Thursday, December 20, 2007

Marc Faber On The Recession We're Already In


By Dr. Marc Faber
Will rate cuts be of much help to the asset markets and the economy? I believe we are in a war between two major adversaries. On the one side we have the Fed (and other central banks) pumping liquidity into the system in a desperate attempt to support the asset markets and the economy. On the other side we have the private sector, which, as Hatzius explained, is being forced to curtail lending due to heavy losses in the credit market and to fight the Fed’s reflation efforts by widening credit spreads. Complicating matters is the fact that both adversaries have powerful allies.
The Fed has the Treasury and the government, as well as the Wall Street elite, as allies. The government could implement massive tax cuts in order to stimulate economic activity; the Treasury could bail out financial institutions, which in reality should be punished by bankruptcy; and the monied Wall Street elite will ensure that politicians and the Fed make it possible for them to continue their con-game. The private sector has allies in the form of inflation, a weak dollar, and a dissatisfied public (declining consumer confidence and lack of trust in government, which is reflected by the strong showing of Ron Paul), all of which form a powerful phalanx when battling the Fed’s reflation attacks. Inflation is a powerful ally for the private sector because it squeezes corporate profits and curbs personal consumption.
According to David Rosenberg, with 90% of companies reporting, third quarter operating EPS fell 8.5% year-on-year; while reported earnings, which include charge-offs, fell 28% year-on-year! Rosenberg also notes that “at $15.29 reported EPS for the S&P 500 in the third quarter of 2007, the P/E multiple on this basis is a lofty 23x — not the 18x ‘cheap’ multiple (or 14x on forward estimates) that is constantly being bandied about in the media.” He adds dryly: “[T]he current $15.29 estimate for reported EPS is the lowest level of earnings since the fourth quarter of 2004. And where was the S&P 500 trading at that time? Answer: It averaged about 1,162 that quarter — just in case you were thinking of buying this dip.” (I can’t wait to hear the Goldilocks’ crowd’s positive spin on these dismal earnings.)
The war between the Fed and the private sector will, in my opinion, be very protracted. The Fed will win some battles, which — along with much brouhaha in the media — will see Pyrrhic victories such as the stock market rally of August to early October, which led in dollar terms to new highs but failed to do so in Euro and gold terms, and was followed in Euro terms by renewed severe weakness. (Just for the record, as of this writing, the S&P 500 is down 9% year-to-date in Euro terms, having peaked out in June.)
Other battles will be won by the private sector, which through its contraction (recession) amidst inflation will lead to sharp downward movements in equity prices.I am well aware that the Bureau of Labor Statistics and the Bureau of Economic Analysis will continue to use bogus figures when reporting inflation, and hence real GDP growth, but they won’t be able to hide the squeeze on corporate profits and the consumer from rising prices. I am writing this report at Thanksgiving, an opportune time to point out that the American Farm Bureau Federation has calculated that the cost to feed ten people dinner in 2007 is US$42.26, up 10.9% from last year and the biggest year-on-year increase in over ten years (David Rosenberg has compiled a Thanksgiving cost-of-giving index, which amalgamates the prices of turkey, sweet potatoes, cranberries and gifts, as well as travel expenses: it rose this year by 7.9%.) I don’t suppose these indexes took into account the rise in heating and electricity costs for the festivities, or the cost of a nice Bordeaux wine and bottle of Cognac, due to the weakness of the dollar. (I might add that in Switzerland it wouldn’t be possible for ten people to be served Christmas dinner for that amount.)
But the point is simply this: cost-of-living increases vastly exceed the reported inflation figures and are squeezing the consumer, which leads to revenue pressure for the corporate sector. (According to the Kaiser Family Foundation, health insurance premiums have risen 78% since 2001, while wages have gained only 19% and “the government’s inflation measure during that stretch was 17%”.) At the same time, corporations are faced with a squeeze on margins due to rising costs.
Pressure on revenues and cost increases contributed to the dismal performance of earnings in the third quarter of 2007. For example, Starbucks (SBUX) increased prices by an average of 9 cents a cup in July. However, customer visits to US stores fell 1% for the quarter ended September 30. Starbucks’ CFO noted that a “similar decline may occur in the fourth quarter although they will be positive for the full year”. (This would seem to indicate that the economy slowed down considerably in the second half.) According to him, “unbeknownst to us, we saw economic headwinds that quite frankly came up probably stronger than I thought.” Earlier, Starbucks’ CEO had remarked: “The consumer is being faced with rising costs in every sector of their lives, and so part of that is reflecting on us.” An informed friend of ours suggested that declining traffic at Starbucks stores in the US is of particular concern, since Starbucks serves all income levels.
Therefore, declining traffic is not just a “sub-prime problem”! I should now like to reiterate what I have explained on a number of previous occasions. Rather than paying too much attention to the media and to analysts’ positive spins, it will pay to watch the market action of equities as a forecaster of business prospects. Starbucks’ stock made a double top between May 2005 and November 2006. After that its shares went downhill, although the stock market continued to rise to its final peak in mid-October 2007. This should have been a warning sign that Starbucks fundamentals were deteriorating.
Similarly, the fact that retail stocks failed to better the July high in the recent August 16 to October 11 rally, which led to a new all-time high for the S&P 500 in dollar terms (but not, as we have shown, in Euro terms), isn’t a good omen for retail sales, consumption, and the economy. I am not the only person who questions the economic statistics published by the US government: writing recently for Kate Welling (, Lee Quaintance and Paul Brodsky of QB Partners observed:“...the credit markets finally clogged towards the end of Q2 2007, closing the major private sector artery policymakers had been using to synthesize domestic output (expressed in nominal dollar terms through nominal GDP growth). True to form, they began creating U.S. dollars out of thin air at an accelerated rate in Q3 2007 (14.7% annualized). The Bureau of Economic Analysis (BEA) published nominal U.S. GDP growth at an annualized rate of 4.7% in Q3 2007. Taking the BEA’s figure at face value and subtracting the annualized rate of monetary inflation, we believe inflation-adjusted U.S. GDP contracted at about a 10% annual rate in Q3 2007. This rate of economic contraction would seem to be consistent with the analysis of the corporate profit slump discussed above, and with the observations made in earlier reports that the US economy is already in recession.

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