Wednesday, September 17, 2008

US unemployment will be 6.6% by June 2009

I recently fell upon a blog that was arguing for the link between new housing starts and unemployment. He showed a graph that looked a lot like this one:

I tend to be very skeptical when people find correlation between two sets of data, but it turns out that housing starts are the real deal. Not only do housing starts correlate well with the unemployment rate, but they are that rarest of animals: a reliable leading indicator. The number of new housing starts can predict 40% of the variation of the unemployment rate 10 months ahead. More specifically, you can predict the unemployment rate 10 months ahead using the following equation:

UE = (2520 / HS) + 3.71

The following graph shows the predicted unemployment rate and the realized rate:

Given the data just released of the number of new housing starts at 854 for August, this predicts an unemployment rate of 6.6% for June 2009. The pain isn't over yet.

Side note: I would have assumed that the absolute number of housing starts would have trended up over time as the population increased, but this hasn't really been the case. I'm guessing this is for demographic distribution reasons: the number of young families buying houses has stayed more constant than the total population.

Tuesday, September 16, 2008

How low should it go?

Following the collapse of Lehman Brothers and the quasi-collapse of Merril Lynch yesterday, the S&P500 went down 5% and closed at 1192, its lowest level in almost 3 years (it was 1178 in October of 2005). How close are we to the bottom?

Recent history offers us one comparable benchmark: following the tech bubble, 9/11 and Enron and WorldCom accounting scandals, the S&P500 finally bottomed out at 776 in October of 2002. If we assume for the sake of simplicity that all recessions/financial crises are of equal severity (obviously false, but it's the best I can do given no other way to quantify them), then one easy target would be for the S&P500 to eventually hit 776, another drop of 1.54 times.

But the index is a nominal value, which should at the very least be adjusted for inflation. The CPI in October 2002 was 180.7 and is now at 220, so we should at least adjust the index to 945.

The S&P500 divisor has also gone down in the last 6 years, as companies have bought back shares with their considerable earnings. The divisor has fallen from 9.221B$ to 8.72B$, a decrease of 1.057 times. So the adjusted S&P500 value is now 999.

Lastly, the GDP has increased. Folding together the GDP increase and CPI, we see that nominal GDP has increased from 9.25T$ to 12.64T$, an increase of 1.366 times. 776 * 1.366 * 1.057 = 1120. This would match the lowest market cap / GDP ratio since 1996.

Bottom line: if you truly believe that this crisis/recession will be as bad or worse as 2002, we're not at the bottom yet. Don't jump in before 1120.