Back in December 2013, as we do after every periodic bout of irrational exuberance by Goldman’s chief economist Jan Hatzius et al (who can forget our post from December 2010 “Goldman Jumps Shark, Goes Bullish, Hikes Outlook” in which Hatzius hiked his 2011 GDP forecast from 1.9% to 2.7% only to end the year at 1.8%, and we won’t even comment on the longer-term forecasts) designed merely to provide a context for Goldman’s equity flow and prop-trading axes, we said it was only a matter of time before Goldman (and the rest of the Goldman-following sellside econo-penguins) is forced to once again trim its economic forecasts. Overnight, two months after our prediction, the FDIC-backed hedge fund did just that, after Goldman’s Hatzius announced that “we have taken down our GDP estimates to 2½% in Q1 and 3% in Q2, from 2.7% [ZH: actually 3.0% as of Thursday] and 3½% previously.”
That didn’t take long – we expect many more such cuts in the weeks and months to come after Wall Street is shocked, shocked, to learn that the market once again frontran a huge recovery that is not coming simply because the H2 bounce was entirely due to massive inventory accumulation (and a housing shopping spree that was solely driven by speculative investors reflecting nothing but the Fed’s easy money), that now has to be liquidated and subtract over 1% from full year GDP. That, and of course the coming EM crash as a result of what everyone will soon realize is a world in which not only did nobody get the “tapering is priced in” memo, but also the plunge in markets which results in a reflexive drop in the economy that may in fact end up in recession, forcing the Fed to do what once again, what it always does – print.
So how does Hatzius explain the reason for this now traditional overoptimism? He doesn’t, instead assigning it to – get this – “spurious weakness.” He does, however, mention the impact of the recent EM turbulence in the context of data that has been week for a month with a phenomenon that only took center stage a week or so ago is disingenuous at best, and PhD economist-stupid at worst. Which is why he tries to talk it down:
Both the US economic data and financial market sentiment have taken a turn for the worse since the start of the year. Exhibit 1 shows that our US-MAP surprise index has fallen into negative territory and our current activity indicator (CAI) has slowed from an average of 3.1% in October/November to 2.3% in December, primarily because of the weakness in the employment and housing indicators.
The US Economy Is Not Very Exposed to EM
What lies behind this weaker news? A tempting explanation is the turbulence in emerging economies and markets. As our EM Markets team has noted, we do not expect the difficulties there to disappear quickly as they reflect a need for significant adjustments in a range of countries in an environment of higher global real interest rates and lower commodity prices. So at least the headline risk from the EM troubles for US financial markets is likely to persist for some time.
However, as our Global Economics team has noted, the exposure of developed market economies to EM troubles is quite limited, and this conclusion applies particularly to the US. Exhibit 2 provides a summary of US exposures to emerging markets through three channels: (1) merchandise exports as a share of US GDP, (2) banking system claims as a share of US bank assets, and (3) corporate profits by the EM subsidiaries of US multinationals as a share of overall US corporate profits. In each case, we show both the overall exposure to emerging markets and the exposure to a smaller group of key EM economies in recent focus (Argentina, Brazil, Russia, South Africa, Turkey, Indonesia and India).
Broadly speaking, the exposures look small. US exports are worth 5% of GDP when looking at EM economies broadly and 0.7% when looking at the most affected countries. If we assume a 10% drop in overall EM import demand as a result of the recent troubles this would mechanically shave 0.5 percentage points from real GDP growth. But this is close to a worst-case assumption, as it would match the worst point of the very severe Asian crisis of the late 1990s. It is also worth noting that our US GDP forecast already assumes a small negative contribution from net trade. So we do not see our forecast as particularly vulnerable in this respect.
US banking exposures are likewise quite small, accounting for 5.5% of total banking assets when looking at EM overall and 1.9% when looking at the most affected countries. Although the exposures obviously vary significantly between different types of banks, it is difficult to see how credit losses in EM would deal a large blow to the US banking system short of a worst-case outcome for the EM cycle. Finally, the profitability of the US corporate sector is also not particularly exposed to trouble in its EM subsidiaries, at least in aggregate. We estimate that EM subsidiaries account for 5.5% of US corporate profits overall and for 1.0% when looking only at the most troubled economies. Again, short of a very bad outcome with significant contagion across EM and the broader global economy, this is a manageable issue.
So… not very exposed to EMs? Curious then what Jan would say about LTCM’s exposure to the EMs in 1997, and to the US financial system as a result. “Modest at best” perhaps… unless of course Goldman was loaded to the gills with shorts at the time and was seeking to liquidate. We will be sure to keep a close eye on how fast it takes Jan Hatzius to flip flop on this key issue, as the EM crisis subtracts another 1%+ from US 2014 GDP.
Which brings us to the topic of Inventories. Here is what we, lacking an Econ PhD or an entire economics department at our disposal, said in early December: “Here Is The “Growth” – Inventory Hoarding Accounts For Nearly 60% Of GDP Increase In Past Year“, and provided the following chart:
We concluded: “The problem with inventory hoarding, however, is that at some point it will have to be “unhoarded.” Which is why expect many downward revisions to future GDP as this inventory overhang has to be destocked.”
We were two months ahead of the curve. So here is Goldman doing precisely what we said would happen, namely cutting its GDP forecast precisely due to upcoming inventory destocking.
Inventory Payback, But Probably Only in the GDP Data
There is another, more technical factor that probably will subtract noticeably from GDP growth in early 2014, namely the sharp pickup in inventory accumulation in the GDP data for the second half of 2013 and the likely payback over the next few quarters. As shown in Exhibit 3, the level of inventory investment stood at 0.9% of GDP in 2013Q4, toward the top end of the range over the past 25 years. Such a rapid pace is unlikely to be sustained, and this probably implies a mechanical negative impulse from inventories to GDP growth over the next couple of quarters. Inventories are likely to be a drag in 2014H1, and we have taken down our GDP estimates to 2½% in Q1 and 3% in Q2, from 2.7% and 3½% previously.
Once again, we will one up Goldman and say that since the downswing in any economic data set always overshoots to both the upside and downside, the impact from the inventory liquidation, once commenced will tumble well below the unchanged line, and by the end of 2014, adversely impact economic output by as much as 2%. Add the impact from EMs and suddenly you are looking at a very realistic recession scenario.
So what to expect in the coming days? It is here that Goldman’s chief economist, once providing respectable insight, gets downright sad. As in “respected man becoming a clown” sad. Case in point: we are said to expect better January payroll number because while January was freezing, the payroll survey week was warmer than normal. It really doesn’t get any more ridiculous than this. But hey, if “economists” want to believe that the weather is impacting payrolls, or housing (which we proved conclusively had nothing to do with the weather), they are welcome to do so. Also believe in the tooth fairy, or that Joe LaVorgna’s forecasting track record is better than Groundhog Phil’s. Cutting straight to Goldman’s failed attempt at non-comedy:
Looking for Decent January Data Next Week
Consistent with all this, the January ISM and employment data due next week are likely to look reasonably firm. Our preliminary forecast for the nonfarm payroll report is a bounceback to a 200,000 pace of increase. There are two key reasons why we expect the report to look strong:
1. Better weather (yes, really). Although the month of January as a whole was quite cold, the payroll survey week was actually somewhat warmer than normal, and we expect no significant weather impact on the seasonally adjusted level of payrolls this month. Given our estimate that the cold weather in the December survey week depressed the seasonally adjusted level of payrolls last month by about 50,000, this implies a positive weather impact on the payroll change of about 50,000.
2. Bounceback from spurious weakness. Even excluding the weather impact, the December employment gain looks to be about 50,000 below the recent trend. In our view, this is implausibly weak relative to other job market measures such as jobless claims, Conference Board labor market perceptions, and most hiring surveys. This could result in a bounceback to an above-trend pace even outside the weather impact, although it is also possible that the December reading will be revised up.
We also expect a relatively strong household employment survey. In particular, we see a drop in the unemployment rate from 6.7% to 6.6%, partly because the expiration of emergency unemployment benefits at year-end may have caused another drop in labor force participation and partly because we expect a good increase in household employment, which has likewise underperformed job market indicators such as claims. Admittedly, it is also possible that the employment weakness in the establishment and household survey is genuine, and other labor market indicators will soon turn down as well, but that is not our expectation.
It is ours.
Because, gasp, why is it always weakness that is “spurious“? What about spurious strength, especially one derived from $1 trillion in Fed balance sheet expansion which is now tapering, but not before artificially boosting all those other non-hard data indicators that “spuriously” are showing a far better economy than what is actually happening on the ground? Or did Goldman’s crack economists forget about this most critical crutch to growth, which as now see all too well, is being pulled long before the economy was anywhere near “escape velocity” or the now defunct virtuous cycle.
In other words, as we predicted on taper day, now that everyone has seen through the latest attempt to talk up the economy, look for all economic indicators to collapse, serving as “justification” not only for the Fed to halt its tapering, but to ultimately boost the one thing it knows how to do: CTRL-P.