Equity and commodity prices only appear to be on a relentless rise. They remain vulnerable to dissapointments ahead. But, that vulnerability was certainly not evident on Friday. Both equity and commodity markets even managed to take the Friday report of a jump in the unemployment rate to 10.2% in October (from 9.8% in September) in its stride. After initially declining, the equity market moved back above 10,000 on the Dow and gold prices strengthened. The equity market was partially boosted by a rise in GE shares, spurred by analysts upgrading the company on a perceived improvement in their investment portfolio.
While it is true that employment is a lagging economic indicator, the pronounced weakness in the October employment suggests, at a minimum, economic sluggishness ahead. But, the potential for major adverse surprises does not end there. The 3.5% growth in third quarter real GDP growth could well be the strongest experienced in the next five quarters. Indeed a return to a decline in real GDP can not be ruled out in one or more quarters next year. That was the pattern in most prior post World War 11 recessions. There were one or more postive quarters of real GDP growth followed by one or more quarters of renewed declines of real GDP before the recession ended. This time renewed economic weakness will have as potential catalysts a new wave of home mortgage foreclosures, credit card cutbacks, commercial real estate foreclosures, state and local credit distress, and the end of Federal stimulus.
The details of the October employment report are far from reassuring. The 190,000 decline in nonfarm payrolls, though larger than the consensus estimate is, perhaps, the most market-friendly aspect of the report. While this nonfarm payroll decline is almost identical to the 188,000 average the past three months, it is down sharply from a 357,000 monthly average the prior three months and especially from a 645,000 monthly average from November 2008 to April 2009. But other aspects of the employment report are dire.
The Bureau of Labor Statistics household survey(from which the unemployment rate is derived) is both more reliable and accurate, especially in recessions. This survey posted a horrendous 558,000 October drop in employment, raising the official total of those unemployed to a frightening 15.7 million. But wait, it gets worse. In addition to those officially unemployed there were 9.3 million individuals who were only able to find part-time work despite seeking and preferring to work full time. Furthermore, some 2.4 million others have dropped out of the labor force because they have become discouraged at the lack of job prospects, though they have sought work in the past 12 months. That brings the number of individuals in employment distress to over 27 million. There is no imminent economic recovery for this huge portion of the consumer sector.
Without a significant rebound in consumer spending, a sustained economic recovery is highly questionable. Consumers remain overleveraged, deeply in debt and overburdened with financial obligations even at reduced interest rates. That has led not only to a continuing rise in home mortgage foreclosures but also a rising trend of personal bankruptcies. Consumer spending will of necessity be forced lower as a trend percentage of GDP from above 70% to perhaps below 68% as consumers repay debt and increase their savings rate from essentially zero to 5% more more.
Other details of the employment report are also ominous. The index of aggregate hours worked, which is used by economists to forecast real GDP, declined further in October to 98.3, from 98.5 in September and 98.9 in the third quarter. This performance suggests less economic strength in the fourth quarter than widely expected.
The weakness or sluggishness of real GDP growth projected is not likely to sustain the rise in the prices of many commodities. That would be all the more so if there is actually a decline in real GDP for even one quarter next year. Natural gas prices are low, while oil prices are rebounding, a seeming inconsistancy. The outlook is for continued deflation. There is far too much excess capacity of production and labor to produce sustainable bottleneck or shortage price pressures and/or pricing power. It is only temporary speculative pressures and long-term inflation fears that can produce such price spikes as we have experienced. That realty will alone keep the Fed's policy accomodative for an extended period, probably through all of 2010. And deflation, or at best low inflation, will keep bond yields low or even declining through next year. Low borrowing costs are a positive for the equity markets, but they do not seem sufficient to outweigh the clear negatives of disappointing economic growth, more sluggish than anticipated earnings performance and already fully priced market levels. The price-earnings levels are already far too high and the dividend returns, at 2.1%, far too low. Thus, it is only prudent to anticipate an equity market price retrenchment.
Philip Braverman, Preesident
Braverman Econonomic and Financial Consulting
One Hewitt Square, #249
East Northport, New York 11731
This and prior reports can be accessed by going to Internet Explorer and typing the following: philipbraverman.blogspot.com
I can be reached at philipbraverman@Gmail.com
Friday, November 6, 2009
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