Is this really the strong economy we are being lead to believe?

In the news we have been bombarded with reports of a “Strong Economy.” Is this the real story, or just the talking heads trying to prevent a panic on the markets?

Here are few of the recent “uplifting” comments made by members of the Federal Reserve and US Treasury:

- U.S. Federal Reserve Governor Susan Bies – March 9, 2007
Outside of the housing and auto industries, ``the economy is strong’’

- Philadelphia Federal Reserve President Charles Plosser – March 6, 2007
“The economy is still on track to achieving my forecast for close to 3 percent growth for 2007”

- St. Louis Federal Reserve President William Poole – March 5, 2007
“To me, and, I believe, the mainstream of forecasters both in government and out, we do not see a recession on the horizon”

- Treasury Secretary Henry Paulson – March 2, 2007
“Market moves don’t reflect strong economy”

- Federal Reserve Chairman Ben Bernanke - Feb 28, 2007
“My view is that taking all the new data into account, that there is really no material change in our expectations for the U.S. economy since I last reported to Congress a couple weeks ago”

Yet, it seems there is another side to the U.S. economic story. Prominent analysts who actually live, work, and create influence within the financial industries, are backing up a more “realistic” view with key data and investigations into the facts:

Confirmation of the announced collapse by Business Economist Jean-Pierre Chevallier (http://chevallier.turgot.org)discusses how free cash flow is pointing to an anemic GDP growth of just 1% year over year based upon the savings rate M2-M1. This is a purely technical approach on determining the state of the economy using monetary aggregates directly from the Federal Reserve to determine free cash flow. Nonetheless, for over 50 years these calculations have been correct in predicting the economic climate for any country with central banking.

From the current subprime credit crunch to a generalized credit crunch: the incoming financial train wreck by Nouriel Roubini (http://www.rgemonitor.com/blog/roubini) explains how there is a severe credit crunch in the sub-prime segment of the mortgage market. As Roubini explains the credit risk spreading to other mortgages outside of sub-prime could have severe macroeconomic effects.

A report from Dale Westhoff of Bear Stearns (http://today.reuters.com/news/articleinvesting.aspx?type=companyNews&storyid=244324) foreshadows a loss of 1.1 million potential U.S. homebuyers due to stricter lending standards. He estimates a 30 percent, or $180 billion, contraction in the subprime sector in 2007, and a 25 percent, or $100 billion, decline in Alt-A loan production from last year. As Westhoff is quoted saying “That’s a non-trivial number.”

The economic reach of such losses to a primary revenue, employment, and consumer cash flow creation industry could undoubtedly be widespread. Our GDP (our marker of prosperity and recession) is approximately 70% dependent on the American consumer’s ability to earn or simply receive money, and spend it back into the economy. Predicted housing declines will directly impact the various mortgage, insurance, and construction related companies, though the trickle down effect to the consumer’s pocketbook could create an even bigger aftershock.

This leads us into another interesting topic, employment. Mr. Market rebounded slightly at week’s end upon the news of a brighter unemployment outlook. But are things really looking brighter, or is it merely a manipulation of data, or the calm before the storm?

In his analysis of the February Jobs / Employment Data, Financial Advisor Mike Shedlock (http://globaleconomicanalysis.blogspot.com) reports on the BLS February employment statistics and explains the details behind the 97,000 jobs created and the reduction in unemployment from 4.6% to 4.5%. Shedlock explains how a “household survey” determines this unemployment rate, rather than actual tax, company, and unemployment filings. He also points us to the 3 month average in job growth, which is barely keeping up with population growth. Further, Shedlock notes that an astounding 40% of the jobs created were in government while 76,000 construction and manufacturing jobs were lost. As large as this number sounds, it may just be a mere tip of the iceberg…

In fact, the BLS reported residential construction employment has only fallen 4% from the peak in 2006, even though housing starts have already plummeted about 35%. The key analyst at Calculated Risk (http://calculatedrisk.blogspot.com/) is forecasting a much larger loss of 400,000 to 600,000 residential construction job losses over the first 6 months of 2007. A look into the full spectrum of numbers shows that starts may represent the future of job creation, but completions (or building in process) actually reflects our current employment. As home builders scramble to minimize losses, completions are still near record levels. With an average of over 11 months from start to completion in many of today’s housing projects, it is no reach to estimate that we may be experiencing some lag time. As well stated on Calculated Risk “…completions will follow starts off the cliff soon ... and so will residential construction employment.”

Have we “hit bottom” or are we just beginning to fall off the peak? Now out of the hot seat, even ex-Fed Chairman Alan Greenspan is beginning to buckle under the “possibility” of economic recession.

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Anthony Fleming

CEO

FMI Capital

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