The economy is in far worse shape than even some of the dubious but bleak official economic reports suggest. And there is no cyclical economic bottom in sight any time soon, despite Washington efforts and promises to throw ever more money at the problems.
One rarely reported measure of unemployment, which includes those only marginally employed, is already at 13.5% and likely to go far higher. Even the official widely followed unemployment rate will top 10% this year or next. It is no wonder that consumer confidence measures are establishing new lows. The Conference Board consumer confidence index at 38 in December, is down 15% from 44.7 in November and 58.1% from 90.6 a year ago. That points to a continued drop in consumer spending. There is certainly no prospective sales relief any time soon for the beleagured automobile manufacturers. Domestic auto units sold in December, even with major promotions, were down 32% from a year ago, virtually identical to the 33% plunge for imported auto units sold.
Housing is still far from bottoming out. Expect another 20% nationwide home price drop from here, as well as a continued surge in home mortgage defaults and foreclosures. Commercial real estate is certainly not immune. Office, store and apartment rents are also headed lower. The US has too much retail store space and too much office space. The deleveraging process will take a heavy toll in a further contraction of the financial sector and retailing.
The index of leading indicators will undoubtedly continue well under year ago levels, thereby month by month forcasting a continued recession for at least another six months ahead at a minumum. But, other longer-lead measures suggest the recession will persist right through 2009 into 2010.
Corporate profits will continue to slump. The S&P 500 index earnings per share now looks likely to be cut to or under $50 from some $100 or more last year. That, and the almost certain cuts in dividends that will be produced, is likely to be a strong catalyst for sharply lower equity prices ahead, including a retest of last November lows and quite likely the establishment of new even lower cyclical lows. The Dow Jones Industrials are now up just 15% above its November low. But, the Dow, S&P 500 and Nasdaq Composite are now down for this year to date, considered an ominous portent, given the market belief that a January rise increases the odds of a rise for the year and a January drop a decline for the year.
With all the forgoing it is only reasonable to anticipate that the various measures of inflation will soon be pointing to deflation. The December CPI,to be reported next Friday, should be down 1%. This follows the November consumer price index, which was down 1.7% from October and up just 1.0% from a year earlier. November finished producer prices were unchanged from a year earlier but are likely to be down in the next report. The JOC(Journal of Commerce)-ECRI industrial price index as of January 9 was down a precipitous 41% from a year ago, clearly flashing an outright deflation signal. Most commodity prices, with the notable exception of gold and possibly oil, are likely to continue weak with the persistent global recession. That in turn points to lower market interest rates, especially bond yields which rise with rising inflation expectations and decline with slowing inflation or outright deflation expectations. Indeed, the primary force keeping nonTreasury bond yields high is market concern over the potential for corporate and municipal default, termed "default risk", not inflation.
Similarly, the prime near-term reason for gold purchases is the potential for financial disarray, not inflation. The deep recession in India eliminates much of that country's traditional buying support for gold. But, persistant panic sentiment elsewhere, sufficient to create a shortage of gold vault space, keeps gold prices buoyant. But, some years ahead, perhaps five years, inflation concerns will return with a vengence and on a sustained basis. Until then gold holdings should be viewed as precautionary, despite increased deflation prospects which normally argues against gold.
The official BLS (Bureau of Labor Statistics) unemployment rate spiked up 0.4 percentage points to 7.2% for December from 6.8% in November. Nonfarm payrolls were reported to have plunged 524,000 in December alone, following a revised 584,000 drop in November and a deeper than originally reported drop in October. According to the BLS, The country has now lost a total of 2.6 million jobs in 2008, the largest drop since 1945. As horrendous as the December employment report is, there had been market concerns that the official report would be even worse. That even more dire expectation for the Friday BLS employment report was generated by a revamped ADP estimate, released on Wednesday,that private nonfarm private payrolls(excluding government employment) plummeted 693,000 in December. The disparity between the two series suggests either or both that the BLS report understates the actual loss of jobs and that there will be further steep job losses in the months ahead. A BLS understatement of nonfarm payroll job losses is also suggested by the frightening 806,000 December decline in employment reported in the BLS household survey, which is believed to be the far more reliable series in recession. Also, nonfarm payrolls continue to be irresponsibly inflated by the BLS, by 70,000 in December, to reflect the jobs the BLS merely assumes are being created by companies they do not sample. That inappropriately trims the nonfarm payroll loss by an equal number. The monthly pattern of downward revisions to nonfarm payrolls also indicates an unrelenting understatement of job losses in nonfarm payrolls.
What should you do with this information? It suggests that you should remain cautious,particularly in commiting new funds to equities. Shun them or to the extent possible, limit equity investments to high dividend,low price-earnings ratios (9 or less)in recession-proof companies. Instead of equities, emphasize safety, such as highly-rated debt instruments.
Despite last week's Barrons article urging readers to sell Treasuries, I still believe Treasury bonds and Treasury zero-coupon strips not only have value but offer a strong potential for capital gains. The peak Treasury coupon bond yield (at the apex of the maturity yield curve)at the market close on Friday was 3.43%, on the the 5.5% coupon Treasury bond scheduled to mature August 15,2028 and priced at 129.375 per $100 face value. Because almost all Treasury bonds can not be called by the government prior to maturity, the premium paid above par ($100 face value), will not be lost until maturity or if the bond is sold prior to maturity at less than you pay for it. However, because the bond is not callable, if Treasury market yields decline, as the economy weakens further and deflation risks escalate, as I expect, the market price on this and other Treasury bonds will rise further.
The peak Treasury zero coupon yield last Friday was 3.77% on the strip with a May 15,2023 maturity priced at $58.56 per $!00 at maturity. Even if Treasury market yields were not to decline over the next year, the market price on this zero strip would still rise as the the strip moves closer to maturity and the yields decline quarter by quarter along the yield curve. One year from now, under the circumstances I described, the price on the May 15, 2023 stip would rise to at least $61.06 per $100 face value, or a price rise of 4.3%. Of course, if market yields decline, as I expect, the profit on the May 15, 2023 strip would be larger.
This past week there was a long-term GE bond offering to yield some 7%. That is an excellent yield for a AAA rated issue reflecting excessive default risk.
There has already been a lessening in the near panic perceived default risk of late last year, as measured by the large yield spreads over comparable Treasury maturity yields. But there will be more of a decline in that yield spread and percieved default risk still to be realized. That suggests considering somewhat lesser credits as well if adequatly compensated in yield.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Subscribe to:
Post Comments (Atom)
No comments:
Post a Comment