Friday's further declines in Treasury yields and equity prices was in response to disappointment with a weaker than expected September employment report and other evidence that the economic recovery may be faltering. But, this is just a hint of the declines in yields and equities to come as employment continues to deteriorate, accompanied by other evidence that the widely presumed rapid economic recovery will not be sustained or is at the very least highly vulnerable. That increasingly recognized reality will keep the Fed's near zero Federal funds rate policy on hold for an extended period, probably throughout 2010 at least, as well as dissipating overblown concerns over impending inflation and renewing fears of outright deflation. It will take some four or five years, if not longer, to close the gap of excess labor and capacity to produce created by the recession, which acts to deter inflation and pressure prices and wages lower. Moreover, the CPI will likely continue to decline as the homeowners rent category, accounting for 24% of the CPI and 31% of the core, drifts lower with a projected renewed decline in home prices,reversing its recent rise, spurred by a coming wave of forclosures.
As weak as the headline September employment report may seem, the underlying detals are far more worrisome. As has been widely reported, September nonfarm payrolls declined 263,000, versus a 201,000 August drop, the 21st consecutive monthly decline. At the same time the official unemployment rate rose to 9.8% from 9.7% in August. Since the recession began in December 2007, the official number of unemployed has soared by 7.6 million to reach 15.1 million by September 2009.
As bad as these employment headlines are, the underlying data paint a much worse employment picture. The more reliable household survey, from which the unemployment rate is derived, showed an horrendous 785,000 September employment plunge. That is far from suggesting a sustainable economic recovery in the consumer sector, which typically accounts for some 70% of GDP growth. The civilian labor force, which in economic expansions typically rises, suffered a 571,000 precipitous drop in September as discouraged workers gave up looking for work or felt forced to take early retirement or went back to school. Applications for Social security benefits have been soaring.
As this analyst has repeated observed, the monthly nonfarm payroll declines reported would have been far worse if they had not been artificially boosted by an estimate of phantom hiring by new firms that had not been surveyed. Now, in benchmark revisions, the BLS is only beginning to recognize this mistake. It reported, on a preliminary basis, that March 2009 nonfarm payrolls were actually 824,000 lower than it previously reported.
The U6 measure of unemployment, which includes discouraged workers and those who took part-time work because they could not find full-time employment, reached 17.0% in September, seasonally adjusted, up from 16.8% in August. By this measure, there are more than 25 million unemployed in this country. But, this is a pervasive global problem. In China, even with its own massive stimulus program there are conservatively an estimated 40 million unemployed. Yes, you read that right. While the US unemployment rate began droppinf with the cyclical business recoveries from the 1973-75 and 1981-82 recessions, there were extended lags before unemployment dropped following the 1990 and 2001 recessions. This time the lag before employment recovers is likely to be particularly long.
There are adverse economic consequences from the continuing and perhaps even newly accelerating decline in US employment. The Bureau Labor Statistics reported that the index of aggregate hours worked fell 0.5% in September, following an already significant 0.2% August drop. The third quarter average of this seies is down 0.8% from the second quarter, arguing against the liklihood of the upper ranges of 3.5% to 5.0% estimates of a sharp rebound in third quarter real GDP growth. Moreover, the accelerating declines in aggregate hours worked toward the end of the third quarter indicate that whatever the third quarter rise actually is in real GDP, it is unlikely to be sustaned in the fourth quarter. That prospect is reinforced by other
data. Though weekly earnings rose in the third quarter, they fell in September. Car sales plunged with the end of the cash for clunkers program, a precedent for the impact of the end of Federal stimulus for other sectors of the US economy. That is why Congress is considering extending stimulus.
This prospect of persistent or renewed weakness in consumer spending and the econmy, especially after the Federal stimulus runs its course limits the potential for a rise in corprate earnings. And that in turn places a cap, at the very least, on the rise in equity prices, which are already inflated judging by a number of measures. Equity price levels are already pricey based price-earnings ratios, above 20, well above the 15 times earnings long-term average. Moreover, equity prices are still well above their 200-day moving average, an indication of potentially unsustainable levels. This and the continuing severe credit problems besetting lenders and all but the largest firms that can borrow dirctly in the credit markets point to further near-term declines in equity prices. The proposed special additional one-time FDIC assessment on banks to help replenish the insurance fund would only further crimp bank lending. The efforts of CIT, the largest private lender to small and medium sized companies, to stave off bankruptcy,will keep their lending retrained. Even US exporters will not be exempt from strained earnings as the speculative commodity buying and inventory building in general runs its course.
The risks to equity prices and/or the potential for persistent deflation must now be widely recognized, judging by the rally in long-term Treasuries, corporates and municipal bonds. Municipal yields are by some measures at a 40-year low, down by half a percentage point in September, even with concerns over municipal finance. This is only partly due to a low volume of new isses. As long-time readers will note, this is just as I have been forecasting. Though much of the prospective rally has already taken place, there is still more to come. The ten-year Treasury note yield, 3.22% on Friday, down from a recent high of 4.0%, is likely to fall to between 2.75% to 3.0% by or before year-end. Still lower yields are possible. Even a return close to the previous 2.0% low can not be ruled out. Also, the maturity yield spread between the Treasury 10-year and the Treasury 30-year, which has already been narrowing, is likely to narrow further, perhaps to 50 basis points (one-half of a percentage point). The end of the Fed purchases of Treasuries may actually bolster confidence that the decline in Treasury yields is a market phenomenon and not artificially induced by the Fed.
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 prior reports can be accessed by going to internet explorer and typing the following:philipbraverman.blogspot.com
The next Braverman report will released in early November following release of the October BLS employment report. Until then it remains wise to continue cautious.
Saturday, October 3, 2009
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