The market ascribes specific reasons as the cause of the latest market declines in equities as well as the rise in gold prices above $1,000 per ounce. But these and other longer term trends are likely to persist for basic reasons, long after the latest presumed justifications, such as the threat of bank nationalization, are forgotten. The real reason is that the global economy and financial system are in close to free fall despite the desperate and seemingly aggressive efforts of governments around the globe to deal with mostly the symptoms rather than the causes of the problem.
The economic decline is so pervasive that it is bound to inevitably lead to outright deflation for consumer prices, as it has already produced pronounced deflation in producer prices, commodity prices and home prices. Though the consumer price index (CPI)was up in February, the rise is an aberration. Even with this monthly CPI rise, February consumer prices were unchanged (0.0%) from February last year. This compares with a 0.1% year-over-year rise in the CPI in January and down sharply from a 4.3% year-over-year rise in February a year ago. Thus, consumer prices are already on the threshold of outright deflation. In coming months the desperate efforts of retailers to survive will further cut the prices of a broad range of consumer products. That should lead to year-over-year declines in consumer prices, a pattern that should persist for a considerable length of time.
That deflation prospect has broad adverse implications for the equity market. It strongly suggests that as prices are cut to stave off failure and bankruptcy, corprate profits will decline still further. That and the continued erosion of dividends will lead to significantly lower lows in equity prices.
The coming deflation reality in all price indices will also help keep Treasury bond yields low despite misplaced concerns that the large step up in Federal budget deficits and Treasury borrowing will lead to an early spike in inflation. While inflation will eventually reappear, that is unlikely to occur for an extended number of years, perhaps five years or more. There can be no reflation until the global recovery has been underway for a considerable length of time. It will take years before there is a sustained global recovery. The Administration's estimate that the recovery could begin in the third quarter this year should be dismissed as merely boosterism. An economic recovery in 2010 is possible but by no means assured. Even then, the recovery is more likely to be sluggish than robust. Even in a recovery from a typical recession, and this is far from a typical recession, there is an extended period, often years, before the excesses of unused productive capacity of manufacturing, mines and labor are used up enough to reestablish pricing power. This time that period will be far longer than typical. That points to years of deflation, followed by more years of very low inflation. That virtually assures a long period of low Treasury bond yields, because inflation expectations are a prime determinant of Treasury bond yields.
At this point many of those reading this will point out that the rise in the Federal budget deficit and consequent increase in Treasury borrowing demands will vastly increase the supply of Treasury debts marketed far beyond the increase in a typical recession. That argument has led to widespread expectations that this Treasury debt expansion would require a substantial increase in Treasury yields. However, the decline in private sector borrowing and the increase in Fed and other purchases of Treasuries will keep Treasury yields low or move them still lower. The rise in gold prices reflects a flight from currency,economic and equity market uncertainties and fears , which are likely to persist, even if inflation is not a realistic near term prospect.
Expect next weeks revision of fourth quarter real GDP decline to exceed 5.0%, a far deeper decline than the 3.8% drop originally reported. But, the first quarter real GDP decline, to be reported at the end of April will be as large or larger, probably between 5.0% and 6.0%. The next employment report for February, released March 6, is likely to reveal a 600,000 or larger decline in nonfarm payrolls and a further rise in the unemployment rate judging by the high 627,000 weekly rise in initial claims for unemployment benefits in recent weeks.
The US Treasury attempted to reassure the equity market on Friday that it intends to preserve private ownership of the US banking system. The Treasury also leaked indications that details of its plan to solve the banking system's profound problems would be released over coming weeks. These efforts were an attempt to quash market fears that at least a temporary nationalization of major banks may be required. Such fears were ignited by comments by Senator Dodd and former Fed Chairman Greenspan indicating that nationalization of some banks may be required. That in turn led to market fears that bank equity values would be completely wiped out in the nationalization process even if temporary. If the US Tresury is considering nationalization, it could achieve many of its objectives without nationalization if it would quarantee deposits regardless of the size of the deposit.
The next economic and finance report will be posted in two weeks, dated March 6, following release of the projected horrendous February employment report.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email Address: philipbraverman@ Gmail.com
Friday, February 20, 2009
Friday, February 13, 2009
Disappointing bank bailout proposals and stimulus package led to a selloff in equities
The wellspring of market patience and confidence is drying up amidst signs of continuing leadership ineptitude and political expediency. There is no bold plan that impels the market or the public to confidence in an early economic or financial turnaround. As a consequence, there will be a continuing tale of economic and financial woe.
Expect the credit crunch to persist, bank and other bankruptcies to continue proliferating, the recession to deepen through this year into next, for official unemployment rates to continue rising into double digits, with real unofficial unemployments rates to reach even higher levels, outright deflation to take hold and equity prices to decline further. US Housing prices, at the heart of the US and global financial and economic meltdown, are likely to drop significantly further, perhaps by an additional 15% to even 20% nationwide. This is despite the welcome but too narrow and very temporary halt to forclosures announced by Fannie Mae, Freddie Mac, Chase and Citibank. As well meaning as the Federal government's efforts are, they are too little, too late. too disjointed, too mis-directed, and too ill-concived. The stimulus and bailout efforts continue to primarily target only the consequences or symptoms, not the root cause of the global economic and financial meltdown. Too much of the so called stimulus spending will have its primary impact next year. And much of it will be used to pay down debt or merely as a substitute for lost revenue, whether for individuals, business or state and local governments. That ammounts to palliative care.
In 1932, President Franklin Delano Roosevelt said "These unhappy times call for the building of plans...that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyrimid". That focus on the bottom for the current problem implies a focus on the borrowers of sub-prime mortages and other mortgages in distress. Relieving that distress would go far to quickly arrest the financial problems underlying the mortgage-related paper debacle and the threatened bankruptcy of the financial system.
A variation of a plan proposed by Barron's would go a long way towards accomplishing the desired objective. Barron's proposes injecting $200 billion in "TARP" money in exchange for a 25% reduction in the mortgage principal owed on sub-prime mortgage loans. I would go much further. I would count the funds already invested by TARP as a down payment on that remedial objective. And I would extend the partial mortgage principal forgiveness approach to Alt-A mortgage loans as well.
At least a one-year moritorium on foreclosure for homeowner occupied homes would reduce or arrest the downward pressure on home prices. Abuses to the system by those able to pay their mortgage but choose not would be a price worth paying to stop the downward spiral in home prices fed by the forced bank sales of forclosed properties. Those homes that have already been foreclosed should be offered back to the prior homeowner on subsidezed rentals that allow for eventual repurchse on favorable terms. Banks should not be required, as they are currently, to quickly sell the foreclosed homes. That only forces them to typically take steep loss charge-offs against their capital. Instead, the banks should be permitted to hold the properties on their books without chargeoffs, particularly if they are offered to former resident owners on favorable terms.
There should be a mixed Federal-private program to buy up unoccupied homes and rent them to potential resident home-owners at attractive terms. That would limit or arrest the decline in home prices, attract speculative buyers and help end housing distress.
It would also be appropriate to put in place at least a temporary reprieve on the mark-to-market accounting requirement which forces banks to write down the asset value of mortgage loans and other assets even when there is no sale of the asset, no realistic market price, and not even a delinquency or default on the loan. When there is such a write-down of the asset, the financial institution is required to charge the unrealized loss against capital. These phantom losses can even force the institution into bankruptcy. It is senseless to maintain this requirement even in this emergency period.
There is a wider yield spread between the reduced Fed charge for funds to banks and the onerous mortgage rates being charged on some mortgages by those banks to homeowners in distress. That wider yield spread translates into profits for banks that should be passed by the banks back to the homeowner in the form of lower mortgage rates on existing or refinanced mortgages. It can be argued that the financial crisis is a result of predatory lending, collusion, fraud, stupidity,irresponsibility or at the very least morally reprhensible greed on the part of lenders, mortgage brokers, appraisers, investment bankers, the rating agencies and borowers. That trumps the supposed sanctity of mortgage contracts, especialy when maintaing that sanctity could bankrupt the financial sysytem.
Instead of such common sense proposals there is profound disappointment with both the lack of specifics in Treasury Secretary Geithner's bank bailout plan, the long delay in formulating a consistent and workable solution and the unfocused mere spending aspects of the Federal stimulus package, That disappointment this week led to a continuing selloff in the equity market, especially financials, and a weak sale of the Treasury new 30-year bond last Thursday. Conversely, the lack of confidence that the government's initiaties will be effective without producing either inflation or deflation was a spur to gold prices, which are making a new run on the $1,000 plus previous high.
The equity market was down particularly sharply. For the week, financial stocks were down as much as 10%, while the Dow industrials were down 5%. Indeed, at 7,850 at Friday's close, the Dow industrials were only 4% above last November's low and apparently heading for at least a retest of those lows or more likely new lows. This negative equity market performance, though realistic given the economy's profound weakness, is all the more surprisingly given the market's tendency to at least temporarily turn euphoric with a new President and a new set of stimulative initiatives. Instead, the equity market remains clearly defensive, with health care one of the few sectors trading at or above its 200 day moving average. Some analysts believe that until this defensive sector turns negative, the potential for the rest of the market to rally on a sustained basis is limited.
The new Treasury 30-year bond was auctioned Thursday at a yield of 3.54%, only to sell off to a yield of 3.69% on Friday. (The higher market yields on the 30-year Treasury bond translated into a a more than 4 point drop in its market price.) The yield will decline as the new issues move into stonger hands. Nevertheless, the Treasury market seems caught in a see-saw balance between conflicting concerns and market forces.
Helping to keep safe-haven purchases of Treasuries in place are concerns that the stimulus package and other Federal initiatives may not be either large enough or sufficiently effective to keep the recession from deepening. Indeed, the realty of the deepening recession is keeping the fear of outright deflation alive, a positive for higher Treasury prices and low Treasury bond yields. Also supporting the Treasury market are foreign purchases and the threat of Fed purchases of longer-term Treasuries to help bring down mortgage rates, which are often determined by the yield spread from Treasury yields. In the past, the rule of thumb has been that high-grade 30-year corporate bonds (when there is little or no risk of default) would yield some 1 percentage point above 30-year Treasury bonds. And 30-year mortgages would normally yield some 2 percentage points above 30-year Treasury bonds. Thus, given those historical relationships, there is an incentive for the Fed to buy Treasury bonds as an almost promised means of better achieving its broader mortgage market objectives. However, there appears to be some recent back-pedeling on this issue considering Fed Chairman Bernanke's comment that there is some disagreement on the Federal Reserve Board on this issue of Fed purchases of Treasury bonds.
Other forces are driving Treasury bond yields higher. The Treasury market fears the size of the budget will swamp buying demand both here and abroad for Treasuries. Buying demand overseas will be reduced as their trade surpluses wane and the need to stimulate their domestic economies forces a diversion of new funds away from purchases of Treasuries. The realty is that most Treasury financing is short term, where Federal Reserve buying can readily augment or replace domestic or foreign buying. Less predictable is the potential of ever more sizable shorting of Treasuries to finance the purchase of corporate bonds, especially high-yield junk bonds, where the yield spread is exceptionally attractive. Of course, the yield spread between Treasuries and junk bonds is exceptionally wide for a good reason. The risk of default in that sector is exceptionally high. It remains to be seen if the incidence of loss through bankruptcy is as moderate as 16% as some investors anticipate. The speculative buying of junk bonds also reflects a shift of investment from other sources, such as money funds. Regardless of the source of the investment in junk bonds, the buying has already contributed to a narrowing in the quality yield spreads from Treasuries to junk bonds, as well as to high grade corporates, a far more prudent investment in the current enviornment.
Some odds and ends. Last week GE injected substantial funds in GE capital in the hopes of maintaining their AAA rating. Thus far, that only helped the yield on its longer dated bonds edge down from 8.0% to 7.9%. However, a further substantial decline in this yield is inevitable as the excessive GE default risk priced into its bond yield subsides and Treasury yields stay low for an extended period.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Expect the credit crunch to persist, bank and other bankruptcies to continue proliferating, the recession to deepen through this year into next, for official unemployment rates to continue rising into double digits, with real unofficial unemployments rates to reach even higher levels, outright deflation to take hold and equity prices to decline further. US Housing prices, at the heart of the US and global financial and economic meltdown, are likely to drop significantly further, perhaps by an additional 15% to even 20% nationwide. This is despite the welcome but too narrow and very temporary halt to forclosures announced by Fannie Mae, Freddie Mac, Chase and Citibank. As well meaning as the Federal government's efforts are, they are too little, too late. too disjointed, too mis-directed, and too ill-concived. The stimulus and bailout efforts continue to primarily target only the consequences or symptoms, not the root cause of the global economic and financial meltdown. Too much of the so called stimulus spending will have its primary impact next year. And much of it will be used to pay down debt or merely as a substitute for lost revenue, whether for individuals, business or state and local governments. That ammounts to palliative care.
In 1932, President Franklin Delano Roosevelt said "These unhappy times call for the building of plans...that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyrimid". That focus on the bottom for the current problem implies a focus on the borrowers of sub-prime mortages and other mortgages in distress. Relieving that distress would go far to quickly arrest the financial problems underlying the mortgage-related paper debacle and the threatened bankruptcy of the financial system.
A variation of a plan proposed by Barron's would go a long way towards accomplishing the desired objective. Barron's proposes injecting $200 billion in "TARP" money in exchange for a 25% reduction in the mortgage principal owed on sub-prime mortgage loans. I would go much further. I would count the funds already invested by TARP as a down payment on that remedial objective. And I would extend the partial mortgage principal forgiveness approach to Alt-A mortgage loans as well.
At least a one-year moritorium on foreclosure for homeowner occupied homes would reduce or arrest the downward pressure on home prices. Abuses to the system by those able to pay their mortgage but choose not would be a price worth paying to stop the downward spiral in home prices fed by the forced bank sales of forclosed properties. Those homes that have already been foreclosed should be offered back to the prior homeowner on subsidezed rentals that allow for eventual repurchse on favorable terms. Banks should not be required, as they are currently, to quickly sell the foreclosed homes. That only forces them to typically take steep loss charge-offs against their capital. Instead, the banks should be permitted to hold the properties on their books without chargeoffs, particularly if they are offered to former resident owners on favorable terms.
There should be a mixed Federal-private program to buy up unoccupied homes and rent them to potential resident home-owners at attractive terms. That would limit or arrest the decline in home prices, attract speculative buyers and help end housing distress.
It would also be appropriate to put in place at least a temporary reprieve on the mark-to-market accounting requirement which forces banks to write down the asset value of mortgage loans and other assets even when there is no sale of the asset, no realistic market price, and not even a delinquency or default on the loan. When there is such a write-down of the asset, the financial institution is required to charge the unrealized loss against capital. These phantom losses can even force the institution into bankruptcy. It is senseless to maintain this requirement even in this emergency period.
There is a wider yield spread between the reduced Fed charge for funds to banks and the onerous mortgage rates being charged on some mortgages by those banks to homeowners in distress. That wider yield spread translates into profits for banks that should be passed by the banks back to the homeowner in the form of lower mortgage rates on existing or refinanced mortgages. It can be argued that the financial crisis is a result of predatory lending, collusion, fraud, stupidity,irresponsibility or at the very least morally reprhensible greed on the part of lenders, mortgage brokers, appraisers, investment bankers, the rating agencies and borowers. That trumps the supposed sanctity of mortgage contracts, especialy when maintaing that sanctity could bankrupt the financial sysytem.
Instead of such common sense proposals there is profound disappointment with both the lack of specifics in Treasury Secretary Geithner's bank bailout plan, the long delay in formulating a consistent and workable solution and the unfocused mere spending aspects of the Federal stimulus package, That disappointment this week led to a continuing selloff in the equity market, especially financials, and a weak sale of the Treasury new 30-year bond last Thursday. Conversely, the lack of confidence that the government's initiaties will be effective without producing either inflation or deflation was a spur to gold prices, which are making a new run on the $1,000 plus previous high.
The equity market was down particularly sharply. For the week, financial stocks were down as much as 10%, while the Dow industrials were down 5%. Indeed, at 7,850 at Friday's close, the Dow industrials were only 4% above last November's low and apparently heading for at least a retest of those lows or more likely new lows. This negative equity market performance, though realistic given the economy's profound weakness, is all the more surprisingly given the market's tendency to at least temporarily turn euphoric with a new President and a new set of stimulative initiatives. Instead, the equity market remains clearly defensive, with health care one of the few sectors trading at or above its 200 day moving average. Some analysts believe that until this defensive sector turns negative, the potential for the rest of the market to rally on a sustained basis is limited.
The new Treasury 30-year bond was auctioned Thursday at a yield of 3.54%, only to sell off to a yield of 3.69% on Friday. (The higher market yields on the 30-year Treasury bond translated into a a more than 4 point drop in its market price.) The yield will decline as the new issues move into stonger hands. Nevertheless, the Treasury market seems caught in a see-saw balance between conflicting concerns and market forces.
Helping to keep safe-haven purchases of Treasuries in place are concerns that the stimulus package and other Federal initiatives may not be either large enough or sufficiently effective to keep the recession from deepening. Indeed, the realty of the deepening recession is keeping the fear of outright deflation alive, a positive for higher Treasury prices and low Treasury bond yields. Also supporting the Treasury market are foreign purchases and the threat of Fed purchases of longer-term Treasuries to help bring down mortgage rates, which are often determined by the yield spread from Treasury yields. In the past, the rule of thumb has been that high-grade 30-year corporate bonds (when there is little or no risk of default) would yield some 1 percentage point above 30-year Treasury bonds. And 30-year mortgages would normally yield some 2 percentage points above 30-year Treasury bonds. Thus, given those historical relationships, there is an incentive for the Fed to buy Treasury bonds as an almost promised means of better achieving its broader mortgage market objectives. However, there appears to be some recent back-pedeling on this issue considering Fed Chairman Bernanke's comment that there is some disagreement on the Federal Reserve Board on this issue of Fed purchases of Treasury bonds.
Other forces are driving Treasury bond yields higher. The Treasury market fears the size of the budget will swamp buying demand both here and abroad for Treasuries. Buying demand overseas will be reduced as their trade surpluses wane and the need to stimulate their domestic economies forces a diversion of new funds away from purchases of Treasuries. The realty is that most Treasury financing is short term, where Federal Reserve buying can readily augment or replace domestic or foreign buying. Less predictable is the potential of ever more sizable shorting of Treasuries to finance the purchase of corporate bonds, especially high-yield junk bonds, where the yield spread is exceptionally attractive. Of course, the yield spread between Treasuries and junk bonds is exceptionally wide for a good reason. The risk of default in that sector is exceptionally high. It remains to be seen if the incidence of loss through bankruptcy is as moderate as 16% as some investors anticipate. The speculative buying of junk bonds also reflects a shift of investment from other sources, such as money funds. Regardless of the source of the investment in junk bonds, the buying has already contributed to a narrowing in the quality yield spreads from Treasuries to junk bonds, as well as to high grade corporates, a far more prudent investment in the current enviornment.
Some odds and ends. Last week GE injected substantial funds in GE capital in the hopes of maintaining their AAA rating. Thus far, that only helped the yield on its longer dated bonds edge down from 8.0% to 7.9%. However, a further substantial decline in this yield is inevitable as the excessive GE default risk priced into its bond yield subsides and Treasury yields stay low for an extended period.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Friday, February 6, 2009
Employment loss so dire it is viewed as a spur to stimulus and false recovery hopes
In a perverse twist, the employment report was so negative that it was widely viewed as assuring passage of a sizable stimulus package. And in an unrealistic excess of optimism, the equity market rallied in the mistaken belief that the stimulus and the efforts of the Fed and Treasury will be sufficient to promptly revive the economy and corporate profits. There were also hopes for a bold plan scheduled to be unveiled Monday by Treasury Secretary Geithner to restructure the financial industry. Unfortunately, even with the benefit of the economic stimulus and other governmental financial and economic supportive efforts, the recession will be both deep and prolonged. There is no prospect of an early turnaround in the plunge in employment. And without a rise in jobs there is no likehood of an early rebound in consumer spending, which in recent years has accounted for some 70% of GDP.
The stimulus package will at best mitigate the risk of the deep recession turning into a depression. Furthermore, relatively little of the stimulus will have an impact in the current fiscal year; perhaps as little one fifth. The tax cuts will be used for debt reduction or to increase savings to the extent they are not used for basic essentials. Consumers do not widely perceive this as an appropriate time for the purchase of big ticket, postponable purchases. With at least one in ten households delinquent or in default on their mortgage or personal debts and many of the remainder worried that they will soon be unemployed or in financial distress, an upsurge in unnecessary spending on durable goods is an unlikely use of the tax cuts. The decline in oil prices did not turn the recession around and tax cuts, as welcome as they may be, will not do trick either. The recession is too entrenched for that. There are too many losses still to be recognized, and too much deleveraging still to take place, for an early end to the recession.
The widespread recognition of the deep and prolonged recession realty has put business executives in a survival mode. They are desperate to cut costs to insure that they weather the storm that still lies ahead. That means postponing or cancelling capital investment, laying off all but critically essential workers, cutting dividends and trimming or ending nonwage payments and expenses where possible. Austerity has or soon will arrive.
That depressing list of problems currently suggests shunning equities and instead investing only in very safe debts such as Treasuries, high grade bonds of state and local governments and of those corporations that are assured of survival. Even some of thse have difficulties. Though they are far more likely to weather them and survive than lesser rated debt instruments. For example, GE, which is likely to be among the survivers, had indicted it would do what was necessary to preserve its AAA rating without cutting its generous dividend this year. GE's CEO is now indicating that the company is reviewing its dividend for the second half of the year and can live with a AA rating. Its long term bonds now yield 7.9%. State and local governments are adopting the same survival strategies as corporations. This does not appear to be as yet the point in time to look beyond the valley of dispair we are just entering to some dream of an early recovery.
You will be able to buy equities at lower prices late this year or even next year. The current equity market euphoria will be reversed, as were the numerous similar events in the depression of the 1930's.
The Treasury bond market sold off this week as investors shifted funds from Treasuries to equities. The 10-year Treasury yield, for example, jumped to 2.99% on Friday, up from 2.84% a week earlier. This is partly in anticipation of the coming Treasury financing, which typically puts temporary upward pressure on Treasury yields. Despite concerns over the necessary volume of US Treasury borrowing to finance the huge projected Federal budget deficits, Treasuries remain a safe-haven investment.Their yields will decline anew. If necessary, the Federal Reserve will purchase longer term Treasuries, as they indicated they would, to keep other debt yields from rising and choking off any hope of revival. No other conclusion appears reasonable given that the US economy is close to being in free-fall and deflation a real risk. The January employment report is a case in point.
January nonfarm payrolls plunged 598,000, the largest decline in 34 years and the longest employment decline since the 1930's depression. The January decline followed a downward revised 577,000 December drop. Both the outsized 626,000 spurt in initial claims for unemploment benefits in the latest week and the 591,000 rise in the prior week were reported after data were gathered for the January employment survey. Thus, it is only reasonable to expect another sharp drop in nonfarm payrolls in next month's employment report. Indeed, there is no reason to expect a let up in the litany of bad employment news for the remainder of this year and quite likely well into next year.
In the household survey, official unemployment surged to 11.6 million in January, for a 7.6% unemployment rate. That is up from 11.1 million unemployed in December, for a 7.2% unemployment rate. Over the past year there was a 4.1 million jump in official unemployment and a 2.7 percentage point spike in the unemployment rate. The deterioration in the employment picture is likely to carry the official unemployment rate back to or above its previous 10.8% 1982 post World War 11 high and into at least a double digit 10% to 11% territory. But, the official unemployment statistics, as worrisome as they are, grossly understate the deterioration in the unemployment picture. In addition to the 11.6 million officially unemployed, there were also 7.8 million who were involuntarily working part time because they could not find full time work. As a consequence of including such unemployed and underemployed categories,the unemployment rate would be twice as high. For example, the U6 unemployment rate before seasonal adjustment was actually 15.4% in January, up from 13.5% in December, with the unemployed defined to include both those so discouraged at their inability to find work that they are no longer looking for work and those who are working part time because they could not find full time employment. That is a far better indication of the economic distress of the consumer sector than the still relatively moderate 7.6% official unemployment rate.
The index of aggregate weekly hours worked fell 0.7% in January, continuing at roughly the fourth quarter pace. Considering that this series is widely viewed as an advance indicator of real GDP, expect a 5% or steeper drop in first quarter real GDP to be first reported at the end of April than the 3.8% fourth quarter decline.
The only discernable bright spot in the employment report was a 0.3% rise in average hourly wages in January and a 3.9% rise year-over-year. However, this rise is inconsistent with the rapidly worsening employment situation and can not long continue. All in all, the economic data this past week were too dismal to indefinately sustain unrealistically optimistic equity market hopes.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email Address: philipbraverman@Gmail.com
The stimulus package will at best mitigate the risk of the deep recession turning into a depression. Furthermore, relatively little of the stimulus will have an impact in the current fiscal year; perhaps as little one fifth. The tax cuts will be used for debt reduction or to increase savings to the extent they are not used for basic essentials. Consumers do not widely perceive this as an appropriate time for the purchase of big ticket, postponable purchases. With at least one in ten households delinquent or in default on their mortgage or personal debts and many of the remainder worried that they will soon be unemployed or in financial distress, an upsurge in unnecessary spending on durable goods is an unlikely use of the tax cuts. The decline in oil prices did not turn the recession around and tax cuts, as welcome as they may be, will not do trick either. The recession is too entrenched for that. There are too many losses still to be recognized, and too much deleveraging still to take place, for an early end to the recession.
The widespread recognition of the deep and prolonged recession realty has put business executives in a survival mode. They are desperate to cut costs to insure that they weather the storm that still lies ahead. That means postponing or cancelling capital investment, laying off all but critically essential workers, cutting dividends and trimming or ending nonwage payments and expenses where possible. Austerity has or soon will arrive.
That depressing list of problems currently suggests shunning equities and instead investing only in very safe debts such as Treasuries, high grade bonds of state and local governments and of those corporations that are assured of survival. Even some of thse have difficulties. Though they are far more likely to weather them and survive than lesser rated debt instruments. For example, GE, which is likely to be among the survivers, had indicted it would do what was necessary to preserve its AAA rating without cutting its generous dividend this year. GE's CEO is now indicating that the company is reviewing its dividend for the second half of the year and can live with a AA rating. Its long term bonds now yield 7.9%. State and local governments are adopting the same survival strategies as corporations. This does not appear to be as yet the point in time to look beyond the valley of dispair we are just entering to some dream of an early recovery.
You will be able to buy equities at lower prices late this year or even next year. The current equity market euphoria will be reversed, as were the numerous similar events in the depression of the 1930's.
The Treasury bond market sold off this week as investors shifted funds from Treasuries to equities. The 10-year Treasury yield, for example, jumped to 2.99% on Friday, up from 2.84% a week earlier. This is partly in anticipation of the coming Treasury financing, which typically puts temporary upward pressure on Treasury yields. Despite concerns over the necessary volume of US Treasury borrowing to finance the huge projected Federal budget deficits, Treasuries remain a safe-haven investment.Their yields will decline anew. If necessary, the Federal Reserve will purchase longer term Treasuries, as they indicated they would, to keep other debt yields from rising and choking off any hope of revival. No other conclusion appears reasonable given that the US economy is close to being in free-fall and deflation a real risk. The January employment report is a case in point.
January nonfarm payrolls plunged 598,000, the largest decline in 34 years and the longest employment decline since the 1930's depression. The January decline followed a downward revised 577,000 December drop. Both the outsized 626,000 spurt in initial claims for unemploment benefits in the latest week and the 591,000 rise in the prior week were reported after data were gathered for the January employment survey. Thus, it is only reasonable to expect another sharp drop in nonfarm payrolls in next month's employment report. Indeed, there is no reason to expect a let up in the litany of bad employment news for the remainder of this year and quite likely well into next year.
In the household survey, official unemployment surged to 11.6 million in January, for a 7.6% unemployment rate. That is up from 11.1 million unemployed in December, for a 7.2% unemployment rate. Over the past year there was a 4.1 million jump in official unemployment and a 2.7 percentage point spike in the unemployment rate. The deterioration in the employment picture is likely to carry the official unemployment rate back to or above its previous 10.8% 1982 post World War 11 high and into at least a double digit 10% to 11% territory. But, the official unemployment statistics, as worrisome as they are, grossly understate the deterioration in the unemployment picture. In addition to the 11.6 million officially unemployed, there were also 7.8 million who were involuntarily working part time because they could not find full time work. As a consequence of including such unemployed and underemployed categories,the unemployment rate would be twice as high. For example, the U6 unemployment rate before seasonal adjustment was actually 15.4% in January, up from 13.5% in December, with the unemployed defined to include both those so discouraged at their inability to find work that they are no longer looking for work and those who are working part time because they could not find full time employment. That is a far better indication of the economic distress of the consumer sector than the still relatively moderate 7.6% official unemployment rate.
The index of aggregate weekly hours worked fell 0.7% in January, continuing at roughly the fourth quarter pace. Considering that this series is widely viewed as an advance indicator of real GDP, expect a 5% or steeper drop in first quarter real GDP to be first reported at the end of April than the 3.8% fourth quarter decline.
The only discernable bright spot in the employment report was a 0.3% rise in average hourly wages in January and a 3.9% rise year-over-year. However, this rise is inconsistent with the rapidly worsening employment situation and can not long continue. All in all, the economic data this past week were too dismal to indefinately sustain unrealistically optimistic equity market hopes.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email Address: philipbraverman@Gmail.com
Subscribe to:
Posts (Atom)