The equity market ended the week on a particularly strong note. It reached 919 for the S&P 500, up 3.6% for the week, just under its recent high. There were near comparable increases for other equity market indices. Moreover, the futures market indicates an additional equity price advance on Monday. This is an especially bullish indication for a Friday, especially after the strongest three month rally in at least a decade and in some respects the strongest since 1938.
This equity market performance suggests pronounced confidence in the prospect of further significant equity price advances. That sign of momentum makes my recommendation for setting shorts made two weeks ago seem grossly premature. It is more appropriate to be cautious in the face of the market's pronounced confidence, at least until that confidence begins to fade or reaches higher actionable contrarian extremes of overconfidence. For the momement it appears likely that the market will break out of its recent narrow price range decisively to the upside, perhaps for an extended run of a number of months. Nevertheless, it is still appropriate to ask, is the equity markets optimism justified? My answer remains a resounding no.
The paniced short covering that accounted for much of the equity market price rise the past three months has now been exhausted. Short positions are now much smaller.
The price-earnings ratio remains grossly excessive given the current economic environment and far from indicating current bargain equity price levels. For the S&P 500, the p/e ratio is now roughly 20 for this year. But some others calculate it at a more moderate 15. But, even by that more conservative measurement the p/e is still only close to its long term average. Consumer stocks, at more than twice that average, appear particularly vulnerable, while energy and commodity stocks, with a p/e ratio in the single digits, appear less so.
Much of the equity markets' advance reflects a presumed recovery in the global economy that is spurring buying of energy, commodity and emerging market related stocks. For example, oil futures were up 30% for the month, reaching $66 a barrel. But, that is still under the likely $75 marginal cost of production. The global economy remains in retreat. The snap back in commodity buying is both precautionary and speculative. If, as I expect, the phantom strength of the global recovery proves bitterly disappointing, there will be a new retreat in commodity prices and related equities.
Some US economic reports are admitedly stronger than the previous monthly reports, suggesting to many that the worst of the recessio is over. But, even if so, that is hardly a justification for unbridled optimism that the economic recovery is at hand. Indeed,there is unlikely to be a V shaped recovery. It could well be a W shape, with yet another leg down or more likely a sluggish shallow saucer shaped recovery when it does come. April durable goods orders rose to 161.5 from 158.4 the prior month. But, that is still far under the 213.6 level a year ago. Moreover, that rise has to be considered an anomally considering that April durable goods purchases were down, March factory shipments declined and both consumer and business spending are still falling.
Similarly, the Conference Board May consumer confidence at 54.9, is up from 40.8 the month before. But, that is far from a mark of exhuberant consumer confidence. It may reflect nothing more than the rise in the equity market and the absence of another mega financial firm bankruptcy. Moreover, that confidence rise does not auger an imminent parallel rise in consumer spending. The two series are not highly correlated.
Mortgage delinquency rates continue to soar for both sub-prime and conventional borrowers, suggesting that a further escalation of foreclosures is not far behind. That will put further downward pressure on home prices, the market value of mortgage-related paper at the heart of the global financial mess and financial institutions holding the toxic debt. Thus, there is little basis for concluding, as many have repeatedly, that the housing debacle and related financial institution distress is ending or has already done so.
Next week's monthly employment report for May is likely to be down some 525,000, just under the 539,000 decline in April, but well under the over 600,000 peak declines of prior months. But, that would hardly mark a significant turnaround in the economy let alone in the lagging labor market. Initial claims for unemployment benefits, 623,000 in the latest week, continue to exceed 600,000, far from the 400,000 threshold of recovery. That points to a May unemployment rate of over 9.0%, probably 9.2%, up from 8.9% in April and 8.5% in March. The outlook still favors the official unemployment rate still topping 10.0% and possibly even reaching 11.0%. The u6 unemployment rate, which includes discouraged unemployed that have given up looking for work and workers only martginally employed, is a better measure of the pronounced employment distress experienced in the US. By that measure, the unemployment rate is already approaching 16%. That does not justify confidence.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email Address:philipbravermar@Gmail.com
This and prior reports can be accessed by going to Internet Explorer and typing the following:
philipbraverman.blogspot.com
Saturday, May 30, 2009
Saturday, May 23, 2009
Treasury yields rise on excessive fears of a US downgrade, borrowing and inflation
US Treasury note and bond yields rose sharply this past week. The Treasury ten-year note yield, for example, reached 3.46% Friday, up from 3.12% a week ago. But this yield rise is not only unlikely to be sustained, it will almost certainly be reversed. That is because its root causes will be, for the most part, inevitably seen as either exaggerated or unwarranted. And if the Fed is not to preside over a significant deepening in the housing sector decline and a reversal of the few feint signs of economic improvement, it will have to not only expand but quicken its pace of Treasury buying. Otherwise, mortgage rates and bond yields will sooner or later rise enough to choke off any hope of an early economic recovery.
The Treasury yield rise this week came despite a deterioration in equity prices from Tuesday through Friday, which might normally be expected to create safe-haven buying of governments. Even after their roughly 30% rise from their March 9 lows, equity prices not only remain below their recent bear-market rally peak, they are still well under their two-hundred day moving average downtrend, suggesting the cyclical decline in equity prices remains intact. However, despite this equity market negative to lean on, the Treasury market was instead focused on its own set of worries, some real some imagined. These include worries over where the buyers for the new Treasury borrowing would come from, a decline in the dollar, fears of an imminent upsurge in inflation amidst a resurgence of economic growth, and anxiety that US Treasury debt might soon be downgraded.
US Treasuries were adversely affected merely through guilt by association this week when Standard & Poors put United Kingdom debt on negative credit watch. That action implied that S&P saw signs of a potential or impending rise in UK debt risk. Attention was focused on a projected multi-year increase in the volume of UK sovereign debt as a percentage of GDP. If this warning goes unheeded, S&P may eventually act, but perhaps not for years. And even then, S&P would almost certainly only downgrade UK debt to AA from its current AAA rating. Virtually every major nation is in roughly the same financially stressed position as it attempts to borrow its way out of the deep recession/depression by both stimulating its economy and forstalling the failure of its key financial institutions. But the prospective debt to GDP percentage of the UK appears higher than the comparable percentage for its principal trading partners, including the US.
The dollar plunged this week. But, that is likely to prove temporary. The economies of Germany, Japan and Mexico, major US trading partners, are all falling at a faster pace than the US. While the GDP of the US declined at a 6.1% annual rate in the first quarter, GDP in germany fell 14.4%, Japan was down at a 15.2% rate and Mexican GDP plunged at an horrendous 21.5% rate.
Optimism on the outlook for the US economy was bolstered by a 1.0% rise in the April Index of leading indicators. This is the first rise after a string of declines. Though it is welcome, forecasters are aware that it takes three consecutive increases in this data series to confirm an impending bottoming out in the economy, typically some six months hence. Thus, a single month's rise should not be the basis for more than hope. The index of coincident indicators confirmed that the economy is still dropping. Similarly. initial claims for unemployment benefits, at 631,000 in the latest week are down only slightly from the prior week and from their highs, but that signifies nothing. The latest initial claims pace remains far from the 400,000 threshold of recovery. Indeed, unemployment is still rising sharply. The Confernce Board's measure of consumer confidence, at 39.2 for April, is up from 26.9 the previous month, but still well below even 62.8 a year earlier. This is far from signaling a recovery in consumer confidence, consumer spending or the economy.
Oil prices were up in recent days. But, that does not signal an imminent resurgence of inflation. Indeed,current prices are still below the probable $75 or so marginal cost of production. Even with speculative and precautionary stockpiling, oil demand is down due to the global recession and it is likely to take years of economic recovery before inflation pressures re-emerge. There is too much excessive capacity of production and labor to sustain any meaningful inflation stepup. on the contrary, deflation remains a threat. The May 22 Jounal of Commerce-ECRI industrial price index,at 78.18, is up slightly from the previous week, but stil down 42% from a year ago.
Safe haven buying of Treasuries will re-emerge as the equity market resumes or extends its price decline. As the dollar resumes its relative strength, the incentive to buy Treasuries will be enhanced. Despite the question of where Treasury buyers will come from repeated in every recession, Treasury yields declined cyclically in almost every recent recession. Treasury yields do rise initially in recovery. But, to the markets repeated surprise, the pace of recent economic recoveries has typically been so disappointing and inflation fears so overblown, that Treasury yields almost invariably reach their cyclical low in that economic recovery period. When the recovery from this recession does eventually emerge, it is likely to be even more feeble and protracted than most, with far less inflation than typical. That is likely to be true even with the Fed's substantial money expansion, because it is credit not money that matters. And the credit deleveraging process still has far to go, curtailing the inflation threat.
Philip Braverman,President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
This and prior weekly reports can be accessed by going to Internet Explorer and typing the following: philipbraverman.blogspot.com
The Treasury yield rise this week came despite a deterioration in equity prices from Tuesday through Friday, which might normally be expected to create safe-haven buying of governments. Even after their roughly 30% rise from their March 9 lows, equity prices not only remain below their recent bear-market rally peak, they are still well under their two-hundred day moving average downtrend, suggesting the cyclical decline in equity prices remains intact. However, despite this equity market negative to lean on, the Treasury market was instead focused on its own set of worries, some real some imagined. These include worries over where the buyers for the new Treasury borrowing would come from, a decline in the dollar, fears of an imminent upsurge in inflation amidst a resurgence of economic growth, and anxiety that US Treasury debt might soon be downgraded.
US Treasuries were adversely affected merely through guilt by association this week when Standard & Poors put United Kingdom debt on negative credit watch. That action implied that S&P saw signs of a potential or impending rise in UK debt risk. Attention was focused on a projected multi-year increase in the volume of UK sovereign debt as a percentage of GDP. If this warning goes unheeded, S&P may eventually act, but perhaps not for years. And even then, S&P would almost certainly only downgrade UK debt to AA from its current AAA rating. Virtually every major nation is in roughly the same financially stressed position as it attempts to borrow its way out of the deep recession/depression by both stimulating its economy and forstalling the failure of its key financial institutions. But the prospective debt to GDP percentage of the UK appears higher than the comparable percentage for its principal trading partners, including the US.
The dollar plunged this week. But, that is likely to prove temporary. The economies of Germany, Japan and Mexico, major US trading partners, are all falling at a faster pace than the US. While the GDP of the US declined at a 6.1% annual rate in the first quarter, GDP in germany fell 14.4%, Japan was down at a 15.2% rate and Mexican GDP plunged at an horrendous 21.5% rate.
Optimism on the outlook for the US economy was bolstered by a 1.0% rise in the April Index of leading indicators. This is the first rise after a string of declines. Though it is welcome, forecasters are aware that it takes three consecutive increases in this data series to confirm an impending bottoming out in the economy, typically some six months hence. Thus, a single month's rise should not be the basis for more than hope. The index of coincident indicators confirmed that the economy is still dropping. Similarly. initial claims for unemployment benefits, at 631,000 in the latest week are down only slightly from the prior week and from their highs, but that signifies nothing. The latest initial claims pace remains far from the 400,000 threshold of recovery. Indeed, unemployment is still rising sharply. The Confernce Board's measure of consumer confidence, at 39.2 for April, is up from 26.9 the previous month, but still well below even 62.8 a year earlier. This is far from signaling a recovery in consumer confidence, consumer spending or the economy.
Oil prices were up in recent days. But, that does not signal an imminent resurgence of inflation. Indeed,current prices are still below the probable $75 or so marginal cost of production. Even with speculative and precautionary stockpiling, oil demand is down due to the global recession and it is likely to take years of economic recovery before inflation pressures re-emerge. There is too much excessive capacity of production and labor to sustain any meaningful inflation stepup. on the contrary, deflation remains a threat. The May 22 Jounal of Commerce-ECRI industrial price index,at 78.18, is up slightly from the previous week, but stil down 42% from a year ago.
Safe haven buying of Treasuries will re-emerge as the equity market resumes or extends its price decline. As the dollar resumes its relative strength, the incentive to buy Treasuries will be enhanced. Despite the question of where Treasury buyers will come from repeated in every recession, Treasury yields declined cyclically in almost every recent recession. Treasury yields do rise initially in recovery. But, to the markets repeated surprise, the pace of recent economic recoveries has typically been so disappointing and inflation fears so overblown, that Treasury yields almost invariably reach their cyclical low in that economic recovery period. When the recovery from this recession does eventually emerge, it is likely to be even more feeble and protracted than most, with far less inflation than typical. That is likely to be true even with the Fed's substantial money expansion, because it is credit not money that matters. And the credit deleveraging process still has far to go, curtailing the inflation threat.
Philip Braverman,President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
This and prior weekly reports can be accessed by going to Internet Explorer and typing the following: philipbraverman.blogspot.com
Saturday, May 16, 2009
Time to take profits in equities and reset shorts
Amost nothing in life is certain. But, the high for this bear market rally has most likely been reached or very soon will be. The outlook is for a renewed trend decline in equities beginning in coming weeks to at least retest their March 9 lows, and possibly even establish new index lows. That equity market price retreat will reawaken the safe-harbor attraction of US Treasuries, producing lower Treasury bond yields. And that will further reduce bond yields on medium through high-grade corporate credits. Indeed, that process of improvement in corporate bond prices has been underway, even while Treasury yields were rising, reflecting the improved corporate access to market funds and the lightening in percieved underlying default risk.
There are many reasons for the equity market's likely coming change of direction from rally to decline. These include a lessening in the unwarranted "green shoots" euphoria that the recession is already ending and that the economy is actually on the mend. There is an increasing recognition that the recession will persist, even if the rate of decline is not quite as headlong.
The earnings season is coming to an end. And the results suggest that at current price levels the equity markets are overbought. The per share earnings for the S&P 500 at just over $10 for the first quarter, suggests some $45 or less for the year. That equates with a relatively rich 20-times earnings price level, well above the 15 times price-earnings ratio long-term average and the far lower p-e ratio levels amidst past long wave p-e ratio cyclical declines.
While the Federal government assessment of the bank stress test reports were less worrisome than had been feared, there is an increasing realization that to a considerable extent the banks were given a free ride. The economic stress that was built into the bank loss picture is by no means extreme and the presumed loss under the supposed worst case scenario is far smaller than a worst case scenario would actually create.
The upsurge in new equity offerings is bolstering the financial position of the companies involved, but it is also watering down the equity position of current stockholders. The latter is a clearly percieved market negative.
The same mixed message for the markets can be discerned from the Federal governments intrusion in corporate affairs. While the prevention of a domino chain of simultaneous failures is certainly welcome, the unintended consequences are adverse for those firms that did not benefit from the Federal governments largesse. For example, small and medium sized banks have had their FDIC insurance premiums so sizably raised to help pay for the bailout of the larger banks that there will be little or no net earnings benefits from the low cost of their deposit funds. Similarly, Ford, which received no Federal assistance, will bear the competitive cost of the bailout of GM that keeps them in business despite GM's past inefficiencies. Perhaps even more onerous from the equity markets point of view is the degree of control of corporate affairs that is being implied by recent comments by Federal officials. These include references to limitations on corporate pay and bonuses, performance related pay schemes, replacement of boards of directors and CEOs and especially efforts to limit profits for health related firms and others. Even though some of these changes may be long overdue, the upshot is a percieved encroachment on capitalism that is anathema to equity markets.
Recent inflation reports keep the prospect of a quick resumption of inflation at bay. There is outright deflation in the CPI year over year, even with the overstated so called "imputed rent" component. The huge excess capacity of production and labor in the US and globally precludes any meaningful step-up of inflation literally for years. The massive expansion in the money supply means nothing so long as credit is not expanding. And it is not. A massive deleveraging of the past credit expansion of business and the consumer is still required. The point of this is that there will be little or no pricing power in the hands of corporations sufficient to significantly boost earnings for years to come.
The conclusion to be drawn from the forgoing is that there are far more near term risks than are generally recognized in investing in equities at this juncture and more opportunity than is widely percieved in investing in investment-grade corporate bonds.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address:philipbraverman@Gmail.com
This and prior reports can be accessed by going to internet explorer and typing in the following internet address: philipbraverman.blogspot.com
There are many reasons for the equity market's likely coming change of direction from rally to decline. These include a lessening in the unwarranted "green shoots" euphoria that the recession is already ending and that the economy is actually on the mend. There is an increasing recognition that the recession will persist, even if the rate of decline is not quite as headlong.
The earnings season is coming to an end. And the results suggest that at current price levels the equity markets are overbought. The per share earnings for the S&P 500 at just over $10 for the first quarter, suggests some $45 or less for the year. That equates with a relatively rich 20-times earnings price level, well above the 15 times price-earnings ratio long-term average and the far lower p-e ratio levels amidst past long wave p-e ratio cyclical declines.
While the Federal government assessment of the bank stress test reports were less worrisome than had been feared, there is an increasing realization that to a considerable extent the banks were given a free ride. The economic stress that was built into the bank loss picture is by no means extreme and the presumed loss under the supposed worst case scenario is far smaller than a worst case scenario would actually create.
The upsurge in new equity offerings is bolstering the financial position of the companies involved, but it is also watering down the equity position of current stockholders. The latter is a clearly percieved market negative.
The same mixed message for the markets can be discerned from the Federal governments intrusion in corporate affairs. While the prevention of a domino chain of simultaneous failures is certainly welcome, the unintended consequences are adverse for those firms that did not benefit from the Federal governments largesse. For example, small and medium sized banks have had their FDIC insurance premiums so sizably raised to help pay for the bailout of the larger banks that there will be little or no net earnings benefits from the low cost of their deposit funds. Similarly, Ford, which received no Federal assistance, will bear the competitive cost of the bailout of GM that keeps them in business despite GM's past inefficiencies. Perhaps even more onerous from the equity markets point of view is the degree of control of corporate affairs that is being implied by recent comments by Federal officials. These include references to limitations on corporate pay and bonuses, performance related pay schemes, replacement of boards of directors and CEOs and especially efforts to limit profits for health related firms and others. Even though some of these changes may be long overdue, the upshot is a percieved encroachment on capitalism that is anathema to equity markets.
Recent inflation reports keep the prospect of a quick resumption of inflation at bay. There is outright deflation in the CPI year over year, even with the overstated so called "imputed rent" component. The huge excess capacity of production and labor in the US and globally precludes any meaningful step-up of inflation literally for years. The massive expansion in the money supply means nothing so long as credit is not expanding. And it is not. A massive deleveraging of the past credit expansion of business and the consumer is still required. The point of this is that there will be little or no pricing power in the hands of corporations sufficient to significantly boost earnings for years to come.
The conclusion to be drawn from the forgoing is that there are far more near term risks than are generally recognized in investing in equities at this juncture and more opportunity than is widely percieved in investing in investment-grade corporate bonds.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address:philipbraverman@Gmail.com
This and prior reports can be accessed by going to internet explorer and typing in the following internet address: philipbraverman.blogspot.com
Friday, May 1, 2009
Is the worst of the recession over?
No! Not if that means means an end to declines in real GDP, increasing consumer spending, a rebound in retail sales, rising production, advancing business investment, an end to bank problems, a rise in real estate prices or rising employment. None of those welcome development are at hand or even discernable on some distant horizon. That reality raises serious questions over the sustainability of both the equity market rally and the six week rise in Treasury bond yields beyond the sizable Treasury quarterly refunding next week. Equity prices will soon decline anew, helping drive Treasury bond yields lower as well.
It would be nice to believe that we have not only seen the worse of the recession, but that the first feint signs of recovery are emerging. But, just because we hunger for it is no reason to misinterpret the evidence as many, if not most, appear to be doing. One prime example of this misreading was the positive market reaction to the report of first quarter real GDP, which was down an horendous 6.1%, following a 6.3% plunge in the fourth quarter last year. That is the economy's worst two quarter performance in half a century. (Incidently, I forecast a 6% first quarter real GDP decline.) But, the optimists saw a positive sign in the 6.1% first quarter GDP decline because among the components of the report there was a rise in consumer spending and a drop in inventories. They mistakenly interpreted this disparity as laying the groundwork for an imminent economic recovery. If consumer spending were to continue rising, a mighty big if, a sustained reduction in inventories might be viewed as unlikely. In that event, the assumption is that business would restock inventories, leading to a pickup in orders, production and employment. That is likely to be the eventual sequence of developmements. But, certainly not now.
Let us look a little closer. The consumer spending component of real GDP was up at a2.2% annual rate in the first quarter, after having been down sharply in the fourth quarter, when sharply curtailed credit availability crimped spending. And for the circumstances, even that relatively modest rebound is likely to be shaved in the revisions and its bullish significance dismissed. Unfortunately, the first quarter real GDP report is preliminary, based on partial reports, before much of the March data was available. The March report for consumer spending showed a decline, suggesting a downward revision for the consumer spending component of first quarter real GDP and potenially for the overall series itself. Furthermore, consumer spending was temporarily boosted at the beginning of the year by the desperate retail post Christmas price slashing, reduced tax witholding and a seasonal adjustment that did not recognize the extraordinary nature of these developments. Even with a slight improvement in consumer confidence to dismal levels from prior even more bleak sentiment levels and tax stimulus, the rising trend of unemployment and reductions in credit will continue to keep consumer spending extremely constrained. Moreover, though business inventories are down from a year ago, at 1.43, the February business inventory-to-sales ratio remains well above the 1.25 level a year ago. Thus, such inventories have not fallen as much as sales, probably reflecting a misguided overconcern that an upsurge of inflation is looming just around thge corner. Instead, deflation remains the far more immediate prospect.
Reinforcing this general point of view on the lack of support for an early turn in the economy, Warren Buffet indicated that he sees no evidence of recovery in housing or retail sales. That view will be further supported by coming negative economic reports. For example, Next Friday, the April employment report should reveal a 600,000 or larger decline in nonfarm payrolls and a rise in the unemployment rate to 8.8%.
There are also more problems ahead in finance, banks and insurance companies.
Virtually every major bank will require additional capital. And the required capital injections will be huge so as to cover the vast additional loan losses yet to be realized, which will come on top of the huge losses already recognized. That may seem hard to believe given the extensive Federal support already provided the troubled financial sector, the prospect of additional assistance and especially the seemingly much improved first quarter profit performance reported by most banks. As I reported last week, those improved earnings admitedly reflect both sustainable and unsustainable components. There is a wide earnings spread between the near zero cost of funds and earnings on loans and investments that is likely to persist. But, first quarter bank earnings also undoubtedly reflected one-time events, including temporary trading profits on the preannounced Federal purchase of Agency securities from the banks and the imposition of less stringent mark-to-market writedown accounting rules. Thus, the bank earnings performance is likely to darken again reflecting narrowing trading profits as well as worsening losses.
Despite massive mortgage refinancing and other stimulus efforts, home price declines will continue. Together with the new acceleration in foreclosures, that will lead to further losses on residential mortgages and mortgage-backed debt. In addition, there will be a wave of substantial bank losses on credit card debt, student loans, personal loans and commercial real estate mortgage debt.
The results of the bank stress tests are not scheduled to be released until next Thursday. And the release date may be a further delayed. However, there have already been official advance indications that some 14 of the 19 banks reviewed will be required to substantially boost their capital. These most notably include Citibank and Bank of America. The plan reportedly is to pressure those banks cited to raise additional capital in the private sector, though that is likely to prove both difficult and very costly. If they are unable to do so, the Federal government will provide it, bringing bank nationalization that much closer. According to Time magazine, Citigroup will experience some $106 billion in losses through the end of 2010 that will require it to obtain some $22 billion in additional capital. Other banks among the 19 reviewed may require smaller infusions of capital or, in the case of Chase, perhaps none at all.
In honor of Mother's day, there will be no report next week.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
This and prior reports can be accessed by going to Internet Exporer and typing in the following: philipbraverman.blogspot.com
It would be nice to believe that we have not only seen the worse of the recession, but that the first feint signs of recovery are emerging. But, just because we hunger for it is no reason to misinterpret the evidence as many, if not most, appear to be doing. One prime example of this misreading was the positive market reaction to the report of first quarter real GDP, which was down an horendous 6.1%, following a 6.3% plunge in the fourth quarter last year. That is the economy's worst two quarter performance in half a century. (Incidently, I forecast a 6% first quarter real GDP decline.) But, the optimists saw a positive sign in the 6.1% first quarter GDP decline because among the components of the report there was a rise in consumer spending and a drop in inventories. They mistakenly interpreted this disparity as laying the groundwork for an imminent economic recovery. If consumer spending were to continue rising, a mighty big if, a sustained reduction in inventories might be viewed as unlikely. In that event, the assumption is that business would restock inventories, leading to a pickup in orders, production and employment. That is likely to be the eventual sequence of developmements. But, certainly not now.
Let us look a little closer. The consumer spending component of real GDP was up at a2.2% annual rate in the first quarter, after having been down sharply in the fourth quarter, when sharply curtailed credit availability crimped spending. And for the circumstances, even that relatively modest rebound is likely to be shaved in the revisions and its bullish significance dismissed. Unfortunately, the first quarter real GDP report is preliminary, based on partial reports, before much of the March data was available. The March report for consumer spending showed a decline, suggesting a downward revision for the consumer spending component of first quarter real GDP and potenially for the overall series itself. Furthermore, consumer spending was temporarily boosted at the beginning of the year by the desperate retail post Christmas price slashing, reduced tax witholding and a seasonal adjustment that did not recognize the extraordinary nature of these developments. Even with a slight improvement in consumer confidence to dismal levels from prior even more bleak sentiment levels and tax stimulus, the rising trend of unemployment and reductions in credit will continue to keep consumer spending extremely constrained. Moreover, though business inventories are down from a year ago, at 1.43, the February business inventory-to-sales ratio remains well above the 1.25 level a year ago. Thus, such inventories have not fallen as much as sales, probably reflecting a misguided overconcern that an upsurge of inflation is looming just around thge corner. Instead, deflation remains the far more immediate prospect.
Reinforcing this general point of view on the lack of support for an early turn in the economy, Warren Buffet indicated that he sees no evidence of recovery in housing or retail sales. That view will be further supported by coming negative economic reports. For example, Next Friday, the April employment report should reveal a 600,000 or larger decline in nonfarm payrolls and a rise in the unemployment rate to 8.8%.
There are also more problems ahead in finance, banks and insurance companies.
Virtually every major bank will require additional capital. And the required capital injections will be huge so as to cover the vast additional loan losses yet to be realized, which will come on top of the huge losses already recognized. That may seem hard to believe given the extensive Federal support already provided the troubled financial sector, the prospect of additional assistance and especially the seemingly much improved first quarter profit performance reported by most banks. As I reported last week, those improved earnings admitedly reflect both sustainable and unsustainable components. There is a wide earnings spread between the near zero cost of funds and earnings on loans and investments that is likely to persist. But, first quarter bank earnings also undoubtedly reflected one-time events, including temporary trading profits on the preannounced Federal purchase of Agency securities from the banks and the imposition of less stringent mark-to-market writedown accounting rules. Thus, the bank earnings performance is likely to darken again reflecting narrowing trading profits as well as worsening losses.
Despite massive mortgage refinancing and other stimulus efforts, home price declines will continue. Together with the new acceleration in foreclosures, that will lead to further losses on residential mortgages and mortgage-backed debt. In addition, there will be a wave of substantial bank losses on credit card debt, student loans, personal loans and commercial real estate mortgage debt.
The results of the bank stress tests are not scheduled to be released until next Thursday. And the release date may be a further delayed. However, there have already been official advance indications that some 14 of the 19 banks reviewed will be required to substantially boost their capital. These most notably include Citibank and Bank of America. The plan reportedly is to pressure those banks cited to raise additional capital in the private sector, though that is likely to prove both difficult and very costly. If they are unable to do so, the Federal government will provide it, bringing bank nationalization that much closer. According to Time magazine, Citigroup will experience some $106 billion in losses through the end of 2010 that will require it to obtain some $22 billion in additional capital. Other banks among the 19 reviewed may require smaller infusions of capital or, in the case of Chase, perhaps none at all.
In honor of Mother's day, there will be no report next week.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
This and prior reports can be accessed by going to Internet Exporer and typing in the following: philipbraverman.blogspot.com
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