The pessimistic outlook for 2009 flows from the prospect of a continuing and deepening recession. US real GDP is expected to decline an horrendous 4% to 6% in both the fourth quarter this year and the first quarter next year. For the full year 2009, US real GDP is likely to be down some 2% to 3%, a precipitous decline.
The US recession will continue to be reinforced by a worsening global economic and financial decline. The prodigous efforts to stimulate the economy here and abroad and bailout bankrupt or beleagured financial institutions and auto companies may avoid a worse adjustment. But, it is not enough to reverse a generation of excesses. The deleveraging process still has much further to run, especially among hedge funds and individuals among other sectors.
The economic turnaround is likely to be delayed for an extended period, probably until Spring 2010. By that time home prices are like to drop another 15% to 20%, enough to make homes more affordable relative to average personal income. It will probably take that long to significantly trim the burdensome 11 months overhang of unsold homes at the current sales pace, particularly with a coming wave of additional forclosures with mortgage resets. But, there is far more to this recession than just the debacle in housing and housing finance. There is also a consumer led recession, a bursting of an unbridled credit bubble producing a pronounced credit contraction, a bursting of a commodity bubble, and soaring unemployment that is likely to exceed 10%, among other virtually unprecedented problems.
This week the Fed cut the Federal Funds to between zero and 0.25%. Even more significant, the Fed indicated that it would use every option, essentially whatever it takes, to reverse the recession. The Fed also indicated that it would expand its lending programs to bring down interest rates, especially on mortgages. In addition,the Fed is considering buying longer-term Treasuries. These Fed rate levels and actions are projected to persist all through the year ahead.
Those various steps and the prospect of further supportive actions were instrumentalal in driving Treasury yields to new lows. The yield on 30-year Treasuries fell to 2.55% at weeks end from 3.33% the week before and 4.22% in mid-November. The yield on the Treasury 10-year fell to 2.13% from 2.33% the week before. But the Fed's actions were intended to accomplish more than just reduce yields on Treasuries. They were intended to drive yields down enough to encourage risk taking and hopfully lending, especially including mortgage lending.
While there is an increase in mortgage applications, there no evidence of a pronounced increase or willingness of banks or other instutions to lend for other purposes. However, there has been a decline in market yields on medium to high-grade corporate bonds. For example, the AAA-rated 6.75% GE bonds of 2032 declined in yield to 6.1% from 7.4% as recently as the beginning of December, even though Standard & Poors put the issuer on negative review, suggesting a possible rating downgrade. The yields on lesser grade bonds, such as A-rated credit quality bonds, also improved this week. That was true even of the 11 banks that Standard & Poors actually did downgrade this past week.
It is my view that bond yields will continue to decline through the year ahead, though not in staight line. The expectation of still lower bond yields partly reflects projected deflation. The year over year official consumer price inflation rate is rapidly headed in that direction. Nevertheless, the consensus forecast of most economists expects a rise in Treasury bond yields both by midyear and a further rise by yearend.
Equity prices are up considerably from their lows and may well rise further early in the new year, perhaps even for as long as into the Spring. However, the severity of the recession and the surprising weakness of corporate earnings (an averager per share of some $55 for the S&P 500)will likely lead to at least a retest of the old price lows. Indeed, it is quite possible that new price lows will be established before there is a solid equity price recovery late next year.
My next blog is scheduled for January 3, 2009. Happy Holidays and best wishes for a happy new year.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address:philipbraverman@Gmail.com
Saturday, December 20, 2008
Saturday, December 13, 2008
The recession will deepen even with aid for autos and additional stimulus
The recession is bound to deepen significantly, bringing with it outright deflation,lower market yields, soaring bankruptcies, plunging corporate profits and massive layoffs. That is a realistic appraisal of the economic and financial outlook even with the $1 trillion stimulus package recommended by the President-elect Obama team and the likely prospect of a Bush Administration commitment of Federal funds to stave off the threatened near-term bankruptcy of GM and Chrysler and eventually Ford as well. There are too many economic and financial problems still to be resolved. These include the continuing plunge in home prices, a massive wave of coming foreclosures as mortgages reset at higher interest rates, a continuing credit crunch for individuals, businesses, and state and local governments, and for some a further or drastic cut in credit availability.
Federal financial assistance to the big three auto manufacturers wiil only purchase time for the auto industry to at best begin to craft an effective response to the plunge in auto sales and allow for the shift in responsibility for further Federal assistance to the next Administration and Congress. Unfortunately, health care and pension obligations for retired US auto workers, so called legacy costs, outstrip comparable imbedded costs for competing foreign cars, even those produced in the US. The $70 per hour average labor cost of the big three US auto manufacturers vastly exceeds the roughly $45 per hour average labor costs for foreign name cars manufactured in the US. Those differences amount to some $2,000 higher costs for the US auto manufacturers than their foreign competitors. Also, there are too many big three models for efficient production and marketing. However, binding contracts with their dealer network make it virtually impossible for the US auto manufacturers to make necessary changes without the assistance of a bankruptcy court. Those problems would make effective competition very difficult even under normal circumstances. And these are not normal circumstances. With the threat of bankruptcy especially hanging over GM, there is already a noticable further deterioration in dealer showroom customer traffic. Foreign auto manufacturers also face difficulties, though not quite as pronounced. Nevertheless, in general, they are getting assistance from their governments.
Without US auto industry assistance, the recession will risk being turned into a depression. But, even with this aid, the recession is destined to dramatically worsen. This past week's rise in initial claims for unemployment benefits to 573,000 (for the week of December 6), a 26-year high, up from 515,000 the week before, suggests another outsized decline in the December employment, to be reported in the first week of January. December nonfarm payrolls are likely to drop sharply, probabaly as large or even larger than the precipitous 533,000 November decline. The December unemployment rate is likely to rise to 6.9% or 7.0% from 6.7%. But, the rise in the official unemployment rate will likely continue all through 2009 into 2010, possibly reaching 10% or more.
With such prospects and a likely outright decline in consumer and business prices it should come as no surprise that there has been a flight to the safey of US Treasury securities. The flight has been so pronounced that short-term three month Treasury bill yields not only fell to zero, they temporarily declined into negative yield territory as investors became more concerned with safety and liquidity than with the return on their investments. There were sharp declines in yields on longer term maturities as well. The yield on the Treasury ten-year note declined to a intraday low of 2.497% on Friday, but ended the week at 2.57% down from 2.91% two weeks earlier and 3.74% on November 14. The yield on the Treasury 30-year also fell in tandem to 3.06% in the latest week from 3.43% two weeks ago and 4.22% on November 14. It may be time to take some profits in Treasuries prior to the turn of the year on a precautionary basis. Some institutions may be building up a portfolio only for year end statement purposes, called window dressing, planning to sell Treasuries and move into riskier assets in the new year. That might temporarily boost equities at the expense of Treasuries. But, any significant backup in Treasury yields would would create a new buying opportunity, just as any significant rise in equities could constitute a shorting opportunity.
The 3.0% Treasury bond yield is only consistent with a projected zero inflation rate. A 1% projected decline in inflation would be consistent with a 2.0% Treasury 30-year yield. That forecast could even be conservative. In Japan, Japanese government bond yields fell below 1.0% amidst their deflation experience.
Next week the Fed is likely to cut its Federal Funds rate from its current 1.0% already historically low target, by anywhere from one-quarter to three quarters of a percentage point, with a resulting funds rate level of 0.25%, 0.50% or 0.75%. Unfortunately, it will not do the trick. Credit availability remains far too constrained.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Federal financial assistance to the big three auto manufacturers wiil only purchase time for the auto industry to at best begin to craft an effective response to the plunge in auto sales and allow for the shift in responsibility for further Federal assistance to the next Administration and Congress. Unfortunately, health care and pension obligations for retired US auto workers, so called legacy costs, outstrip comparable imbedded costs for competing foreign cars, even those produced in the US. The $70 per hour average labor cost of the big three US auto manufacturers vastly exceeds the roughly $45 per hour average labor costs for foreign name cars manufactured in the US. Those differences amount to some $2,000 higher costs for the US auto manufacturers than their foreign competitors. Also, there are too many big three models for efficient production and marketing. However, binding contracts with their dealer network make it virtually impossible for the US auto manufacturers to make necessary changes without the assistance of a bankruptcy court. Those problems would make effective competition very difficult even under normal circumstances. And these are not normal circumstances. With the threat of bankruptcy especially hanging over GM, there is already a noticable further deterioration in dealer showroom customer traffic. Foreign auto manufacturers also face difficulties, though not quite as pronounced. Nevertheless, in general, they are getting assistance from their governments.
Without US auto industry assistance, the recession will risk being turned into a depression. But, even with this aid, the recession is destined to dramatically worsen. This past week's rise in initial claims for unemployment benefits to 573,000 (for the week of December 6), a 26-year high, up from 515,000 the week before, suggests another outsized decline in the December employment, to be reported in the first week of January. December nonfarm payrolls are likely to drop sharply, probabaly as large or even larger than the precipitous 533,000 November decline. The December unemployment rate is likely to rise to 6.9% or 7.0% from 6.7%. But, the rise in the official unemployment rate will likely continue all through 2009 into 2010, possibly reaching 10% or more.
With such prospects and a likely outright decline in consumer and business prices it should come as no surprise that there has been a flight to the safey of US Treasury securities. The flight has been so pronounced that short-term three month Treasury bill yields not only fell to zero, they temporarily declined into negative yield territory as investors became more concerned with safety and liquidity than with the return on their investments. There were sharp declines in yields on longer term maturities as well. The yield on the Treasury ten-year note declined to a intraday low of 2.497% on Friday, but ended the week at 2.57% down from 2.91% two weeks earlier and 3.74% on November 14. The yield on the Treasury 30-year also fell in tandem to 3.06% in the latest week from 3.43% two weeks ago and 4.22% on November 14. It may be time to take some profits in Treasuries prior to the turn of the year on a precautionary basis. Some institutions may be building up a portfolio only for year end statement purposes, called window dressing, planning to sell Treasuries and move into riskier assets in the new year. That might temporarily boost equities at the expense of Treasuries. But, any significant backup in Treasury yields would would create a new buying opportunity, just as any significant rise in equities could constitute a shorting opportunity.
The 3.0% Treasury bond yield is only consistent with a projected zero inflation rate. A 1% projected decline in inflation would be consistent with a 2.0% Treasury 30-year yield. That forecast could even be conservative. In Japan, Japanese government bond yields fell below 1.0% amidst their deflation experience.
Next week the Fed is likely to cut its Federal Funds rate from its current 1.0% already historically low target, by anywhere from one-quarter to three quarters of a percentage point, with a resulting funds rate level of 0.25%, 0.50% or 0.75%. Unfortunately, it will not do the trick. Credit availability remains far too constrained.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Saturday, November 29, 2008
Deflation and plunging economy promise lower Treasury yields and equity prices
The US and global recession is destined to worsen significantly from here, with all the widespread pain and suffering that implies. This recession is expected to be as severe as any since the great Depression of the 1930's. It is projected to include soaring unemployment, deflation, proliferating bankruptcies, continuing stringent credit availability, and plunging corporate profits. It will be not only deep, but prolonged. It will likely extend to at least the end of 2009, and quite possibly into 2010.
Next Friday's November employment report is likely reveal a 300,000 drop in nonfarm payrolls (versus a 240,000 decline in October) with a rise in the unemployment rate, perhaps to 6.8% from 6.5% in October. But,that is far from the end of worsening unemployment, which is expected to top 10% by year-end 2009 or early 2010.
Third quarter real GDP was down 0.5%. But, fourth quarter real GDP, to be released at the end of January, is likely to be down a frightening 4% to 6%. And next year's real GDP should be down a further 2% to 4%.
The index of leading indicators continues to slide, not only month to month, but from the same month last year, presaging a clear economic drop for at least the next six months and undoubtedly well beyond.
The housing sector is still far from a true market clearing level of home prices, which continue to decline. The inventory of unsold homes is equal to some 11 months of sales, roughly twice normal. And despite the Federal governments disjointed and ineffective efforts to stem the housing plunge, proliferating home mortgage delinquencies, defaults and forclosures promise to add further to the volume of unsold homes and, as a consequence, the downward trend of home prices.
With the sole exception of Federal spending, every major component of the US economy (consumer spending, business spending and state and local spending)is projected to drop through next year and possibly beyond. Consumers and business will be constrained by plunging confidence, rising unemployment, sliding income growth and reduced or nonexistant credit availability. The decline in State and local spending is mandated by law in most states in response to flagging tax receipts and soaring budget deficits. That combined prospect is reinforced by recent declines in consumer spending, personal consumption, durable goods orders, and fixed investment. The recession will soon get far worse.
In concert, this dire economic outlook seems inconsistent with the improvement in some key financial markets last week, such as equities, that moved up sharply in price, while other sectors, such as Treasury yields, continue to respond to the recession reality. That disparate pattern is unlikely to be sustained.
Treasury yields plunged further this past week, reflecting a continued investor flight to saftey and liquidity, a persistent intense credit crunch, weakness in the economy, the prospect of further Fed easing and especially expected outright deflation. The Treasury ten-year yield closed the week at a seemingly low 2.91%, extending the steep downtrend in Treasury yields in recent weeks. It was just a month ago that the Treasury ten year yield was 3.97%. Though this yield is fast approaching the Goldman Sachs 2.75% target, a still lower target appears achievable. This is suggested by the potential for outright deflation, which would suggest a Treasury 30-year yield of below 3.0% versus 3.43% currently. Lower Treasury yields are also supported by the still wide maturity yield spreads(between very short-term Treasuries and longer term Treasuries), a continuing cause for panic in lesser quality debt, and a likely further cut in the Fed basic lending rate. Also, persausive are the far lower yields on Japanese government bonds in their recession experience, which unfortunately may be the template for the US. Bond yields have also begun to decline on top grade corporates. The yield on long maturity GE bonds(rated AAA), for example, have declined under 7.5% from above 8.0%. That signals the possible advantage of beginning a shift from Treasuries to GE or other AAA bonds, though the bid-asked spread remains wide. But yields on lower rated bonds were still at very distressed levels and rising.
The equity market price indices were down for November. But, they were up sharply for the past week, as well as in the futures market for the Dow and S%P 500 (but down for the Nasdaq). On balance that suggests a rise into at least the beginning of next week. But will the rally persist? Once again the equity market bounced off roughly similar price lows, indicating to many equity market analysts that a base of support is being built that will establish or confirm an equity market bottom. That potential can not be ruled out, but to me it still seems likely that the market will not only retest its previous lows, but establish new price lows. The outlook for profits, bankruptcies, dividend reductions and the economy still appear far too dire for the current equity market rally to be sustained. More than likely it is just another bear market relief rally based on misplaced optimism that the Obama team, the stimulus package President elect Obama has promised, the new bailout of Citibank and prospective aid to the US auto industry will forestall worse developments. This is just the deceptive calm of the eye of the hurricane, not its end.
Philip Braverman
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Next Friday's November employment report is likely reveal a 300,000 drop in nonfarm payrolls (versus a 240,000 decline in October) with a rise in the unemployment rate, perhaps to 6.8% from 6.5% in October. But,that is far from the end of worsening unemployment, which is expected to top 10% by year-end 2009 or early 2010.
Third quarter real GDP was down 0.5%. But, fourth quarter real GDP, to be released at the end of January, is likely to be down a frightening 4% to 6%. And next year's real GDP should be down a further 2% to 4%.
The index of leading indicators continues to slide, not only month to month, but from the same month last year, presaging a clear economic drop for at least the next six months and undoubtedly well beyond.
The housing sector is still far from a true market clearing level of home prices, which continue to decline. The inventory of unsold homes is equal to some 11 months of sales, roughly twice normal. And despite the Federal governments disjointed and ineffective efforts to stem the housing plunge, proliferating home mortgage delinquencies, defaults and forclosures promise to add further to the volume of unsold homes and, as a consequence, the downward trend of home prices.
With the sole exception of Federal spending, every major component of the US economy (consumer spending, business spending and state and local spending)is projected to drop through next year and possibly beyond. Consumers and business will be constrained by plunging confidence, rising unemployment, sliding income growth and reduced or nonexistant credit availability. The decline in State and local spending is mandated by law in most states in response to flagging tax receipts and soaring budget deficits. That combined prospect is reinforced by recent declines in consumer spending, personal consumption, durable goods orders, and fixed investment. The recession will soon get far worse.
In concert, this dire economic outlook seems inconsistent with the improvement in some key financial markets last week, such as equities, that moved up sharply in price, while other sectors, such as Treasury yields, continue to respond to the recession reality. That disparate pattern is unlikely to be sustained.
Treasury yields plunged further this past week, reflecting a continued investor flight to saftey and liquidity, a persistent intense credit crunch, weakness in the economy, the prospect of further Fed easing and especially expected outright deflation. The Treasury ten-year yield closed the week at a seemingly low 2.91%, extending the steep downtrend in Treasury yields in recent weeks. It was just a month ago that the Treasury ten year yield was 3.97%. Though this yield is fast approaching the Goldman Sachs 2.75% target, a still lower target appears achievable. This is suggested by the potential for outright deflation, which would suggest a Treasury 30-year yield of below 3.0% versus 3.43% currently. Lower Treasury yields are also supported by the still wide maturity yield spreads(between very short-term Treasuries and longer term Treasuries), a continuing cause for panic in lesser quality debt, and a likely further cut in the Fed basic lending rate. Also, persausive are the far lower yields on Japanese government bonds in their recession experience, which unfortunately may be the template for the US. Bond yields have also begun to decline on top grade corporates. The yield on long maturity GE bonds(rated AAA), for example, have declined under 7.5% from above 8.0%. That signals the possible advantage of beginning a shift from Treasuries to GE or other AAA bonds, though the bid-asked spread remains wide. But yields on lower rated bonds were still at very distressed levels and rising.
The equity market price indices were down for November. But, they were up sharply for the past week, as well as in the futures market for the Dow and S%P 500 (but down for the Nasdaq). On balance that suggests a rise into at least the beginning of next week. But will the rally persist? Once again the equity market bounced off roughly similar price lows, indicating to many equity market analysts that a base of support is being built that will establish or confirm an equity market bottom. That potential can not be ruled out, but to me it still seems likely that the market will not only retest its previous lows, but establish new price lows. The outlook for profits, bankruptcies, dividend reductions and the economy still appear far too dire for the current equity market rally to be sustained. More than likely it is just another bear market relief rally based on misplaced optimism that the Obama team, the stimulus package President elect Obama has promised, the new bailout of Citibank and prospective aid to the US auto industry will forestall worse developments. This is just the deceptive calm of the eye of the hurricane, not its end.
Philip Braverman
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Friday, November 21, 2008
Friday's rise in equity prices and Treasury yields will be more than reversed
The equity market, including many financial stocks, closed the week with a sharp rally concentrated in the final hour of trading. For Friday alone, the equity indices were up some 6% or more. Moreover, there are indications this strong rally will extend into Monday's opening, judging by the outsized 7% equity advance in some of the futures market. But, this is still just another bear market rally.
The abrupt Friday turnaround from the steep equity price slide earlier in the week, as well in prior weeks, was primarily prompted by President elect Obama's late Friday choice of New York Fed Chairman Tim Geithner as the new Treasury Secretary. That choice encouraged a more optimistic outlook on the survival of key financial institutions since Tim Geithner has been instrumental in developing the Federal Reserve and Treasury rescue efforts. However, considering that those efforts have not as yet led to any observable or meaningful progress in ending the credit crisis or its consequences, it must be assumed that the market rally merely reflects relief that Geithner is a known not an unknown player. The major financial institutions that received Treasury capital injections are down 46% just since the middle of October. And, for some of these institutions the rate of stock price decent is accelerating. The hope is Geithner will save them. Hope springs eternal, even in the Fall.
I will be more hopeful when more meaningful steps are taken to end the plunge in home prices and financial institution distress. Suspend the pernicious mark to market accounting rules that force institutions to take losses and write down capital that put their very existence in jeorpardy when they have no intention to sell the depressed asset. Provide government guarantees for interbank lending. Buy vacant homes offered at depressed prices. End foreclosures for owner occupied homes for individuals making any good faith effort(a variant of FDIC Director Bair's proposal). Refinance mortgages to reduce the payments to a more reasonable percentage of after-tax income, such 25% to 30%, as lending guidelines suggest. Provide increased tax subsidies to puchasers of existing homes. Reintroduce the uptick rule in short selling.
Despite the markets latest flirtation with misplaced euphoria, equity prices were still down 5% for the week. The Dow Jones industrial average at 8046.42 was down 16% the past two weeks and is down 43% from its 14164.53 October 9,2007 peak. With that decline it already ranks as one of the worst cyclical drops since the 1930's depression. But, the Nasdaq composite index, largely technology stocks, is down far more. Though the Nasdaq composite was up on Friday to 1384.35, it was still down 73% from its bubble bursting March 10,2000 high of 5048.52. But there appears no basis for confidence that the outlook for corporate profits, credit availability, or economic recovery will be improving any time soon.
Treasury yields also rebounded sharply on Friday. The Treasury ten-year yield, for example, closed the week at 3.23%, up from 3.14% on Thursday. But those 10-year yields are still down substantially from 3.73% the previous Friday and 3.79% the Friday before that. The Treasury market benefited from a massive flight to the safety of direct US Government obligations as the equity market appeared to be in a virtual free fall. The Friday selloff was partly profit taking and a temporary reversal of investment flows back into the equity market.
Despite these Friday moves and potential for an extention into next week, the trend toward lower equity prices and lower Treasury yields is likely to remain very much in place. With the recession only now deepening precipitously and likely to get far worse before it gets better, and with more intense fears of deflation a near certainty, still lower equity prices and Treasury yields appear inevitable. Citibank this week announced massive layoffs. There are more such announcements to come among banks, hedge funds and insurance companies as more of their losses come to light. And Fannie Mae and Freddie Mac losses are soaring. Producer prices slumped 2.8% seasonally adjusted in October from September, a record one-month decline. Consumer prices fell 1% seasonally adjusted in October from its September level. This is also the largest one-month slide on record and a hint of coming outright deflation that suggests the Fed will be forced to cut its funds rate even below the current 1.0% level. The yield spread between Treasury inflation protected debt(TIPs) and regular Treasury coupon yields, which the Fed uses as a guide to action, indicates a market deflation expectation of more than 0.5% over the next five years, an ominous development. Initial claims for unemployment benefits are at new cyclical highs, suggesting worse unemployment news to come. A 10% peak unemployment rate is now increasingly likely, as is a 4% to 6% drop in fourth quarter real GDP.
The auto manufacturers are in a financial squeeze reflecting plunging consumer and business demand for their products, high production costs, onerous contracts with their dealer networks and crippling healthcare and pension benefit costs for retirees as well as current workers. These so called "legacy costs" are nowhere near as burdensome for their competitors. In bankruptcy all contracts are nullified and subject to change by negotiation or by the bankruptcy court. The Democrats are committed to temporarily aiding the companies to survive but not if they will remain addicted to Federal assistance.
Philip Braverman, President
Braverman economic and Financial consulting
One Hewitt Square #249
East Northprt, New York 11731
Email address:philipbraverman@Gmail.com
The abrupt Friday turnaround from the steep equity price slide earlier in the week, as well in prior weeks, was primarily prompted by President elect Obama's late Friday choice of New York Fed Chairman Tim Geithner as the new Treasury Secretary. That choice encouraged a more optimistic outlook on the survival of key financial institutions since Tim Geithner has been instrumental in developing the Federal Reserve and Treasury rescue efforts. However, considering that those efforts have not as yet led to any observable or meaningful progress in ending the credit crisis or its consequences, it must be assumed that the market rally merely reflects relief that Geithner is a known not an unknown player. The major financial institutions that received Treasury capital injections are down 46% just since the middle of October. And, for some of these institutions the rate of stock price decent is accelerating. The hope is Geithner will save them. Hope springs eternal, even in the Fall.
I will be more hopeful when more meaningful steps are taken to end the plunge in home prices and financial institution distress. Suspend the pernicious mark to market accounting rules that force institutions to take losses and write down capital that put their very existence in jeorpardy when they have no intention to sell the depressed asset. Provide government guarantees for interbank lending. Buy vacant homes offered at depressed prices. End foreclosures for owner occupied homes for individuals making any good faith effort(a variant of FDIC Director Bair's proposal). Refinance mortgages to reduce the payments to a more reasonable percentage of after-tax income, such 25% to 30%, as lending guidelines suggest. Provide increased tax subsidies to puchasers of existing homes. Reintroduce the uptick rule in short selling.
Despite the markets latest flirtation with misplaced euphoria, equity prices were still down 5% for the week. The Dow Jones industrial average at 8046.42 was down 16% the past two weeks and is down 43% from its 14164.53 October 9,2007 peak. With that decline it already ranks as one of the worst cyclical drops since the 1930's depression. But, the Nasdaq composite index, largely technology stocks, is down far more. Though the Nasdaq composite was up on Friday to 1384.35, it was still down 73% from its bubble bursting March 10,2000 high of 5048.52. But there appears no basis for confidence that the outlook for corporate profits, credit availability, or economic recovery will be improving any time soon.
Treasury yields also rebounded sharply on Friday. The Treasury ten-year yield, for example, closed the week at 3.23%, up from 3.14% on Thursday. But those 10-year yields are still down substantially from 3.73% the previous Friday and 3.79% the Friday before that. The Treasury market benefited from a massive flight to the safety of direct US Government obligations as the equity market appeared to be in a virtual free fall. The Friday selloff was partly profit taking and a temporary reversal of investment flows back into the equity market.
Despite these Friday moves and potential for an extention into next week, the trend toward lower equity prices and lower Treasury yields is likely to remain very much in place. With the recession only now deepening precipitously and likely to get far worse before it gets better, and with more intense fears of deflation a near certainty, still lower equity prices and Treasury yields appear inevitable. Citibank this week announced massive layoffs. There are more such announcements to come among banks, hedge funds and insurance companies as more of their losses come to light. And Fannie Mae and Freddie Mac losses are soaring. Producer prices slumped 2.8% seasonally adjusted in October from September, a record one-month decline. Consumer prices fell 1% seasonally adjusted in October from its September level. This is also the largest one-month slide on record and a hint of coming outright deflation that suggests the Fed will be forced to cut its funds rate even below the current 1.0% level. The yield spread between Treasury inflation protected debt(TIPs) and regular Treasury coupon yields, which the Fed uses as a guide to action, indicates a market deflation expectation of more than 0.5% over the next five years, an ominous development. Initial claims for unemployment benefits are at new cyclical highs, suggesting worse unemployment news to come. A 10% peak unemployment rate is now increasingly likely, as is a 4% to 6% drop in fourth quarter real GDP.
The auto manufacturers are in a financial squeeze reflecting plunging consumer and business demand for their products, high production costs, onerous contracts with their dealer networks and crippling healthcare and pension benefit costs for retirees as well as current workers. These so called "legacy costs" are nowhere near as burdensome for their competitors. In bankruptcy all contracts are nullified and subject to change by negotiation or by the bankruptcy court. The Democrats are committed to temporarily aiding the companies to survive but not if they will remain addicted to Federal assistance.
Philip Braverman, President
Braverman economic and Financial consulting
One Hewitt Square #249
East Northprt, New York 11731
Email address:philipbraverman@Gmail.com
Friday, November 14, 2008
The recession plunge accelerates even faster than governments rescue stimulus
The outlook continues to be exceptionally negative for the US and global economy, as well as for the global financial markets. Even with some signs of marginal improvement in credit spreads, the availability of credit still remains effectively constrained for virtually all sectors of the economy, including business, the consumer and state and local governments. Lending instutions remain extremely cautious. And, at long last, the European Community now officially recognizes that it has slipped into recession, suggesting more easing and stimulus to come. But, as in the US, that will only mitigate the severity of the recession, not arrest it.
Despite Treasury, Fed and FDIC liberal injections of funds and the promise of still more, the persistent tightness of credit will continue to curtail demand for goods services and labor. That is still the outlook even with the Treasury decision announced this week of shifting the emphasis of the remaining $700 billion bailout TARP package to supporting various types of consumer lending. The likely consequence will still be be a steep drop in US real GDP of some 4% in the fourth quarter this year and a decline of between 2% and 4% in the first half next year, with the recession likely extending through the second half next year as well.
The record 2.8% drop in October retail sales reported Friday suggests a disasterous holiday selling season. That would be a tragedy for the already distressed retail sector which critically depends on this holiday selling season for much or all of its annual profits, and in some instances survival. It should come as no surprise that consumers, accounting for some seven-tenths of the economy's spending, are turning profoundly cautious. That is to be expected given equity market losses. the home price plunge, soaring foreclosure rates,lessened access to credit and plummeting employment. Indeed, the latest surge in weekly initial claims for unemployment benefits, to 516,000 in the week ended November 8 (from an already high 484,000 the week before), suggests a prononunced worsening in November employment. The monthly employment report for November will likely include a 300,000 or larger drop in nonfarm payrolls, versus the 240,000 October decline. Moreover, that speedup in the rate of decent in employment seems destined to persist. The unemployment rate appears likely to eventually exceed 8.5%. Even a 10% level, matching the 1982 high, cannot be ruled out.
These dire economic prospects imply a steep slide in corporate profits, a key determinant of equity market prices. That and the long-term cyclical return to single digit price-earnings ratios after previous speculative equity market binges, suggest not only a continued retesting of the October equity market price lows, but more than likely new price lows. In 1982, for example, the Standard & Poors 500 index price-earnings index bottomed out at 6.6, versus a current P/E ratio of roughly 12 times next years projected sharply reduced earnings. In 1974 the P/E ratio bottomed out at 7.9. In 1932 the comparable P/E level at the bottom was 5.6. That suggests the potential for significantly lower equity market prices before a true sustainable price bottom is reached.
Similarly, the drop off in global demand will continue to reverse the binge in commodity and real estate speculation. That promises to not only slow inflation, but to turn it into outright deflation. There are already signs of that phenomenon. For example, the JOC-ECRI industrial price index at 74.1 as of November 14, is down to almost half the 145.9 level a year ago. Thus, the increasingly reasonable prospect of outright deflation should inevitably produce a further decline in Treasury bond yields, extending the recent slide. For example, the Treasury 10-year yield closed at 3.73% on Friday, down from 3.79% the prior week and 3.97% the week before that. This is despite growing market concern that the unprecedently huge volume of Treasury borrowing supply necessitated by the rescue efforts will so eclipse the markets demand appetite as to force market yields significantly higher. While nothing in life is certain, past experience suggests that lessened inflation will win out in this conflict, as it did in the depression and other periods when government stimulus far exceeded declining tax receipts to produce massive budget deficits and Treasury borrowing. And yet in each of those prior periods, Treasury yields declined throughout the maturity yield curve from Treasury bills to Treasury bonds. Of course prudent Treasury debt management was a contributory factor.
Markets this past week continued their roller coaster gains and more than offsetting declines in equity prices and Treasury yields. The Dow Jones Industrial Index fell 5%for the week, extending the previous weeks slide. But most of the latest week's drop came late Friday, erasing sharp gains both on Friday and earlier in the week. The Friday decline was all the more significant considering excessive and unrealistic market hopes that this weekend G-7 meeting will produce a solution to the ever deeper and wider global economic and fincial crisis. The most that can be hoped for from this meeting is a statement of intent from the participants that they will do what they can to deal with the global problems. That is far from enough to to resolve the still gathering global storm of economic and financial problems,
Looking ahead, the markets still have to weather the fallout from the forced deleveraging of hedge funds, insurance companies and other financial instutions as they meet huge withdrawal demands over coming months. That will require renewed waves of selling of assets at distress prices.
Philip Braverman President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@gmail.com
Despite Treasury, Fed and FDIC liberal injections of funds and the promise of still more, the persistent tightness of credit will continue to curtail demand for goods services and labor. That is still the outlook even with the Treasury decision announced this week of shifting the emphasis of the remaining $700 billion bailout TARP package to supporting various types of consumer lending. The likely consequence will still be be a steep drop in US real GDP of some 4% in the fourth quarter this year and a decline of between 2% and 4% in the first half next year, with the recession likely extending through the second half next year as well.
The record 2.8% drop in October retail sales reported Friday suggests a disasterous holiday selling season. That would be a tragedy for the already distressed retail sector which critically depends on this holiday selling season for much or all of its annual profits, and in some instances survival. It should come as no surprise that consumers, accounting for some seven-tenths of the economy's spending, are turning profoundly cautious. That is to be expected given equity market losses. the home price plunge, soaring foreclosure rates,lessened access to credit and plummeting employment. Indeed, the latest surge in weekly initial claims for unemployment benefits, to 516,000 in the week ended November 8 (from an already high 484,000 the week before), suggests a prononunced worsening in November employment. The monthly employment report for November will likely include a 300,000 or larger drop in nonfarm payrolls, versus the 240,000 October decline. Moreover, that speedup in the rate of decent in employment seems destined to persist. The unemployment rate appears likely to eventually exceed 8.5%. Even a 10% level, matching the 1982 high, cannot be ruled out.
These dire economic prospects imply a steep slide in corporate profits, a key determinant of equity market prices. That and the long-term cyclical return to single digit price-earnings ratios after previous speculative equity market binges, suggest not only a continued retesting of the October equity market price lows, but more than likely new price lows. In 1982, for example, the Standard & Poors 500 index price-earnings index bottomed out at 6.6, versus a current P/E ratio of roughly 12 times next years projected sharply reduced earnings. In 1974 the P/E ratio bottomed out at 7.9. In 1932 the comparable P/E level at the bottom was 5.6. That suggests the potential for significantly lower equity market prices before a true sustainable price bottom is reached.
Similarly, the drop off in global demand will continue to reverse the binge in commodity and real estate speculation. That promises to not only slow inflation, but to turn it into outright deflation. There are already signs of that phenomenon. For example, the JOC-ECRI industrial price index at 74.1 as of November 14, is down to almost half the 145.9 level a year ago. Thus, the increasingly reasonable prospect of outright deflation should inevitably produce a further decline in Treasury bond yields, extending the recent slide. For example, the Treasury 10-year yield closed at 3.73% on Friday, down from 3.79% the prior week and 3.97% the week before that. This is despite growing market concern that the unprecedently huge volume of Treasury borrowing supply necessitated by the rescue efforts will so eclipse the markets demand appetite as to force market yields significantly higher. While nothing in life is certain, past experience suggests that lessened inflation will win out in this conflict, as it did in the depression and other periods when government stimulus far exceeded declining tax receipts to produce massive budget deficits and Treasury borrowing. And yet in each of those prior periods, Treasury yields declined throughout the maturity yield curve from Treasury bills to Treasury bonds. Of course prudent Treasury debt management was a contributory factor.
Markets this past week continued their roller coaster gains and more than offsetting declines in equity prices and Treasury yields. The Dow Jones Industrial Index fell 5%for the week, extending the previous weeks slide. But most of the latest week's drop came late Friday, erasing sharp gains both on Friday and earlier in the week. The Friday decline was all the more significant considering excessive and unrealistic market hopes that this weekend G-7 meeting will produce a solution to the ever deeper and wider global economic and fincial crisis. The most that can be hoped for from this meeting is a statement of intent from the participants that they will do what they can to deal with the global problems. That is far from enough to to resolve the still gathering global storm of economic and financial problems,
Looking ahead, the markets still have to weather the fallout from the forced deleveraging of hedge funds, insurance companies and other financial instutions as they meet huge withdrawal demands over coming months. That will require renewed waves of selling of assets at distress prices.
Philip Braverman President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@gmail.com
Friday, November 7, 2008
Rapidly deteriorating employment foreshadows a deep and long recession
Despite market developments on Friday, including an equity market rally and a slight back up in Treasury intermediate-term maturity yields, equity prices and Treasury yields are still down for the week. Moreover, even with an extention of the equity rally likely on Monday, judging by the futures market, the outlook still favors new and pronounced declines in equity prices and Treasury bond yields.
The equity market somewhat followed the general script that I laid out for this past week, in last week's commentary. That included a celebratory rally on Tuesday in anticipation of now President-elect Obama's election victory, a steep selloff on Wednesday and Thursday in anticipation of a 300,000 or higher nonfarm payroll drop forecast by Goldman Sachs and some others. Then came the Friday rally, partly in relief that the actual October nonfarm payroll decline, though large, was smaller than the market had feared. But there were also reports that some market participants felt the actual employment report was dire enough to spur positive market expectations of more and major stimulus, either by the current Administration or the next, and futher easing by the Fed and other central banks. There
were also reports of coming stimulus efforts from emerging economies,especially the so called BRIC countries, Brazil,Russia,India and China.
The Treasury's new borrowing next week will likely put some upward pressure on market yields. Nevertheless, Treasury yields are already down considerably from the preceding Friday levels. The ten-year Treasury yield, for example, closed the week at 3.79%, down from 3.97% the previous Friday. And Treasury yields will probably decline further after the Treasury securities to be auctioned next week are firmly placed. Ultimately, as outright deflation concerns take center stage, the ten-year Treasury yield should fall to and perhaps below 3.0%. That market yield level would be consistent with expectations of just zero inflation, not even outright deflation, with consumer prices falling below year earlier levels.
The leap to 6.5% in the headline October unemployment rate, from 6.1% in September, and the 240,000 drop in nonfarm payrolls were disturbing enough. However, there was even worse news in the details. In the more reliable household employment survey, from which the unemployment rate is derived, there was an unusually large 306,000 October rise in the labor force, as well as a 297,000 decline in employment. Together that produced an horrendous 603,000 October drop in employment, more than twice the decline reported in the more widely followed nonfarm payrolls.
The employment declines were across the spectrum of nonfarm employment categories. Except for government, education and health care, every other other employment group experienced a sizable drop. This included October declines of 90,000 in manufacturing, 49,000 in construction, 38,000 in retailing and 45,000 in business services.
The official total of those unemployed is now 10.1 million. But even that total would be sustantially higher if additional types of functional unemployment were included, such as workers who took temporary or part-time work because they could not secure full-time work or had become so discouraged over dismal job prospects that they are no longer actively looking for employment.
Nonfarm payrolls over previous months were revised substantially lower. In September, nonfarm payrolls plunged 284,000, versus the 159,000 reported initially. And in August there was actually a 127,000 decline, rather than 73,000 previously reported. Thus far this year, even relying on the understated nonfarm payroll decline, there has been a numbing 1.2 million loss of employment, with more than half that decline experienced in just the past three months alone. These and other worse than first realized economic reports suggest that the 0.3% decline in third quarter real GDP eventually will be revised significantly lower. For example, the Index of aggregate hours worked, a component of the monthly employment report and a relatively reliable indicator of real GDP, declined 0.8% between June and September, suggestive of a much steeper than 0.3% GDP drop .
Similarly, the Index of aggregate hours worked, together with other data, also suggest a much sharper drop in real GDP in the current quarter. The Index of aggregate hours worked declined 0.3% in October, both seasonally adjusted and seasonally unadjusted. But, the October sesonally adjusted declines were a particularly pronounced 1.0% in manufacturing, 1.2% in construction and 1.0% in retailing. These and other economic reports appear consistent with the 2% to 4% decline at a minimum in real GDP I have previously suggested for both the fourth quarter this year and at least the first half next year.
The deleveraging process will continue. The strained effort by hedge funds to meet their margin calls with collateral is the latest focus of worry in the ongoing and ever widening credit and economic crisis. Heightened concern over the deteriorating cash position of the auto manufacturers, as well as auto paper lenders and holders, plunging retail sales and consumer confidence are just the latest indications that the global economy's financial problems are far from being resolved. Even the promise of efforts to deal with the foreclosure problem and a new tax refund will only at best soften the worst recession since the 1980s, and possibly since the 1930s.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: Philipbraverman@Gmail.com
The equity market somewhat followed the general script that I laid out for this past week, in last week's commentary. That included a celebratory rally on Tuesday in anticipation of now President-elect Obama's election victory, a steep selloff on Wednesday and Thursday in anticipation of a 300,000 or higher nonfarm payroll drop forecast by Goldman Sachs and some others. Then came the Friday rally, partly in relief that the actual October nonfarm payroll decline, though large, was smaller than the market had feared. But there were also reports that some market participants felt the actual employment report was dire enough to spur positive market expectations of more and major stimulus, either by the current Administration or the next, and futher easing by the Fed and other central banks. There
were also reports of coming stimulus efforts from emerging economies,especially the so called BRIC countries, Brazil,Russia,India and China.
The Treasury's new borrowing next week will likely put some upward pressure on market yields. Nevertheless, Treasury yields are already down considerably from the preceding Friday levels. The ten-year Treasury yield, for example, closed the week at 3.79%, down from 3.97% the previous Friday. And Treasury yields will probably decline further after the Treasury securities to be auctioned next week are firmly placed. Ultimately, as outright deflation concerns take center stage, the ten-year Treasury yield should fall to and perhaps below 3.0%. That market yield level would be consistent with expectations of just zero inflation, not even outright deflation, with consumer prices falling below year earlier levels.
The leap to 6.5% in the headline October unemployment rate, from 6.1% in September, and the 240,000 drop in nonfarm payrolls were disturbing enough. However, there was even worse news in the details. In the more reliable household employment survey, from which the unemployment rate is derived, there was an unusually large 306,000 October rise in the labor force, as well as a 297,000 decline in employment. Together that produced an horrendous 603,000 October drop in employment, more than twice the decline reported in the more widely followed nonfarm payrolls.
The employment declines were across the spectrum of nonfarm employment categories. Except for government, education and health care, every other other employment group experienced a sizable drop. This included October declines of 90,000 in manufacturing, 49,000 in construction, 38,000 in retailing and 45,000 in business services.
The official total of those unemployed is now 10.1 million. But even that total would be sustantially higher if additional types of functional unemployment were included, such as workers who took temporary or part-time work because they could not secure full-time work or had become so discouraged over dismal job prospects that they are no longer actively looking for employment.
Nonfarm payrolls over previous months were revised substantially lower. In September, nonfarm payrolls plunged 284,000, versus the 159,000 reported initially. And in August there was actually a 127,000 decline, rather than 73,000 previously reported. Thus far this year, even relying on the understated nonfarm payroll decline, there has been a numbing 1.2 million loss of employment, with more than half that decline experienced in just the past three months alone. These and other worse than first realized economic reports suggest that the 0.3% decline in third quarter real GDP eventually will be revised significantly lower. For example, the Index of aggregate hours worked, a component of the monthly employment report and a relatively reliable indicator of real GDP, declined 0.8% between June and September, suggestive of a much steeper than 0.3% GDP drop .
Similarly, the Index of aggregate hours worked, together with other data, also suggest a much sharper drop in real GDP in the current quarter. The Index of aggregate hours worked declined 0.3% in October, both seasonally adjusted and seasonally unadjusted. But, the October sesonally adjusted declines were a particularly pronounced 1.0% in manufacturing, 1.2% in construction and 1.0% in retailing. These and other economic reports appear consistent with the 2% to 4% decline at a minimum in real GDP I have previously suggested for both the fourth quarter this year and at least the first half next year.
The deleveraging process will continue. The strained effort by hedge funds to meet their margin calls with collateral is the latest focus of worry in the ongoing and ever widening credit and economic crisis. Heightened concern over the deteriorating cash position of the auto manufacturers, as well as auto paper lenders and holders, plunging retail sales and consumer confidence are just the latest indications that the global economy's financial problems are far from being resolved. Even the promise of efforts to deal with the foreclosure problem and a new tax refund will only at best soften the worst recession since the 1980s, and possibly since the 1930s.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: Philipbraverman@Gmail.com
Saturday, November 1, 2008
The rally in equities and rise in Treasury yields are only temporary
Equity prices will drop sharply again after the current rally runs its course. Though the election results may well create some equity market euphoria, a renewed market decline could still come soon, perhaps by next Friday on, or even before in anticipation of, the next dramatic worsening of the employment picture. Given the high 475,000 four-week average increase in initial claims for unemployment benefits(479,000 in the latest week), it is reasonable to expect the October employment report next Friday to include a devastating up to 200,000 drop in nonfarm payrolls and a 0.2% further rise in the unemployment rate. Before this recession is over the unemployment rate is likely to top 8.0%.
But, regardless of the Friday employment report, a renewed plunge in equity prices is inevitable, certainty when the corporate profit outlook darkens dramatically, as it will, with the rapidly deteriorating economy. For expected changes in corporate profits are a key leading indicator and determinant of stock prices.
As stock market prices plunge anew there will be a return to the safe haven of Treasury securities. But the primary reason Treasury yields are destined to decline to and through their previous yield lows is the outlook for inflation. The global recession, with its plunging demand for commodities, finished goods and goods at all stages of production, capital investment, housing, real estate in general and labor, will produce not only a pronounced decline in the rate of inflation, but the prospect of outright deflation. Though the enormous size of the Federal rescue efforts will require a substantial increase in Treasury borrowing, the increase will be primarily in short-term maturities, where the demand is strongest and Fed actions most supportive. For the moment, however, the bond market's concern that the prospective increase in the supply of Treasury borrowing will exceed demand is overwhelming any optimism on inflation expectations. That view has even led some to short Treasury bonds. But, deflation potential and its eventual reality will ultimately win out.
If all of that is true, you might ask why the stock market rose sharply last week after one of the steepest declines since the depression over the preceeding three weeks, and why did Treasury yields rise over the past month? In that period, the yield on the ten-year, for example, rose more than a half percentage point to just under 4.0%.
The steep and seemingly consistent decline in prices on equities through the first three weeks of October encouraged such substantial short positioning that it created its own vulnerability. Recognizing that vulnerability, sentiment changed abruptly on Tuesday when it became clear that the Federal Reserve was about to cut the Federal funds rate to 1.0%, That growing positive sentiment was reinforced when the Fed did indeed cut the funds rate to 1.0% with a promise of further cuts as necessary,and especially when there was a round of parallel official interest rate reductions by other central banks across the globe with the expectation of more cuts to come. The combination of those coordinated rate cuts, signs of a slight easing in the commercial paper market and other frozen money markets, taken together, panicked investors who were heavily short into a pronounced short-covering rally. That in turn enticed other buying, especially after the 0.3% decline in third qurter real GDP was marginally better than had been feared. Though the rule of thumb that you can not fight the Fed is often correct. This time that buying rule is highly likely to prove wrong. The recession will be far more severe and protracted than the slight 0.3% third quarter real GDP decline might suggest.
The US economy is currently plunging. Real GDP is likely to decline by between 2% and 4% in the fourth quarter this year and through the first half next year and quite probably beyond. The consumer is being forced to drastically curtail spending. The decline in energy prices is lightening consumers financial burdens, but that improvement is more than offset by plunging consumer confidence, declining job prospects, and skidding income gains. Too much consumer debt and a tightening in credit standards put consumers in a financial bind. In addition, every other component of GDP except for Federal spending is cuurently in retreat. That points clearly to a consequent scale back in corporate earnings and a sharp reduction in consumer price increases, a prescrption for a renewed decline in equity prices and a resumption of the decline in Treasury yields.
One favorable development is the proposal to do something to ameliorate the soaring pace of foreclosures. The FDIC push to restructure Indymax mortgages facing foreclosure and the similar JP Morgan Chase voluntary initiatives to prevent foreclosures are promising developments that may help slow the decline in home prices. But much more needs to be done before there is any real basis for optimism that the credit crisis and far flung damage it has done and continues to do to the US and global economy is nearing an end. Even with all the government initiatives, the global recession is still destined to deepen precipitously.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@gmail.com
But, regardless of the Friday employment report, a renewed plunge in equity prices is inevitable, certainty when the corporate profit outlook darkens dramatically, as it will, with the rapidly deteriorating economy. For expected changes in corporate profits are a key leading indicator and determinant of stock prices.
As stock market prices plunge anew there will be a return to the safe haven of Treasury securities. But the primary reason Treasury yields are destined to decline to and through their previous yield lows is the outlook for inflation. The global recession, with its plunging demand for commodities, finished goods and goods at all stages of production, capital investment, housing, real estate in general and labor, will produce not only a pronounced decline in the rate of inflation, but the prospect of outright deflation. Though the enormous size of the Federal rescue efforts will require a substantial increase in Treasury borrowing, the increase will be primarily in short-term maturities, where the demand is strongest and Fed actions most supportive. For the moment, however, the bond market's concern that the prospective increase in the supply of Treasury borrowing will exceed demand is overwhelming any optimism on inflation expectations. That view has even led some to short Treasury bonds. But, deflation potential and its eventual reality will ultimately win out.
If all of that is true, you might ask why the stock market rose sharply last week after one of the steepest declines since the depression over the preceeding three weeks, and why did Treasury yields rise over the past month? In that period, the yield on the ten-year, for example, rose more than a half percentage point to just under 4.0%.
The steep and seemingly consistent decline in prices on equities through the first three weeks of October encouraged such substantial short positioning that it created its own vulnerability. Recognizing that vulnerability, sentiment changed abruptly on Tuesday when it became clear that the Federal Reserve was about to cut the Federal funds rate to 1.0%, That growing positive sentiment was reinforced when the Fed did indeed cut the funds rate to 1.0% with a promise of further cuts as necessary,and especially when there was a round of parallel official interest rate reductions by other central banks across the globe with the expectation of more cuts to come. The combination of those coordinated rate cuts, signs of a slight easing in the commercial paper market and other frozen money markets, taken together, panicked investors who were heavily short into a pronounced short-covering rally. That in turn enticed other buying, especially after the 0.3% decline in third qurter real GDP was marginally better than had been feared. Though the rule of thumb that you can not fight the Fed is often correct. This time that buying rule is highly likely to prove wrong. The recession will be far more severe and protracted than the slight 0.3% third quarter real GDP decline might suggest.
The US economy is currently plunging. Real GDP is likely to decline by between 2% and 4% in the fourth quarter this year and through the first half next year and quite probably beyond. The consumer is being forced to drastically curtail spending. The decline in energy prices is lightening consumers financial burdens, but that improvement is more than offset by plunging consumer confidence, declining job prospects, and skidding income gains. Too much consumer debt and a tightening in credit standards put consumers in a financial bind. In addition, every other component of GDP except for Federal spending is cuurently in retreat. That points clearly to a consequent scale back in corporate earnings and a sharp reduction in consumer price increases, a prescrption for a renewed decline in equity prices and a resumption of the decline in Treasury yields.
One favorable development is the proposal to do something to ameliorate the soaring pace of foreclosures. The FDIC push to restructure Indymax mortgages facing foreclosure and the similar JP Morgan Chase voluntary initiatives to prevent foreclosures are promising developments that may help slow the decline in home prices. But much more needs to be done before there is any real basis for optimism that the credit crisis and far flung damage it has done and continues to do to the US and global economy is nearing an end. Even with all the government initiatives, the global recession is still destined to deepen precipitously.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@gmail.com
Saturday, October 25, 2008
No lows in sight for bond yields, equity prices or commodities
Look for a decline in third quarter real GDP to be reported next Thursday. That is likely to prompt the Fed to ease further, probably with a one-half percentage point cut in the Federal funds rate to 1.0% from its current 1.5% level. That should open the door for additional easing by other central banks around the globe. Together with other initiatives, that should help further thaw the freeze-up in the global money markets. But, even another round of central bank easing on top of the US Treasury, Fed, FDIC and foreign government initiatives will not be enough to stem the recessionary decline in US and global equity and commodity markets. Global demands and profits are slip sliding away far too fast for that.
Judging by the relentless market price declines last week, the global equity and commodity markets appear to be finally awakenening to the realty of the steep world-wide recession. That should not be surprising considering that there is an outright contraction in real growth across the advanced industrial world and at the very least a marked slowdown in emerging market economies. Even China's growth is slowing so significantly as to prompt their talk of the need for economic stimulus.
This downturn is far more than merely a global credit crisis, though that crisis has been a significant contributory cause. The economic contraction is cutting demand across the spectrum: for consumer goods, inventories, capital equipment,services, raw materials, and employment. The result is a precipitous decline in prices for commodities. While that benefits some, the adverse consequences of the recession, the loss of business, more intense competition, a resultant decline in corporate profits, with reasonable expectations of far more to come, have put prices for equities and commodities in a tail spin.
Though there are guideposts that can be utilized, there is no way of telling exactly how low the prices of equities or commodities will go. There is also uncertainty over where the bottom is for interest rates, including Central Bank rates and Treasury bond yields. The only realistic answer is lower.
Since the contraction in credit is deeper than any of its post 1930-depression predecessers, the consequent drop in the various indices are likely to also be steeper. The largest peak-to-trough drop in the Dow since World War 11 was the 45% decline in the 23 months between January 1973 and December 1974. The 44% drop the past 54 weeks is almost the same, but the monthly pace has been almost twice as fast. The current drop was only exceeded in extent by the 49% decline between March 1937 and March 1938, though the monthly pace of the decline was identical to the current period. Thus, with the current recession only now deepening sharply, it appears prudent to expect both a longer period of decline and a consequent larger decline in equity prices. That would be consistent with a continuation of the average 3.7% per month decent in equity prices thus far experienced, though by no means necessarily in a straight line.
Commodity prices are likely to overshoot on the way down, dropping below the marginal cost of production as inventories are exhausted and producers sell even at prices below cost to generate cash to meet their financial obligations. That has aleady happened in oil with an estimated marginal production cost of some $70 to $80 a barrel. $50 to $60 per barrel oil is certainly possible.
Treasury yields are projected to drop substantially further as inflation first slows, then turns into outright deflation, with current price indices below year earlier levels. That would suggest a return to at least the 3.1% low on the ten-year Treasury experienced in the previous cycle. That would be consistent with a market projection of zero CPI inflation. With deflation and a Federal funds rate below 1%, a distinct possibility, the ten-year Treasury yield could easily fall to and below 3.0% from its current 3.7%. The maturity yield spread between the ten-year and thirty-year is also likely to narrow further, contrary to widespread expectations to the contrary.
This week Chairman Greenspan in testimony before Congress admited surprise at the financial crisis. He will go down in history as the worst Fed Chairman ever. And that is saying something. His was a dereliction in duty to not only properly supervise financial institutions but to prevent excesses in speculation in the equity markets, in housing, in consumer credit, in financial engineering, and in grossly excessive financial institution leveraging. We are paying the price for a return to sanity in the deleveraging process. We need Fed Chairmen that do not need to be liked as they do their job of taking the proverbial credit punchbowl away whenever the speculative economic party really gets started.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Judging by the relentless market price declines last week, the global equity and commodity markets appear to be finally awakenening to the realty of the steep world-wide recession. That should not be surprising considering that there is an outright contraction in real growth across the advanced industrial world and at the very least a marked slowdown in emerging market economies. Even China's growth is slowing so significantly as to prompt their talk of the need for economic stimulus.
This downturn is far more than merely a global credit crisis, though that crisis has been a significant contributory cause. The economic contraction is cutting demand across the spectrum: for consumer goods, inventories, capital equipment,services, raw materials, and employment. The result is a precipitous decline in prices for commodities. While that benefits some, the adverse consequences of the recession, the loss of business, more intense competition, a resultant decline in corporate profits, with reasonable expectations of far more to come, have put prices for equities and commodities in a tail spin.
Though there are guideposts that can be utilized, there is no way of telling exactly how low the prices of equities or commodities will go. There is also uncertainty over where the bottom is for interest rates, including Central Bank rates and Treasury bond yields. The only realistic answer is lower.
Since the contraction in credit is deeper than any of its post 1930-depression predecessers, the consequent drop in the various indices are likely to also be steeper. The largest peak-to-trough drop in the Dow since World War 11 was the 45% decline in the 23 months between January 1973 and December 1974. The 44% drop the past 54 weeks is almost the same, but the monthly pace has been almost twice as fast. The current drop was only exceeded in extent by the 49% decline between March 1937 and March 1938, though the monthly pace of the decline was identical to the current period. Thus, with the current recession only now deepening sharply, it appears prudent to expect both a longer period of decline and a consequent larger decline in equity prices. That would be consistent with a continuation of the average 3.7% per month decent in equity prices thus far experienced, though by no means necessarily in a straight line.
Commodity prices are likely to overshoot on the way down, dropping below the marginal cost of production as inventories are exhausted and producers sell even at prices below cost to generate cash to meet their financial obligations. That has aleady happened in oil with an estimated marginal production cost of some $70 to $80 a barrel. $50 to $60 per barrel oil is certainly possible.
Treasury yields are projected to drop substantially further as inflation first slows, then turns into outright deflation, with current price indices below year earlier levels. That would suggest a return to at least the 3.1% low on the ten-year Treasury experienced in the previous cycle. That would be consistent with a market projection of zero CPI inflation. With deflation and a Federal funds rate below 1%, a distinct possibility, the ten-year Treasury yield could easily fall to and below 3.0% from its current 3.7%. The maturity yield spread between the ten-year and thirty-year is also likely to narrow further, contrary to widespread expectations to the contrary.
This week Chairman Greenspan in testimony before Congress admited surprise at the financial crisis. He will go down in history as the worst Fed Chairman ever. And that is saying something. His was a dereliction in duty to not only properly supervise financial institutions but to prevent excesses in speculation in the equity markets, in housing, in consumer credit, in financial engineering, and in grossly excessive financial institution leveraging. We are paying the price for a return to sanity in the deleveraging process. We need Fed Chairmen that do not need to be liked as they do their job of taking the proverbial credit punchbowl away whenever the speculative economic party really gets started.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Saturday, October 18, 2008
The recession distress is intensifying, threatening outright deflation
There is as yet no realistic basis for equity or credit market optimism, despite the rapid fire changes in Admistration efforts to rescue the financial markets and prevent the rapidly deepening recession from turning into a depression. The initiatives miss the mark. They do not solve the the basic problems besetting the housing sector, the financial markets or the US and global economy.
There was ample evidence this week that financial and economic problems not only remain severe, they are intensifying. That mandates aggressive easing by central banks around the globe, including the Fed, before price deflation has the perverse effect of tightening real central bank policy. That would make it all the more difficult for the Fed stem the tide toward the deepest recession since the great Depression.
Oil prices tempoarily fell below $70 a barrel on reduced global energy demands this week. Expect further declines across the spectrum of commodity prices. Retail sales plunged a steep 1.2% in September. This is the third consecutive monthly drop in consumer retail sales. Considering that consumer spending accounts for some seven tenths of GDP, it is also a clear indication of a recessionary contraction of real GDP to be reported for the third and fourth quarters this year and undoubtedly through most or all of 2009. Despite the decline in energy prices, it also suggests mounting problems for consumers, holders of consumer credit and auto debt, as well as for retailers and the global economy, which depends on US consumer purchases. That dire prospect was reinforced this week with the report of an August decline in consumer credit. This is the first time this type of credit has fallen in a decade. Consumer sentiment as measured by the University of Michigan fell sharply to 57.5 in October from 70.3 in September. Housing starts plunged 6.3% in September to a 17 year low. There was something of a run on hedge funds in the third quarter, forcing them to dump liquid securities at fire sale prices to meet withdrawal demands. There is no reason to expect that hedge fund contraction process to end any time soon, at least not before a substantial number fold.
True, some widely respected technical analysts are trumpeting the sharp rebound in equity prices from their seeming double bottom (a technical buy signal), while fundamental analysts are equally impressed by historic low price-earnings ratios as a significant buy signal. And the legendary investor Warren Buffet's equity purchases, fueled by his sale of Treasuries, and his comment that he intends to be fully invested are powerfully persausive confidence builders. But, there remains far too much contrary evidence to believe in a sustained improvement in any beleagured market, whether equities, debt (other than Government-guaranteed debt), commodities or real estate. They are all going lower in price. So much so that outright deflation, which would be a real economic and financial calamity, must be considered a realistic risk.
The credit crunch remains very much in evidence. The Treasury injection of up to $25 billion in capital in individual selected banks through preferred stock purchases does not adquately restore confidence in interbank lending. The still unrecognized losses on junk assets held on the books of far too many financial institutions (because they would have to declare themselves bankrupt if they did recognize the full extent of the losses) make them vulnerable to unanticipated runs on uninsured deposits. And because virtually every financial institution recognizes that reality, they are hesitant to trust that other institutions will repay any loans made to them. The increase of FDIC deposit insurance to $250,000 per depositor and on noninterest bearing deposits is still not 100% deposit insurance. Despite the injection of Fed and Treasury funds, there is still a pronounced unwillingness to lend that is producing a significant reduction in the availability of credit in the US and globally.
Mortgage interest rates rose this week. The market interest rates on all medium to long term debt rose further above Treasury yields this week as the markets shunned even the slightest form of debt risk. Many shippers cannot get adequate credit and thus can not ship. Even if customers with anything less than pristine credit want to buy a car, they cannot secure financing. GMAC is cutting its lending. Businesses that rely on commercial paper must depend on the direct commercial paper lending from the Fed to pay off maturing loans. It remains a dire financial crisis. Even the temporary suspension of required mark-to-market accounting rules for recognizing current values, a change I suggested, would be no panacea.
The root cause of the financial industry problem is plunging home prices. Soaring home mortgage deliquencies, defaults and foreclosures make still lower home prices a virtual certainty. This promises to undermine the market value of mortgages and mortgage-related paper still further, creating even larger losses for those institutions holding this toxic paper. That requires more and larger injections of capital so that the financial institutions can recognize the losses and still survive. Until this vicious cycle is broken, with an end to the drop in home prices, there can be no confidence that either the underlying or consequent probems of the financial system are being resolved.
There are a number of approaches that can hope to be sucessful in ending the decline in home prices. A Federal, State and local program to buy vacant homes at depressed prices could help. It might well encourage private vulture funds to accelerate their real estate purchases. A moritorium on foreclosures would also accomplish much. Offering home owners in mortgage distress an opportunity to sell an equity stake in their homes in exchange for a partial paydown of their mortgage might also ameliorate the problem. There could also be a temporary or permanent reduction in onerous mortgage terms for homeowners confronted with foreclosure. These suggestions are merely a variation on approaches tried sucessfully in the Depression and during the housing collapse in Mexico in the mid-1990s. Until home prices stabilize and the various other underlying problems besetting financial institutions are effectively resolved, it is only prudent to remain cautious, liquid and safe in your investments.
Philip Braverman, President
Braverman Economic and Finance Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
There was ample evidence this week that financial and economic problems not only remain severe, they are intensifying. That mandates aggressive easing by central banks around the globe, including the Fed, before price deflation has the perverse effect of tightening real central bank policy. That would make it all the more difficult for the Fed stem the tide toward the deepest recession since the great Depression.
Oil prices tempoarily fell below $70 a barrel on reduced global energy demands this week. Expect further declines across the spectrum of commodity prices. Retail sales plunged a steep 1.2% in September. This is the third consecutive monthly drop in consumer retail sales. Considering that consumer spending accounts for some seven tenths of GDP, it is also a clear indication of a recessionary contraction of real GDP to be reported for the third and fourth quarters this year and undoubtedly through most or all of 2009. Despite the decline in energy prices, it also suggests mounting problems for consumers, holders of consumer credit and auto debt, as well as for retailers and the global economy, which depends on US consumer purchases. That dire prospect was reinforced this week with the report of an August decline in consumer credit. This is the first time this type of credit has fallen in a decade. Consumer sentiment as measured by the University of Michigan fell sharply to 57.5 in October from 70.3 in September. Housing starts plunged 6.3% in September to a 17 year low. There was something of a run on hedge funds in the third quarter, forcing them to dump liquid securities at fire sale prices to meet withdrawal demands. There is no reason to expect that hedge fund contraction process to end any time soon, at least not before a substantial number fold.
True, some widely respected technical analysts are trumpeting the sharp rebound in equity prices from their seeming double bottom (a technical buy signal), while fundamental analysts are equally impressed by historic low price-earnings ratios as a significant buy signal. And the legendary investor Warren Buffet's equity purchases, fueled by his sale of Treasuries, and his comment that he intends to be fully invested are powerfully persausive confidence builders. But, there remains far too much contrary evidence to believe in a sustained improvement in any beleagured market, whether equities, debt (other than Government-guaranteed debt), commodities or real estate. They are all going lower in price. So much so that outright deflation, which would be a real economic and financial calamity, must be considered a realistic risk.
The credit crunch remains very much in evidence. The Treasury injection of up to $25 billion in capital in individual selected banks through preferred stock purchases does not adquately restore confidence in interbank lending. The still unrecognized losses on junk assets held on the books of far too many financial institutions (because they would have to declare themselves bankrupt if they did recognize the full extent of the losses) make them vulnerable to unanticipated runs on uninsured deposits. And because virtually every financial institution recognizes that reality, they are hesitant to trust that other institutions will repay any loans made to them. The increase of FDIC deposit insurance to $250,000 per depositor and on noninterest bearing deposits is still not 100% deposit insurance. Despite the injection of Fed and Treasury funds, there is still a pronounced unwillingness to lend that is producing a significant reduction in the availability of credit in the US and globally.
Mortgage interest rates rose this week. The market interest rates on all medium to long term debt rose further above Treasury yields this week as the markets shunned even the slightest form of debt risk. Many shippers cannot get adequate credit and thus can not ship. Even if customers with anything less than pristine credit want to buy a car, they cannot secure financing. GMAC is cutting its lending. Businesses that rely on commercial paper must depend on the direct commercial paper lending from the Fed to pay off maturing loans. It remains a dire financial crisis. Even the temporary suspension of required mark-to-market accounting rules for recognizing current values, a change I suggested, would be no panacea.
The root cause of the financial industry problem is plunging home prices. Soaring home mortgage deliquencies, defaults and foreclosures make still lower home prices a virtual certainty. This promises to undermine the market value of mortgages and mortgage-related paper still further, creating even larger losses for those institutions holding this toxic paper. That requires more and larger injections of capital so that the financial institutions can recognize the losses and still survive. Until this vicious cycle is broken, with an end to the drop in home prices, there can be no confidence that either the underlying or consequent probems of the financial system are being resolved.
There are a number of approaches that can hope to be sucessful in ending the decline in home prices. A Federal, State and local program to buy vacant homes at depressed prices could help. It might well encourage private vulture funds to accelerate their real estate purchases. A moritorium on foreclosures would also accomplish much. Offering home owners in mortgage distress an opportunity to sell an equity stake in their homes in exchange for a partial paydown of their mortgage might also ameliorate the problem. There could also be a temporary or permanent reduction in onerous mortgage terms for homeowners confronted with foreclosure. These suggestions are merely a variation on approaches tried sucessfully in the Depression and during the housing collapse in Mexico in the mid-1990s. Until home prices stabilize and the various other underlying problems besetting financial institutions are effectively resolved, it is only prudent to remain cautious, liquid and safe in your investments.
Philip Braverman, President
Braverman Economic and Finance Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Saturday, October 11, 2008
No bottom yet in equity and home prices, credit crunch, deflation or recession pain
Despite signs in the futures market of an equity market rally Monday on the new G-7 and EU coordinated policy initiatives, there is still almost certainly more financial and economic pain to come.
The cyclical lows are virtually certain to be still ahead in the equity price indicies. This dire forecast is despite the steep declines of 18 percent last week in both the Dow and S&P 500 indicies, the worst one-week recession decline since 1933. Over the past twelve months, the Dow is down 40%, while the S&P 500 is down 43%. These twelve-month percentage drops now exceed the total cyclical equity market decline associated with every post World War II recession with the sole exception of the 45% drop in the Dow from January 1973 through December 1974. But that decline was extended over 23 months, not 12 months as in the current more precipitous drop. Moreover, that cyclical equity market decline hit bottom only four months before the recession ended. In the current recession, the economic decline is only now intensifying significantly and is likely to extend for a number quarters, quite probably through all of 2009 and perhaps into 2010. Given a typical 5 months between the end of the drop in equity prices and the subsequent end of the recession, it would seem to be far too soon ahead of the probable end of this extended recession for the cyclical decline in equities to come to an end. Even an optomistic view that put the end of the recession this Spring would place the bottom of the equity market decline at year end.
The current widespread and increasingly proliferating credit crunch and housing debacle are far more reminiscent of the the 1930s depression than of the typical post World War II recessions. If that is even an approximate template for the current cycle decline in equity prices, we are in for a further steep slide. In the March 1937 through March 1938 period the Dow fell 49%, while between September 1929 and July 1932 the drop was an horrendous 89%. Considering that despite colossal mistakes currently, we are still doing far more things right now than in the Depression. Thus a judgement call would suggest an equity price drop far closer to the 49% than the 89% ends of that unpleasant spectrum. But, that does not imply that prices will continue falling in a staight line. There are almost always sptacular bear market rallies on the way to the bottom. And sometimes those short-covering rallies are so virulent as to be mistaken for a cyclical turnaround.
To some observers, equity prices are already low enough to be considered highly attractive. And for some stocks the lows might even be in place, especially for some financials. But that is not a sufficient reason for the overall stock market decline to come to its cyclical end. Certainly not when the decline in corporate profits is projected to accelerate amidst an intensifying global recession, a consumer and business spending contraction, a worsening housing slump, a yet to be alleviated credit freeze and a commodity price slide.
Perhaps most worrisome is the historical precedent that seems to dictate that whenever the ten-year lagged average of the price-earnings ratio of the stock indices exceed 20, as they have in recent years, this measure ultimately falls to 9 or below. That was the experience following the above 20 price-earnings peaks in 1901, 1929 and 1966. And it is likely to also be the experience currently. To repeat that pattern would require a substantial drop from here, especially considering that corporate earnings are also receding.
The dividend return on equities is also still well below its historic mean, let alone the traditional rule of thumb rule that calls for buying equities only when the dividend return is 6%, and selling when the divdend return declines to 3%.
The dividend rate of return is still far from that traditional buying trigger.
As if this equity market plunge and the consequent loss of wealth was not enough of a source of financial and economic distress, the banking system is frozen. Because bank deposits are not completely insured, banks are fearful of an unanticipated run by large depositors (in excess of $250,000), as has occurred with investment banks , hedge funds and insurance companies. That risk encourages banks to conserve cash and short term assets instead of expanding lending. The reported US Treasury proposal to temporarily insure interbank lending would certainly help free up such lending. The injection of Government funds in the banking system would also help shore up bank solvency. However,there seems to be no end to the array of problems besetting the financial markets and the economy despite the desperate efforts of the authorities to solve them. Thus, I am far from optimistic over likely sustained rally prospects for the equity market or an early recovery in the economy.
Philip Braverman, President
Braverman Economic and Finance Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail address: philipbraverman@Gmail.com
The cyclical lows are virtually certain to be still ahead in the equity price indicies. This dire forecast is despite the steep declines of 18 percent last week in both the Dow and S&P 500 indicies, the worst one-week recession decline since 1933. Over the past twelve months, the Dow is down 40%, while the S&P 500 is down 43%. These twelve-month percentage drops now exceed the total cyclical equity market decline associated with every post World War II recession with the sole exception of the 45% drop in the Dow from January 1973 through December 1974. But that decline was extended over 23 months, not 12 months as in the current more precipitous drop. Moreover, that cyclical equity market decline hit bottom only four months before the recession ended. In the current recession, the economic decline is only now intensifying significantly and is likely to extend for a number quarters, quite probably through all of 2009 and perhaps into 2010. Given a typical 5 months between the end of the drop in equity prices and the subsequent end of the recession, it would seem to be far too soon ahead of the probable end of this extended recession for the cyclical decline in equities to come to an end. Even an optomistic view that put the end of the recession this Spring would place the bottom of the equity market decline at year end.
The current widespread and increasingly proliferating credit crunch and housing debacle are far more reminiscent of the the 1930s depression than of the typical post World War II recessions. If that is even an approximate template for the current cycle decline in equity prices, we are in for a further steep slide. In the March 1937 through March 1938 period the Dow fell 49%, while between September 1929 and July 1932 the drop was an horrendous 89%. Considering that despite colossal mistakes currently, we are still doing far more things right now than in the Depression. Thus a judgement call would suggest an equity price drop far closer to the 49% than the 89% ends of that unpleasant spectrum. But, that does not imply that prices will continue falling in a staight line. There are almost always sptacular bear market rallies on the way to the bottom. And sometimes those short-covering rallies are so virulent as to be mistaken for a cyclical turnaround.
To some observers, equity prices are already low enough to be considered highly attractive. And for some stocks the lows might even be in place, especially for some financials. But that is not a sufficient reason for the overall stock market decline to come to its cyclical end. Certainly not when the decline in corporate profits is projected to accelerate amidst an intensifying global recession, a consumer and business spending contraction, a worsening housing slump, a yet to be alleviated credit freeze and a commodity price slide.
Perhaps most worrisome is the historical precedent that seems to dictate that whenever the ten-year lagged average of the price-earnings ratio of the stock indices exceed 20, as they have in recent years, this measure ultimately falls to 9 or below. That was the experience following the above 20 price-earnings peaks in 1901, 1929 and 1966. And it is likely to also be the experience currently. To repeat that pattern would require a substantial drop from here, especially considering that corporate earnings are also receding.
The dividend return on equities is also still well below its historic mean, let alone the traditional rule of thumb rule that calls for buying equities only when the dividend return is 6%, and selling when the divdend return declines to 3%.
The dividend rate of return is still far from that traditional buying trigger.
As if this equity market plunge and the consequent loss of wealth was not enough of a source of financial and economic distress, the banking system is frozen. Because bank deposits are not completely insured, banks are fearful of an unanticipated run by large depositors (in excess of $250,000), as has occurred with investment banks , hedge funds and insurance companies. That risk encourages banks to conserve cash and short term assets instead of expanding lending. The reported US Treasury proposal to temporarily insure interbank lending would certainly help free up such lending. The injection of Government funds in the banking system would also help shore up bank solvency. However,there seems to be no end to the array of problems besetting the financial markets and the economy despite the desperate efforts of the authorities to solve them. Thus, I am far from optimistic over likely sustained rally prospects for the equity market or an early recovery in the economy.
Philip Braverman, President
Braverman Economic and Finance Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail address: philipbraverman@Gmail.com
Saturday, October 4, 2008
Even with the rescue package, a deepening recession is confirmed by the latest data
Expect the recession to worsen, the credit crunch to remain pronounced, corporate profits to weaken, equity prices to decline further and Treasury yields to trend lower with the decline in commodity prices and lessening in inflation. The yield spreads from Treasuries to lesser credits will continue wide or probably widen further as doubts over credit quality proliferate. And the Fed will ease further.
The enactment of the $700 billion Federal rescue package, together with $150 billion in other financial sweeteners, will only mitigate the severity of the deepening recession clealy evident in the latest slate of economic data.
The September employment report with its 159,000 drop in nonfarm payrolls, substantially worse than in preceding months, hints at worse to come. This is the average monthly level of nonfarm payroll declines in the last recession. Moreover, much of the rise in weekly initial claims for unemployment benefits came late in September, well after the roughly midmonth timing of the nonfarm payroll survey, For example, initial claims were at 497,000 in the week ending September 27, 496,000 in the week ending Septmber 20, clearly above rule of thumb recession levels, and up from 461,000 the week before. Thus, there is reason to expect the next nonfarm payroll drop, in the October report, to be at least as large if not larger than the latest plunge, especially with the Boeing strike. This appears confirmed by the Challanger, Grey and Christmas report of announced and planned layoffs, which are up a third from a year ago. With the credit crisis and consumer spending constraint, expect a continuing wave of layoffs even worse than the 159,000 in September.
Aggregate hours worked in the employment report declined in September, probably sufficient to create a slight negative in third quarter real GDP growth. That sets the stage for a more significant drop in fourth quarter real GDP growth despite the recent decline in energy prices.
The Institute for Supply Management manufacturing Index fell to sharply to 43.5 in September, below the 44 level that is considered a clear indication of recession.
Car sales plunged in recent months. Even with special sales incentives, GM sales were down sharply, though not as severly as the drop in Ford sales. Foreign car producers also experienced a considerable decline in their US sales. With the worsening credit crunch now affecting auto credit and consumers forced by adverse circumstance to curtail discretionary spending, there is every reason to expect the weak auto sales to persist for an extended period.
The stock market's continued selloff after the enactment of the Federal rescue package indicates that the market correctly expects that the set of initiatives will not prevent the credit crunch or the recession from continuing or deepening. The Federal efforts will not prevent home prices from declining further or materially lesson homeowner distress. Losses on mortgage paper will persist, as will the need for financial institutions to raise additional capital just in order to take losses. That is a long step away from an expansion of credit. The Fed will find it neceesary to lower the funds rate further, probably by at least a half percentage point.
The Friday decline in Treasury yields reinforces the view that Treasury yields are still in a downtrend even with the prospect of a substantial increase in borrowing. The reason is that inflation expectations, the prime determinant of Treasury yields, are declining with the deepening recession.
Philip Braverman, President
Braverman Economnic And Finance Consulting
One Hewitt Square #249
East Northport, New York 11731
E-Mail Address: philipbraverman@Gmail.com
The enactment of the $700 billion Federal rescue package, together with $150 billion in other financial sweeteners, will only mitigate the severity of the deepening recession clealy evident in the latest slate of economic data.
The September employment report with its 159,000 drop in nonfarm payrolls, substantially worse than in preceding months, hints at worse to come. This is the average monthly level of nonfarm payroll declines in the last recession. Moreover, much of the rise in weekly initial claims for unemployment benefits came late in September, well after the roughly midmonth timing of the nonfarm payroll survey, For example, initial claims were at 497,000 in the week ending September 27, 496,000 in the week ending Septmber 20, clearly above rule of thumb recession levels, and up from 461,000 the week before. Thus, there is reason to expect the next nonfarm payroll drop, in the October report, to be at least as large if not larger than the latest plunge, especially with the Boeing strike. This appears confirmed by the Challanger, Grey and Christmas report of announced and planned layoffs, which are up a third from a year ago. With the credit crisis and consumer spending constraint, expect a continuing wave of layoffs even worse than the 159,000 in September.
Aggregate hours worked in the employment report declined in September, probably sufficient to create a slight negative in third quarter real GDP growth. That sets the stage for a more significant drop in fourth quarter real GDP growth despite the recent decline in energy prices.
The Institute for Supply Management manufacturing Index fell to sharply to 43.5 in September, below the 44 level that is considered a clear indication of recession.
Car sales plunged in recent months. Even with special sales incentives, GM sales were down sharply, though not as severly as the drop in Ford sales. Foreign car producers also experienced a considerable decline in their US sales. With the worsening credit crunch now affecting auto credit and consumers forced by adverse circumstance to curtail discretionary spending, there is every reason to expect the weak auto sales to persist for an extended period.
The stock market's continued selloff after the enactment of the Federal rescue package indicates that the market correctly expects that the set of initiatives will not prevent the credit crunch or the recession from continuing or deepening. The Federal efforts will not prevent home prices from declining further or materially lesson homeowner distress. Losses on mortgage paper will persist, as will the need for financial institutions to raise additional capital just in order to take losses. That is a long step away from an expansion of credit. The Fed will find it neceesary to lower the funds rate further, probably by at least a half percentage point.
The Friday decline in Treasury yields reinforces the view that Treasury yields are still in a downtrend even with the prospect of a substantial increase in borrowing. The reason is that inflation expectations, the prime determinant of Treasury yields, are declining with the deepening recession.
Philip Braverman, President
Braverman Economnic And Finance Consulting
One Hewitt Square #249
East Northport, New York 11731
E-Mail Address: philipbraverman@Gmail.com
Saturday, September 27, 2008
The rescue package will not end financial distress, the credit crunch or recession
The credit crunch will persist. Banks, other lenders and borrowers are scrambling for liquidity, deposits, borrowings and especially capital. Even the markets for commercial paper and other short funding are exhibiting pronounced signs of distress. Capital infusions are a necessary prerequisite for the survival of publicly owned financial institutions that hold distressed mortgages or mortgage-related debts so as to be able to take the asset-loss writedowns required. Even with injections of additional capital there is unlikely to be an adequate expansion of credit to reverse the credit contraction that has already occured. The sub-prime and Alt-A categories of borrowers can no longer secure credit. Credit standards have been tightened even for prime mortgage borrowers. Investment banks with their excessive leverage of assets to capital as a category have ceased to exist, either through failure or by becoming banks or bank subsidiares. Now other financial institutions from hedge funds to insurance companies have become far more cautious lenders and investors. That in turn appears to be triggering precautionary borrowering and funding concerns on the part of nonfincial businesses.
The housing sector is still in retreat. Home prices are falling and destined to fall further, perhaps twice as far as they have already retreated. That seems a reasonable conclusion considering home mortgage defaults and foreclosures are still soaring, which together with the large inventory of unsold homes, will place an inevitable further downward pressure on home prices. And mortgage funds along with other types of credit remains constrained.
Auto credit and credit card debt are experiencing rising delinquencies and defaults. That is to be expected to not only persist but worsen with the prospect of a consumer led deepening of the recession.
Employment will continue to contract in next weeks Bureau of Labor Statistics nonfarm payroll report for September. Given the spurt in initial claims for unemployment benefits that came too late in the month to be included in the coming September employment report, the October employment report is likely to reveal another sharp decline in nonfarm payrolls. Though the official unemployment rate is likely to remain at 6.1% in the September report, it will rise materially in coming months, probably eventually to 7%. But, in realty the unemployment rate is already some 10% of the labor force, including those who for economic reasons have taken part-time or temporary work and those who have been so discouraged by the absence of job opportunities that they have given up looking for employment.
Even if the Federal rescue package is enacted, it will not be the panecea that many mistakenly believe it to be.
First, there are some things that the heart of the Federal plan, the purchase of distressed mortgage assets, would do. It would help rejuvinate the now virtually nonfunctioning market for mortgage-related assets. JP Morgan Chase estimates that its losses on the Washington Mutual mortgages it has acquired in the takeover will be as high as 54 cents on the dollr on subprime, 31 percent of home-equity loans, 25 percent of option ARMS, but only 9 cents on the dollar of other mortgages. Yet when trades can be made, the prices of mortgage potfolios have been as low as some 22 to 35 cents on the dollar even for mortgage pools that for the most part are not in default and still paying. If the mortgage market was functioning properly, prices for some mortgage paper might be closer to 80 cents on the dollar, based on their projected eventual recovery rate.
Because of that huge disparity and the distructive mark-to-market requirement for valuing assets at their currently depressed prices, the charge-offs against capital are large enough to materially increase the risk of bankruptcy for financial institutions with substantial mortgage holdings. The Federal rescue plan will help set a price for distressed mortgages and mortgage related paper that is closer to its ultimate pay-off value than to its current panic fire-sale liquidation price.
While the Federal rescue package will undoubtedly be useful, it will not end the problems besetting financial institutions, especially the need for additional capital with which to write off losses, the consequent credit squeeze, the housing price decline and the recession. It would only mitigate the severity of the economic and financial contraction that would otherwise occur. As I indicated in previous weeks,there should be a Federal program that attempts to stabilize home prices, perhaps by buying them for future sale at a profit, and at least a temporary suspension of mark-to market requirements. Offering Federal funds to provide short term capital through preferred stock with warrants(as Warren Buffet provided Goldman Sachs) would prove effective.
Nevertheless, the passage of the Federal rescue plan is likely to produce a brief rally in the equity market in the mistaken hope that the initiative will be sufficient to resolve the economy's and financial markets' ills. It won't.
The cyclical lows in corporate profits, equity prices, Treasury bond yields, and inflation still lie well ahead.
Philip Braverman, President
Braverman Economic and Finance Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail Address: philipbraverma@Gmail.com
The housing sector is still in retreat. Home prices are falling and destined to fall further, perhaps twice as far as they have already retreated. That seems a reasonable conclusion considering home mortgage defaults and foreclosures are still soaring, which together with the large inventory of unsold homes, will place an inevitable further downward pressure on home prices. And mortgage funds along with other types of credit remains constrained.
Auto credit and credit card debt are experiencing rising delinquencies and defaults. That is to be expected to not only persist but worsen with the prospect of a consumer led deepening of the recession.
Employment will continue to contract in next weeks Bureau of Labor Statistics nonfarm payroll report for September. Given the spurt in initial claims for unemployment benefits that came too late in the month to be included in the coming September employment report, the October employment report is likely to reveal another sharp decline in nonfarm payrolls. Though the official unemployment rate is likely to remain at 6.1% in the September report, it will rise materially in coming months, probably eventually to 7%. But, in realty the unemployment rate is already some 10% of the labor force, including those who for economic reasons have taken part-time or temporary work and those who have been so discouraged by the absence of job opportunities that they have given up looking for employment.
Even if the Federal rescue package is enacted, it will not be the panecea that many mistakenly believe it to be.
First, there are some things that the heart of the Federal plan, the purchase of distressed mortgage assets, would do. It would help rejuvinate the now virtually nonfunctioning market for mortgage-related assets. JP Morgan Chase estimates that its losses on the Washington Mutual mortgages it has acquired in the takeover will be as high as 54 cents on the dollr on subprime, 31 percent of home-equity loans, 25 percent of option ARMS, but only 9 cents on the dollar of other mortgages. Yet when trades can be made, the prices of mortgage potfolios have been as low as some 22 to 35 cents on the dollar even for mortgage pools that for the most part are not in default and still paying. If the mortgage market was functioning properly, prices for some mortgage paper might be closer to 80 cents on the dollar, based on their projected eventual recovery rate.
Because of that huge disparity and the distructive mark-to-market requirement for valuing assets at their currently depressed prices, the charge-offs against capital are large enough to materially increase the risk of bankruptcy for financial institutions with substantial mortgage holdings. The Federal rescue plan will help set a price for distressed mortgages and mortgage related paper that is closer to its ultimate pay-off value than to its current panic fire-sale liquidation price.
While the Federal rescue package will undoubtedly be useful, it will not end the problems besetting financial institutions, especially the need for additional capital with which to write off losses, the consequent credit squeeze, the housing price decline and the recession. It would only mitigate the severity of the economic and financial contraction that would otherwise occur. As I indicated in previous weeks,there should be a Federal program that attempts to stabilize home prices, perhaps by buying them for future sale at a profit, and at least a temporary suspension of mark-to market requirements. Offering Federal funds to provide short term capital through preferred stock with warrants(as Warren Buffet provided Goldman Sachs) would prove effective.
Nevertheless, the passage of the Federal rescue plan is likely to produce a brief rally in the equity market in the mistaken hope that the initiative will be sufficient to resolve the economy's and financial markets' ills. It won't.
The cyclical lows in corporate profits, equity prices, Treasury bond yields, and inflation still lie well ahead.
Philip Braverman, President
Braverman Economic and Finance Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail Address: philipbraverma@Gmail.com
Saturday, September 20, 2008
Despite equity market euphoria, the worst is ahead for stocks, the economy and credit
Equity prices will decline anew, not only testing old price lows but setting new ones. The US and global recession will worsen. Unemployment will continue rising. The consumer will sharply curtail spending. Commodity prices will trend lower, with gold a possible exception. Credit will remain constrained. That all adds up to persistant and intense problems for financial institutions, business, governments and consumers. The worse is yet to come. I cannot make it any clearer than that.
Treasury yields will decline anew, though a return to the zero rate on Treasury bill yields on the panic flight to quality this past week is unlikely. A decline in inflation fears is likely to outweigh the increased volume of Treasury borrowing, at least for a year or possibly two beyond the recession. The Fed is virtually certain to be forced by circumstances to ease further.
Quality yield spreads will widen. There will be additional financial institution bankruptcies. Indeed, the Administration will be looking for financial bankruptcies to accept, those that do not threaten to destroy the global financial marketplace. The Admistration still wants to subscribe to the view that bankruptcies serve a useful purpose in capitalism, as well as avoiding the appearance of promoting the so called "moral hazard" risk that even incompetence will be bailed out. Losses are likely to force the FDIC to borrow from the Treasury to shore up its asset base. The Federal effort to quarantee money market funds will benefit brokerage firms at the expense of banks.
Corporate profits will erode, even with the slide off in commodity prices. The reason of course is that global demands for goods will slacken, intensifying competition. There has been a speculative over-expansion across the globe. Even China has its share of vacant speculative real estate. So far there is no proposal to significantly ameliorate soaring US home foreclosures and forced US bank sales of such foreclosed properties. The FDIC ended foreclosures at Indymac, the bank it siezed. Such a moritorium on foreclosures of occupied homes when homeowners were making good faith efforts to be current on their mortgages was the pattern when the FDIC was first organized late in the depression. It is time to resurrect that practice.
Do not be misled by the spectacular equity market rally toward weeks end and the lessening in the flight to quality amidst pronounced credit market fears. It will not last. The favorable Thursday and Friday market developments were largely due to a panic short-covering rally on a temporary ban on shorting 799 financial equities (until October 2) and market relief on the proposed $700 billion two-year Resolution Trust Company-type Federal bailout of Wall Street, as well as other forms of financial institution problem solving. The heart of the proposal is the Federal government purchase of up to $700 billion of the possible two to four trillion dollars in distressed mortgages and other related financial instruments currently worth 80 cents or far less on the dollar. The purchases will relieve the pressure on beleagured financial institutions. At the same time it is hoped that the distressed assets will eventually improve in value and price so that the net loss on the Federal purchases are minimal. The Federal entity will presumably not be subject to the disasterous mark-to-market rules that deprive non-Federal corporations of capital.
As far reaching as the new intiatives may seem, the favorable market responses thus far are likely to prove only temporary. Even if the Treasury-Fed proposals are enacted, by no means a certainty, they will not address the deepening global recession, the continuing real estate price contraction and the still intense credit crunch. And they will not solve all the financial industry problems. Far from it. The bailout or takeover of AIG will turn out to be more the exception than the rule. Rather, the acquisition of Merrill by Bank of America is more likely to set the pattern for the resolution of further distressed financial institutions. Thus, the equity market rally is best viewed as a welcome opportunity to raise cash. Even the perennially bullish Jim Cramer of CNBC Mad Money recommended selling twenty percent of your equity holdings on Monday, especially of newly reflated financial institution stocks.
The necessary deleveraging of the debt-bloated financial industry will continue. The requirement to write down the market value of depressed assets even when there is no effective market for those assets under the pernicious mark-to-market rules remains a destructive force in the viability of financial institutions. Thus, unless mark-to- market write downs are at least temporarily suspended, the need for substantial new capital infusions will persist, a prerquisite for recognizing losses. Despite the proposed Federal purchases of distressed assets, the sales of those financial assets will still be at considerable losses. Credit growth will thereby remain contrained. And with credit growth the key determinant of economic activity, that credit contraction will comensurately depress economic growth.
The signs of deepening recession abound. The index of leading indicators is still falling. Industrial production is dropping. The consumer is retrenching. The housing sector is still deteriorating. Home prices nationwide are only down about half as far as they will ultimately fall. Car sales will weaken further. Indeed, the recession will likely persist throughout 2009 and perhaps into 2010. That exceptionally prolonged recession will markedly slow the rate of inflation, both overall and core.
Philip Braverman,President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail address:philipbraverman@Gmail.com
Treasury yields will decline anew, though a return to the zero rate on Treasury bill yields on the panic flight to quality this past week is unlikely. A decline in inflation fears is likely to outweigh the increased volume of Treasury borrowing, at least for a year or possibly two beyond the recession. The Fed is virtually certain to be forced by circumstances to ease further.
Quality yield spreads will widen. There will be additional financial institution bankruptcies. Indeed, the Administration will be looking for financial bankruptcies to accept, those that do not threaten to destroy the global financial marketplace. The Admistration still wants to subscribe to the view that bankruptcies serve a useful purpose in capitalism, as well as avoiding the appearance of promoting the so called "moral hazard" risk that even incompetence will be bailed out. Losses are likely to force the FDIC to borrow from the Treasury to shore up its asset base. The Federal effort to quarantee money market funds will benefit brokerage firms at the expense of banks.
Corporate profits will erode, even with the slide off in commodity prices. The reason of course is that global demands for goods will slacken, intensifying competition. There has been a speculative over-expansion across the globe. Even China has its share of vacant speculative real estate. So far there is no proposal to significantly ameliorate soaring US home foreclosures and forced US bank sales of such foreclosed properties. The FDIC ended foreclosures at Indymac, the bank it siezed. Such a moritorium on foreclosures of occupied homes when homeowners were making good faith efforts to be current on their mortgages was the pattern when the FDIC was first organized late in the depression. It is time to resurrect that practice.
Do not be misled by the spectacular equity market rally toward weeks end and the lessening in the flight to quality amidst pronounced credit market fears. It will not last. The favorable Thursday and Friday market developments were largely due to a panic short-covering rally on a temporary ban on shorting 799 financial equities (until October 2) and market relief on the proposed $700 billion two-year Resolution Trust Company-type Federal bailout of Wall Street, as well as other forms of financial institution problem solving. The heart of the proposal is the Federal government purchase of up to $700 billion of the possible two to four trillion dollars in distressed mortgages and other related financial instruments currently worth 80 cents or far less on the dollar. The purchases will relieve the pressure on beleagured financial institutions. At the same time it is hoped that the distressed assets will eventually improve in value and price so that the net loss on the Federal purchases are minimal. The Federal entity will presumably not be subject to the disasterous mark-to-market rules that deprive non-Federal corporations of capital.
As far reaching as the new intiatives may seem, the favorable market responses thus far are likely to prove only temporary. Even if the Treasury-Fed proposals are enacted, by no means a certainty, they will not address the deepening global recession, the continuing real estate price contraction and the still intense credit crunch. And they will not solve all the financial industry problems. Far from it. The bailout or takeover of AIG will turn out to be more the exception than the rule. Rather, the acquisition of Merrill by Bank of America is more likely to set the pattern for the resolution of further distressed financial institutions. Thus, the equity market rally is best viewed as a welcome opportunity to raise cash. Even the perennially bullish Jim Cramer of CNBC Mad Money recommended selling twenty percent of your equity holdings on Monday, especially of newly reflated financial institution stocks.
The necessary deleveraging of the debt-bloated financial industry will continue. The requirement to write down the market value of depressed assets even when there is no effective market for those assets under the pernicious mark-to-market rules remains a destructive force in the viability of financial institutions. Thus, unless mark-to- market write downs are at least temporarily suspended, the need for substantial new capital infusions will persist, a prerquisite for recognizing losses. Despite the proposed Federal purchases of distressed assets, the sales of those financial assets will still be at considerable losses. Credit growth will thereby remain contrained. And with credit growth the key determinant of economic activity, that credit contraction will comensurately depress economic growth.
The signs of deepening recession abound. The index of leading indicators is still falling. Industrial production is dropping. The consumer is retrenching. The housing sector is still deteriorating. Home prices nationwide are only down about half as far as they will ultimately fall. Car sales will weaken further. Indeed, the recession will likely persist throughout 2009 and perhaps into 2010. That exceptionally prolonged recession will markedly slow the rate of inflation, both overall and core.
Philip Braverman,President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail address:philipbraverman@Gmail.com
Saturday, September 13, 2008
Concerns over financial firms will continue to roil market after Lehman
Every time there is yet another financial crisis many in the market mistakenly assume that the worst has finally passed. But the underlying problems besetting the financial markets, banks, investment banks, and insurance companies, among others, are destined to continue until their root causes are effectively dealt with. More about that later.
This past week, the markets' concerns focused primarily on the desperate travails of Lehman Brothers holdings in their effort to survive. Fears of the market dislocations that would ensue in the wake of the firm's failure drove Federal authorities to attempt to broker their acquisition by a white knight. The Bank of America was prominently mentioned as the potential acquirer. Others,including two UK financial institutions, have also been reported to be actively pursuing a purchase, But a sticking point is reportedly a requirement of acquirers that Treasury funds be made available to offset losses, which Federal authorities refuse to commit yet again. Lehman has been attempting to tough it out and delay, both in writing down its assets and attempting to raise new capital in a decidedly unfriendly market At one point late this week, Lehman bonds were offered at eye-popping yields in the high 30% to low 40% range. To delay further, Lehman is reportedly offering to sell one or more of its prize assets.
It was only the week before last week that market concerns were centered on the survival of Fannie Mae and Freddie Mac and the cascading negative consequences of their threatened demise. That crisis was resolved by putting the mortgage giants into Federal conservership, a politically more acceptable eupheumism for effective nationalization.
After the fears focused on Lehman, Merrill, AIG or Wahington Mutual subside there will be new targets for the potential disaster scenario. The basic reason is that the basic underlying problems are not being addressed, nor is there any sign that they are even adequately recognized. It is no solution to the problem to promise appropriate regulation next time. Or to shore up financial instutions overburdend with losses by injecting sufficient Federal or foreign capital to allow the write down of depressed assets. Those lines of attacking the current array of financial instution problems are no more effective than locking the barn door after the proverbial horse has been stolen or postponing the point of crisis to another day.
As helpful as the various initiatives may be in avoiding an immediate financial calamity, they will not resolve the problems.
The underlying problem is first and foremost a continuing plunge in real estate prices. From that stems all the other problems. Solve that problem and all the other will at least abate if not be rapidly on their way to being resolved. There are any number ways to stem the drop in home prices. With subprime and Alt-A borrowers out of the picture and a worsening credit crunch, new home purchasers and a source of investable funds have to be found. That is all more difficult at this juncture given the rapidly worsening job picture, which is traditionally closly tied to home demand and home prices. The consumer is retrenching as evidenced by the decline in retail sales reported this past week.
The Federal government could take a role by stockpiling vacant homes that could then be rented or sold at favorable terms with a Federal equity participation. A mere active Congressional move in that direction could well be enough to spur vulture funds to buy the large volume of vacant speculator-purchased homes available for sale or foreclosed. State and local governments, paricularly in those states and locals where real estate speculative builing was most intense, should also be active in buying up vacant properties at depressed prices, issuing bonds for the purpose if other funds are unavailable.
Financial institutions should, for the duration of the crisis, be no longer required to mark down assets to market or promptly sell foreclosed properties. Foreign purchasers of homes with substantial down-payments could be fast tracked for approval by homeland security for the right to live in the home. That is a varient on the option given Hong Kong residents, prior to China's take-over of Hong Kong, to gain Canadian citizenship if they invested a substaial sum in a Canadian business. If a concerted effort is made to arrest the plunge in home prices, the crisis can be brought to an earlier and far less onerous conclusion than is otherwise likely.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
This past week, the markets' concerns focused primarily on the desperate travails of Lehman Brothers holdings in their effort to survive. Fears of the market dislocations that would ensue in the wake of the firm's failure drove Federal authorities to attempt to broker their acquisition by a white knight. The Bank of America was prominently mentioned as the potential acquirer. Others,including two UK financial institutions, have also been reported to be actively pursuing a purchase, But a sticking point is reportedly a requirement of acquirers that Treasury funds be made available to offset losses, which Federal authorities refuse to commit yet again. Lehman has been attempting to tough it out and delay, both in writing down its assets and attempting to raise new capital in a decidedly unfriendly market At one point late this week, Lehman bonds were offered at eye-popping yields in the high 30% to low 40% range. To delay further, Lehman is reportedly offering to sell one or more of its prize assets.
It was only the week before last week that market concerns were centered on the survival of Fannie Mae and Freddie Mac and the cascading negative consequences of their threatened demise. That crisis was resolved by putting the mortgage giants into Federal conservership, a politically more acceptable eupheumism for effective nationalization.
After the fears focused on Lehman, Merrill, AIG or Wahington Mutual subside there will be new targets for the potential disaster scenario. The basic reason is that the basic underlying problems are not being addressed, nor is there any sign that they are even adequately recognized. It is no solution to the problem to promise appropriate regulation next time. Or to shore up financial instutions overburdend with losses by injecting sufficient Federal or foreign capital to allow the write down of depressed assets. Those lines of attacking the current array of financial instution problems are no more effective than locking the barn door after the proverbial horse has been stolen or postponing the point of crisis to another day.
As helpful as the various initiatives may be in avoiding an immediate financial calamity, they will not resolve the problems.
The underlying problem is first and foremost a continuing plunge in real estate prices. From that stems all the other problems. Solve that problem and all the other will at least abate if not be rapidly on their way to being resolved. There are any number ways to stem the drop in home prices. With subprime and Alt-A borrowers out of the picture and a worsening credit crunch, new home purchasers and a source of investable funds have to be found. That is all more difficult at this juncture given the rapidly worsening job picture, which is traditionally closly tied to home demand and home prices. The consumer is retrenching as evidenced by the decline in retail sales reported this past week.
The Federal government could take a role by stockpiling vacant homes that could then be rented or sold at favorable terms with a Federal equity participation. A mere active Congressional move in that direction could well be enough to spur vulture funds to buy the large volume of vacant speculator-purchased homes available for sale or foreclosed. State and local governments, paricularly in those states and locals where real estate speculative builing was most intense, should also be active in buying up vacant properties at depressed prices, issuing bonds for the purpose if other funds are unavailable.
Financial institutions should, for the duration of the crisis, be no longer required to mark down assets to market or promptly sell foreclosed properties. Foreign purchasers of homes with substantial down-payments could be fast tracked for approval by homeland security for the right to live in the home. That is a varient on the option given Hong Kong residents, prior to China's take-over of Hong Kong, to gain Canadian citizenship if they invested a substaial sum in a Canadian business. If a concerted effort is made to arrest the plunge in home prices, the crisis can be brought to an earlier and far less onerous conclusion than is otherwise likely.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Saturday, September 6, 2008
Expected support for Freddie and Fannie delays equity selloff on employment plunge
The markets were in the midst of an adverse reaction to the August surge in the unemployment rate on Friday when reports surfaced of a possible US Treasury bail-out of Fannie Mae and Freddie Mac. That was enough to turn a sharp equity market selloff into a small gain and reverse a flight to the safety in Treasuries. But, unfortunately, those late Friday reactions are temporary.
The Treasury will certainly attempt to bolster the two mortgage entities sufficiently to keep them afloat and their debts liquid, but it is highly unlikely to want to nationalize them and then go on the major expansion necessary to revitalize the housing market. That would make too much sense in the midst of the worst financial crisis since the great depression. After all, the Treasury Secretary headed up Goldman Sacks when that firm, along with the rest of the financial community, inept regulators, including the Fed, and Congress, was contributing to the irresponsible financial engineering that Warren Buffet has called "weapons of mass destruction". And mass destruction they have wrought. But the process of distruction is far from over.
What forced the Treasury to act were signs that an international central bank flight from Fannie and Freddie paper to US Treasuries was beginning. There is an international agreement that each country is responsible for stemming a domestic financial meltdown that could disrupt the functioning of the international financial market. And a collapse of the $10 Trillion plus housing paper market would certainly fit that definition, and then some.
Even with Treasury action, US and global financial problems will persist. Thus far, the recognized financial institution losses and writedowns have totaled some $500 billion globally. The total will probably reach at least twice that, some one trillion dollars or more. That will certainly put a crimp in credit availability and thereby dampen economic global growth, what there will be left of it. It is my view that as credit availability goes, so goes economic growth. I know that for monetarists it borders on heresy to say that it is not money growth, but credit expansion that is the key determinant of economic growth. Milton Friedman misspecified early credit data as money. But it makes little differnce. Both money and credit growth will slow sharply as a result of the reckless squandering of our financial integrity for what, short-term profits. Foreigners sold us televions and cars that are still functioning in exchange for our financial toxic waste.
What should we do now? We should recognize that first and foremost it is necessary to stem the plunge in home prices. Focus on that objective. As unpleasant a prospect as Government purchase of private assets may be in a capitalist society, that is one solution. Increase Federal grants to state and local governments to purchase vacant properties to be made available for purchase on favorable terms to needy families. There should also be a halt to foreclosures on any occupied home that the owner is making a good faith effort to keep. This was the approach taken by the FDIC when it was first organized. Banks should no longer be forced to quickly sell homes they have acquired or mark down to market assets for which there is virtually no market. Both requirements are counterproductive in this environment. They only serve to further depress home and financial asset prices. Unless and until such actions are taken the losses will continue to mount, forcing more and more financial institutions to the wall, increasing investing caution to the point of decision making paralysis.
The signs of a deepening US and global recession are proliferating. The jump in the unemployment rate to 6.1% in August from 5.7% in July reflected a 342,000 drop in August employment in the household survey. That usually more reliable indication of employment loss in recessions suggests the Bureau of Labor Statistics officially estimated 84,000 August drop in nonfarm payrolls, after a 100,000 drop in June and 60,000 in July, grossly understates the actual deterioration in the labor market. One reason: this latest nonfarm payroll estimate is after deducting an assumed 125,000 quessed rise in nonsurveyed employment at new small businesses. Thus, without this wrongheaded guess, there was actually a 209,000 August drop in surveyed nonfarm payrolls.
By some measures, the unemployed, underemployed and discouraged workers in aggregate constitute more than ten percent of the labor force, and rising towards 11 percent. Commodity demand and prices are in a recessionary retreat. That may improve the earnings outlook for some stressed manufacturers squeezed between consumer price resistance and rising commodity costs. But, the realty remains that despite that positive, the overall corporate earnings outlook will continue to fade amidst a deepening recession.
The dollar will continue to strengthen. Not because our recession is ending, far from it. But, rather because the UK, continental european and Japanese recessions are just beginning, with the economy of Russia and Asia at the very least slowing. Commodity prices will continue retreating. That will produce a significant slowing in inflation and inflation expectations. The equity market will trend lower, not only retesting, but piercing the previous cyclical lows, along with Treasury yields. The Fed will remain on hold until the pace of bank failures intensifies, probably leading to at least two quarter percentage point Fed easing moves. There is much financial pain still to come.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
Email address: philipbraverman@Gmail.com
The Treasury will certainly attempt to bolster the two mortgage entities sufficiently to keep them afloat and their debts liquid, but it is highly unlikely to want to nationalize them and then go on the major expansion necessary to revitalize the housing market. That would make too much sense in the midst of the worst financial crisis since the great depression. After all, the Treasury Secretary headed up Goldman Sacks when that firm, along with the rest of the financial community, inept regulators, including the Fed, and Congress, was contributing to the irresponsible financial engineering that Warren Buffet has called "weapons of mass destruction". And mass destruction they have wrought. But the process of distruction is far from over.
What forced the Treasury to act were signs that an international central bank flight from Fannie and Freddie paper to US Treasuries was beginning. There is an international agreement that each country is responsible for stemming a domestic financial meltdown that could disrupt the functioning of the international financial market. And a collapse of the $10 Trillion plus housing paper market would certainly fit that definition, and then some.
Even with Treasury action, US and global financial problems will persist. Thus far, the recognized financial institution losses and writedowns have totaled some $500 billion globally. The total will probably reach at least twice that, some one trillion dollars or more. That will certainly put a crimp in credit availability and thereby dampen economic global growth, what there will be left of it. It is my view that as credit availability goes, so goes economic growth. I know that for monetarists it borders on heresy to say that it is not money growth, but credit expansion that is the key determinant of economic growth. Milton Friedman misspecified early credit data as money. But it makes little differnce. Both money and credit growth will slow sharply as a result of the reckless squandering of our financial integrity for what, short-term profits. Foreigners sold us televions and cars that are still functioning in exchange for our financial toxic waste.
What should we do now? We should recognize that first and foremost it is necessary to stem the plunge in home prices. Focus on that objective. As unpleasant a prospect as Government purchase of private assets may be in a capitalist society, that is one solution. Increase Federal grants to state and local governments to purchase vacant properties to be made available for purchase on favorable terms to needy families. There should also be a halt to foreclosures on any occupied home that the owner is making a good faith effort to keep. This was the approach taken by the FDIC when it was first organized. Banks should no longer be forced to quickly sell homes they have acquired or mark down to market assets for which there is virtually no market. Both requirements are counterproductive in this environment. They only serve to further depress home and financial asset prices. Unless and until such actions are taken the losses will continue to mount, forcing more and more financial institutions to the wall, increasing investing caution to the point of decision making paralysis.
The signs of a deepening US and global recession are proliferating. The jump in the unemployment rate to 6.1% in August from 5.7% in July reflected a 342,000 drop in August employment in the household survey. That usually more reliable indication of employment loss in recessions suggests the Bureau of Labor Statistics officially estimated 84,000 August drop in nonfarm payrolls, after a 100,000 drop in June and 60,000 in July, grossly understates the actual deterioration in the labor market. One reason: this latest nonfarm payroll estimate is after deducting an assumed 125,000 quessed rise in nonsurveyed employment at new small businesses. Thus, without this wrongheaded guess, there was actually a 209,000 August drop in surveyed nonfarm payrolls.
By some measures, the unemployed, underemployed and discouraged workers in aggregate constitute more than ten percent of the labor force, and rising towards 11 percent. Commodity demand and prices are in a recessionary retreat. That may improve the earnings outlook for some stressed manufacturers squeezed between consumer price resistance and rising commodity costs. But, the realty remains that despite that positive, the overall corporate earnings outlook will continue to fade amidst a deepening recession.
The dollar will continue to strengthen. Not because our recession is ending, far from it. But, rather because the UK, continental european and Japanese recessions are just beginning, with the economy of Russia and Asia at the very least slowing. Commodity prices will continue retreating. That will produce a significant slowing in inflation and inflation expectations. The equity market will trend lower, not only retesting, but piercing the previous cyclical lows, along with Treasury yields. The Fed will remain on hold until the pace of bank failures intensifies, probably leading to at least two quarter percentage point Fed easing moves. There is much financial pain still to come.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
Email address: philipbraverman@Gmail.com
Saturday, August 30, 2008
Key economic data worsen, despite an optmistic misreading by some observers
Optimists were crowing over some superficially hopeful economic signs reported this past week. However, instead of a portant of better times ahead, taken together, the data confirm an almost certain deepening of the US and global recession.
First, the misleading but seemingly positive good news. Second quarter real GDP was officially reported to have increased 3.3%, up from the 1.9% rise previously estimated. Some observers foolishly pronounced "the recession that never was is now over". In realty the recession is only now beginning in earnest. Indeed, the economy is likely to be far worse in 2009 than in 2008.
The 3.3% second quarter real GDP rise was inflated by tax rebate boosted consumer spending, as well as by exports, that were temporarily spurred by both the weaker dollar and the runup to the Olympics. In the current quarter the global economy's strength is eroding, curtaling the demand for our exports.
In addition, an almost certain conceptional error in underestimating the GDP deflator artificially overstates the real GDP growth rate. The undereporting of inflation in the GDP deflator, that I indicated weeks ago and in earlier reports, stems from rapidly rising import prices in the second quarter that are deducted from total inflation to determine the rate of domestic inflation. In the process, domestic inflation was understated and real GDP inflated.
Ironically, when the rate of increase in import prices slows, as they have thus far in the third quarter, the calculations may well produce a consequent step-up in the rise in domestic inflation. And that would tend to depress real GDP, probably enough to produce outright declines. Indeed, without the special factors that boosted second quarter real GDP, it would also have shown a decline.
July existing home sales rose a welcome 3.1% from June. That and other faint signs of improvement have led some observers to mistakenly conclude that the housing sector is finally bottoming. That elusive development is still far off considering the impressive array of housing market negatives. Though existing home sales rose to a 5 million seasonally adjusted annual rate in July, that is still well under the 6.5million rate in 2006 and early 2007. The inventory of unsold homes is continuing to rise, reaching an 11.2 months rate at the current sales pace, up 1.7 months from a year ago. Also, with foreclosures still rising, mortgage credit constrained and retreating employment, among other market negatives, the housing outlook continues bleak.
Among the key economic negative reports this week there was one standout. Personal income declined 0.7% in July even with the last remnants of the tax rebates. The bulk of those tax rebates were paid out in May, boosting personal income by 1.8%. In July, without those rebates and after income taxes, disposable personal income declined 0.5%. Now, with the tax rebates behind us and a continuing retreat in employment and slow wage gains, we are probably just at the beginning of a sustained retreat in personal consumer income and consumer spending.
The recession will become sufficiently evident to not only quell inflation fears and reignite disinflation fears but produce new major financial institution crises that, surprise, will probably even lead to expectations of additional Fed easing.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address:philipbraverman@Gmail.com
First, the misleading but seemingly positive good news. Second quarter real GDP was officially reported to have increased 3.3%, up from the 1.9% rise previously estimated. Some observers foolishly pronounced "the recession that never was is now over". In realty the recession is only now beginning in earnest. Indeed, the economy is likely to be far worse in 2009 than in 2008.
The 3.3% second quarter real GDP rise was inflated by tax rebate boosted consumer spending, as well as by exports, that were temporarily spurred by both the weaker dollar and the runup to the Olympics. In the current quarter the global economy's strength is eroding, curtaling the demand for our exports.
In addition, an almost certain conceptional error in underestimating the GDP deflator artificially overstates the real GDP growth rate. The undereporting of inflation in the GDP deflator, that I indicated weeks ago and in earlier reports, stems from rapidly rising import prices in the second quarter that are deducted from total inflation to determine the rate of domestic inflation. In the process, domestic inflation was understated and real GDP inflated.
Ironically, when the rate of increase in import prices slows, as they have thus far in the third quarter, the calculations may well produce a consequent step-up in the rise in domestic inflation. And that would tend to depress real GDP, probably enough to produce outright declines. Indeed, without the special factors that boosted second quarter real GDP, it would also have shown a decline.
July existing home sales rose a welcome 3.1% from June. That and other faint signs of improvement have led some observers to mistakenly conclude that the housing sector is finally bottoming. That elusive development is still far off considering the impressive array of housing market negatives. Though existing home sales rose to a 5 million seasonally adjusted annual rate in July, that is still well under the 6.5million rate in 2006 and early 2007. The inventory of unsold homes is continuing to rise, reaching an 11.2 months rate at the current sales pace, up 1.7 months from a year ago. Also, with foreclosures still rising, mortgage credit constrained and retreating employment, among other market negatives, the housing outlook continues bleak.
Among the key economic negative reports this week there was one standout. Personal income declined 0.7% in July even with the last remnants of the tax rebates. The bulk of those tax rebates were paid out in May, boosting personal income by 1.8%. In July, without those rebates and after income taxes, disposable personal income declined 0.5%. Now, with the tax rebates behind us and a continuing retreat in employment and slow wage gains, we are probably just at the beginning of a sustained retreat in personal consumer income and consumer spending.
The recession will become sufficiently evident to not only quell inflation fears and reignite disinflation fears but produce new major financial institution crises that, surprise, will probably even lead to expectations of additional Fed easing.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address:philipbraverman@Gmail.com
Friday, August 22, 2008
The US recession will be increasingly evident in the data for second half 2008
The US recession will deepen in the second half of 2008. Indeed, there is no sign of a cyclical economic recovery even on the distant horizon. That is the clear conclusion from recent economic reports, continuing financial industry problems and the absence of any effective means in sight for quelling the cascading economic and financial preoblems besetting the US and global economy.
The outsized 0.7% one-month July plunge in the the Conference Board's index of leading indicators, down 4.4% from a year ago, ominously suggests a steepening in the pace of economic deterioration over the next six months. The four week moving average of initial claims for unemployment benefits is firmly in the traditional recession territory of 400,000 plus claimants. This portends a steeper decline in nonfarm payrolls in the next employment report and a continuing rise in the unemployment rate. The US recession is barely beginning. It will widen far beyond housing and the financial community.
The outlook is for further declines in home prices as the still huge excess supply of unsold homes, mortgage defaults and forclosures weighs on the real estate market. The nationwide home price decline is likely to range from 30% to 40%, roughly twice or more the decline thus far. The availability of home mortgage credit remains contrained for all but those with the most pristine credit. Fannie Mae and Fredie Mac and other mortgage market participants remain overburdened with losses as even prime mortgages taken out in recent years are increasingly delinquent. Fannie Mae and Freddie Mac are destined for increased Government involvement, if not an outright Federal takeover. Warren Buffet put it succinctly with his comment "game over" alluding to the two GSE mortgage firms that in recent days had reportedly unsucessfully approached private sources for long-term assistance. The yield speads on these institutions paper relative to Treasuries is widening appreciably. Even with a presumed Treasury guarantee, this past week the Freddie Mac five year yield was 1.13 percentage points above the five year Treasury yield, versus roughly one-quarter percentage point in 2007. Foreign buying interest in thir paper appears to be waning. The rating companies are considering even further downgrades of mortgage-related instruments, including Fannie Mae and Fredie Mac preferred stock, further eroding the instutions access to market funds. These instutions problems are mounting,
Banks and investment banks are confronted with the prospect of further losses, asset writedowns and the need for fresh capital injections. The rating companies, seemingly attempting to compensate for past lapses in judgement, are incrementally downgrading mortgage-backed paper and other questionable assets, especially those for which no realistic market exists. As long as the requirement exists that bank assets be marked to market and that foreclosed properties be promptly sold, bank losses will continue to mount. The report that The Korean Development Bank was a possible white knight interested in rescuing Lehman helped that stock recover and aided other financials. However, the Korean bank (KDB) raised questions over its intentions with a comment that it is just exporing its options. Indeed, KDB would need its Government's approval acquire Lehman. The financial sector will continue to deteriorate as losses and deleveraging persist. That increases the prospect of additional bank failures. That in turn raises questions over the viability of the FDIC without additional assistance. The failure of IndyMac alone required the commitment of 10% of the FDIC's assets.
Temporary market boosts this week included Fed Chairman Bernanke's comment that inflation is expected to moderate over the medium term, suggesting no imminent Fed firming. How could there be a firming when the Fed Chairman correctly characterizes the financial market as fragile, though that is an understatement of realty. The Fed Chairman needed to calm inflation and Fed firming fears generated this week by the 1.2% July spike in the producer price index. However, it is reasonable to expect that inflation pressures will moderate as the global recession takes hold, dampening the demand for resources.
There are continuing signs of a global recession. The UK and the rest of Europe, in particular, are weakening economically. The UK second quarter real GDP was flat, a likely prelude to recession after 63 quarters of growth. Recognizing this reality, the UK pound fell to its lowest level in two years. European business confidence is retreating. The equity market in China is off more than 50% from its peak, an indication of economic and profit slippage ahead. As a consequence, the Chinese government is considering economic stimulus initiatives after the Olympics. There has been a massive speculative Chinese real estate building binge well ahead of any reasonable demand that is imposing its own strains on Chinese investors and lenders. But there has also been unsustainable speculation in other areas of the Chinese economy that may be in the process of being deflated.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address:philipbraverman@Gmail.com
The outsized 0.7% one-month July plunge in the the Conference Board's index of leading indicators, down 4.4% from a year ago, ominously suggests a steepening in the pace of economic deterioration over the next six months. The four week moving average of initial claims for unemployment benefits is firmly in the traditional recession territory of 400,000 plus claimants. This portends a steeper decline in nonfarm payrolls in the next employment report and a continuing rise in the unemployment rate. The US recession is barely beginning. It will widen far beyond housing and the financial community.
The outlook is for further declines in home prices as the still huge excess supply of unsold homes, mortgage defaults and forclosures weighs on the real estate market. The nationwide home price decline is likely to range from 30% to 40%, roughly twice or more the decline thus far. The availability of home mortgage credit remains contrained for all but those with the most pristine credit. Fannie Mae and Fredie Mac and other mortgage market participants remain overburdened with losses as even prime mortgages taken out in recent years are increasingly delinquent. Fannie Mae and Freddie Mac are destined for increased Government involvement, if not an outright Federal takeover. Warren Buffet put it succinctly with his comment "game over" alluding to the two GSE mortgage firms that in recent days had reportedly unsucessfully approached private sources for long-term assistance. The yield speads on these institutions paper relative to Treasuries is widening appreciably. Even with a presumed Treasury guarantee, this past week the Freddie Mac five year yield was 1.13 percentage points above the five year Treasury yield, versus roughly one-quarter percentage point in 2007. Foreign buying interest in thir paper appears to be waning. The rating companies are considering even further downgrades of mortgage-related instruments, including Fannie Mae and Fredie Mac preferred stock, further eroding the instutions access to market funds. These instutions problems are mounting,
Banks and investment banks are confronted with the prospect of further losses, asset writedowns and the need for fresh capital injections. The rating companies, seemingly attempting to compensate for past lapses in judgement, are incrementally downgrading mortgage-backed paper and other questionable assets, especially those for which no realistic market exists. As long as the requirement exists that bank assets be marked to market and that foreclosed properties be promptly sold, bank losses will continue to mount. The report that The Korean Development Bank was a possible white knight interested in rescuing Lehman helped that stock recover and aided other financials. However, the Korean bank (KDB) raised questions over its intentions with a comment that it is just exporing its options. Indeed, KDB would need its Government's approval acquire Lehman. The financial sector will continue to deteriorate as losses and deleveraging persist. That increases the prospect of additional bank failures. That in turn raises questions over the viability of the FDIC without additional assistance. The failure of IndyMac alone required the commitment of 10% of the FDIC's assets.
Temporary market boosts this week included Fed Chairman Bernanke's comment that inflation is expected to moderate over the medium term, suggesting no imminent Fed firming. How could there be a firming when the Fed Chairman correctly characterizes the financial market as fragile, though that is an understatement of realty. The Fed Chairman needed to calm inflation and Fed firming fears generated this week by the 1.2% July spike in the producer price index. However, it is reasonable to expect that inflation pressures will moderate as the global recession takes hold, dampening the demand for resources.
There are continuing signs of a global recession. The UK and the rest of Europe, in particular, are weakening economically. The UK second quarter real GDP was flat, a likely prelude to recession after 63 quarters of growth. Recognizing this reality, the UK pound fell to its lowest level in two years. European business confidence is retreating. The equity market in China is off more than 50% from its peak, an indication of economic and profit slippage ahead. As a consequence, the Chinese government is considering economic stimulus initiatives after the Olympics. There has been a massive speculative Chinese real estate building binge well ahead of any reasonable demand that is imposing its own strains on Chinese investors and lenders. But there has also been unsustainable speculation in other areas of the Chinese economy that may be in the process of being deflated.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address:philipbraverman@Gmail.com
Saturday, August 16, 2008
Market inflation fears are receding for the time being
The equity market continued its bear market rally this past week despite the increased international tensions stemming from the Russian attack on Georgia and all that development's dire long-term implications. The impetus for the further stock market rise was primarily the drop in oil prices, other commodity prices and the strengthening dollar. This positve set of price declines and currency moves overwhemed signs of economic deterioration in Europe and Japan, equity market prices declines abroad and evidence of increases in global inflation, especially in the US.
The Consumer Price Index jumped 0.8% in July for an alarming 5.6% spurt from a year ago. This is the largest increase in almost two decades, And yet the market acted as if the consumer price report actually indicated a surprise weakening in inflation. For example, the yield on Treasury notes and bonds, which moves up and down largely with inflation expectations, declined appreciably. The Treasury 10-year note yield fell to 3.84% on Friday from 4.2% just a few weeks back. The reason of course for a decline in inflation expectations (and Treasury yields) was a continuing decline in commodity prices, especially for oil and gold, and a strengthening dollar. In effect, the market believed that inflation expectations (which are forward looking), should respond to these variables and not the backward looking Consumer Price Index, which was largely boosted by energy and food prices. For without food and energy, the so called core Consumer Price Index was up a more restrained 2.5% from July last year.
With the global economy sliding toward recession, there is bound to be a decline in economic demand for basic resources and a consequent decline in price pressures. The European Union reports that GDP declined at a 0.8% annual rate in the second quarter. This expands the countries in or on the threshold of recession to the US, the UK, the EU, and Japan. Even China's economy shows signs of slowing down. Thus, it is reasonable to expect a general slowing of inflation during the recession and for some time into the recovery period as excess capacity and productivity gains restrain inflation.
But once the global economy is back on track, firmly into recovery and the excess capacity cushion is exhausted, inflation will reassert itself. Considering that the current recession promises to be prolonged, the return of inflation should not be considered a near-term prospect.
In the meantime, the recessionary forces of the housing debacle, credit crunch, consumer financial squeeze, financial institution distress, rising unemployment and curtailed consumer spending will eventually restrain inflation, These forces will also curtail corporate profits. That will ultimately lead to a renewed weakening in equity prices. The temporary improvement in equity prices of airlines and other firms benefiting from the decline in energy prices is just that, temporary.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail address: philipbraverman@gmail.com
The Consumer Price Index jumped 0.8% in July for an alarming 5.6% spurt from a year ago. This is the largest increase in almost two decades, And yet the market acted as if the consumer price report actually indicated a surprise weakening in inflation. For example, the yield on Treasury notes and bonds, which moves up and down largely with inflation expectations, declined appreciably. The Treasury 10-year note yield fell to 3.84% on Friday from 4.2% just a few weeks back. The reason of course for a decline in inflation expectations (and Treasury yields) was a continuing decline in commodity prices, especially for oil and gold, and a strengthening dollar. In effect, the market believed that inflation expectations (which are forward looking), should respond to these variables and not the backward looking Consumer Price Index, which was largely boosted by energy and food prices. For without food and energy, the so called core Consumer Price Index was up a more restrained 2.5% from July last year.
With the global economy sliding toward recession, there is bound to be a decline in economic demand for basic resources and a consequent decline in price pressures. The European Union reports that GDP declined at a 0.8% annual rate in the second quarter. This expands the countries in or on the threshold of recession to the US, the UK, the EU, and Japan. Even China's economy shows signs of slowing down. Thus, it is reasonable to expect a general slowing of inflation during the recession and for some time into the recovery period as excess capacity and productivity gains restrain inflation.
But once the global economy is back on track, firmly into recovery and the excess capacity cushion is exhausted, inflation will reassert itself. Considering that the current recession promises to be prolonged, the return of inflation should not be considered a near-term prospect.
In the meantime, the recessionary forces of the housing debacle, credit crunch, consumer financial squeeze, financial institution distress, rising unemployment and curtailed consumer spending will eventually restrain inflation, These forces will also curtail corporate profits. That will ultimately lead to a renewed weakening in equity prices. The temporary improvement in equity prices of airlines and other firms benefiting from the decline in energy prices is just that, temporary.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail address: philipbraverman@gmail.com
Saturday, August 9, 2008
Only a bear market rally in equities
By its very nature, the latest explosive advance in equities seems nothing more than a bear market rally, destined to be completely reversed. The outsized 303 point increase in the Dow on Friday, a 2.6% rise, is essentially a typical bear market phenomenon. In the current bear market, as well as in previous bear market periods, there were often such outsized spectacular increases. But the same can not be said of periods of cyclical stock market advances. For example,there were no such outsized up days in the cyclical advance between 2002 and 2007. In contrast, in the precipitous 38% 2000 through 2002 bear market plunge that preceeded that last cyclical advance, there were a number of such startlingly sharp daily increases. Indeed, in that particular 2000-2002 bear market there was even a rally that extended for six months, before being erased. But, other factors cuurently suggest that this bear market rally will not extend anywhere near that long.
Also, even with the sharp equity price increases last week, the stock market indices are still well within a longer-term downtrend that is virtually certain to persist. For example, the Friday close in the Dow at 11,732, up 3.6% for the week, remains under its 12,450 200-day moving average. Similarly the Nasdaq, at 2,414 at the Friday close, up 4.5% for the week, remains below its 200-day moving average level of 2,450. The S&P 500 index is similarly below its 200-day moving average. This year's previous bear market rally, in April and May, failed as the various equity indices touched or pierced their respective 200-day moving average levels. Whether that likely pattern actually repeats itself is of course unknown. But those 200-day moving average levels remain important resistance levels.
From the equity markets misplaced point of view, it sees some market positives reinforcing the current rally. Oil and other commodity prices are declining. The dollar is not only stabilizing, it appears to be strengthening. The Fed, as I suggested some time back, is retreating from its threatened firming. We are moving toward the Presidential campaign season, which has tended to be favorable for equities. The Administration and the Fed appear to be committed to solving the nations housing and related financial problems. There are some buybacks of the frozen auction rate securities. And some recent housing data provide at least a semblence of support for the wrongheaded notion that the housing recession is bottoming out. These developments do not adequately justify, nor will they be able to sustain the rally amidst a still deteriorating economy, rising unemployment, a credit crunch, an actually worsening housing picture, the financially stressed consumer and the beginnings of a global recession.
First, the so called market positives are not as equity-market favorable as equity market particpants believe they are. The decline in oil and other commodity prices is partly or largely a reflection of weakening demand amidst a devloping US and
global recession. That does not bode well for corporate profits here or abroad. And as corporate profit projections go, so goes equity market price expectations. The outlook for oil is also muddied by the military conflict between Russia and Georgia and the potential for flareups in other oil hotspots.
The strengthening dollar is in large part a reflection of a weakening of the Euro, the UK pound and the Yen. That reflects sluggish economic prospects for the economies of the EC, the UK and Japan and the growing liklihood of their eventual easing moves. That does not create bright prospects for the continued bouyancy of US exports and companies that depend on exports for sales and profits.
The Fed is maintaining its current Federal funds rate target because the US economy is weakening further, rather than rebounding as the Fed had mistakenly hoped, the financial and housing crisis persists and inflation concerns are moderating with the decline in commodity prices.
Though the US Treasury and Fed are committed to ameliorating the Financial crisis, there is no reason to believe the financial crisis is even close to running its course. With $300 billion in new capital raised, only a fraction of the perhaps $1 trillion to $2 trillion in aggregate losses, there is likely to be more financial pain ahead. MBIA's reported quarterly profit, after three quarters of losses, does not offset the report of a further major loss at Fannie Mae, with more mortgage-related and other losses to come throughout the financial coomunity.
The welcome buybacks of some auction rate money market instruments by some financial institutions from their customers merely moves the troubled assets to a different balance sheet. It does not solve the instruments illiquidity problem.
Initial claims for unemployment benefits increased to 455,000 in the latest week, up from 448,000 the week before. The four-week moving average reached the 400,000traditional recession threshold. Some improvement in home sales does not negate the continuing downward pressure on home prices from near record inventories of unsold homes, many vacant and/or in foreclosure. That is a sure precription for deepening declines in home prices and continuing housing distress.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail address: philipbraverman@Gmail.com
Also, even with the sharp equity price increases last week, the stock market indices are still well within a longer-term downtrend that is virtually certain to persist. For example, the Friday close in the Dow at 11,732, up 3.6% for the week, remains under its 12,450 200-day moving average. Similarly the Nasdaq, at 2,414 at the Friday close, up 4.5% for the week, remains below its 200-day moving average level of 2,450. The S&P 500 index is similarly below its 200-day moving average. This year's previous bear market rally, in April and May, failed as the various equity indices touched or pierced their respective 200-day moving average levels. Whether that likely pattern actually repeats itself is of course unknown. But those 200-day moving average levels remain important resistance levels.
From the equity markets misplaced point of view, it sees some market positives reinforcing the current rally. Oil and other commodity prices are declining. The dollar is not only stabilizing, it appears to be strengthening. The Fed, as I suggested some time back, is retreating from its threatened firming. We are moving toward the Presidential campaign season, which has tended to be favorable for equities. The Administration and the Fed appear to be committed to solving the nations housing and related financial problems. There are some buybacks of the frozen auction rate securities. And some recent housing data provide at least a semblence of support for the wrongheaded notion that the housing recession is bottoming out. These developments do not adequately justify, nor will they be able to sustain the rally amidst a still deteriorating economy, rising unemployment, a credit crunch, an actually worsening housing picture, the financially stressed consumer and the beginnings of a global recession.
First, the so called market positives are not as equity-market favorable as equity market particpants believe they are. The decline in oil and other commodity prices is partly or largely a reflection of weakening demand amidst a devloping US and
global recession. That does not bode well for corporate profits here or abroad. And as corporate profit projections go, so goes equity market price expectations. The outlook for oil is also muddied by the military conflict between Russia and Georgia and the potential for flareups in other oil hotspots.
The strengthening dollar is in large part a reflection of a weakening of the Euro, the UK pound and the Yen. That reflects sluggish economic prospects for the economies of the EC, the UK and Japan and the growing liklihood of their eventual easing moves. That does not create bright prospects for the continued bouyancy of US exports and companies that depend on exports for sales and profits.
The Fed is maintaining its current Federal funds rate target because the US economy is weakening further, rather than rebounding as the Fed had mistakenly hoped, the financial and housing crisis persists and inflation concerns are moderating with the decline in commodity prices.
Though the US Treasury and Fed are committed to ameliorating the Financial crisis, there is no reason to believe the financial crisis is even close to running its course. With $300 billion in new capital raised, only a fraction of the perhaps $1 trillion to $2 trillion in aggregate losses, there is likely to be more financial pain ahead. MBIA's reported quarterly profit, after three quarters of losses, does not offset the report of a further major loss at Fannie Mae, with more mortgage-related and other losses to come throughout the financial coomunity.
The welcome buybacks of some auction rate money market instruments by some financial institutions from their customers merely moves the troubled assets to a different balance sheet. It does not solve the instruments illiquidity problem.
Initial claims for unemployment benefits increased to 455,000 in the latest week, up from 448,000 the week before. The four-week moving average reached the 400,000traditional recession threshold. Some improvement in home sales does not negate the continuing downward pressure on home prices from near record inventories of unsold homes, many vacant and/or in foreclosure. That is a sure precription for deepening declines in home prices and continuing housing distress.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail address: philipbraverman@Gmail.com
Saturday, August 2, 2008
Employment, the economy and financial institutions are in far worse shape than widely recognized
The US is almost certainly already in recession, with little prospect of coming out of it any time soon. Indeed, there is every reason to expect the recession to deepen sufficiently over coming quarters to erase every shred of the lingering widespread doubt that continues to persist over the recession's existence or even its ultimate probability. Moreover, in my view, the recession seems likely to persist until at least mid-year next year. That would make this recession unusually long. At this point you might well be asking what I am talking about, especially given last Thusday's report of a 1.9% increase in real GDP in the second quarter, up from a 0.9% increase in the first quarter and a 0.2% decline in the fourth quarter last year. To some analysts that progressive improvement is mistakenly interpreted as indicating that the rough patch in the economy is already over. Nothing could be further from realty.
While recent headline data reports seem to portray a very weak economy, admittedly the reports do not necessarily as yet unambiguously provide the convincing evidence that many demand to actually conclude we are in recession. But that is taking the data at face value. Friday's report of a 51,000 July drop in nonfarm payrolls(the seventh consecutive monthly decline)and a jump to 5.7% in the unemployment rate from 5.5% the month before is perceived as weakness but certainly not convincing evidence of recession. Unfortunately, the problem lies with the data itself because of the ways they unintentionally obscure realty, especially at cyclical turning points.
The reported data in many economic series contain a significant element of estimation that unfortunately have the unintended impact of obscuring both recession and recovery cyclical turning points. The employment report is no exception to this pervasive problem. Because new and many small business are not officially recognized as in existence, they cannot be surveyed or sampled. Thus,the Bureau of Labor statistics makes an estimate of the monthly growth of employment based on its estimate of new businesses. The estimates are derived from old surveys, not current reports. The estimates are not intended to be current or to capture cyclical turning points. Needless to say, they do not. This would not be significant if the numbers of the phantom employment gains involved were not so large as to swamp the real changes that occur in the remainder of the data reflecting the real economy. For example over the past year there was a net official decline of 535,000 in nonfarm payrolls. But this was only after an almost certain fictional estimated increase of 853,000 in unsampled and only estimated new and small businesses, many of which do not exist. Merely assuming that the employment gains of the new businesses did not occur (rather than the more likely prospect that their employment in realty declined) would indicate that the economy's actual job loss over the past year was almost certainly at least 1,388,000. Though the household survey that is used to determine the unemployment rate is different from the nonfarm payroll survey, the actual unemployment rate is undoubtedly also higher than the official data implies.
The reported 1.9% second quarter real GDP rise was also grossly overstated as well as artificially boosted by the temporary economic stimulus. Without these special factors second quarter GDP would probably have declined. Consumer spending would have been substantially weaker without the tax rebates. Also, US exports based on the strength of foreign demand temporarily boosted US real GDP. As US demand weakens further, especially in the absence of tax rebates, foreign demand will also weaken. There is already ample evidence of the beginning of that foreign economic slowdown.
There was one likely miscalculation that by itself could have accounted for all the 1.9% second quarter real GDP growth reported. This was too small a GDP inflation deflater to subtract inflation from nominal GDP. Because the rapid increase in import prices is deducted from domestic prices to calculate the GDP deflater, there was an excessive reduction in the domestic deflater to a 1.1% rise, versus a 2.6% rise in the prior quarter and well under the actual 4.9% consumer price inflation rate the past year. Without these special factors, real GDP would have been negative in the second quarter and will probably show a series of actual declines over coming quarters.
Behind the US recession, driving it to further weakness, is the continuing drop in home prices. The Standard & Poors/Case shiller Home Price Index is down 18% from its July 2006 peak. And with 2.1 million vacant homes available for sale, some 800,000 more more than normal, there is bound to be further declines in home prices. That prospect is further reinforced by the continuing rise in foreclosures, the credit crunch, and the unrealized losses still to be faced by banks, investment banks, credit card issuers insurance companies and other elements of the financial sector. The decline in home prices is already encompassing lenders of conventional mortgages, not just sub-prime and Alt-A loans. Expect more financial institution bankruptcies. In concert, these various strands to the recession make a significant worsening inevitable. Investor caution remains warranted.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail address: philipbraverman@gmail.com
While recent headline data reports seem to portray a very weak economy, admittedly the reports do not necessarily as yet unambiguously provide the convincing evidence that many demand to actually conclude we are in recession. But that is taking the data at face value. Friday's report of a 51,000 July drop in nonfarm payrolls(the seventh consecutive monthly decline)and a jump to 5.7% in the unemployment rate from 5.5% the month before is perceived as weakness but certainly not convincing evidence of recession. Unfortunately, the problem lies with the data itself because of the ways they unintentionally obscure realty, especially at cyclical turning points.
The reported data in many economic series contain a significant element of estimation that unfortunately have the unintended impact of obscuring both recession and recovery cyclical turning points. The employment report is no exception to this pervasive problem. Because new and many small business are not officially recognized as in existence, they cannot be surveyed or sampled. Thus,the Bureau of Labor statistics makes an estimate of the monthly growth of employment based on its estimate of new businesses. The estimates are derived from old surveys, not current reports. The estimates are not intended to be current or to capture cyclical turning points. Needless to say, they do not. This would not be significant if the numbers of the phantom employment gains involved were not so large as to swamp the real changes that occur in the remainder of the data reflecting the real economy. For example over the past year there was a net official decline of 535,000 in nonfarm payrolls. But this was only after an almost certain fictional estimated increase of 853,000 in unsampled and only estimated new and small businesses, many of which do not exist. Merely assuming that the employment gains of the new businesses did not occur (rather than the more likely prospect that their employment in realty declined) would indicate that the economy's actual job loss over the past year was almost certainly at least 1,388,000. Though the household survey that is used to determine the unemployment rate is different from the nonfarm payroll survey, the actual unemployment rate is undoubtedly also higher than the official data implies.
The reported 1.9% second quarter real GDP rise was also grossly overstated as well as artificially boosted by the temporary economic stimulus. Without these special factors second quarter GDP would probably have declined. Consumer spending would have been substantially weaker without the tax rebates. Also, US exports based on the strength of foreign demand temporarily boosted US real GDP. As US demand weakens further, especially in the absence of tax rebates, foreign demand will also weaken. There is already ample evidence of the beginning of that foreign economic slowdown.
There was one likely miscalculation that by itself could have accounted for all the 1.9% second quarter real GDP growth reported. This was too small a GDP inflation deflater to subtract inflation from nominal GDP. Because the rapid increase in import prices is deducted from domestic prices to calculate the GDP deflater, there was an excessive reduction in the domestic deflater to a 1.1% rise, versus a 2.6% rise in the prior quarter and well under the actual 4.9% consumer price inflation rate the past year. Without these special factors, real GDP would have been negative in the second quarter and will probably show a series of actual declines over coming quarters.
Behind the US recession, driving it to further weakness, is the continuing drop in home prices. The Standard & Poors/Case shiller Home Price Index is down 18% from its July 2006 peak. And with 2.1 million vacant homes available for sale, some 800,000 more more than normal, there is bound to be further declines in home prices. That prospect is further reinforced by the continuing rise in foreclosures, the credit crunch, and the unrealized losses still to be faced by banks, investment banks, credit card issuers insurance companies and other elements of the financial sector. The decline in home prices is already encompassing lenders of conventional mortgages, not just sub-prime and Alt-A loans. Expect more financial institution bankruptcies. In concert, these various strands to the recession make a significant worsening inevitable. Investor caution remains warranted.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
E-mail address: philipbraverman@gmail.com
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