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