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