Reasons for a shallow recession.

Kondratieff long wave is the short answer.

To expand on this consider the following. Prior to the instigation of a new long wave the following conditions should be met;

*Technological innovation [new inventions]
*Involvement of new countries within economic expansion [BRIC's]
*Changes in money circulation and Gold production

Ignoring for the moment technological innovation, which really requires no clarification, but only some examples, and new country involvement again has been covered ad nauseum, I shall expand upon the last point.

Changes in money circulation refers to the consolidation of industry. Consolidation removes competition, and provides cost cutting via economies of scale. The recent merger and acquisition boom was a huge example of just such a phenomenon.

Thus we can say, as regards the conditions in the first point, all the conditions have been met, thus we can move on to the second set of conditions.

Kondratieffs second observation was that during the start of a new long wave, or during the upswing of a long upward wave, that there are increasing numbers of social upheavals and wars, as economies compete for scarce resources.

I shall not attempt to list and identify all the current changes and wars that are currently afoot, suffice to say, I feel that the conditions are met.

The third empirical observation from Kondratieff was that agricultural prices fall in a downwave and rise in a rising wave. Again, we can tick this box. Agricultural prices on aggregate are rising.

Kondratieffs fourth observation was in regard to the shorter cycles contained within the long cycle. Juglar cycles occur both as rising and falling cycles within the long cycle. During a falling long cycle, a falling Juglar contributes and exacerbates the misery in a falling long wave, the classic examples being the 1973-1974 recession, the 1981-1982 recession, and the big daddy, the 1931-1934 depression.

In a rising long cycle, a falling Juglar however becomes a shallow fall, cushioned by the rising long cycle. This currently seems to be the case. A credit crisis and housing bust of unusual severity are making little impact, or certainly not as much as one would expect currently.

Financial markets, also during falling long cycles experience far more severity within bear markets. Bear markets by contrast in a rising long cycle, are milder by comparison. The 60 year cycle ended the previous long wave circa 2000-2002. The bear market then, compared to the current bear market, leaves little in comparison regarding severity.

Speculation and bubbles can only take place in a rising long cycle. Thus the real estate bubble that existed world wide adds a further tick to the argument supporting the current cycle is a rising long wave.

In a rising wave cycle commodity prices rise, inflation rises, interest rates rise. In this environment, equity outperforms bonds, thus, at some point we see bond liquidation, with the rotation into equities.

 

Productivity analysis

Productivity measures the amount of output that is being produced with given amounts of inputs [land/capital/labour]

Measurement recorded in one of two ways;
*Output per worker
*Output per man hour

Economic growth [GDP] reflects growth of the labour force plus growth of labour productivity. Conversely the opposite is true, falling labour force, or increasing unemployment plus falling productivity results in falling GDP.

An important factor that impacts productivity is the investment of new capital, that raises the Capital/Labour ratio, which is technically known as factor substitution.

Historial trends in Factor Substitution;

………………………………..1960-1973………………..1973-1979…………..1979-1989
Technological progress………2.8%………………………..0.6%………………….0.8%
Factor Substitution………….1.3%………………………..0.9%………………….1.0%
Total labour productivity……4.1%………………………..1.5%………………….1.7%
Labour input………………….1.1%………………………..1.4%………………….1.0%
Total Output…………………5.2%………………………..2.9%………………….2.7%

Here we have in graphical form the years from 1998-2007

Productivity figures are indexed, thus the important base figures are lost, thus distorting analysis. However, trends in the data are important.

For example, if Output per person increases, an increase in wages can offset this, resulting in an unchanged profitability for the corporation.

Cycles in Productivity.
Under classic economic theory, productivity is highly cyclical. Thus, when production falls, after a peak in economic activity, employment declines less rapidly and output per head plummets.

As can be seen from the graphical data, this just does not seem to be the case currently. The metrics requiring further study are Unit Labour Costs and Factor Substitution.

 

POT…closing comments

Now according to this Kagi chart, no buy signal has yet been issued. Certainly from the choppy action on Friday, my heart rate can attest to that, I was about $0.50 from pulling the plug on the LONG trade.

However, by my fingernails, I’m still in it.

 

Unemployment…the next crisis

The banking crisis, as noted several weeks ago, pretty much resolved with Bernankes intervention and rather innovative solutions to the banks dilemmas. Whether they were all legal, is immaterial, they cauterised the hemmorage.

Not so easy a problem to solve will be the increasing momentum within unemployment. Employment is known as one of the sticky economic metrics, and for good reason.

The crisis will simply morph from the financial sector [in stock market terms] into any and all sectors where employment impacts the financial condition of the statements.

Economic data in the US have taken a notable turn for the worse. Most im­portantly, the already weakening employment outlook is being further undermined by a widely diffused build-up in inventory and falling profitability. History suggests that the latter two factors lead to significant employment losses.

While the financial system, within the major money centre banks and broker/dealers, have taken steps to enhance balance sheets, they speak essentially to addressing the consequences of excessive leveraging and imprudent financial alchemy. As such, the nasty turn in the real economy may fuel another wave of disruptions that, this time around, would also have an impact on mid-size and smaller banks

The focus will also be on the reaction of policymakers. Here the outlook is mixed. The good news is that the crisis is now moving to an area where traditional policy tools are more effective. This is in sharp contrast to the situation of the past few months, where central banks were forced to use instruments that were too blunt for the purpose at hand.

But there is also bad news. The sharp slowdown in the US real economy will occur in the context of continued global inflationary pressures. As such, the Federal Reserve’s dual objectives – maintaining price stability and solid economic growth – will become increasingly inconsistent and difficult to reconcile. Indeed, if the Fed is again forced to carry the bulk of the burden of the US policy response, it will find itself in the unpleasant and undesirable situation of potentially undermining its inflation-fighting credibility in order to prevent an already bad situation from becoming even worse

Hours worked, is the sharp end of the stick with regards to employment. Employment is sticky, thus, overtime hours are always reduced prior to any permanent reductions in the workforce.

We have seen over the past few months increasingly poor employment stats, sugar coated via the birth/death black box model

Let’s look at different sectors;

Financial sector

Construction;

Retail;

Mining;

Transport & Utilities;
Note here, the interesting divergence twixt the real economy, and stockmarket.
More on this at a later date.

Education & Health

But you get the general idea. The market has been through all of this previously, historically speaking, thus, it is unlikely that there will be a new bull market, based on the facts that too many sectors are going to be problem areas.

Obviously, further analysis into business cycles, sector rotation, and asset classes would potentially improve returns down the short-term, intermediate term road.

 

Credit Default Swaps

April 16 (Bloomberg) — Credit-default swaps worldwide expanded to cover $62.2 trillion of debt in 2007 as investors rushed to protect against losses triggered by the collapse of the U.S. subprime mortgage market.

Contracts outstanding rose 37 percent in the second half of 2007 from $45.5 trillion in the first half, the New York-based International Swaps and Derivatives Association said today. The market, which has grown from $34.5 trillion in 2006, doubled in each of the previous three years as traders used the derivatives as a cheaper and easier way to invest in corporate debt.

While the amounts at risk are just a fraction of notional amounts, these give us a good sense of market activity,” ISDA Chief Executive Officer Robert Pickel said in a statement from the industry group’s annual meeting in Vienna.

Using data from the Bank for International Settlements, ISDA estimated the gross market value of all outstanding derivatives contracts is about $9.8 trillion. That would be the amount owed to banks or investors if the contracts were liquidated. Subtracting off-setting payments owed between trading partners, that number would fall to about $2.3 trillion, the group said.

This really is a similar market to the insurance market, traded in a similar, though less liquid, Options market. Insurance, is most successful, from a sellers and purchasers point of view, when based on robust actuarial data.

Debt, has actuarial data, not as robust as say Life insurance data, but, debt requires certain quantitative safeguards before it qualifies, sadly lacking in much of the later debt, and already written down via defaults.

As the debt, underwritten by CDS contracts, moves back in time, standards should be higher, thus resulting in profitable underwriting…but, we shall see.