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
Saturday, November 29, 2008
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
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