “melt-up” to a 14,000 Dow and cited a WSJ story that referred to Wednesday’s market action as a “buying panic.”
I could continue to refute her article on a line-by-line basis, but you get the drift. It’s quite a performance, consistent with her history.
