Despite mixed economic reports, recession will push equities and yields to new lows

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