The signs of economic recovery are at risk of fading with the end of the Federal economic stimulus, which currently appears likely to largely disappear in the second half of this year. That development could even lead to a second dip into recession. Of course there could be an additional round of Federal stimulus, in an attempt to shore up employment and limit the loss of Democratic seats in Congress in the November elections. But, that would only postpone the inevitable economic retreat. Moreover, a new stimulus would pose other dangers. The percentage of US Federal debt held by the public to GDP, already at 60% and promising to exceed 80% in the next decade under current law, would be pushed into a danger zone threatening dollar stability.
There are too many continuing negatives underlying the fragile economic recovery to make it anything but vulnerable. That points to no meaningful change in the Fed's highly accomodative policy throughout the year. growing inflation fears will give way to renewed deflation fears and quite likely deflation realty. Inflation will inevitably materialize, but not this or even next year. Treasury bond yields will decline anew. And the stock market, which appears to be in a relentless uptrend, will eventually give up significant ground, perhaps later this quarter or next. Though it may seem like an extreme forecast, it is even possible that the entire equity market advance will come to be viewed as a bear market rally. Following are some of the reasons.
Corporate profits may be rising, but that is more a continued reflection of cost cutting (which cannot long persist)than of a vigorous rise in basic demand. And much of the rise in demand that does exist is spured by domestic and foreign stimulus which will not be mantained indefinitly. Thus, even with a rise in projected S&P 500 index operating earnings to some $72 to $75 a share this year,up 25% from last year, the equity market rally, predicated on that rise, is vulnerable.
Consumer spending, which has accounted for some two-thirds or more of GDP, will remain contrained as consumers attempt to reduce their excessive indebtedness. That process of debt reduction is counted as savings,and naturally cuts their discretionary spending. The reasons for consumer spending caution are obvious. There is a vast number of unemployed and underemployed that has forced a reduction in consumer spending. The threat of additional increases in unemployment will continue to engender spending caution ahead, despite the slight year-over-year increases in Christmas holiday spending. Consumers are continuing to experience a rise in consumer and credit card debt delinquencies, defaults and bankruptcies. And there are still billions of dollars of supposedly liquid auction rate securities held by individuals that remain frozen in limbo.
The details underlying the December employment report help make employment pessimism a more realistic prospect. While the official unemployment rate remained at 10.0%, that was only because of a huge 661,000 plunge in the labor force (largely reflecting a 589,000 drop in employment), rather than the trend rise in the labor force that is to be expected in more normal times or the surge that is bound to emerge when jobs are percieved to be available. If the labor force had not dropped, the December unemployment rate would have spiked to 10.4%. It is only a matter of time until the official unemployment rate reaches and exceeds that level. Even 11% is quite possible. But the official unemployment rate grossly understates the degree of economic distress. The U-6 unemployment rate, called the under-employment rate, is 17.3%, just under its 17.4% peak. This measure includes the unemployed, the marginally employed temporary workers who could not find the full time employment they seek and those so discouraged by the lack of work they have given up looking. But even this measure does not include very long-term discouraged workers and those who have gone back to school because of frustration in finding employment. And aggegate hours worked were unchanged in December, suggesting less forward momentum in the economy heading into the first quarter than widely expected.
Though the Fed has increased the money supply, credit remains constrained. Banks are not lending. Nor is there likely to be any significant increase any time soon considering the continuing heavy burden of bad loans and investments that they hold on their books. The write off of capital to compensate for losses on holdings was postponed by the change in the Federal Accounting Standards Board rules that gave the institutions discretion to avoid write-downs of assets that they do not intend to sell. Without a significant expansion in bank lending there can not be a vigorous or sustained economic expansion.
State and local governments are running ever increasing budget deficits as tax receipts are cut by the recession and medicare and other required expenditures rise. Their combined deficits are projected at $350 billion in both 2010 and 2011. That is understanably forcing a cut in their discretionary spending and employment, even with increased taxes.
Commercial real estate is contracting as vacancies in offices, retailing, hotels and apartments cut revenues and market values. That makes it virtually immpossible for owners to keep up with payments on mortgages on recent purchases. Already some 6%of these mortgages are delinquent, with that rate potentially doubling by year-end. Market values of commercial real estate have plunged, making resales of recent purchases without major losses unlikely. That distress will create steep losses for regional banks, significant lenders on commercial properties. Some $40 billion of commercial mortgage backed bonds will mature this year creating strains since funds are not likely to be readily available to fully pay them off, nor is the market likely to renew them at acceptable yields. That situation risks one or more major commercial real estate failures.
In addition, the one-family residential market is likely to continue depressed despite signs of a seeming turn-around. A continuing or increased wave of residential foreclosures is likely. Across the country almost one in four home mortgage borrowers is under water on their homes, with a market resale value lower than their outstanding mortgage balance. The rate is almost half in Florida and Arizona and 65% in Nevada. Being under water on their mortgage has been among the primary catalysts for foreclosure. As if that were not enough of a problem, the Fed is scheduled to end its purchases of mortgages by the end of March, which could spur a rise in mortgage rates. And the stimulus of a tax benefit for home purchases ends in April, by which time contracts to purchase must be signed. In November, long before those potential depressants come into play, pending home sales had already plunged 15.5% and new home sales fell 11.3%. Expect another 10% drop in home prices, largely centered in upscale homes.
Taken together, these various trends will depress the economy anew, most likely in the second half of the year.
Philip Braverman, President
Braverman Economic 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 in philipbraverman.blogsot.com
I can be reached at philipbraverman@Gmail.com
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