Is a new recession foreshadowed by recent slow economic activity?

There should be little doubt that the economy is in the process of slowing further. The recent slate of economic reports are clearly disappointing. That includes a May rise in the unemployment rate to 9.1%,up from 8.8% in March and 9.0% in April, and a mere 54,000 May increase in nonfarm payrolls versus an average 222,000 rise the prior three months. Indeed, there are indications that the greatest private sector employment weakness is among small firms which makes incredible a Bureau of Labor Statistics mere guess that there was a 206,000 May rise in completely unsampled small firm hirings, accounting for one third of the total rise in payrolls before seasonal adjustment. Thus, even the 54,000 seasonally adjusted May rise in nonfarm payrolls may be grossly overstated. As if that were not enough, this week's reports of the Chicago PMI,Purchasing Managers Index,the ISM, Institute of Supply Management, and housing statistics were all also considerably weaker.

But, something even more ominous may well be brewing.

Long-lead economic indicators and other relationships point to the possibility of one or more quarters of negative real GDP growth later this year or next. The Institute for Business Cycle Research sees a new economic downturn looming in their propriatary long lead economic indicators.

The economic model of one Federal Reserve Bank links the recent decline in US Treasury intermediate note and long-term bond yields, and the resultant narrowing in the maturity yield spread, to a decline in real GDP growth in coming quarters.

Housing has proven to be a reliable very long-lead economic indicator. Thus, the renewed decline in various housing measures, from still very depressed levels, points to a relapse in housing that may well portend broader weakness for the overall economy. Indeed, Sam Zell, the legendary real estate Guru, has indicated that he cannot yet buy commercial real estate in the US, at least not until property prices drop significantly to market clearing levels. But, he stressed that can not happen while lending institutions are unwilling to forclose on major delinquent mortgages for fear of the consequent writedown of their capital as they recognize sizable losses. Condominium and coop prices in Manhattan are reportedly an exception to the weakness prevailing in much of the rest of the country, especially in retirement and vacation centers where investor speculation created a massive bubble. And there is also too much office and retail space available, suggesting downward pressure on rentals and prices.

State and local budget deficits are still too large to be closed by a rise in taxes, which is impractical in a distressed economy. Thus, further and significant spending cuts and layoffs will be required.

The efforts of Republicans to curtail Federal spending, so as to limit the balloning Federal budget deficit, will make it virtually impossible to bring major new stimulative Federal spending programs into realty. Thus, there will be little prospect of new Federal spending to offset the economic slowdown or the faze-out of previous Federal stimulus efforts, which incidently seem to have been of little use. There are those who believe that Federal stimulus is ineffective and recent experience certainly appears to support that contention.

It could well be that the battleground of the next Presidential election is being fought and decided currently. No incumbent President since FDR has won reelection with the unemployment rate above 7.0%. And the Republicans, who know this, are waging a battle not only against the Federal budget deficit, but against the economic recovery and, consequently, the President. That could be a dangerous political strategy, even if new economic stimulus would prove ineffective.

A number of other potentially decisive forces are in play that add to the risks of a major economic downturn or even a recession. These include the continuing credit crisis in Europe, extending far beyond Greece. The entire southern tier of Europe has financial problems. This includes Portugal,Spain,Italy and Greece, as well as Ireland. Germany and France cannot continue to bail out the weak economies to preserve the European economic union and the European banks with substantial holdings of distressed southern tier European debts. The prescription of imposed austerity in exchange for the aid packages and bailouts will at the very least significantly undermine and slow European economic growth.

There is also the pronounced efforts of China to slow their overheating economy in order to reign in inflation and curtail speculation, especially in real estate.

Japan is contibuting to a probable slowing in the global economy due to extensive problems stemming from their earthquake and nuclear power plant meltdown.

Uncertainties are proliferating over the consequences of the so called Arab Spring. These various forces can so undermine confidence in the economic outlook that capital investment decisions are prudently postponed, even with advantageous US tax treatment.

While the US equity market has been declining for a number of weeks,the magnitude of the weekly decline has not yet reached the crtical 4.0% plus decline in the value line index and other broad equity market indices in a single week that have in the past proven reliable sell signals. But, given the outlook for the economy, high margin debt and other warning signs, the liklihood is that the 4.0% plus decline in a single week sell signal will soon materialize.

The decline in Treasury yields will likely persist as the economy weakens further and the Fed's QEll, their second quantative easing, comes to an end. This Treasury yield decline, which has already carried the 10-year Treasury yield to 3.00%, from a recent high of 3.60%, will probably eventually carry the yield back to 2.5% or below.And that should benefit the prices of highly rated corporate and municipal bonds as well.

Philip Braverman, President
One Hewitt Square #249
East Northport, New York 11731


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