ISM shows manufacturing sector close to recovery

Today the July 2009 Manufacturing ISM Report On Business was released and the widely followed PMI Index came in ahead of expectations at 48.9.  Any number below 50 represents contraction, so this figure shows that the manufacturing sector in the US contracted for an 18th consecutive month.  Nevertheless, the improvement since the beginning of the year is marked and given the trend, the sector will likely be above 50 next month or soon thereafter.

ISM 2009-07

Last month I mentioned that new orders were no longer increasing as the reading had slipped below 50.  That was very worrying to me and it makes new orders a number to watch going forward.  There was a brisk uptick in new orders in July that, if sustained, will mean that increased production is not just a result of restocking of inventory but of actual order flow for product.

Now, if you read Calculated Risk’s take on this report, you would get the impression that things are still looking pretty bad in the manufacturing sector.  I have immense respect for the work done at CR , but that type of post reflects a clear bearish bias.  I have a bearish bias as toward the US economy as well, otherwise my blog wouldn’t be named Credit Writedowns.  However, I see the facts as they are presented – and this report was very bullish.

Not only did new orders tick up, but a number of other data points show expansion: production, supplier deliveries and order backlogs, in particular.  You should also note that the ISM data suggests the overall economy is growing for a third month in a row.

Given this data and other recent bullish economic reports, don’t be surprised if Q3 GDP change prints a positive number.  If it does, it is very likely that the recession is all but over right now.  Mind you, I still am talking about a weak Q4 or Q1 2010 recovery and possible double dip.  But, I am aware that it is mostly upside economic risk that is apparent in the US. The data cannot be ignored.  And right now, it is very bullish.

Manufacturing ISM Report On Business – ISM website

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David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).


August 2, 2009

Genesis 1:31 says “And God saw every thing that he had made, and, behold, it was very good. And the evening and the morning were the sixth day.“ A few millennia later, we find that the world’s most popular book can be applied metaphorically to the US House of Representatives, as it labors in the creation of clunker-nomics.

The first billion voted by the Congress for the $4500 clunker rebate program was exhausted in 6 days. Practicing for deity status, the House beheld and determined “it was very good.” They immediately passed a $2 billion addition. That bill now goes to the Senate, which will pass something similar, and then to a conference committee to resolve some differences about rules. We expect additional funding will be forthcoming quickly. Congress loves to spend and Americans love to receive.

In the spirit of Genesis, Adam and Eve American, otherwise affectionately known as John and Jane Doe, recognize a good deal when they see one. They had an old clunker worth a few hundred. Suddenly they can exchange it for $4500 if they buy the new one now. The rest they can finance at very low interest rates, thanks to the Federal Reserve and the Treasury for extending TARP and other funds so that lenders can offer them liberal terms. They seized the moment – who can blame them?

This will boost short-term activity in the US. Neil Soss of Credit Suisse estimates, “Our math suggests that vehicle sales could spike in July, perhaps to a run rate near 12.5 million units (at a seasonally adjusted annual rate) from the 9.6mn average of Q2.” He adds that “in response to cash-for-clunkers … the personal savings rate will drop sharply in the next months, even as the longer run trend is still headed higher.” That will ramp up auto production in the 3rd quarter. Neil concludes, “As a consequence, we are revising up our Q3 real GDP forecast to 2.0% (from 1.3%) and our Q4 forecast to 2.5% (from 2.0%).

Okay. We know that older and fuel-inefficient cars are supposed to be scrapped. That is supposed to be an environmental improvement. And we know that the United Auto Workers like this stimulus, for obvious reasons. So do the government-owned or government-sponsored auto manufacturers. The last private firm, Ford, will benefit, too.

Does the clunker stimulus result in enough gain to offset the net present value of the perpetual cost to finance it? Fair question? We think so. Is there an answer? Maybe, but the proof is very difficult to establish. It you are interested in this discussion, invite a few friends over for a beer and talk about it. But make sure the beer is brewed in America by the United Beer Brewer Workers. And when you toast, toast Ford and be a patriot.

Did anyone ask how many of these car sales are being “borrowed from the future?” We didn’t see it in the Congressional commentary. If it was there, it did not influence the political decision.

Has anyone looked at what we have done in a macro sense? We will try.

The United States borrowed 1 billion dollars. It is unlikely to ever pay it back. The annual interest will add $50 million to the federal budget each and every year, forever. We are assuming it is financed today with 30-year Treasury bonds. The additional $2 billion of borrowed clunker money will add another $100 million in interest. So clunker-nomics has committed the nation to make this interest payment forever.

Practicing an industrial policy by inserting government into a mixed economy is the new America. No one measures the exchange of short-term gain being substituted for longer-term taxes or inflation or debt-burdened slower growth. Those economists who are full believers in expectations analysis argue that the market will immediately adjust prices to reflect this exchange. Maybe so in the mathematical models that they use to justify that argument.

We think this expectations analysis fails in the real world. Adam and Eve American are not economists. They make their decisions for their individual benefit and in terms they can understand and assess. They know what a $4500 free gift is. They understand it. They do not deal with trillions of dollars; they do not conduct ever-increasing auctions of Treasury notes and bonds; they do not deal in foreign exchange and reserve transfers. That is not their fault. The have daily lives to live and they are facing their own struggles.

So they delegate some of these borrowing and spending decisions to the Congress because they have no other choice. In the House the long term is limited to the two years until the next election cycle is faced. So the House will easily exchange $1 billion in spending for $50 million in added budget interest.

Thus we have an asymmetric exchange. We gratify now; we borrow to do it; we defer the day of reckoning; it grows bigger and bigger but seems to be perpetually deferred. Every once in a while a crisis unfolds and the system fails, as it did with Lehman Brothers last September. That triggers a new round of upward ratcheting of this asymmetric system.

When does it end? First question without an answer? Will the end be fire, or ice? Also, no answer. What should we do to protect ourselves? Much harder, but there are some answers. Diversify worldwide. Seek a mix of investing to protect wealth. Lastly, enjoy life and the weekend in the spirit of Genesis. Rest on the seventh day, if you can.

And remember that God gives you only so many days on the planet but doesn’t count the ones you spend fishing. We will wink at CNBC viewers on Friday, August 7 from Leen’s Lodge at the annual Shadow Fed fishing retreat, where 35 of us will debate and dissect asymmetric information and deficit finance. For now, we hope your seventh day is restful for you.

David R. Kotok, Chairman and Chief Investment Officer, email:

Extended Benefits and Exhaustion Rate (Updated)

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The details on exhaustees — the people have used up their total Unemployment benefits — are pretty daunting. I mentioned this to Doug Kass last week, who referenced our prior post on the subject at Real Money, and it caused quite a stir.

Let’s explain what this means and update a chart on the subject.

If you lose your job, you get Unemployment Benefits, an insurance program that you pay into so long as you are getting a salary.  After 26 weeks, you will exhaust those benefits and become an exhaustee.

But, wait, there’s more!

These days, via the stimulus plan, we have the Emergency Unemployment Compensation (EUC)  which is good for 20 weeks. Then, there is the Supplemental EUC, which depending upon what your state thinks of the Federal largesse of handing out money to the recently unemployed, ranges anywhere from 13 to 20 more weeks.

The most recent data run was for the week of July 11. As of that week, the Extendees — which consists of soon-to-be-Exhaustees — gained 25k, raising the total unemployed receiving extended benefits to about 2.66 million people. One year ago, there were only 127 thousand receiving extended benefits.

And, as the NYT noted yesterday, there are another 1.5 million people likely to become Exhaustees over the next few months. . . .


Nice graphic from Calculated Risk showing how severe this is:



Continuing Claims “Exhaustion Rate” (June 22nd, 2009)

Continuing Claims vs. Economically Lagging Unemployment (May 10th, 200)

Prolonged Aid to Unemployed Is Running Out
NYT August 1, 2009

GDP Worse, Not Better,Than Expected

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Bill King notes in the Think Tank that GDP was actually worse than consensus expected.

How is a minus 1% worse than a minus 1.5% ?  He looks at the first half of 2009, and blames the Q1 revisions:

“We will again utilize basic math to illustrate the scam. If Q4 08 GDP was 100 units, and Q1 09 was reported at -5.5% and Q2 09 GDP was expected to be -1.5%, the expectation was for GDP of 100 units minus 5.5% or 94.5 units, minus 1.5% or 93.08 units.

With the revision of Q1 09 GDP to -6.4% the Q1 GDP units become 100 minus 6.4% or 93.6 units. So Q2 is minus 1% or 92.664. Ergo aggregate GDP was worse than expected!”

The 0.5% GDP beat comes on top of a 0.9% downward revision. Hence, the net surprise was a compounded negative 0.4%.

And that’s before the likely downward revisions to Q2 . . .

King Report: GDP Follies

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The GDP report last Friday evinces the folly of US government economic statistics and Wall Street consensus analysis.

Most of the Street heralded the 1% decline in Q2 GDP because it was 0.5 better than consensus – even though the US government admitted in the release that its GDP estimates over the past several years were consistently wrong! So why should the latest report be any more accurate?!?!

We feel compelled to address the scheme of ‘past month lower revisions producing better than expected m/m or q/q results’ even though the aggregate metric is worse than expected. We have incessantly noted and commented on this scam but most of the trading & investing universe elides it.

We will again utilize basic math to illustrate the scam. If Q4 08 GDP was 100 units, and Q1 09 was reported at -5.5% and Q2 09 GDP was expected to be -1.5%, the expectation was for GDP of 100 units minus 5.5% or 94.5 units, minus 1.5% or 93.08 units.

With the revision of Q1 09 GDP to -6.4% the Q1 GDP units become 100 minus 6.4% or 93.6 units. So Q2 is minus 1% or 92.664. Ergo aggregate GDP was worse than expected!!!!

As we warned, lower imports, a sign of economic weakness, contributed a net 1.4% to GDP.

Once again beancounters ‘fooled’ with inflation to produce higher GDP than warranted.

John Williams: The relatively narrower quarterly contraction in the second quarter reflected the impact of greater weakness being thrown back into the first quarter, in revision, and the use of artificially reduced inflation. The implicit price deflator for the second quarter was 0.2% versus a revised 1.9% (was 2.8%) in the first quarter.

Last week we complained that despite records in fiscal stimulus, Fed largesse, nationalization and rigging of markets the best that can be said is the pace of economic decline is slowing.

Despite a 10.9% surge in federal government spending and virtually no inflation adjustment all that beancounters could fabricate (June data is still incomplete) is a 1% ‘official’ decline in GDP.

David Rosenberg echoes our observation: Imagine, government transfers to the household sector exploded at a 33% annual rate, while tax payments imploded at a 33% annual rate and the best we can do is a -1.2% annualized decline in consumer spending in real terms and flat in nominal terms?…In the absence of the fiscal largesse, it is quite conceivable that consumer spending would have shrunk at a 10% annual rate last quarter!”

And, it is not just labour income that is still in deflation mode. Practically all forms of income are deflating from a year ago — interest income is down 4.5%, dividend income is down 23.0% and proprietary income is down 8.0%. The only income that is really going up is the income from Uncle Sam, which is up more than 10.0% and we have reached a point where a record of nearly one-fifth of personal income is being accounted for by paychecks out of Washington…

Even with decades of understated inflation and overstated of GDP, the current economic contraction is the worse since the Great Depression.

The GDP report also shatters the notion that the stock market is omniscient and demonstrates that Wall Street analysis could not discern the worst economic and financial collapse since the Great Recession.

While the US was in recession since at least Q4 2007, most of the Street did not forecast recession. Stocks, most notably the DJTA, missed the worst economic downturn since the Great Depression. As we keep averring, record funny money, lax regulation and smiley-faced fascism has transformed the stock market from a gauge of economic activity into a generator of economic activity.

Insights from The Big Picture Conference

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If you could not make the Big Picture Conference, here’s your opportunity to hear straight from some of the most interesting commentators on the markets, the bailout, the press and myth of risk management.

The Big Picture Conference is more than 5 hours of insightful commentary can be viewed as many times as you like for a 30-day period. The entire conference is $59.99 for five different sessions.

Or you may view each session separately for $19.99 each.

Rep. Alan Grayson explains his position on oversight of the Fed’s bailout and discusses reforming the banking system with Nassim Taleb.

Nassim Taleb talks about his 10 points for a more robust capitalism.

Josh Rosner dissects the credit markets.

Doug Kass gives his views on the equity markets and explains his March call of a generational low.

The financial media explains the pressures on financial media with Dan Gross (Newsweek), Jesse Eisinger (Portfolio), Randall Forsyth (Barron’s) and Tom Keene (Bloomberg)

Click through to register and then watch at your convenience.

Click Here for the Full Conference Video for $59.99

Markets: Today versus March 9 Lows

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Rosie via Abelson:

“DAVE ROSENBERG IS AMONG the vanishing breed of die-hards (we confess, in case you haven’t guessed, to being another) who still cling to the notion that stocks’ explosive rise since March is perhaps the mother of all bear-market rallies, but nonetheless still a bear-market rally. The essence of his skepticism — which we happily second — is simply that the economy, contrary to Wall Street’s jubilant insistence, has yet to turn the corner.

He wonders, moreover, whether the March 6 lows in the stock market were the real McCoy. Although, in contrast to us, Dave persists in keeping an open mind, he’s doubtful that they were. On March 6, he recounts, the market was trading at two times book, with a 13 times multiple on forward earnings and a P/E of 18 on trailing earnings, and a 3% dividend yield. Pretty rich valuations by all three measures of earnings, but pretty skimpy on yield, to rate as a true market low.

And today, after a 45% rise, the metrics, to dip into the Street cliché, are positively mind-boggling. The dividend yield on the S&P 500, Dave notes, is a meager 2¾%, and payouts so far this year have lagged some 32% behind last year’s not-exactly-torrid pace.

In a like astounding vein, he observes, the trailing P/E on operating earnings (adjusted, he explains, “to take out everything that is bad”) is now at 24 times, while — and if you have a queasy stomach you can skip this number — on trailing reported earnings, the multiple is a mere 760-plus!

“Something tells us,” Dave sighs, “that the marginal buyer of equities today at that price may well be the same person who was loading up on real estate during the summer of ‘06.”

Fascinating stuff . . .


The Great Beer Bash
Barron’s, August 3, 2009

Falling Imports versus Falling Exports (GDP = -2.38%)

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I noted earlier that the oddity of imports versus exports calculation would produce a positive contribution to GDP. Let’s look at the details of this, and find a way to understand what this means.

First, off conceptualize the difference between what imports and exports are. At the most basic level, Imports represent our consumption of overseas production, i.e., We buy what they make.

Exports are where overseas consumers purchase our production, i.e., They buy what we make.

What were the specifics of the GDP data regarding import/export?

-Real imports of goods and services decreased 15.1%

-Real exports of goods and services decreased 7.0%

So in Q2, both consumption by us of overseas goods and services and by them of US made goods and serivces declined significantly.

The Differential between imports and exports — who dropped fastest — was the key to this quarter’s GDP data.

According to Bloomberg, Decreasing Exports subtracted 0.76% from GDP. At the same time, falling Imports added 2.14%.  Net contribution of the fact that Imports are free falling twice as fast as Exports are = 1.38%.

If they were both falling at the same rate — if Europe and Asia’s consumers were hurting as much as ours –  GDP would have been -2.38%.

If it seems weird to you that the ratio of domestic and overseas shrinking economies and their reduced consumption somehow turned into a positive GDP contributor, well, welcome to the wonderful world of government statistics.

Advance GDP = -1.0%

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Official GDP release:

“Real gross domestic product — the output of goods and services produced by labor and property located in the United States — decreased at an annual rate of 1.0 percent in the second quarter of 2009, (that is, from the first quarter to the second), according to the “advance” estimate released by the Bureau of Economic Analysis.  In the first quarter, real GDP decreased 6.4 percent.

The decrease in real GDP in the second quarter primarily reflected negative contributions from
nonresidential fixed investment, personal consumption expenditures (PCE), residential fixed investment, private inventory investment, and exports that were partly offset by positive contributions from federal government spending and state and local government spending.  Imports, which are a subtraction in the calculation of GDP, decreased . . .

The much smaller decrease in real GDP in the second quarter than in the first primarily reflected much smaller decreases in nonresidential fixed investment, in exports, and in private inventory
investment, upturns in federal government spending and in state and local government spending, and a smaller decrease in residential fixed investment that were partly offset by a much smaller decrease in imports and a downturn in PCE.”

A few other items:

-Federal Spending up a huge 11%;

-Real personal consumption expenditures decreased 1.2%;

-Smaller decreases were seen in business investment, exports and inventories;

-This is the first time we have had 4 consecutive negative quarters of GDP since record keeping began in 1947;

-Real nonresidential fixed investment decreased 8.9%;

-Last Quarter’s GDP was revised down from negative 5.5% to negative 6.4%;

Peter Boockvar notes that GDP fell more than expected as the deflator rose just .2% (vs expectations of a gain of 1%). Had the deflator been in line, REAL GDP would have fallen 1.8%.

Bottomline: An improving, but weak report.


Gross Domestic Product: Second Quarter 2009 (Advance Estimate)
BEA, JULY 31, 2009

New Classifications for Personal Consumption Expenditures (Wonky)

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Today, we get the Bureau of Economic Analysis (BEA)  comprehen­sive, or benchmark, revision of the national income and product accounts (NIPAs). The last such revision was released in December 2003. ture components of gross domestic product (GDP) and some of the income components.

For those of you who want more info, consider the following sources:

Floyd Norris does a nice job providing an overview of the impact of the benchmarking:

Revisionist History, by the Numbers
Floyd Norris
High and Low Finance, July 30, 2009, 5:32 PM

The BEA explains its own 2009 revision in (agonizing) details:

On July 31, 2009, the Bureau of Economic Analysis (BEA) will release the results of a comprehensive, or benchmark, revision of the national income and product accounts (NIPAs).  The comprehensive revision will incorporate the results of the 2002 benchmark input-output (I-O) accounts as well as changes in definitions, classifications, statistical methods, source data, and presentation.

Advance information about the comprehensive revision will be posted here as it becomes available.

A few white papers detail the changes

Preview of the 2009 Comprehensive Revision  of the NIPAs Statistical Changes by Clinton P. McCully and Steven Payson describe the statistical changes being made. (BEA, May  2009)

Preview of the 2009 Comprehensive Revision of the National Income and Product Accounts by Clinton P. McCully and Teresita D. Teensma provides de­tailed explanation of the new classification system. (BEA, May  2008)

Preview of the 2009 Comprehensive Revision of the NIPAs Changes in Definitions and Presentations by Eugene P. Seskin and Shelly Smith discusses  major changes in definitions and classifications (BEA, March  2009)

The Fed Beige Book: Maybe a bottom but where’s the bounce?

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The Federal Reserve released its latest beige book report detailing economic conditions across the country based upon observed evidence and conversations. The 12 Fed district banks “indicated that the pace of decline has moderated since the last report or that activity has begun to stabilize, albeit at a low level.”

It indicates that retail activity is weak with essentially no wage pressure. This may be good news on the inflation front but is negative for the employment situation. There was some improvement in healthcare and technology.

Continue reading The Fed Beige Book: Maybe a bottom but where’s the bounce?

The Fed Beige Book: Maybe a bottom but where’s the bounce? originally appeared on BloggingStocks on Wed, 29 Jul 2009 16:45:00 EST. Please see our terms for use of feeds.

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Oil drops below $67

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Falling Oil PricesThe past two weeks we have seen oil prices steadily trade higher, but the sellers came out today in reaction to rising concern over consumer confidence and pushed prices lower.

Oil dropped under $67 a barrel today as Wall Street learned that consumer confidence had dropped for the second straight month in July. A major reason for low consumer confidence can be attributed to rapidly rising unemployment in the country.

Continue reading Oil drops below $67

Oil drops below $67 originally appeared on BloggingStocks on Tue, 28 Jul 2009 18:30:00 EST. Please see our terms for use of feeds.

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Consumer confidence continues to drop

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The nations high unemployment rate impacted consumer confidence again in July, the second straight month that people’s faith in the economy has wavered.

The Conference Board’s index that measures consumer confidence dipped to 46.6, down from June’s measure of 49.3. The good news is that we are well above the low we hit back in February at 25.3.

A big factor influencing confidence these days is the nation’s unemployment rate, which is expected to rise through 10% in the not too distant future, with 15 states already reporting 10% or greater unemployment.

Continue reading Consumer confidence continues to drop

Consumer confidence continues to drop originally appeared on BloggingStocks on Tue, 28 Jul 2009 15:50:00 EST. Please see our terms for use of feeds.

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Are Intrade Traders Giving Up on The Public Option?

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Over at, traders can bet whether a US health care plan with a public option will be signed into law before the end of the year. It has actually been one of the more actively traded contracts on Intrade with 2,706 contracts already changing hands. Over the last two days, the odds based on the contract price have dropped…

Case Shiller Index Has First Monthly Increase Since 2006

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In another sign of economic stabilization, the Case Shiller 20-City Home price index rose 0.5% from April to May. This was the first monthly rise since July 2006, and it provides further ammo for economic bulls who are anticipating an economic rebound. Skeptics, on the other hand, will write off this rise as a seasonal blip and focus on the…

Which Are the Credible Industry Trade Groups?

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On Sunday, I mentioned the Association of American Railroads “Rail Time Indicators.” It was not showing any green shoots.

That post, plus yesterday’s rant on the NAR (More NAR Nonsense), led to a friend at Columbia University asking the following question: “Which of these associations are credible versus those that are NAR-like?”

The best way to determine that is to look at the data they release, juxtaposed against any quotes from their spokesman/economist. Are they spinning, sugarcoating or otherwise “prettying up” the news release? Once you get through that review, take a closer look at their disclosed methodologies. Are they defendable approaches that produce negative as well s positive outcomes? Or are they biased, and unlikely to ever say a bad word about their respective industry or economic sectors?

My favorite example of worthless data comes from the NAR — specifically, their Housing Affordability Index.  During the entire housing boom and credit bubble, they NAR HAI showed only one single month when houses were considered “less than affordable.” That is simply a pathetic joke making that index worthless.

Other trade groups seem less biased and more reliable.  The AAR seems like a legitimate group. As another example, let’s also take a look at the American Trucking Associations’ data. Specifically, the monthly advanced seasonally adjusted (SA) For-Hire Truck Tonnage Index, released late yesterday afternoon. Following May’s 3.2% jump (seasonally adjusted of course) it fell 2.4% in June. This dropped the index to 99.8 (2000=100). The change in tonnage hauled by fleets before any seasonal adjustment was up 5.2% in June from May. Compare this with June 2008, when tonnage fell 13.6%. So far, the June 08 contraction was the largest year-over-year decrease of the current cycle, exceeding the 13.2 percent drop in April.

Now consider the “no-spin” statement from the ATA’s Chief Economist, Bob Costello that accompanied this data release:

“While I am hopeful that the worst is behind us, I just don’t see anything on the economic horizon that suggests freight tonnage is about to rise significantly or consistently. The consumer is still facing too many headwinds, including employment losses, tight credit, and falling home values, to name a few, that will make it very difficult for household spending to jump in the near term. As a result, this is likely to be the first time in memory that truck tonnage doesn’t lead the macro economy out of a recession. Today, many new product orders can be fulfilled with current inventories, not new production, thus suppressing truck tonnage.”

That seems to me to be straight talk — no spin, no wishful thinking — just the straight shit. You gotta respect any economist who doesn’t mince words and simply gives you his views, straight up, no chaser.

What are the better industry trade groups? Which non government, non-academic associations produce reliable, spin free data?


chart via ATA


NAR Housing Affordability Index is Worthless (August 13th, 2008)

ATA Truck Tonnage Index Fell 2.4 Percent in June
AMERICAN TRUCKING ASSOCIATIONS, July 27, 2009 4:45 PM{8E1C7279-ED27-4C03-B189-CEEEE26BBB12}

See also:
Tracking NAR Spin (April 23rd, 2008)

Worst. Forecasters. Ever?
The cockeyed optimists of the National Association of Realtors.
Daniel Gross
Slate, Monday, Dec. 10, 2007

NAR and Housing Forecasts (June 7th, 2007)

Welsh Investment letter – July 22, 2009

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As discussed since March, GDP will likely be positive in the fourth quarter and maybe in the third quarter, if inventory restocking kicks into gear. If both the third and fourth quarters are positive, the National Bureau of Economic Research could determine sometime in the first half of 2010 that the recession ended in July or August 2009. Before anyone breaks out the champagne in celebration, it must be noted that in declaring an end to a recession, NBER is only identifying the trough in business activity. In determining the beginning and end of a recession, NBER looks at employment, real personal income minus government transfers, industrial production, retail sales, in addition to GDP. In the last two recessions, NBER decided the trough in activity coincided with an increase in industrial production in April 1991 and December 2001. As a result, NBER determined the 1991 recession ended in March, and in November 2001. If the past is any guide, NBER could determine that the current recession ended, in the month preceding a turn around in industrial production. The next few months could prove interesting in this regard. In June, industrial production fell -.4%, after posting a deep drop of -1.2% in May. For the second quarter as a whole, industrial production fell at an annual rate of -11.6%, after plunging -19.1% in the first quarter.

In my December 2007 letter, I stated that the Federal Reserve was going to have a more difficult time containing the coming credit crisis, since so much credit creation was taking place outside the banking system. Twenty-five years ago, banks provided almost 75% of the credit to the economy. In recent years, it had fallen to 35%, while the securitization of mortgages, home equity loans, auto loans, credit card debt, student debt and company receivables provided more than 40% of the credit. “Since the market place is supplying a greater proportion of credit creation to finance economic growth, the Federal Reserve’s capability to manage the credit creation engine has diminished. This is why this crisis is quite different than the other crisis faced by the Fed in the last 20 years. Most investors really don’t understand the credit creation process, and as a result, don’t comprehend the scope of this crisis, or the Fed’s limited ability to deal with it. It really is different this time.”

As much as the phrase “It really is different this time” applied to the credit crisis we were facing in December 2007, it also is appropriate in assessing the sustainability of the coming recovery. As noted last month, the decline from a growth rate of 2.8% in the second quarter of 2008 to a negative -6.1% in the fourth quarter, and rebound into a positive GDP print by the fourth quarter of 2009 is going to look every bit like a V-shaped recovery.

In tracking the end of a recession, NBER is merely identifying when the economy in aggregate reached its lowest point. It tells us virtually nothing about the quality and strength of the recovery that follows the trough. In the three worst recessions since World War II (1957-1958, 1973-1975, 1981-1982), real GDP (nominal GDP less inflation) averaged 5.6% in the first full calendar year after the recession ended. If measured from the trough of those recessions, real GDP growth averaged 7.8%. The coming recovery will be far weaker than prior recoveries. Those recessions were precipitated by the Federal Reserve increasing rates enough to significantly slow economic growth, causing a buildup of inventories, a reduction in production to pare inventory levels, and an increase in unemployment. Since the higher cost of money negatively impacted demand for homes and cars, pent up demand was unleashed as soon as the Federal Reserve lowered interest rates, which launched a strong self sustaining recovery.

The current recession was precipitated by the largest global financial crisis in history, not by a large increase in interest rates. The collapse in credit creation has resulted in the deepest synchronized contraction in global trade and economic growth since the 1930’s. The depth of this recession, and commensurate increase in unemployment, and declines in business investment and trade, has made this financial crisis worse and more protracted. The magic elixir of lower rates, which spurred the strong recoveries after the 1957-1958, 1973-1975, and 1981-1982 recessions, has proven a placebo. Lower rates have helped, but the demand for housing and cars has collapsed, so there is no pent up demand for the recovery to draw upon. The banking system remains crippled. Lending standards are very high for most forms of credit, credit availability remains restrained, and the volume of securitized credit is still off by more than 80%.

When the Fed lowered interest rates in 2001 and 2002, it sparked a pick up in demand for cars and trucks. But the main reason the assembly lines kept humming was that every car and truck loan could be securitized. Between 2002 and 2006, more than 90% of the Detroit automaker’s profit came from financing, not from manufacturing cars and trucks. On the surface, the car business looked healthy, but under the hood the decay was plain to see, and exposed once the securitization market vaporized. And despite all the Fed’s efforts, the securitization markets remain moribund.

Before the housing bubble became a bubble, lower rates in 2001 and 2002 made it possible for millions of home owners to refinance their mortgage. This increased their disposable income and spending, helping to offset the decline in business investment in 2002. Household debt as a percent of disposable income actually rose 6% during the 2001 recession, which had never happened before during a recession. Lower mortgage rates are helping rejuvenate refinancing activity again. But for the 20% to 25% of homeowners whose mortgage exceeds the value of their home, refinancing is often off the table. And for the 16.5% who are unemployed or underemployed, refinancing is almost out of the question.

As the economy emerged from the 1973-1975, 1981-1982, and 1991 recessions, the savings rate had been 8% to 10% for decades. This provided consumers the wherewithal to increase their spending after the Fed lowered interest rates. Between 1993 and early 2008, the savings rate plunged to less than 1%. According to Christianson Capital Advisors, Americans saved $57.4 billion in 2007, and spent $92.3 billion on legalized gambling. One of the secular changes I forecast in the April 2008 letter was an increase in the savings rate, as consumers confronted the reality of lower home values and stock prices. As I noted then, an increase in the savings rate of just 1% would shave .7% off annual GDP growth since consumer spending is 70% of GDP. This suggested that GDP growth would be lower in coming years, as consumers gradually increased their savings back toward 8% to 10%. According to the Bureau of Economic Analysis, the savings rate soared to 6.9% in May. However, that grossly overstates the reality. Of the $167.1 billion increase in personal income in May, $157.6 billion came from The American Recovery and Reinvestment Act of 2009, in the form of a $250 one-time check to social security recipients. Wage and salary income actually fell $12.4 billion. If the impact of the one-time income transfer is excluded, personal income grew just .2%, rather than the headline grabbing 1.4%. In coming months, the savings rate will fall back under 3%, since real income growth is likely to remain weak well into next year.

State spending represents 12% of GDP, and has averaged an annual increase of 6% over the last 30 years, adding almost .7% to annual GDP. Unlike the Federal government, states by law cannot run fiscal deficits, but that certainly hasn’t inhibited spending! However, the worst recession since the 1930’s is forcing state governments to change. According to the Rockefeller Institute of Government, 47 of the 50 states experienced a decline in tax revenue in the first quarter. Overall, state tax collections dropped 11.7% versus March 31, 2008. The decline in tax revenue was the steepest in the 46 years quarterly data has been available. Importantly, the decline in tax revenue appeared to worsen in the second quarter with tax revenues down 20% from last year. In the first quarter, personal income tax collections fell 17.5%, weak retail sales sent sales tax collections down 8.3%, while corporate taxes fell 18.8%. In aggregate, states face a budget short fall that could approach $350 billion over the next 2 years. According to the Rockefeller Institute, it could take five years before state tax collections recover to their pre-recession levels.

In the first quarter state tax revenues were down to 2005 levels, erasing 3 years of gains that paid for new programs and salary increases. Although some states are actually cutting jobs, many states are enacting furloughs for employees that amount to pay cuts of 5% to 14%, as in Hawaii. Across the country, 15,000 school districts have reduced or eliminated summer school programs. But many states are also raising taxes and fees to close their budget gaps. These tax increases will reduce consumer’s take home pay, weaken spending, and offset some of the Federal stimulus. Since states are on the frontline in delivering services to the American people, higher taxes and fees, along with a reduction in services are going to make millions of citizens unhappy. There will be marches on state capitals before the end of 2010.

Exports represent about 12% of GDP, very similar to the contribution made by state spending. Over the last year, exports have fallen 21%, while imports have plunged 32%. As a result, the trade deficit is the lowest since 1999. In May, exports grew 1.6%, driven in part by an order for 20 Boeing airplanes. As I discussed in the May letter, in the quirky world of GDP accounting, a decline in imports adds to GDP, since imports represent production outside the U.S. This methodology is used even if the decline in imports is the result of economic weakness, as it surely was in the first quarter. A 34.1% decline in imports added +6.05% to first quarter GDP, while the 30% decline in exports subtracted -4.06%. As a result, GDP was boosted by 2% in the first quarter. Since imports declined and exports grew in the second quarter, this methodology will add more than 2% to the second quarter GDP report, and suggest the economy is in better shape than it really is.

Since the credit crisis first broke in August 2007, the European Central Bank has been behind the curve by 6 to 9 months. In June 2008, the ECB raised rates to fight inflation, which even at the time seemed terribly misguided. On June 25, the ECB pumped a record $622 billion into Euro-zone money markets at 1%. These funds will replace prior short term loans, extending maturities out a full year, and increase the total amount of ECB support. Lending in the Euro-zone has collapsed from 10% in mid-2008 to just 1.8% in May, the lowest since records began in 1992. European banks have been slower than their U.S. counterparts to write down the value of impaired assets, and they were leveraged 40 to 1, versus the leverage of 30 to 1 used by U.S. banks. Standard & Poor’s estimates that bad loan write-offs at Europe’s 50 largest banks will double next year. This could curb lending even more and weaken growth in the E.U., which represents 28% of world GDP. The IMF estimates that the EU will only grow .6% in 2010. Weak growth in Europe and Great Britain will not help the U.S. materially increase its exports in 2010.

As I discussed in the January letter, the sharp decline in sales and production has created a global economy awash in excess capacity. “When sales are falling, every dollar of revenue becomes more important, so many companies will increasingly compete on price to boost revenue. Companies will also move to lower costs, and millions of workers around the world will lose their job.” Over the last 30 years, capacity utilization in the U.S. has averaged 81. In June, the overall operating rate fell to 68, a record low dating to 1967. The operating rate for manufacturing fell to 64.6, the lowest ever since 1948. There is more excess capacity now than in the deep recessions in 1957-1958, 1973-1975, and 1981-1982. This means most companies can delay any increase in business investment, since they have so much unused capacity. The July survey by the National Association of Business Economics confirms this, as 62% of the respondents are not increasing capital spending. This is not likely to significantly change until companies experience a meaningful increase in demand. Even then, it will take time to use up the massive overhang of excess capacity.

In June, another 467,000 jobs were lost, and that was after the Labor Department added 185,000 jobs based on its birth/death model. A total of 6.5 million jobs have been lost since December 2007. Average hourly earnings rose just three cents between April and June, the smallest quarterly increase since at least 1964. The average work week fell to 33.0 hours, the lowest level ever recorded, and from 33.8 hours in December 2007. The 48 minute decline in the work week since December 2007 represents 3.3 million jobs that may have been lost had employers not reduced the hours worked so aggressively. The unemployment rate climbed to 9.5%, almost double the 4.8% rate in December 2007, and the under employment rate reached 16.5%. The average length of official unemployment increased to 24.5 weeks, the longest since 1948. In May, there were 5.7 unemployed workers for every job opening. According to Manpower Inc., hiring plans for the third quarter were the lowest since their data began in 1989. As Federal Reserve Chairman Bernanke stated in his “Semiannual Monetary Policy Report to the Congress “Job insecurity, together with declines in home values and tight credit, is likely to limit gains in consumer spending. The possibility that the recent stabilization in household spending will prove transient is an important downside risk to the outlook.”

Most economists consider unemployment a lagging indicator. But in a recession precipitated by a credit crisis, the usual rules don’t apply. The magnitude of 6.5 million lost jobs has been a leading contributor to the depth and duration of this recession, since job losses and underemployment have caused default rates on every type of consumer loan to soar. According to the American Bankers Association, late payments on 8 loan types rose to a record 3.23% as of March 31. Since another 1.2 million jobs have been lost in the second quarter, more record loan losses are coming.

consumer-credit1Over the last two years, I’ve often cited the following statistic, since consumer spending is integral to changes in demand in our economy. Household debt as a percent of GDP rose from 44% in 1982 to 98% in 2007. As all this debt was accumulating, consumer demand was goosing GDP growth. Consumers could carry more debt without a huge increase in their monthly payments, since interest rates fell from 15% to 20% in 1982 to generational lows in recent years. With short term rates near zero, this mountainous debt burden cannot be eased with lower rates. It will have to be paid off the old fashioned way – hard work over time. It’s not going to be easy. Since 1982, household debt as a percent of disposable income (income after taxes) has risen from 60%, to 133% at the end of 2007. It has since eased to 128%. In May, the San Francisco Fed determined it would take 10 years to get the ratio down to 100%, and shave .75% off consumption growth every year. If consumers increase savings .7% a year, and pay down household debt, GDP growth will be 1% less annually for a decade.

Over the last week, a number of prominent companies have reported earnings, which have exceeded depressed expectations. Analysts have dismissed the conspicuous weakness in revenue from year ago levels. Here’s a short list: IBM -13.3%, Intel -15.3%, Cisco -16.6%, CSX -24.8%, GE -9.0%, Caterpillar -21.8%, Dupont -19.1%. Most of the companies were able to exceed earnings estimates by aggressively cutting costs, and in most cases, laying off thousands of employees. That’s like getting fat by eating your own leg. Most analysts are excited, since earnings are expected to soar in coming quarters, as revenue growth returns, with most of it dropping to the bottom line. If this was a normal recession, it would be reasonable to expect a normal recovery in demand. Although government stimulus spending will give the economy a lift into the first half of 2010, consumer spending will remain weak, as the unemployment rate breaches 10%, and the underemployment rate flirts with 20%. Business investment will be retarded by excess capacity, and a cost control mindset by executives. Spending by states is going to be weak certainly by historical standards. And the global nature of this recession is going to restrain export growth. Where’s the beef?

We’re going to get what looks like a V-shaped recovery in GDP, and it will pack the nutritional value of a Twinkee.


California has long been considered a trendsetter for the rest of the country and its budget woes and push toward renewable energy are noteworthy. Unusually generous retirement benefits are and will continue to cost many cities, counties, and school districts in California dearly. For instance, a retired administrator for Vernon, California receives $499,675 per year. A retired fire chief from the Morage Orinda Fire District collects $241,000 annually. A retired professor from UCLA gets $296,556 each year. Pension funds collectively lost $1 trillion last year, but the guaranteed payouts to retirees are ultimately backed by the taxpayers. These examples are extreme, but many public pension funds throughout the country are going to face severe funding issues in coming years. The generosity of public pension funds and the future liability they will impose on taxpayers is sure to ignite a backlash.

Last November, California enacted a law that will require California utilities to garner 33% of their power from renewable sources by 2020. State energy agencies estimate the cost at $114 billion, and consumers will pay for most of it. In addition, new environmental laws could force 19 power plans that produce 15% of California’s energy to shut down. Recently, the California Energy Commission warned that California could find itself uncomfortably tight on power supplies by 2011, which could lead to power outages. Just what the 7th largest economy in the world needs to jump start growth. On June 26, Congress passed the Waxman-Markey Climate Change bill that requires states to obtain 15% of their electricity from renewable sources by 2020. Excluding hydropower, about 4% of U.S. electricity currently comes from renewables. I have no idea what this will cost, and I’m sure members of Congress don’t either. Whatever it costs, it will come out of our pockets, and ultimately increase the cost of energy for everyone.

From an economic standpoint only, the higher taxes coming after 2010, the higher taxes for Medicare, the higher taxes for Social Security, the higher taxes for health care, the higher taxes for cap and trade, and to push alternative energy sources are guaranteed to be a boon for economic activity. By the time taxes represent 100% of GDP, the economy is going to be in an unprecedented boom! Obviously, somewhere between 0% taxation and 100% taxation there is a tipping point. We’re going to find out what it is in the next decade, unfortunately after the fact.


In recent years, there has been a negative correlation between the Dollar, and gold and oil. For instance, starting in November 2005 the Dollar began a lengthy descent from 92.60 that ended in July 2008 just above 70. During this decline, gold rallied from under $450 to $1,000 and oil from $60 a barrel to $147. Most of the action really kicked in though, after the Dollar’s decline accelerated from 85.00 in early 2007, when gold was $650 and oil was just over $50 a barrel. Last year, the Dollar soared from 71 in mid July to 87.70 in late October, and to a slightly lower peak of 87.40 in early December. Gold declined from $980 in mid July last year to under $700 in late October, as the Dollar made its initial high. Oil plunged from $147 in mid July last year to $50 in early December, as the Dollar made its secondary high.

There has also been a negative correlation between the Dollar and stocks. After the low in the Dollar in mid July 2008, the S&P plunged from 1220. The high in the Dollar’s rally occurred on November 21, which is when the S&P made a low at 741. As the Dollar fell from 88.46 on November 21 to 81.15 on December 31, the S&P climbed to 943 on January 6. Between December 31 and March 4, the Dollar jumped from 81.15 to 89.63, and the S&P fell from 943 to its low of 666 on March 6. The Dollar subsequently dropped from March 4 to June 2, when it bottomed at 78.33. The S&P soared from 666 on March 4 to 949 on June 2, just under its high of 956 on June 11.

In a June 5 Special Update and the June letter, I thought the Dollar had either made an intermediate low on June 2, or would do so after a wave 4 bounce. In my July 9 Special Update, I concluded that the Dollar was going to drop below the June 2 low, which suggested that gold and the stock market would rally. Since that Update, the Dollar has dipped from 79.94 to 78.80, gold has jumped from $912 to $951, oil has climbed from under $59 to over $65, and the S&P has popped from 882 to 954. Per the July 9 Update, the long dollar position at 79.79 was stopped at 79.15 on July 20. If the Dollar is in wave 5, the up coming low will be significant, not only for the Dollar, but for gold, oil, and the stock market. In terms of sentiment, just 7% of traders were bullish on the Dollar in a recent survey.

The price target for the Dollar low is a range between 76.76, based on the width of the wave 4 triangle from the June 2 low, and 77.48. The 77.48 level is the .618 retracement of the rally from 70.70 in March 2008, and the November high at 88.46. The minimum requirement is a drop below the June 2 low at 78.33. For now, buy the Dollar if the cash drops to 76.80.


In the June letter, I thought the S&P would pull back to initial support between 875 and 885. In my July 9 Special Update, I noted that the S&P had dipped to 869 on July 6, before closing at 879. I pointed out that the head and shoulders pattern that had formed in the S&P had gotten a lot of attention, even from non-technicians. This suggested that the S&P would bounce to 900-910. As discussed in the June letter, “I still believe that the rally from the March low will take an up, down, up form, which means that the odds still favor a rally above 956 after this correction.” However, I did not expect the market to run up to the June 11 high this quickly. This suggests that the down portion of the up, down, up pattern probably finished on July 8, and the market has started the final up move from the March low. Short term the market is overbought and near the resistance at 956, so a pull back to 920-930 is likely. After this pullback, the next rally should break above 960 and carry the S&P up to 1007, which was the November 4, 2008 high. However, once the Dollar puts in its intermediate low, the risk of a larger correction in the stock market will increase. And if I’m right about the strength of the recovery in 2010, the stock market will be vulnerable to a significant decline. We’ll cross that bridge when we get there.


The Dollar has fallen from 89.62 in March to 78.80, a decline of 12%. It is noteworthy that Gold has not been able to break out above $1,000 since the Dollar peaked in March. Plus, all the talk about the coming wave of inflation from Fed money printing was supposed to boost Gold. The moment of truth is approaching. If the dollar does establish an intermediate low, Gold will be particularly vulnerable. In the short term, Gold should get a lift from additional Dollar weakness. Per the July 9 Update, the stop on the Gold short at $960 was lowered from $984 to $947.50, which was triggered on July 20. Short December Gold at $975, using $991.50 as a stop. Per the Update, the stop on the GLD short at $94.00 was lowered from $96.60 to $93.00, which was triggered on July 20. Short GLD at $95.20, using $96.30 as a stop. Per the Update, the long DZZ short gold ETF from $20.69 was stopped at $20.69.


Last month, I recommended buying the 20-year Treasury ETF TLT at 91.00, which was triggered on July 20. If the Dollar continues to weaken, bond yields could rise. Use a stop of $89.50, which is the .786 retracement of the rally from $87.56 to $96.81. Raise the stop to $93.30, if TLT exceeds $96.81, and sell if it reaches $97.80.

E. James Welsh

Leading Indicators Say “The End is Near”

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click for larger graphic

via NYT


I saved this from Saturday’s Off the Charts column by Floyd Norris:

THE American recession appears to be nearing an end, but only after it has become the deepest downturn in more than half a century.

The index of leading indicators, which signals turning points in the economy, is rising at a rate that has accurately indicated the end of every recession since the index began to be compiled in 1959.

The index was reported this week to have risen for the third consecutive month in June, and to have risen at a 12.8 percent annual rate over those three months. Such a rise, pointed out Harm Bandholz, an economist with UniCredit Group, “has always marked the end of the contraction.” Mr. Bandholz said he expected that the National Bureau of Economic Research, the official arbiter of American economic cycles, would eventually conclude that the recession bottomed out in August or September of this year.

Why isn’t the Conference Board ready to declare the recession over? The index of coincident indicators — now down for eight consecutive months (down 17 of the last 19 months). That indicator is often used by the National Bureau of Economic Research in making dating decisions, and its failure to stabilize is likely why we haven’t seen any declaration that the  downturn is officially over yet.


Leading Indicators Are Signaling the Recession’s End
Floyd Norris
NYT, July 24, 2009

Cash for Clunkers

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Want to see if your vehicle qualifies? Then go here:


Important Things to Know

• Your vehicle must be less than 25 years old on the trade-in date
• Only purchase or lease of new vehicles qualify
• Generally, trade-in vehicles must get 18 or less MPG (some very large pick-up trucks and cargo vans have different requirements)
• Trade-in vehicles must be registered and insured continuously for the full year preceding the trade-in
• You don’t need a voucher, dealers will apply a credit at purchase
• Program runs through Nov 1, 2009 or when the funds are exhausted, whichever comes first.
• The program requires the scrapping of your eligible trade-in vehicle, and that the dealer disclose to you an estimate of the scrap value of your trade-in. The scrap value, however minimal, will be in addition to the rebate, and not in place of the rebate.


See also:
Cash for Clunkers Facts

Cash-for-Clunkers Clears Hurdle
WSJ, JUNE 13, 2009

Rail Time Indicators

This post is by from The Big Picture

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The Association of American Railroads has begun publishing “Rail Time Indicators,” their monthly look at Rail Transport related data.

Here’s an excerpt from their most recent report:

• Carloads originated on U.S. railroads in June 2009 were down 19.5% (252,078 carloads) from June 2008 to 1,037,928 carloads. June 2009 was the eighth straight double-digit monthly carload decline, but it was a smaller decline than the previous two months. Average weekly carloads in June 2009 (259,482) were 10,311 carloads higher than in May 2009.

• U.S. intermodal traffic (which is not included in carloads) was down 18.2% (168,031 trailers and containers) in June 2009 to 755,000 units. (See table next page.)

• For the second quarter of 2009, U.S. rail carloadings were down 22.2% (945,652 carloads); second quarter intermodal traffic was down 18.3% 538,345 trailers and containers).

• For the first six months of 2009, U.S. rail carloadings were down 19.3% (1,573,998 carloads); intermodal traffic in the first half of 2009 was down 17.0% (950,147 trailers and containers).

And of course, a chart — 2007, 08 and 09 — note the seasonality around June each year:




From their report:

“AAR combines rail traffic data with more than 15 key economic indicators (such as consumer confidence, housing starts, and industrial production) in a non-technical snapshot of the U.S. economy. By assembling this information in a single place, and presenting rail traffic in the context of the broader economy, Rail Time Indicators provides a convenient, clear look at the key trends that can reveal where the economy — and, therefore, rail traffic — are going.”

Weekly AAR data detail rail carloadings for 19 major commodity categories, as well as intermodal
trailers and containers, for the previous week for a group of railroads that collectively account for the vast majority of total U.S. and Canadian rail traffic.

Freight railroading is a “derived demand” industry — demand for rail service occurs as a result of
demand elsewhere in the economy for the products that railroads haul.  Thus, freight rail traffic is a useful economic indicator, both for the overall economy and for specific sub-sectors.

Interesting to see something that’s not pure spin from a trade group . .  .


Rail Time Indicators
A Review of Key Economic Trends Shaping the Demand for Rail Transportation
Association of American Railroads July 21, 2009

Rail Time Indicators July 2009