The recession will intensify, employment will decline further and consumer spending and corporate profits will erode. The recession will become global and with it there will be a decline in the demand for and the prices of basic resources. That set of developments will drive both home prices and equity prices sharply lower, probably to some 30% or so below their peaks. The losses at financial institutions, already approaching $500 billion, may reach $1 trillion or more. That will require substantial further increases in capital. Those losses and a parallel decline in inflation expectations as commodity prices retreat will produce a renewed decline in Treasury bond yields to or below their previous yield lows.
The depth and severity of recessions has invariably depended on the presence and extent of one or more key economic negatives. These have primarily consisted of a drop in equity prices, a credit crunch, a decline in housing, or a rise in oil prices. To have all four of these depressants reinforcing one another currently makes a significant recession inevitable. While the drop in equity prices has not yet reached the 30% average decline of post World War ll recessions (but it almost assuredly will),the drop in housing is already the most severe since the depression. The current credit crunch promises to rival the worst experienced since the 1930's, while the rise in oil prices, even adjusted for inflation, already tops that of the 1970s.
The burdens that these powerful recessionary forces are imposing on consumers, business and governments threatens to make this recession either one of the longest or most severe, or both, in five decades. The massive deterioration in wealth already realized from the drop in equity prices, the decline in home prices, the losses in mortgage-related debt and other exotic financial instruments have already soared into the trillions. And the loss of wealth is a major economic depressant. If all of this is indeed true, why you may ask has it taken so long for the recession to unambiguously materialize? And why does the data often seem so contradictory? This past week, for example, there were unexpected increases in consumer confidence, durable goods orders and the index of leading indicators. All these series are still down appreciably from there highs. But the increases undoubtedly have much to do with the temporary boost from the tax rebates. Other data series continue to point to growing economic declines. The admittedly volatile initial claims for unemployment benefits reached 406,000, crossing the 400,000 threshold that traditionally marks recessionary territory.
There are a number of reasons that help explain both the glacial decline in economic growth and the widespread doubt that prevails both in the marketplace and among economists over prospects for the economy and markets. The stimulus provided in the US by the Fed cut in the funds rate, the tax rebate, war expenditures and global demand for US exports have in concert temporarily softened the economic blows. But the benefits of all these factors will prove temporary because they will not be increased or in some cases even maintained. Europe and Japan are also demonstrating economic weakness. And US demand for imports will substantially slacken.That will increasingly transmit recession to the global economy. In addition, there is excessive and misplaced confidence that the Admistration's efforts to support Fannie Mae and Freddie Mac as well as support and protect other financial institutions will effectively put an end to the losses these institutions have been experiencing. While the Admistration's efforts have bolstered confidence and softened the immediate problems,they will not arrest the decline in home prices. Accordingly, the losses will continue to mount, requiring substantial increases in new capital and undoubtedly contributing to further declines in financial institution equity prices. Those problems should continue to keep Fed interest rate policy anchored despite the step up in anti-inflation rhetoric hinting at an early firming.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
Email address:philipbraverman@Gmail.com
Saturday, July 26, 2008
Saturday, July 19, 2008
SEC bullying and geopolitical devlopments create temporary "dead-cat" equity bounce
The downtrend in equity prices will resume after the current largely short-covering rebound runs its course. The plunge in equity prices, especially in financials, had accelerated at too fast a pace, reaching levels that made the shorts vulnerable to even the slightest hint of positive news or developments that encouraged profit taking. The market positives included geopolitical developments that lessened fears of war-induced disruptions in oil supplies, an SEC attack on short positioning in key financials and some less dire earnings reports than had been feared. Taken together, these developments suggest this is merely another temporary bear market rally interrupting a longer extended cyclical drop in equity prices that has much further to run. Expect a further 10% to 20% drop in equity market indices from here. But, this pessimisitic view of the sustainability of this past week's rally is not how many in the market see it.
The consensus market opinion appears to be that the bear market selloff in equities has not only ended, but that a sustainable rally has begun, especially in the beleagured financial sector. There is also a growing belief that the selloff in oil prices is recent days is merely the beginning of a sustained popping of the commodity price bubble. The mantra of some hedge funds is now to completely reverse their pet trade of shorting financials and being long energy by going long financials and shorting energy. That switch will be the correct move eventually. But not now.
Before explaining what underlies my long-term views, it is worth citing some of the real causes of this past week's market developments. The decision of the US to try to negotiate a verifiable freeze of Iran's march to nuclear weaponry put reported preparations for an Israeli air attack on Iran's nuclear facilities on hold. Senior US officials were dispatched to Israel to explain the new policy. That took a huge chunk of the fear factor and uncertainly supporting the surge in oil prices out of the market. The consequent drop in oil prices to below $129 a barrel was viewed as a major plus for those companies and individuals most squeezed by high energy prices. Comments by some Fed spokesmen that a Fed firming should not wait until calm returned to the financial markets may also have had an impact by raising expectations that a consequent firmer dollar would lessen upward pressure on oil and other dollar denominated commodities. The reports of an increase in domestic inventories of crude oil and gasoline and growing support for offshore US oil drilling were also factors, but likely less significant in a global oil market. The limited reduction in demand for oil in the US (the so called price-induced demand destruction)is still being offset by oil demand increases in China and elsewhere.
The Administration this week threatened short sellers, particularly in key financials into covering their short positions. The SEC fired warning shots across the bow of short sellers by prohibiting naked short selling in 19 of the largest financial institutions and, perhaps most significant,instituting broad-scale investigations into the practice of false rumor mongering for financial gain. Naked shorts are defined as selling stocks without borrowing the stock sold within three days of the short sale. It certainly does not appear to be merely a coincidence that the most beleagured financial institutions named (or more appropriately, defended) by the SEC for special protection were among the biggest gainers from the SEC's Tuesday notice through Friday's close. For example, in just that four-day period Fannie Mae's stock price was up an astounding 90%, Freddie Mac rose 74%, Bank of America was up 48%, Lehman rose 45% and citigroup increased 33%. Did the underlying situation for these institutions change that radically for the better in those four days? I think not. Many mistakenly attributed the rise to less than feared negative earnings reports by some institutions and a few relatively positive earnings reports. That and growing confidence that Treasury support of Fannie and Frddie will not extend to nationalization and a wiping out of shareholder equity were also factors but less so. Most likely shorts in the 19 financials named by the SEC will be reset at higher price levels as the rally runs out of steam. In addition, the focus of the shortsellers will increasingly shift to the regional banks and financials that are seen as the most vulnerable. The FDIC prudently expects dozens of these regional institutions to fail.
From all this it should be clear that this past week's rally was not spurred by a change in market fundamentals. But where the markets go ultimately does depend critically on those fundaments. The plunge in home prices and spike in food and energy costs are the major underlying forces driving financial institution distress, the credit crunch, the consumer financial squeeze,the US economic downturn, the corporate profit squeeze and the bear market in equities. There has been no meaningful change in the impact of and outlook for those critical economic determinants. The drop in home prices is projected to be significantly extended, perhaps to twice the decline thus far experienced nationally. That price drop will be impelled by an outsized inventory of unsold homes, mounting bank distress sales of foreclosed or soon to be foreclosed homes, reduced credit availability, and worening employment prospects. As the drop in home prices continues, it will increasingly wipe out the equity of even the 20% down, conventional-motgage home buyer. That will extend the problems well beyond the holders of subprime and Alt-A mortgages and such mortgage related paper. Accordingly, financial institution losses will continue to mount increasing the volume of writeoffs and need for new capital injections.
Even with oil prices off their highs, the financial burdens that will be imposed on consumers and corporate energy puchasers will still be horrendous, especially this winter, curtailing nonoil purchases and corporate profits and deepening the recession. Also, there is no guarantee the negotiations with Iran will be sucessful. In that event, there are rumors of an air attack scheduled for January, before the new President takes office. It is hard to know if there is truth to the rumor, if it is a negotiating ploy or merely an attempt to boost oil prices. Perhaps the latter given comments by a senior pentagon official that the last thing we need now is a third military front. Also, there is concern that China has sharply limited polluting production to improve air quality prior to and during the Olympic games. It is not clear what will occur after the Olympics end. Will china increase its demands for critical resources, boosting prices for oil and other commodities, as it resumes highly polluting production for export, or has there been so much overbulding ahead of the Olympics that there is a domestic construction slowdown, reducing the pace of commodity demands? Probably both. But China's demand for oil is likely to remain strong until the slow moving onset of the global recession finally takes hold.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
E-Mail Address: philipbraverman@Gmail.com
The consensus market opinion appears to be that the bear market selloff in equities has not only ended, but that a sustainable rally has begun, especially in the beleagured financial sector. There is also a growing belief that the selloff in oil prices is recent days is merely the beginning of a sustained popping of the commodity price bubble. The mantra of some hedge funds is now to completely reverse their pet trade of shorting financials and being long energy by going long financials and shorting energy. That switch will be the correct move eventually. But not now.
Before explaining what underlies my long-term views, it is worth citing some of the real causes of this past week's market developments. The decision of the US to try to negotiate a verifiable freeze of Iran's march to nuclear weaponry put reported preparations for an Israeli air attack on Iran's nuclear facilities on hold. Senior US officials were dispatched to Israel to explain the new policy. That took a huge chunk of the fear factor and uncertainly supporting the surge in oil prices out of the market. The consequent drop in oil prices to below $129 a barrel was viewed as a major plus for those companies and individuals most squeezed by high energy prices. Comments by some Fed spokesmen that a Fed firming should not wait until calm returned to the financial markets may also have had an impact by raising expectations that a consequent firmer dollar would lessen upward pressure on oil and other dollar denominated commodities. The reports of an increase in domestic inventories of crude oil and gasoline and growing support for offshore US oil drilling were also factors, but likely less significant in a global oil market. The limited reduction in demand for oil in the US (the so called price-induced demand destruction)is still being offset by oil demand increases in China and elsewhere.
The Administration this week threatened short sellers, particularly in key financials into covering their short positions. The SEC fired warning shots across the bow of short sellers by prohibiting naked short selling in 19 of the largest financial institutions and, perhaps most significant,instituting broad-scale investigations into the practice of false rumor mongering for financial gain. Naked shorts are defined as selling stocks without borrowing the stock sold within three days of the short sale. It certainly does not appear to be merely a coincidence that the most beleagured financial institutions named (or more appropriately, defended) by the SEC for special protection were among the biggest gainers from the SEC's Tuesday notice through Friday's close. For example, in just that four-day period Fannie Mae's stock price was up an astounding 90%, Freddie Mac rose 74%, Bank of America was up 48%, Lehman rose 45% and citigroup increased 33%. Did the underlying situation for these institutions change that radically for the better in those four days? I think not. Many mistakenly attributed the rise to less than feared negative earnings reports by some institutions and a few relatively positive earnings reports. That and growing confidence that Treasury support of Fannie and Frddie will not extend to nationalization and a wiping out of shareholder equity were also factors but less so. Most likely shorts in the 19 financials named by the SEC will be reset at higher price levels as the rally runs out of steam. In addition, the focus of the shortsellers will increasingly shift to the regional banks and financials that are seen as the most vulnerable. The FDIC prudently expects dozens of these regional institutions to fail.
From all this it should be clear that this past week's rally was not spurred by a change in market fundamentals. But where the markets go ultimately does depend critically on those fundaments. The plunge in home prices and spike in food and energy costs are the major underlying forces driving financial institution distress, the credit crunch, the consumer financial squeeze,the US economic downturn, the corporate profit squeeze and the bear market in equities. There has been no meaningful change in the impact of and outlook for those critical economic determinants. The drop in home prices is projected to be significantly extended, perhaps to twice the decline thus far experienced nationally. That price drop will be impelled by an outsized inventory of unsold homes, mounting bank distress sales of foreclosed or soon to be foreclosed homes, reduced credit availability, and worening employment prospects. As the drop in home prices continues, it will increasingly wipe out the equity of even the 20% down, conventional-motgage home buyer. That will extend the problems well beyond the holders of subprime and Alt-A mortgages and such mortgage related paper. Accordingly, financial institution losses will continue to mount increasing the volume of writeoffs and need for new capital injections.
Even with oil prices off their highs, the financial burdens that will be imposed on consumers and corporate energy puchasers will still be horrendous, especially this winter, curtailing nonoil purchases and corporate profits and deepening the recession. Also, there is no guarantee the negotiations with Iran will be sucessful. In that event, there are rumors of an air attack scheduled for January, before the new President takes office. It is hard to know if there is truth to the rumor, if it is a negotiating ploy or merely an attempt to boost oil prices. Perhaps the latter given comments by a senior pentagon official that the last thing we need now is a third military front. Also, there is concern that China has sharply limited polluting production to improve air quality prior to and during the Olympic games. It is not clear what will occur after the Olympics end. Will china increase its demands for critical resources, boosting prices for oil and other commodities, as it resumes highly polluting production for export, or has there been so much overbulding ahead of the Olympics that there is a domestic construction slowdown, reducing the pace of commodity demands? Probably both. But China's demand for oil is likely to remain strong until the slow moving onset of the global recession finally takes hold.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
E-Mail Address: philipbraverman@Gmail.com
Saturday, July 12, 2008
Survival risk of Fannie Mae and Freddie Mac and seizure of IndyMac roil markets
The inter-related housing and credit crisis is destined to continue. Despite seeming efforts by the Fed, the regulatory authorites, the Congress and the Admistration to deal with the housing, mortgage and credit problems, there is no convincing evidence that this muli-faceted crisis is being effectively resolved. As is often the case, officialdom hopes that confidence will be restored by the appearance of a change in regulations, a line of credit, some action or some presumed authoratative statement. It rarely if ever works. Indeed, they may well make matters worse as the often empty offorts, statements and promises only demonstrate the incompetence of those handling the problems.
Before suggesting how the current situation might be realistically dealt with, it is necessary to better understand its source. The root cause of the underlying housing problem was that too much money and excessively easy credit were thrown at housing. It is an old truth that if enough money is thrown at any asset or asset class, no matter how valuable initially, it will eventually be inflated to the point of excess and its price bubble will burst, trashing it. The sub-prime, Alt-a, no document "liar" mortgage loans, no-amortization or negative amortization loans, and mortgage loans equal to 125% of inflated appraised value all served to excessively inflate home prices. That in turn created a speculative binge in home construction and investor home buying that was bound to eventually lead to a housing crash, the like of which has not been seen since the Depression of the 1930's.
To make matters worse, there was no adequate restraining oversight by those Federal regulatory insitutions, the Fed included, that were chartered for just that purpose. There was no restrictive hand, only permissiveness. Congress and the Administation, whatever the party in power, rarely if ever has the political will to take the unpopular but appropriate watch-dog action. For that reason Congress has long recognized that it must put political distance between itself and those individuals and regulatory authorities charged with making the unpopular but necessary decisions that have been aptly characterized as essentially taking the punchbowl away as soon as the party really gets going. Unfortunately, there is a tendency for the initial zealotry of the supervisory authorities of regulatory agencies born in crisis to over time eventually give way to complacency and ultimately to outright supporters of the entities they are required to supervise.
In an effort to essentialy lock the barn door after the horse was stolen, regulations have since been imposed that make the sources of excessive and inappropriate speculative borrowing more difficult to come by. But the credit market, through the credit crunch crisis, was already accomplishing that objective. That is not where the problem now lies. If half the credit supporting the demand for any commodity or service is removed, its price will fall. The removal of the speculative portion of the mortgage credit bubble is trashing housing. True, much of the decline in home prices is centered in those geographical areas where speculation was most pronounced. But, the problem is also national in scope, affecting conventional mortgages as well as sub-prime. The 18% decline in home prices nationally, by some estimates, and the prospect of a 30% or larger decline before the home price slide ends, is undermining confidence and erasing any homeowner equity for tens of millions of American homeowners. Furthermore, homeowner distress is compounded by the rise in energy and food prices, the inability of financially stressed consumers to continue to use their disappearing home equity as an ATM machine and the worsening employment situation.
Given this set of circumstances, the only rational solution is a Federally mandated moritorium on foreclosures, even if limited by special circumstances. Those special circumstances should at least include homeowner occupied homes, a demonstrated effort on the part of the borrower to make mortgage payments or a reasonable share of income if employed, or documented extenuating circumstances that make it difficult or impossible for the homeowner to fully keep up with mortgage payments. This was essentially the policy put in place by the FDIC when it was first originated in the late stages of the 1930's Depression. The FDIC considered all delinquent mortgages where the homeowner occupied the home and there was even the slightest effort or intent to make mortgage payments as a workout mortgage, not to be foreclosed. Such an approach seems even more appropriate currently, given the prevalence of inappropriate or even predatory lending practices and the complicity of lax regulation. Moreover, by arresting the cascading foreclosure tidal wave, the relentless downward pressure on home prices could be significantly lessened. That might encourage buying of the existing inventory of homes available for sale as well as encouraging renewed interest in mortgage-backed paper. That in turn would lessen the mark to market writedown downs required of financial instutions. Other steps that could be employed include a required but temporary reduction in the mortgage rate on liberally interpreted qualifying "distressed" mortgages, suspension of mark-to-market requirements, a suspension of the required early bank sale of already foreclosed homes, and a rebate of income taxes for the past four years for delinquent homeowners to be paid to mortgage lenders to bring the mortgage up to date. This latter device is roughly comparable to the four years of refunds of income taxes repaid to builders who experience current losses.
This week, still more financial institutions were put at risk of survival by the continuing losses in home mortgages, in real estate and in both related and unrelated complex derivitive financial instruments. The credit and equity markets are losing confidence in one affected financial institution after another. The latest to experience a literal run on its deposits was the Indy Mac bank, actually a savings and loan assocition with $32 billion in assets specializing in Alt-A no document mortgages, which are lower quality than conventional mortgage loans. The FDIC seized the institution and will be responsible for its deposits. That may entail the commitment of some 10% of the FDIC's assets.
Even more significant are market questions over the survival of Fannie Mae and Freddie Mac, the backbone of the mortgage market. Some claim the two institutions are already technically insolvent. I personally, along with others, have been critical of the two firms loose accounting and other questionable practices for years. They operate on a shoestring capital base. The most likely course is for the Federal government to maintain the legal seperation of the two institutions from the US Treasury by merely lending funds or purchasing a special instrument from them. The least desirable approch would be nationalization, which would involve accepting their $5 trillion in mortgage guarantees as US Treasury obligations. That fear drove Treasury bond yields higher on Friday.
On other fronts, the downtrend in equity prices will persist and the decline in Treasury yields will resume as it becomes clear that the economic downturn is becoming global, producing a cyclical decline in inflation pressures. Eventually, when the recovery is in full swing and the economic slack is eroded, secular inflation pressures in commodities can be expected to resume. But, before that, and for an extended period of time, the recessionary business cycle effects will come to be the dominant force affecting inflation and bond yields, driving them lower.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Before suggesting how the current situation might be realistically dealt with, it is necessary to better understand its source. The root cause of the underlying housing problem was that too much money and excessively easy credit were thrown at housing. It is an old truth that if enough money is thrown at any asset or asset class, no matter how valuable initially, it will eventually be inflated to the point of excess and its price bubble will burst, trashing it. The sub-prime, Alt-a, no document "liar" mortgage loans, no-amortization or negative amortization loans, and mortgage loans equal to 125% of inflated appraised value all served to excessively inflate home prices. That in turn created a speculative binge in home construction and investor home buying that was bound to eventually lead to a housing crash, the like of which has not been seen since the Depression of the 1930's.
To make matters worse, there was no adequate restraining oversight by those Federal regulatory insitutions, the Fed included, that were chartered for just that purpose. There was no restrictive hand, only permissiveness. Congress and the Administation, whatever the party in power, rarely if ever has the political will to take the unpopular but appropriate watch-dog action. For that reason Congress has long recognized that it must put political distance between itself and those individuals and regulatory authorities charged with making the unpopular but necessary decisions that have been aptly characterized as essentially taking the punchbowl away as soon as the party really gets going. Unfortunately, there is a tendency for the initial zealotry of the supervisory authorities of regulatory agencies born in crisis to over time eventually give way to complacency and ultimately to outright supporters of the entities they are required to supervise.
In an effort to essentialy lock the barn door after the horse was stolen, regulations have since been imposed that make the sources of excessive and inappropriate speculative borrowing more difficult to come by. But the credit market, through the credit crunch crisis, was already accomplishing that objective. That is not where the problem now lies. If half the credit supporting the demand for any commodity or service is removed, its price will fall. The removal of the speculative portion of the mortgage credit bubble is trashing housing. True, much of the decline in home prices is centered in those geographical areas where speculation was most pronounced. But, the problem is also national in scope, affecting conventional mortgages as well as sub-prime. The 18% decline in home prices nationally, by some estimates, and the prospect of a 30% or larger decline before the home price slide ends, is undermining confidence and erasing any homeowner equity for tens of millions of American homeowners. Furthermore, homeowner distress is compounded by the rise in energy and food prices, the inability of financially stressed consumers to continue to use their disappearing home equity as an ATM machine and the worsening employment situation.
Given this set of circumstances, the only rational solution is a Federally mandated moritorium on foreclosures, even if limited by special circumstances. Those special circumstances should at least include homeowner occupied homes, a demonstrated effort on the part of the borrower to make mortgage payments or a reasonable share of income if employed, or documented extenuating circumstances that make it difficult or impossible for the homeowner to fully keep up with mortgage payments. This was essentially the policy put in place by the FDIC when it was first originated in the late stages of the 1930's Depression. The FDIC considered all delinquent mortgages where the homeowner occupied the home and there was even the slightest effort or intent to make mortgage payments as a workout mortgage, not to be foreclosed. Such an approach seems even more appropriate currently, given the prevalence of inappropriate or even predatory lending practices and the complicity of lax regulation. Moreover, by arresting the cascading foreclosure tidal wave, the relentless downward pressure on home prices could be significantly lessened. That might encourage buying of the existing inventory of homes available for sale as well as encouraging renewed interest in mortgage-backed paper. That in turn would lessen the mark to market writedown downs required of financial instutions. Other steps that could be employed include a required but temporary reduction in the mortgage rate on liberally interpreted qualifying "distressed" mortgages, suspension of mark-to-market requirements, a suspension of the required early bank sale of already foreclosed homes, and a rebate of income taxes for the past four years for delinquent homeowners to be paid to mortgage lenders to bring the mortgage up to date. This latter device is roughly comparable to the four years of refunds of income taxes repaid to builders who experience current losses.
This week, still more financial institutions were put at risk of survival by the continuing losses in home mortgages, in real estate and in both related and unrelated complex derivitive financial instruments. The credit and equity markets are losing confidence in one affected financial institution after another. The latest to experience a literal run on its deposits was the Indy Mac bank, actually a savings and loan assocition with $32 billion in assets specializing in Alt-A no document mortgages, which are lower quality than conventional mortgage loans. The FDIC seized the institution and will be responsible for its deposits. That may entail the commitment of some 10% of the FDIC's assets.
Even more significant are market questions over the survival of Fannie Mae and Freddie Mac, the backbone of the mortgage market. Some claim the two institutions are already technically insolvent. I personally, along with others, have been critical of the two firms loose accounting and other questionable practices for years. They operate on a shoestring capital base. The most likely course is for the Federal government to maintain the legal seperation of the two institutions from the US Treasury by merely lending funds or purchasing a special instrument from them. The least desirable approch would be nationalization, which would involve accepting their $5 trillion in mortgage guarantees as US Treasury obligations. That fear drove Treasury bond yields higher on Friday.
On other fronts, the downtrend in equity prices will persist and the decline in Treasury yields will resume as it becomes clear that the economic downturn is becoming global, producing a cyclical decline in inflation pressures. Eventually, when the recovery is in full swing and the economic slack is eroded, secular inflation pressures in commodities can be expected to resume. But, before that, and for an extended period of time, the recessionary business cycle effects will come to be the dominant force affecting inflation and bond yields, driving them lower.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Saturday, July 5, 2008
Equity bear market and renewed decline in Treasury yields have much further to run
With a 20.3% decline from its October 2007 peak, the Dow Jones industrial average is now officially in bear market territory. The Standard & Poors 500 stock index is not quite there yet with a 19.3% drop from last year's peak. But with so much depressing the economy, increasing job losses, high oil prices, negative investor sentiment and the deteriorating outlook for corporate profits, a parallel decline in the S&P and other stock market indices appears virtually inevitable. Indeed, various market measures and history indicate there is far worse to come.
This does not rule out a temporary "dead cat" equity market bounce after the outsized June price drop, which has triggered some renewed buying interest from bottom fishers. But, even such a brief and misleading rally is open to question. Three quarters of New York Stock Exchange issues have fallen below their 200-day moving average price level, typically an ominous sign of significant technical weakness and of simply more selling than buying. That is certainly understandable considering that there are increasing reports that working Americans are cashing out their retirement savings in a last ditch effort to just meet basic needs or save their home from foreclosure. In the cashing out process they are puting downward pressure on equity prices. And they are not alone. Equity markets around the globe are also evidencing downtrends.
What does history tell us about equity market prospects from here, after prior stock indices fell into bear market territory. There have been nine cyclical declines in the Dow that exceeded 20% since 1960. They ranged from a mild 21.1% decline in 1967, to a severe 45.1% plunge in 1973, with a mean of 33.1% and an arithmetic average for all nine drops of 31.1%. In duration the bear markets averaged 14 months versus the 8months since the current bear market's October 2007 peak. If it is assumed that the extent and duration of this bear market will just match the arithmetic average, it is not too late to raise cash or liquidate losing holdings, which you can buy back later at lower prices. An alternative would be to hedge or neutralize your long equity portfolio with a short position in an exchange traded fund such as the proshares S&P 500. Of course, for the more agressive investor, a naked short position in such a fund is consistent with the outlook suggested by past experience.
There are reasons to be concerned that the bear market decline this time could be worse than the average decline and closer to the deepest of these post-1960 prior bear markets, the 45% 1973 decline. Like the current bear market, that decline was triggered by a steep rise in oil prices, concerns over adequate oil supplies and a plunge in the sales of gas guzzlers. In addition, the current equity market downdraft also reflects the worst housing market since the great depression, a credit crunch, a contraction or deleveraging of the financial community and their desperate effort raise new capital, an appropriate increase in investor caution and a pronounced financial squeeze on consumers and business.
Last Thursday's reports make it clear that the US unemployment situation continues to deteriorate. Nonfarm payrolls declined 62.000 in June, matching the revised 62,000May decline. But the decline in the private sector was steeper, mitigated by a rise in government employment. The unemployment rate remained at 5.5%, validating the sharp rise the month before. Initial claims for unemployment benefits in the latast week rose just above the 400,000 level that has historically been used as a rule of thumb demarcation line ushering in a recession. Long term unemployment and the duration of unemployment continue to worsen. But those statistics would be far worse if they included the large number of unemployed who took part-time work at lower pay only because they could not find full-time employment. The PMI report indicated that the service sector is now contracting. Though the PMI report for manufacturing edged above 50, that is almost certainly temporarily.
While signs of incipient or actual recession continue to abound, so do signs of inflatiom. That combination, along with other problems, has contributed to a rise in corporate and municipal bond yields, especially lower quality credits. The widening quality and steepening maturity yield curve is a typical early onset of recession development. There has also been a steepening of the Treasury maturity yield curve. As the recession deepens, cutting demand for goods and services, especially when the recession becomes global, undercutting the demand for oil and other key commodities, both inflation and inflation expectations will moderate. With that development, long term yields, especially for Treasuries, will decline. The decline in long-term yields for lesser credits and the narrowing in the quality yield spread is likely to await the first signs of an improvement in the economy, suggesting a coming strengthening of those borrowers credit worthiness.
Though the ECB firmed this past week, comments suggested that it was not the beginning of an extended firming trend. That is certainly understandable given growing signs that Europe is headed for recession as well. That will make it easier for the Fed to maintain its current 2.0% funds rate or even ease further as the US recession deepens.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731
E-mail address: philipbraverman@Gmail.com
This does not rule out a temporary "dead cat" equity market bounce after the outsized June price drop, which has triggered some renewed buying interest from bottom fishers. But, even such a brief and misleading rally is open to question. Three quarters of New York Stock Exchange issues have fallen below their 200-day moving average price level, typically an ominous sign of significant technical weakness and of simply more selling than buying. That is certainly understandable considering that there are increasing reports that working Americans are cashing out their retirement savings in a last ditch effort to just meet basic needs or save their home from foreclosure. In the cashing out process they are puting downward pressure on equity prices. And they are not alone. Equity markets around the globe are also evidencing downtrends.
What does history tell us about equity market prospects from here, after prior stock indices fell into bear market territory. There have been nine cyclical declines in the Dow that exceeded 20% since 1960. They ranged from a mild 21.1% decline in 1967, to a severe 45.1% plunge in 1973, with a mean of 33.1% and an arithmetic average for all nine drops of 31.1%. In duration the bear markets averaged 14 months versus the 8months since the current bear market's October 2007 peak. If it is assumed that the extent and duration of this bear market will just match the arithmetic average, it is not too late to raise cash or liquidate losing holdings, which you can buy back later at lower prices. An alternative would be to hedge or neutralize your long equity portfolio with a short position in an exchange traded fund such as the proshares S&P 500. Of course, for the more agressive investor, a naked short position in such a fund is consistent with the outlook suggested by past experience.
There are reasons to be concerned that the bear market decline this time could be worse than the average decline and closer to the deepest of these post-1960 prior bear markets, the 45% 1973 decline. Like the current bear market, that decline was triggered by a steep rise in oil prices, concerns over adequate oil supplies and a plunge in the sales of gas guzzlers. In addition, the current equity market downdraft also reflects the worst housing market since the great depression, a credit crunch, a contraction or deleveraging of the financial community and their desperate effort raise new capital, an appropriate increase in investor caution and a pronounced financial squeeze on consumers and business.
Last Thursday's reports make it clear that the US unemployment situation continues to deteriorate. Nonfarm payrolls declined 62.000 in June, matching the revised 62,000May decline. But the decline in the private sector was steeper, mitigated by a rise in government employment. The unemployment rate remained at 5.5%, validating the sharp rise the month before. Initial claims for unemployment benefits in the latast week rose just above the 400,000 level that has historically been used as a rule of thumb demarcation line ushering in a recession. Long term unemployment and the duration of unemployment continue to worsen. But those statistics would be far worse if they included the large number of unemployed who took part-time work at lower pay only because they could not find full-time employment. The PMI report indicated that the service sector is now contracting. Though the PMI report for manufacturing edged above 50, that is almost certainly temporarily.
While signs of incipient or actual recession continue to abound, so do signs of inflatiom. That combination, along with other problems, has contributed to a rise in corporate and municipal bond yields, especially lower quality credits. The widening quality and steepening maturity yield curve is a typical early onset of recession development. There has also been a steepening of the Treasury maturity yield curve. As the recession deepens, cutting demand for goods and services, especially when the recession becomes global, undercutting the demand for oil and other key commodities, both inflation and inflation expectations will moderate. With that development, long term yields, especially for Treasuries, will decline. The decline in long-term yields for lesser credits and the narrowing in the quality yield spread is likely to await the first signs of an improvement in the economy, suggesting a coming strengthening of those borrowers credit worthiness.
Though the ECB firmed this past week, comments suggested that it was not the beginning of an extended firming trend. That is certainly understandable given growing signs that Europe is headed for recession as well. That will make it easier for the Fed to maintain its current 2.0% funds rate or even ease further as the US recession deepens.
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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