From Bloomberg: Howard Davidowitz, chairman of Davidowitz & Associates Inc., talks about U.S. consumers and the outlook for the retail industry. Davidowitz also discusses the performance of Sears Holdings Corp., prospects for online retailers and mobile shopping, and commercial real estate.

Follow the link to view; it isn’t embeddable – he is terrific and right on the money.

Edit: And then this shows up in the news: Borders delaying payments to some vendors. A clear casualty of Amazon. Which underlines Mr Davidowitz’s point – what are they going to do with those enormous empty bookstores?

Economic group-think is in full control of the media. We are bombarded with breathless reports of the strength of Christmas shopping, which is allegedly a harbinger of true economic recovery. As observed by David Rosenberg -

The percentage of brokerage house analysts and economists to raise their 2011 GDP forecasts has risen substantially. Out of 49 economists surveyed, 35 say the U.S. economy will outperform the already upwardly revised GDP forecasts, only 14 say we will underperform. This is capitulation of historical proportions…. While the equity market has turned in a simply stunning performance with virtual non-dash stop advances since Labour Day, it does appear as though a lot of froth has come to the fore — sentiment measures, the VIX index, and the put/call ratio, all strongly suggest that in the very short term time, investors have become as enthusiastic about the macro economic outlook as they were towards the tail end of 2007. The rest is history. It took a tremendous amount of courage to fight the tape back then as it most assuredly is the case today.

According to Mr Bernanke, the stock market drives the economy, not the other way around as most of us idiots have been told. Accordingly, Mr B has turned all his attention to driving the stock market higher, which allegedly creates a “wealth effect.” The spending of this new-found “wealth” then drives the economy, says John Maynard Bernanke. So the stock market is higher, we know that. What else do we know about the stock market?

1. Sentiment. In Barron’s round table, not a single strategist sees the prospect for a market decline. Investors Intelligence now shows the proportion of bullish investors up to 58.8% from 55.8% a week ago, and the bear share is at 20.6%. The American Association of Individual Investors poll had the highest percentage of bulls (63) since October 2004, and the lowest percentage of bears (16), the biggest disparity since the last market peak in October of 2007. Finally, the National Association of Active Investment Managers (NAAIM) shows that on average they are 82% invested. This is in the high end of the range and shows that these managers are quite bullish. So bullish sentiment has now reached a new high for the year and is now the highest since 2007; just ahead of the market slide. The JAWS indicator is at an extremely high 3.14, meaning that the (historically) smart money is very bearish while the dumb money is very bullish.
2. Yield. The yield on the S&P 500 is very low by historical standards. The last time S&P yields were around this level was in the summer of 2000. Enough said. Over the course of 2010, according to David Rosenberg, numerous analysts were saying that people must own stocks because the dividend yields will be more than that of the 10-year Treasury. But today with the S&P 500 dividend yield is 2% and the 10-year T-note yield is 3.4%. When the S&P yield gets above its long-term average of 4.35%, say to 6% or so, then stocks will likely be a long-term buy.
3. Valuation Stocks are overvalued at the present levels. For December, the Shiller P/E ratio says stocks are now trading at a whopping 22.7 times earnings! In normal economic periods, the Shiller P/E is between 14 and 16 times earnings. Coming out of the bursting of a credit bubble, the P/E ratio historically is 12. Coming out of a credit bubble of the magnitude we just had, the P/E should be at single digits.
4. Retail investors and insiders. The intended recipients of the “wealth effect” aren’t buying it for a minute. In fact, they’re selling it, and they’ve been doing so for four years now. Corporate insiders, who supposedly have the best insight into the future of their companies have also been dumping their shares for months. Typical for recent periods, for the week ending on Dec. 10, insider selling outpaced insider buying for S&P 500 companies by a ratio of 177 to 1.
5. Margin debt is the highest since the fall of Lehman, as fear of under-performance causes the hedge fund universe to leverage up like there’s no chance of anything going down ever again. Beta at alpha prices, as I’ve mentioned before.
6. This is an awful time to invest, per John Hussman. And then there’s this little tidbit.

Of course, speculation is rife in the commodity markets as well. Crude is closing in on $100 a barrel, which acts as a tax on everyone, a further drag on the economy. Agricultural product prices have also been driven up, in fact the CRB index is up more than 25% since early September, thanks to J.M. Bernanke’s QE2. These prices are causing a margin squeeze as manufacturers find it hard to raise prices, even though their costs are going up.

Do trees grow to the sky? Who is right, the bulls or the bears? We’ll see, probably in January. But one thing is clear, and that is the hedge funds and banks (like they need the money) are the principal recipients of Ben’s wealth effect, as the retail investor has become pretty much disgusted with the Wall Street shenanigans and is taking his and her money elsewhere. On the other hand, it looks to me like they’re all on the same side of the boat and that means it is likely to tip over real soon now.

Now, moving on to the real economy, we should start with the segment that has historically been the leader of any sustained economic recovery – real estate. We’ll just let the Dallas Fed speak here:

“Prices, in fact, have begun to slide again in recent weeks. In short, pulling demand forward has not produced a sustainable stabilization in home prices, which cannot escape the pressure exerted by oversupply,….With nearly half of total bank assets backed by residential real estate, both homeowners on the cusp of negative equity and the banking system as a whole remain concerned amid the resumption of home price declines…..The latest price declines will undoubtedly cause more economic dislocation. As the crisis enters its fifth year, uncertainty is as prevalent as ever and continues to hinder a more robust economic recovery. Given that time has not proven beneficial in rendering pricing clarity, allowing the market to clear may be the path of least distress.”

Italics mine. Allow the market to clear? What nonsense, any government bureaucrat should know that markets cannot be trusted to operate freely. Off with their heads. Flying under the radar here is the the foreclosure fiasco, where servicers seem to be consistently unable to produce accurate records or original documentation to support their foreclosure actions. There is a sneaking suspicion running around that a huge number of mortgages were never properly (legally) conveyed into the trusts that were used to securitize them, exposing originators, trustees and servicers to huge potential liabilities to investors as they discover they don’t actually own anything. This is ticking, but it is being discovered in the courts at the courts’ pace – slowly. It may go away or grow, no-one who knows is admitting anything at this point, and the few instances of damaging testimony have been instantly disavowed by the institutions implicated.

The Commercial Property Price Index is back at 2001 levels, 42% lower than its 2007 peak. Needless to say, this is causing great distress. Because commercial property financing is different from housing financing and there is a much higher propensity to work out problems, this has had a limited impact so far. But there is major exposure in the banking system to this market segment.

We’re looking at another leg down in housing prices and a continuing run of defaults in commercial real estate. Both of these trends are negative for the economy and, of course, highly deflationary.

The main thrust of Nancy Pelosi’s “stimulus” spending which is now winding down was preserving employment in state and local government. Of course, this simply allowed these governments to defer their problems rather than tackle the issues of over-spending and particularly over-compensation of public employees. David Rosenberg speaks:

Arguably the most understated, yet significant, issue facing both U.S. economy and U.S. markets is the escalating fiscal strains at the state and local government levels, particularly those jurisdictions with uncomfortably high pension liabilities. Have a look at Alabama town shows the cost of neglecting a pension fund on the front page of the NYT as well as Chapter 9 weighed in pension woes on page C1 on WSJ.

In the absence of Chapter 9 declarations or dramatic federal aid, fixing the fiscal problems at lower levels of government is very likely going to require some radical restraint, perhaps even breaking up existing contracts for current retirees and tapping tax payers for additional revenues. The story has some how become lost in all the excitement over the New Tax Deal cobbled together between the White House and the lame duck Congress just a few weeks ago.

Picking on New Jersey as an example (because there’s a good piece) we see a foreshadowing of the war between the public sector employee unions, who believe that they have an irrevocable right to benefits that are beyond generous, and the taxpayer struggling to make ends meet in a sinking economy.

New Jersey’s pension gap grew to $53.9 billion in the last fiscal year, up from $45.8 billion, thanks to market losses and a lack of state funding, according to figures released Thursday by the state.

The looming pension burden, largely ignored by the state for the past decade, has ballooned into a nearly unmanageable problem that will push state and local finances into a corner in coming years, dropping large bills in the laps of already strained taxpayers.

Gov. Chris Christie’s administration said the gap, which reflected the state’s investment positions as of June 30, highlighted the need for proposed cuts to current public workers’ pensions.

The new calculations mean the state has 62% of the money it needs to pay retirement benefits promised to roughly 720,000 state and local workers over the next decade, down from 66% a year earlier. But the state is using an annual 8.25% rate of return, which critics say masks the problem by being overly optimistic

“As all states, they’re getting it wrong,” said Eileen Norcross, a George Mason University researcher who has studied New Jersey’s budget and pensions. Using a 3.5% rate of return, she had estimated the previous liability at $173 billion.

The worst, of course, are the big blue (Democratic) states – New York, Illinois and California. Mish has a piece. Politics in these states are dominated by the wealthy public employee unions, but the taxpayers are growing restive. As California’s new governor, Jerry Brown, told the legislature:

We’ve been living in fantasy land. It is much worse than I thought. I’m shocked.”

Yeah right. The Democrats must defend the unions in these states, because they are the core of the Democrats’ political base. Of course, this provides the Republicans with a strong motive to resist bailouts:

The prospect of a blue state fiscal crisis is an uncomfortable and threatening one for the GOP; it spells potential catastrophe for the Democrats. The bankruptcy of the big blue states would symbolize the bankruptcy of Democratic party policies to wide swathes of the voting public. Tensions within the Democratic Party would explode: unionized public sector workers would simply not be able to emerge from this kind of crisis without savage layoffs and agonizing cuts in their pay, benefits and pension packages. All the promises (mostly) Democratic politicians have made to them over decades will be exposed for the hollow frauds they were.

Bottom line is that spending and benefits in these states will be cut – how in what proportion is yet to be seen. But the impact on the economy will be substantial and negative.

The most recent BLS employment report was disappointing, but was written off by bullish analysts as an outlier. Yet Gallup polling is showing a significant increase in un- and under-employment for December, rising from 17.1% at the beginning of December to 19.2% as of the last report on Dec 22. And this is a 30-day moving average, which responds slowly. A slightly dated (Dec 9) analysis from Hoisington Management sums up the situation, which has only deteriorated since then:

For the past 19 months, the unemployment rate has been above 9%, underscoring the harshness of labor market conditions. The employment to population ratio, which is a better measure of labor market conditions than the unemployment rate, was at the cyclical low of 58.2% in November, matching the lowest reading since 1984. In addition to the increase in the number of unemployed, the quality of jobs remaining in the system is also falling. 478,000 full-time jobs were lost in November, increasing the six month loss in this most important employment category to 1.6
million (Chart 2). Part-time employment rose by 878,000 over the last six months, offsetting part of the loss in full time jobs, but substituting part-time for full-time employment lowers household income.

The U.S. has 15.1 million unemployed persons and another 11 million underemployed or marginally attached to the labor force. The latter is measured by the broad or U6 unemployment rate which stood at 17% in November. Not
surprisingly, with this excess labor, the 12 month increase in average hourly earnings fell to a new cyclical low of 1.6% in November. A record 43 million persons receiving food stamps confirms the economic distress.

It remains to be seen how much of this is reflected in the next employment report, but the trend is hardly indicative of any success from QE or any wealth effect stimulating domestic employment. As Hoisington goes on to say:

Many consider QE policy to be on a successful path because the psychology of its orchestration has boosted the stock market, thereby creating a wealth effect. However, QE has also set in motion unintended consequences. The same factors that have boosted equities have also lifted commodity prices and mortgage rates, both of which are damaging to economic activity.

What is being stimulated is the Chinese economy, which produces most of the “stuff” being snapped up by shoppers eagerly putting it on Uncle Sam’s credit card, to the point that the Bank of China raised interest rates over Christmas in an attempt to slow runaway inflation. (Which won’t work, you need Volcker-type shock tactics to do that, not quarter point moves). Of course China has an immense property bubble to worry about, as do the related commodity countries that supply the inputs – Australia and Canada.

Put together these bubbles with the U.S. bubble, and then turn to the European mess where years of living off credit cards have bankrupted the weaker economies, and I see a prospect for a very bearish year ahead. Happy New Year.

This morning’s GDP revision included the lowest GDP deflator in 50 years. Also featured today was a weak home sales report, and an even weaker mortgage application report as Ben’s QE II runs over the lifeboats of the homeowners.

Ben has argues on numerous occasions that QE was the right thing for the Bank of Japan to do, but it failed because the BoJ lost its nerve and did not do “enough.” (John Maynard Keynes starring as the hero of “It’s Never Enough.”) He is therefore determined not to fall into the same (liquidity) trap and so he will not stop until he has done “enough.”

There are those (like me) that might think that the Japanese economy has survived, after a fashion, because the BoJ didn’t do “too much.” Which, in this blogger’s not-very-humble opinion, is the amount that will cause a bubble so big (how big is that?) that its bursting will essentially wreck the economy by triggering a deflationary spiral.

Ben’s electronic presses are running at full speed – many days we have multiple POMOs – M2 is rising by leaps and bounds and so is the stock market. But the pile of debt is so high that the economy can no longer grow based on expanding debt. Monetizing it is barely keeping our heads above water. We’re not getting price inflation, and Gallup polling shows that employment has lost all the gains since June. This disinflationary situation is the net result of the Fed’s previous efforts to blow credit bubbles that hyperstimulate the economy. I suggest that “too much” is a function of how fast Ben prints, and the faster Ben prints, the faster QE2 will lose traction. And then debt liquidation will set in with a vengeance.

We probably already have a mini-spiral in the housing market. In a deflationary spiral, people defer purchases because they anticipate lower prices in the future. Of course, this reduces demand, which causes prices to fall, reinforcing the tendency to wait. Etc etc. and the circles around the drain get tighter and tighter.

This is the sort of stuff that really frosts me. In 1998 Proposition 10 initiated a 50-cent tax on tobacco products to benefit children age five and younger. Nonsense, but so fine. Each county was required to create a commission to parcel out the money, which is allocated depending on such things as birth rates, to community programs. Orange County last year got $29.7 million to spend.

So the commission has a commissioner and a staff of 23. The commissioner gets a cool $327,000 a year, and nearly half the staff make over $100,000. This for the enormously difficult job of reviewing and approving grant applications. Basically these folks are just helping themselves to free money – I mean I could somewhat understand it if the commission had to raise funds from contributions or something, but no, it just cuts checks. Oh, but “it’s for the children.” Yeah, right. And I don’t even want to know how much the non-profits that are receiving the grants actually benefit anyone.

For his part, Ruane says it is unfair to compare his pay to others by budgets or staff size. As former head of the county’s Environmental Management Agency, Ruane was in charge of 1,500 employees. He says his current position is far more demanding and complex.

All I can say is that the Environmental Management Agency must be a complete waste of time and resources if his present responsibilities are “more demanding and complex.” You know, these folks think the taxpayers are complete idiots and I can see why so long as they are allowed to get away with this stuff.