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
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