Despite signs of economic recovery, a clouded outlook will keep markets stressed

Markets are increasingly concerned over the sustainability of the economic recovery. There are new head winds. Worries abound over some troubled soverign credits. The current focus is on Greece, Portugal and Spain. But there could well be others.

US commercial real estate (office buildings, apartments, retail space and hotels) is undergoing a significant and grim price retreat as vacancies rise and rents accordingly drop. That makes it difficult for commercial real estate owners who recently purchased their properties at inflated prices to either meet their mortgage payment or refinance. That is producing a wave of delinquecies,defaults and foreclosures. In turn, that creates major difficulties for mortgage lenders, especially regional banks, that have large holdings of such loans.

The signs of economic recovery are primarily a response to the widespread stimulus spending in the US and abroad. But if, as is likely, the economy cannot maintain its modest forward momentum once stimulus is withdrawn, the economy will falter. With growing concern over its astronomical budget deficits, the US and other nations will not be able to extend these outsized deficits for long and certainly not without triggering a crisis of confidence in one currency after another.

There is no basis for expecting a vigorous revival of consumer spending, the typical mainstay of the US economic recoveries. Consumers are in the process of deleveraging their already excessive reliance on debt. That is leading to a decline in consumer credit and a rise in consumer savings. That argues against a sustainable consumer spending led recovery.

There is justifiable and significant concern over the likely strength of export demand ahead. There is a risk that China, and perhaps other nations, are building speculative inventories of key commodites, such as copper, and spurring construction for which there is no current demand, in an effort to keep employment up and protect against a sustained and outsized rise in commodity prices. Such demand can not be maintained. That points to a slowdown in export growth and a decline in the demand for and the price of commodities. That development would lessen concern over an early and prounounced acceleration in inflation and Fed interest rate tightening to stem its advance.

There is also a concern over a seeming antibank populist tack taken by Congress and the Admistration.

Such an array of concerns is likely behind the recent apparent topping out of the equity market. Also, at its recent peak, the equity market had rallied to levels roughly as much above the 200-day moving average as it had been below its 200-day moving average at its March 2009 lows. Just as an excessive decline helped trigger the market rebound, the reverse can also be true. That suggests that if speculative bubble levels have not already been reached, they soon will be. The equity market is also reponding to the seeming economic significance of recent reports.

The equity market edged up slightly on Friday, after being conflicted by cross currents in the January employment report that caused it to flip back and forth between losses and gains. The unemployment rate declined to 9.7% from 10.0% in December. But, January nonfarm payrolls fell 20,000, a disappointment considering that a rise was expected. The Friday slight rise in equity prices followed a Thursday selloff over disappointment at a jump in initial claims for unemployment benefits. This is just a suggestion of what lies in store for the markets if, as I expect, economic growth slips from its heady pace in the fourth and possibly first quarter, to a crawl or a new decline later this year or early next. That development would keep Fed interest rate policy highly accomodative for an extended period, raise the renewed threat of outright deflation and reinforce the decline in Treasury bond yields already in place.

The potential for adverse economic prospects and other developments have also helped tax-exempt State and municipal bond yields decline. The proposals to raise marginal Federal income tax rates are certainly a factor. Also contibuting to that downtrend in tax-exempt yields is the issuance of taxable state and local bonds under the Build America Bond program (BAB), which involves a payment to the issuer by the Federal Government for a portion of the interest payment. The consequent minimal volume of new issuance of tax exempt bonds has helped to reduce their yields to or below the yields on US government debt of comparable maturities, where they have more traditionally been. Tax exempt State and municipal yields have typically been at 80% to 90% of the yield on a US Treasury bond. Thus a 30-year US Treasury bond yield of 4.5% would normally suggest a high-grade municipal yield of 4.0% or less. Even with State and local entities experiencing financial difficulties that raises concerns over credit quality, high-grade tax-exempt municipal yields are dropping to well below 5.0% again. But there are still exceptions available in the market that yield 5.0% or more. In New York, there are the 5.25% coupon 2035 maturity tax-exempt Liberty revenue bonds backed by both Goldman Sachs and their new headquarters building, and there are the tax-exempt Hudson Yards 2047 maturity revenue bonds, which are partially supported by the State. Puerto Rico tax exempt bonds are also available with 5.0% or higher yields, as are bonds in various other states and localties.

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 the following: philipbraverman.blogspot.com

I can be reached at philipbraverman@gmail.com