There is increasing evidence that the recession is winding down. But that does not imply anything but a rocky road ahead for the economy, even if there is likely to be real economic growth in the second half of the year. Next year the outlook is clouded anew.
The sluggish recovery will be vulnerable to new or continuing major threats to the economy. These threats include a protracted rise in unemployment next year, continuing debt overburdened consumers, rising personal debt delinquecies, defaults and bankruptcies, little or no consumer income growth, and a significant rise in the consumer savings rate, with sluggish consumer spending relative to income. As a result of the constraints on consumer spending, retailing will continue to suffer disappointing sales. After the cash for clunkers stimulus runs its course,car sales will plunge anew. Housing will remain depressed by a further rise in foreclosures, continuing mortgage lender caution and the end of the tax incentive for first time home buyers this November. Commercial real estate and commercial mortgage lenders will experience serious losses. Commodity prices and business sales will decline sharply once speculative inventories are rebuilt. Inflation fears will dissipate, followed by renewed concerns over pervasive deflation. Lending institutions remain saddled with some $1 trillion in inadequately recognized losses that constrain their capital and lending. Similar problems in Japan led to an extended period of sluggish economic growth,repeated bouts of deflation and an equity market at less than one- third its highs. As if all of this were not enough, there should also be concern over the economic consequences of a return of a more virulent form of the swine flu.
The evidence of a moderation in the intensity of the US recession and hopes for an early rebound in economic activity has fueled a continuation of the rally in US equities, a retreat in Treasury bond prices and expectations of a rise in commodity prices. However, there are important reasons to doubt that such consensus views will be sustained. Indeed, there are ample reasons to expect that these seeming market trends will be reversed. To the extent that corporate profits have improved, it is largely due to cost cutting, not an increase in sales. This cost cutting is a "one trick pony" that cannot continue to be endlessly repeated. Accordingly, dissapointing corporate earnings performance is unlikely to sustain current equity price levels, let alone extend the current rally for very long. Take profits, while enjoying the rally while it lasts. But remain cautious. The inevitable decline in equity prices and renewed deflation will reignite safe haven buying of Treasuries.
Looking ahead, third quarter real GDP is likely to be up, at least marginally, perhaps at a 2% annual rate. That rise would partly reflect the positive impact of the Federal cash for clunkers stimulus program, which could account for up to 1%, or half of projected third real GDP expansion. Regardless of the source of the third quarter real GDP expansion, that rise would be a marked change in direction for the economy after a 1% annual rate of decline in the second quarter and a 6.4% rate of plunge in the first quarter.
The equity market was sharply boosted by Friday's report of a slight decline in the July unemployment rate to 9.4% from 9.5% in June. Unfounded optimism that the rise in unemployment is over was seemingly reinforced by the less than feared 247,000 July decline in nonfarm payrolls, well under the 645,000 monthly average starting November last year through April this year. But, the July decline in the unemployment rate was entirely due to a 422,000 plunge in the labor force, undoubtedly a reflection of a sharp rise in discouraged workers who just gave up looking for a job. If this rise in discouraged workers had not occurred the unemployment rate would have increased to 9.6%. The unemployment rate is still likely to keep rising to above 10%, and may yet touch 11%. Though the pace of layoffs is slowing, much of that relative improvement is due to the temporary and unsustainable effects of the stimulus package. It is ironic that when there really is a realistic increase in hope of employment, discouraged workers will come flooding back to the labor force, sharply boosting the unemployment rate. But that time has not yet arrived.
In the meantime, there is a rapid improvement in the prices of bonds of many stressed corporates as their financial position gradually improves. The Admistration has drawn a line in the sand. It will save those firms whose failure would, in their opinion, create systemic risk to the economy. But it will not save those firms whose failure does not appear to pose such a systemic risk. That,for example, explains the Federal assistance to GE, and the decision not to assist CIT. Unfortunately, the failure of CIT would create a systemic risk with cascading losses for hundreds of thousands of midsized to large companies. GE capital, the financing arm of GE, is likely to be exempted from a requirement that firms would have to be financial to continue to avail themselves of Federal commercial paper guarantees. GE capital alone uses some one-fourth of the facility. The decision to grandfather GE capital lifts a cloud over its future that had been resposible for much of the higher bond yields available on its credits. The general narrowing in the yield spread between high grade corporates and Treasuries is typical as the economy appears to be bottoming out. But that narrowing in yield spread still has further to go, at least for those under the Federal umbrella or benefitting from any lessening in economic distress.
The next report will be in early September.
Until then do not be taken in by fears of inflation or expectations of early Fed firming.
The Fed will not dare to firm until late 2010 or 2011, at the earliest, and inflation will not materialize anew for years longer. Deflation remains the real next concern.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
I can be reached at: philipbraverman@gmail.com
This and earlier reports can be accessed at internet explorer by
typing in the following: philipbraverman.blogspot.com
Saturday, August 8, 2009
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