Recession will be protracted, despite Fed hint of a pause in its easing.

The Fed hint that it will soon pause in its easing, together with other seemingly positive signs, encourage unwarranted hopes the recession will be both mild and brief. Indeed, some observers are so misguided as to believe that the economy is merely in a slowdown and will escape a recession entirely. The realty is likely to be far more unpleasant than widely believed. This remains a time for caution. It is certainly not a time to invest in illiquid, or even potentially illiquid, investment vehicles.

Housing weakness is typically a long-lead advance indicator of recession. But the pronounced housing slump this business cycle is likely to be the progenitor of severe and prolonged ills for the broad economy. This cause and effect relationship is understandable considering housing is in the worst slide since the great depression of the 1930s. Even when the credit crunch is ultimately reversed, no sustained recovery in the overall economy seems likely until housing demand reestablishes a firm and sufficient support for that sector and the economy. With rising mortgage resets this year, high energy and food costs and a worsening employment picture, mortgage foreclosures are likely to continue soaring. Builders are still building, adding further to the housing glut. Until the still distant time that housing is improving, with housing demand equal to supply, there is a grave and mounting risk of deteriorating consumer demand. And a consumer spending slump will in turn precipitate a weakening business sector. And both those key sectors have as yet not even begun to realize their potential contraction. But with consumer confidence plunging to a 26-year low, a consumer spending retreat can not be very far behind.

Next week' s key economic reports may only further muddy the market's assesment of economic prospects. Friday's employment report is likely to reveal an additional sharp drop in nonfarm payrolls, perhaps by 80,000 or so, with the unemployment rate holding steady at 5.1% or edging up to 5.2%. But, as with other job reports thus far this year, due to erroneous estimates embedded in this report, it probably also understates the deterioration in the employment picture. Subsequent revisions will undoubtedly reveal a deeper plunge in employment. The advance estimate of first quarter GDP, reported Wednesday, is likely to be only marginally weaker than the 0.6% gain in the fourth quarter. This will be mistaken for a clear sign of an at worst mild and and brief recession. That interpretation will be a unfortunate delusion. Real GDP estimates will be revised lower. And even if the recession has started off mild, it will not remain so. And in all likelihood it is not destined to be brief. Moreover, it will be global in scope, with adverse consequences for commodities and a postive for the dollar.

How long can this recession last? It is likely to persist until 2009 or even 2010. It will take that long for the excesses of sub-prime borrowing and lending, derivitives and other misguided financial creativity to be washed out of the system.

The worst is not over for financial institutions who are still scrambling to recognize losses and raise capital. The requirement to mark assets to market when for some financial instruments there is no market is a prescription for financial disaster. Despite valiant Fed efforts to be creative in its support for the financial community, this sector's problems have not been sufficiently resolved to end the credit crunch.

The Fed now seems likely to cut the funds rate by one-quarter percentage point to 2.0% in next week's meeting and then pause to asses the impact on the economy of their extensive easing initiatives. However, since I do not believe the economy will recover in response to the Fed moves or the income tax rebates, there is likely to be further Fed easing down the road. Before it is done, the Fed will probably again cut the funds rate to 1.0%, its previous low.

Treasury yields are off their lows and moving higher in response to a lessening in the flight to safety, a narrowing in quality yield spreads, increased inflation concerns and dubious hopes for equity market profits. However, the cyclical low in Treasury yields still lies ahead, probably in 2010, at the end of the recession or the first stage of economic recovery amidst rampant deflation concerns. That is the typical late-recession early-recovery cyclical pattern. That is a time when inflation is supressed by the still lingering impact of recession, Fed policy remains easy, unemployment continues high and productivity gains are rapid.

I realize that my views, as expresssed here and in previous weeks in this blog, are out of step with those of the vast majority of economic forecasters. That was not unusual in my long career on wall street. Yet, I was typically correct in the past and I believe events will prove them correct in this cycle as well. If it is any solace to the reader, there are a number of economists whom I hold in high regard whose views to varying extents are in essence similar to my own. In no particular order they include Gary Schilling, Lacy Hunt, Van Hoisington, Peter Bernstein, David and Jay Levy and Stephanie Pomboy. I am proud to be in their company.


Philip Braverman
Braverman Economic Consulting
One Hewitt Square #249
East Northport New York 11731

philipbraverman@Gmail.com

A bear market rally in equities

The equity market rallied last week on an unsustainable sense of relief that the earnings performance of a number of key companies was far better than feared, particularly after GE's disappointing report the week before. The market's positive earnings surprises included Google's report of a 30% jump in first quarter profits from a year earlier, almost double the 17% rise posted in the fourth quarter. IBM's first quarter profit spurted 26%, ahead of the 18% rise forecast for the full year. EBay's net earnings were up 22%, better than the market anticipated. While the reports indicted that the recession has certainly not yet powerfully slowed these companies earnings, the reports were not quite as positive as they at first appear.

Google indicated that clicks on its advertisments increased 20% in the first quarter from a year earlier, a slowdown from a 30% rate of increase in the fourth quarter from a year earlier. This could be a harbinger of a slowdown in the growth of Google add revenue in coming quarters.

Much of the IBM earnings gains was due to the appreciation of foreign currencies. The firms Asia revenue was up 14% with currency gains and 3% without them. The comparable IBM gains for Europe and the Middle East were 16% and 4% after adjusting for currency gains, and for the Americas 8% before and 6% after currency gains. Despite a substantial backlog of service contracts, new IBM service contracts fell 2%in the first quarter.

EBay's active users edged up a mere 1%, the least gain ever reported. The revenue gains of EBay's core business has slowed, while non-core business accelerated, making for a more mixed picture.

Though the psychological relief of the few relatively favorable earnings reports helped push equity market prices back toward their recent highs, this is not the beginning of a sustained cyclical rally. Not only were the positive reports not quite as positive as they seemed, they overshadowed less favorable earnings reports in both business and finance. Advanced Micro Devices posted yet another loss. Though Nokia reported a 25% earnings increase, it forecast a slowing market for the rest of the year. Citigroup and other financial institutions reported losses.

Housing starts plunged a further 12% in the latest month to the lowest levels since the recession of 1990-91. This is a clear indication that housing is still far from bottoming out. A rise in the CPI that pushed it up 4.0% from a year ago was troubling. However, a 2.4% rise from a year ago in core consumer prices, excluding food and energy, suggests that soaring food and energy has not yet spilled over significantly into other broad sectors of the economy. With demand in the broad economy not yet as depressed as it will be when the consumer and business retrench, the restraining impact on prices of the recession still lies ahead. That is why it is still prudent for the Fed to ease further. However, The step-up in inflation has increased market expectations that the Fed's late April easing will be limited to a one-quarter point reduction to 2.0%.

While the equity market is considered the most reliable leading indicator, it is not consistently infallable. The equity market is primed by typically spectacular price increases in the last three months of recession to eargerly over-anticipate the end of a recession. The incentive is that in recent recessions the average price gains of stock indicies are almost twice as large in the final three months of recession as they are in the first three months of actual economic recovery. Recognizing the financial advantages of buying three months ahead of the end of the recession, investors have a tendency to jump the gun and buy long before the appropriate time. But how can I be sure that this just another false start?

While nothing in life is certain, there are too many negative forces at work to believe the recession will be as mild as it has thus far proven to be or so short-lived to be ending at mid-year or sooner as the recent equity market rise suggests. The consumer and business and global economy have not yet materially reacted adversly to the constraints of the credit crunch, the housing debacle, the looming credit card bubble, surging unemployment and the cost squeeze imposed by soaring energy and food costs. The unemployment rate will leap higher and together with other pronounced negatives will turn the plunge in consumer confidence into a retreat in consumer spending. There is a virtual avalanche of mortgage resets coming that will produce further waves of forclosures, falling home prices and additional financial institution losses and capital writedowns. And a steep drop of 49% in China bubble stock prices suggest China's boom is likely to at least be scaled back, most likely in the fourth quarter, after the Olympics. That will produce a global recession, with additional adverse US economic consequences. In concert, that array of negative factors portends a longer and deeper US recession than widely anticipated.

Philip Braverman
Braverman Economic Consulting
One Hewitt Square #249
East Northport, New York 11731

GE earnings fall as the recession and credit crunch broaden their impact

A 5.8% decline in General Electric's first quarter profit is a further indication that the recession and credit crunch are increasingly hitting the general business economy. If GE earnings, with its substantial international focus, can be hurt that much,there is bound to be more bad corporate news ahead. That realization contributed to the outsized Friday decline in the equity market. Though equity prices are still above their lows, there is likely to be at least a retest of those lows and quite likely new lows established. That seems to readily follow from the prospect that the recession not only has significantly further to fall, but is likely to be extended through year end and perhaps into next year. Expect more financial industry losses and write-downs. And more dissapointing earnings reports beyond the financial community and housing. And there are more problems ahead in those sectors.

Housing prices are projected to continue dropping until at least spring 2009. The inventory of unsold homes is already equal to ten or eleven months of the home sales pace, versus a more normal four months of inventory. And there is no indication that the inventory of unsold homes has as yet topped out. Home foreclosures are virtually certain to continue soaring in response to sharply higher mortgage interest rates on the substanial proportion mortgage loans that will be reset, rising unemployment, falling home prices and high energy costs among other factors constraining home- owner discretionary income. The painfully-learned home mortgage lessons of the depression of the 1930s were too readily disregarded. Short-term interest only mortgages were an invitation to home-owner financial disaster then. To correct for those mistakes, self-amortized mortgages with substantial homeowner equity were introduced. But, in recent years mortgages with interest only, negative amortization, loans of up to 125% of appraised value and no document, no income sub-prime loans created a potential for wide-spread financial disaster that has not been fully realized.

Consumer confidence has plunged to a 26-year low. That historic drop portends substantial consumer spending caution. It also suggests the employment picture is bleaker than officially reported. For example, seasonally adjusted nonfarm payrolls were reported to have fallen 80,000 in March and 232,000 in the first quarter. But these employment loss numbers are partially estimated. In March alone, without the estimated part of employment growth, the net loss of payroll jobs could have been as high as 222,000 rather than the 80,000 actually reported. The official employment decline, weak as it currently is, nevertheless notoriously understates reality when the economy is sinking into recession. The suspicion that this typical pattern of employment loss understatement is being repeated appears supported by the unusually steep drop in consumer confidence. Together these elements suggest that consumption,accounting for some seven-tenths of GDP, will soon be contributing to a deepening recession. Weak retail sales at many non-discount retailers suggests that process is already beginning.

Given these wide-ranging problems, the Fed is projected to cut the funds rate to at least 2.0% or more likely 1.75% in this month's meeting. But the Fed easing will in all probability not stop there. A return to the 1.0% Federal funds rate low seems a likely prospect.

Philip Braverman, President
Braverman Economic Consulting
One Hewitt Square #249
East Northport New York 11731

Unemployment report confirms recession and further agressive Fed easing

The recession, already underway, will soon be deepening. That is the clear significance of recent economic reports, especially the jump to 5.1% in the March unemployment report from 4.8% in February and increasingly worrisome net job losses. The 232,000 first quarter decline in non-farm payrolls, which included a drop of 80,000 in March, 76,000 in February and 76,000 in January, points to an intensifying economic downdraft. The latest employment decline continued centered in goods producing industries. However, other parts of the economy are inceasingly showing weakness. Private-sector service jobs fell 5,000, with declines of 35,000 in professional services, and further employment erosion at financial firms and retailing. The areas of weakness will proliferate.

This recession has barely started. There are still finanacial assets that are difficult or virtually impossible to price or sell, except to the Fed or at deep distress prices. And it is not just financial institutions affected by the consequent credit squeeze. The loss of liquidity in the freeze of supposedly liquid auction-rate securities is just one of many problems that threatens to further deepen and broaden the recession. The recession will not be limited to the housing debacle and the immediate consquences of the financial distress and dislocations stemming from the subprime mortgage and related fiascos. Indeed, the recession has already both broadened and intensified.

The rally in equities this past week, whatever its cause, will be reversed as business earnings prove disappointing. The equity market may have mistakenly assumed that the worst for the economy was over. Also, since many expect a second half recovery and knowing the stock market typically bottoms out about half way through a recession, a beginning of the second quarter investment timing may have seemed appropriate. However, the recession is likely to be far more prolonged and deeper than widely anticipated.

The employment report will have other consequences. The Fed is now more likely to cut the Federal funds rate an additional one-half percentage point to 1.75%. That will likely further undermine the dollar. And Treasury bond yields will not only stay low but establish new cyclical lows. The Treasury maturity yield spread between the 2-and 10-year notes (1.66 on Friday, down from 1.81 on Monday) and between 10- and 30-year (0.83 on Friday) will narrow as inflation fears lighten with shrinking damands for goods, services and labor. But that process will be drawn out over time, even beyond the recession. As the Treasury maturity yield spread narrows, it will be time to look to the eventual narrowing in the quality yield spread between Treasuries and lesser grade credits. But, it is far too soon to expect that early sign of economic recovery.

The consumer, accounting for some seven out of every ten dollars of GDP, is likely to soon curtail spending. That will be a natural consequence of worsening job prospects, slowing income growth, decreasing home prices, reduced credit availability, and the heavy financial burdens imposed by high or rising energy and food costs. Given all this, it comes as no surprise that measures of consumer confidence are plunging. Furthermore, consumer bankruptcies, delinquencies and foreclosures are soaring, clear signs of mounting personal financial distress. And this distress is likely to persist despite widepread local, state and Federal efforts to deal with the housing and foreclosure crisis. Indeed, these problems are likely to worsen before they improve. One reason is the proposal to help builders and others to use current losses to gain refunds of income taxes paid in up to four previous years. Though helping the builders survive is a laudable objective, the incentive for builders to use losses to gain tax refunds will produce more homes at fire-sale prices, worsening the housing glut and further depressing home prices. The housing recession seems unlikely to hit bottom until at least spring of 2009.

Another measure of consumer distress and likely cutback in consumer spending is the rising fear of layoffs and difficulty of finding new employment. Initial claims for unemployment benefits in the latest week soared to 407,000, crossing the critical long-standing 400,000 recession-confirming level. Indeed, many analysts believe that the recession threshold for initial claims should be reduced to 375,000. That makes the latest 374,500 four-week average of initial unemployment benefit claims all the more significant. Also, the duration of unemployment is lenthening.

Philip Braverman, President
Braverman Economic consulting
One Hewitt Square #249
East Northport New York 11731