Economic and financial news continues decidedly bearish. But the equity market is focusing instead on the few positive aspects of the reports to turn more hopeful that they see the light at the end of the recession tunnel. What they see is not daylight but the headlight of the recession train bearing down on them.
The continuing plunge in consumer confidence points to where the US economy is headed over the next six months or so. It is pointing in an ominous direction with a drop to 59.5 in the early May University of Michigan consumer sentiment index, from 62.6 the prior month. This marks the lowest level reach by this measure since June 1980, at the onset of a recession. But that was not just any recession. By many measures the 1980 recession, with both post World War II record unemployment and curtailed credit availability, was the most severe since the depression of the 1930's. Given the current plunge in consumer confidence, it is only prudent to assume that the consumer is already feeling the intense financial pain wrought by the worst decline in home prices since the 1930's, as well as by record food and energy prices and an increasingly dismal employment outlook. Indeed, consumers in early May were also sharply more pessimistic over the economy's prospects for the next six months. This loss in consumer confidence and growing economic pessismisn are almost certainly a prelude to a significant drop in spending once the tax refunds have come and gone. The GE decision to sell its consumer appliance division could be seen as a forecast of very tough sledding for discretionary consumer spending for an extended period, especially with a probable protraccted housing recession, a dreary forecast.
However, some observers chose to focus on a few misleading bright spots in the otherwise continuing dismal housing ptcture. April housing starts rebounded 8.2%. This was due entirely to a 36% jump in Multifamily starts, reversing a comparable March plunge. Single family starts dipped 1.7%, their twelth consecutive monthly decline. Though housing permits increased 4.9%, a component of the index of leading indicators, there is no reason to believe that housing is anywhere near bottoming out. And it is certainly is not the beginning of an upswing in housing. Housing starts were at a 1.03 million seasonally-adjusted annual rate in April, just under half their peak 2005 levels. But, at major builder Toll Brothers, new contracts in the latest quarter are running at under 30% of their peak 2005 level. With this weakness in new contracts and walk-through traffic at new home models reported at historic lows, further housing weakness ahead is a forgone conclusion. Thus, it comes as no surprise that The National Association of Home Builder Confidence index edged down to a very pessimistic 19 in May, just one point above its all-time low of 18 reach in December. The consensus real estate professionals forecast of a bottom to the drop in home prices by spring 2009 may be optimistic. Moreover, the price decline may be only half over. There is severe pain in this sector to come.
Industrial production plmmeted o.7% in April, more than reversing a 0.2% March rise and extending a 07% February decline. Even without the recessionary auto production sector, industrial production was still down 0.6% in April. This indicates a relatively broad economy-wide production decline. There were significant declines in business equipment and consumer appliance production. This suggests weakening demands for both business and consumer goods domestically that more than offset increases for exports due to the weaker dollar. Capacity utilization dropped to 79.7% in April from 80.4% in March. This is very far from the 88% or higher capacity utilization levels where production bottle-neck price pressure levels often begin to emerge, Thus, despite continuing inflation concerns, there is no indication of likely inflation pressures emerging from production or labor costs. The New York Fed maufacturing index declined to minus 3.2 in May from 0.6 in April. The Philadephia Fed general conditions index was minus 15.6 in May. While less dire than the 24.9 in April it, like the New York Fed index, hinted at a further contraction in industrial production in May.
The Fed is far from confident that it has done enough to turn the credit crunch around. That helps explain Fed efforts to persaude Congess to give it the authority to immediately pay interest on the reseves that banks hold at the Fed, rather than wait for its legislated start in 2011. Fed Chairman Bernanke warned that market fragility persists. He encouraged banks to build "generous" capital cushions, repair balance sheets, and extend "new credit, which supports economic expansion". William Dudley, executive Vice President of the New York Fed indicated that much of the new bank capital raised has been offset by new losses on loans and finanancial instruments.
More banks are revealing sizable losses, capital write-downs and the need for new capital raising efforts. Among the latest is the Mizuho Financial Group, Japan's second largest bank measured by assets. It reported a $6.1 billion loss related to sub-prime mortgages and mortgage-backed paper. This loss was 14% larger than it reported just a month ago and warned that the loss could be still larger. While primary attention has been focused on the largest financial institutions with exposure to the sub-prime mortgage meltdown, smaller banks are disprortionately exposed to the real estate market and potential losses. For example, banks with assets of $1billion or more on average have real estate loans on their books equal to one-fifth of their total loans. In striking contrast, banks with assets of under $1 billion on average have over two-fifths of their loan portfolio concentrated in real estate. On the face of it, these smaller banks are exposed to significantly more proportional risk of loss as home prices continue to plunge. The credit crunch is far from over and the recession is barely beginning.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
philipbraverman@Gmail.com
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