Have We Turned The Corner On The Recession?
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. Finally a Little Good News for the Economy
2. Geithner’s Latest Toxic Asset Bank Bailout
3. Does the PPIP Have Any Chance of Working?
4. Fed to Buy $300 Billion in Treasuries & a Lot More
5. CBO Assessment of Obama’s Record 2010 Budget
6. Conclusions, Market Implications & What to Do Now
Some weeks, it’s tough to find a good topic to write about. Then other weeks, I’m overwhelmed with all there is to write about, as is the case this week. So, we’ll touch several bases in this week’s E-Letter. We’ll begin with the latest economic news, some of which was surprisingly positive (especially housing). Unfortunately, the latest good news does not necessarily mean we’ve seen the bottom of the recession or the bear market.
On Monday of last week, Treasury Secretary Geithner announced the much-awaited new plan to take toxic assets off the books of troubled banks. The plan is called the Public-Private Investment Program. Under this new program, the government along with private investors would buy up toxic assets by way of auctions to get these loans off the banks’ books. But will the plan work? I’m not optimistic. We’ll discuss this in some detail as we go along.
As if the Obama administration is not spending enough already, the Fed recently announced that it will print and spend over $1 trillion in the months ahead to buy at least $300 billion in direct purchases of Treasury securities and at least another $750 billion for purchasing more toxic assets from banks and other sources. Where will it end? No one knows.
In my March 10 E-Letter, I predicted that President Obama’s $3.55 trillion federal budget for fiscal 2010 would result in a deficit of more than $2 trillion, as opposed to the administration’s estimate of $1.75 trillion. Turns out I was wrong – the Congressional Budget Office predicted last week that Obama’s 2010 budget deficit will hit $2.3 trillion. Wow, this will be bad! The CBO agrees with me that Obama’s economic assumptions are too optimistic.
Following those discussions, I will give you my latest thoughts on where we stand in the big picture. With the latest smattering of good news on the economy and the nice rebound in the stock markets, some analysts are concluding that we’ve turned the corner on the recession and the financial crisis. I think it’s premature to make that call, and I will not be surprised if we see another downward leg before long. In fact, it may have already begun. Let’s get started.
Finally a Little Good News for the Economy
As everyone reading this is all too aware, the economic news so far this year has been horrible. Rarely has any good news been seen in recent months. But there was some good news last week, and it came in a very good spot – housing. Existing home sales in February unexpectedly rose by 5.3% above January levels to an annual rate of 4.72 million units. It was the largest monthly jump since 2003; still, sales were down almost 5% below yearago levels.
The increase in sales of existing homes was strongest in the West and in Florida, one of the worst hit markets. February sales of existing homes in Florida rose 20%. Florida Realtors also reported a 15% gain in statewide sales of existing condominiums in February, continuing a trend in recent months for higher statewide sales of both the existing home and existing condo markets compared to yearago levels.
The median sales price for existing homes nationwide rose to $165,400 in February, the first monthly increase in over a year, but it remains 15.5% below yearago levels. Unfortunately, the inventory of unsold existing homes rose again in February, despite the improved sales figures, thus putting the backlog at an estimated 9.7 months supply at the current sales pace.
New homes sales also increased by 4.7% in February to an annual rate of 337,000 units. Economists had expected new home sales to decline to a rate of 300,000 annualized units, so this was welcome news. While the unexpected rise in new home sales might be seen as a positive movement for the beleaguered housing market, the February rate for new home construction is still the second-lowest reading since the last recession in 2002. The median price of a purchased new home fell to $200,900 in February, down over 18% from a year ago.
Housing starts jumped well above expectations in February, rising 22% over January levels. Rising housing starts might not sound like a good thing, as that could mean even more homes on the market, but reportedly over 80% of the February construction starts were for apartment complexes, not new single family homes. Also, building permits climbed in February for the first time in over a year.
On another front, durable goods orders rose a surprising 3.4% in February following six consecutive monthly declines. This news was bittersweet because the Commerce Department revised January durable goods orders further downward from -5.2% to -7.3%.
Elsewhere, the economic news continued to disappoint. Last Thursday, the government reported that 4Q GDP fell at an annual rate of -6.3%, down from -6.2% as reported last month. Consumer confidence continued to plunge in February to only 25.0, a new record low, down from 37.4 in January. However, the latest Rasmussen tracking poll shows that consumer confidence has rebounded a bit in March.
The Index of Leading Economic Indicators fell 0.4% in February. The LEI has fallen very sharply since the last peak in July 2007. The unemployment rate jumped to 8.1% in February from 7.6% in January. The consensus is for a rise to 8.5% in March and at least 9% by yearend. These are just a few of the negative reports we’ve seen over the last month.
In summary, while we’ve seen a few positive reports on the economy and the housing sector in particular over the last month, we are far from out of the woods on the recession and the financial crisis. Now, let’s move on to the latest bank bailout proposed by Treasury Secretary Timothy Geithner.
Geithner’s Latest Toxic Asset Bank Bailout
After Treasury Secretary Geithner announced his new Public-Private Investment Program (“PPIP”) on Monday of last week, the Dow Jones promptly rallied over 500 points. That followed a rally of almost 1,000 points since the low in early March. The Dow and the S&P 500 bounced just over 20% from their recent lows – that is until the latest near 5% downward reversal over the last two trading sessions (Friday and Monday). While the equity markets clearly liked the government’s latest bank bailout plan, serious questions remain – such as, will it work, and will private investor groups want to get in bed with the government, which threatened to impose a 90% tax on AIG executive bonuses?
We’ll get to those questions and others as we go along, but first let’s examine how the Public-Private Investment Program is supposedly designed to work. In an online article in FORTUNE, CNNMoney.com’s Jon Birger provided the following summary on how the PPIP is expected to work as follows:
Many thanks to Jon Birger of CNNMoney.com for that summary. Obviously, there are still many unanswered questions about the Public-Private Investment Program. Geithner’s roll out of the program last week was very short on details, and many private investors are going to be very wary of getting in bed with the government to buy up these toxic assets, even if the discounts are very attractive.
Does the PPIP Have Any Chance of Working?
If President Obama wants this plan to have any chance of working, he needs to make sure the Senate does not go along with the House in passing the 90% retroactive income tax on the AIG executives that received big bonuses. Hedge funds, private equity funds and the like will not want to pony up money to buy toxic assets if they fear that the government will change the rules on profit sharing in these PPIP transactions.
I have read several articles recently that indicated the Treasury was already planning to recoup the AIG bonuses by subtracting that amount from the next round of bailout money AIG will need. That would have been an easy way to get the money back and put the onus on top AIG management to claw back the bonuses. But the Democrats in the House couldn’t resist the opportunity to grandstand in front of the American people with an illegal, retroactive 90% income tax on the AIG bonus money.
Political commentator Dick Morris has an interesting take on the PPIP. Morris believes strongly that President Obama wants the PPIP to fail. Morris is convinced that, while Obama says publicly that he does not want to nationalize the big banks, privately Obama and Rahm Emanuel would very much like to see the government take over these large money center banks that have taken bailout money.
Morris argues that this is precisely why the president has been lambasting Wall Street and the big banks for weeks now, in the hope that private investors will not jump into the PPIP with both feet. Morris also believes that this is why Obama packaged the PPIP as Geithner’s plan, not his own, so that if it fails he won’t get the blame. If it does fail, Morris predicts that Obama will then nationalize the troubled banks. I sincerely hope this assessment is wrong!
As noted earlier, the stock markets reacted extremely strongly following Geithner’s announcement of the Public-Private Investment Program. If it is to have any chance of working, he needs to get the details out fast, including assurances that the government won’t change the rules in the middle of the game. We’ll see.
Fed To Buy $300 Billion in Treasuries & a Lot More
The Fed Open Market Committee met on March 17-18, and the policymakers approved some bold new (yet troublesome) actions. Citing that the economy continues to worsen and the credit markets are still dysfunctional, the FOMC voted unanimously to authorize the Fed to make direct Treasury security purchases of $300 billion over the next six months, with a suggestion that much more could be authorized later on if needed.
This move is controversial because the Fed will have to print the $300 billion to pay for the purchases of Treasury securities. Many fear that this action (and likely more to come) will further sew the seeds of significantly higher inflation when we emerge from this recession. But as I have written often in recent letters, the Fed is scared to death of deflation and will do whatever they feel is required to avert a debt deflation in the economy.
At the same FOMC meeting, Bernanke & Company also voted to double the Fed’s purchases of mortgage-backed securities and take on more agency debt. That means the Fed will purchase another $750 billion in toxic mortgage-related securities this year. Between the Treasury purchases and the additional mortgage-related securities – all of which they will have to print money for - the Fed’s balance sheet liabilities will skyrocket to well above $3 trillion this year.
Following this announcement, yields on 10-year Treasury notes plummeted in the largest one-day decline on record to near 2.5%, down from above 3% just two days before. Stocks also rallied on March 18 and since then (at least until the last two days), a clear indication that many investors approve of the Fed’s unprecedented actions in buying Treasury debt directly and doubling its purchases of toxic assets.
But it should also be noted that the US dollar plunged on the news that the Fed would be buying $300 billion in Treasuries and another $750 billion in toxic assets, and the implication that those numbers may well go even higher later this year. Keep in mind that these numbers are in addition to the $2+ trillion budget deficit we will have in fiscal 2010 (more on that below) and well over $1 trillion in each of the next several years.
Given the staggering size of these numbers, I don’t see the US dollar going anywhere but down over the next several years. Maybe that’s why China is threatening to stop buying US Treasuries and calling for a serious discussion of a new world currency at the upcoming G-20 Summit on April 2. I will discuss this issue more in coming weeks.
CBO Assessment of Obama’s Record 2010 Budget
In my March 10 E-Letter, I discussed President Obama’s record $3.55 trillion budget for fiscal 2010, with its projected budget deficit of a record $1.75 trillion. I also discussed why I believe the deficit next year will be well north of $2 trillion. Last week, the supposedly non-partisan (but Democrat controlled) Congressional Budget Office (CBO) released its own analysis of President Obama’s proposed budget for 2010 and the next 10 years.
If you recall, I noted in my March 10 letter that I believe the Obama administration used economic assumptions that were too optimistic. I pointed out that Obama’s projections for GDP growth were too rosy. Likewise, I noted that his assumptions for unemployment were considerably too low. I concluded that discussion by saying: But it will not surprise me if the deficit is $2 trillion or more in 2010. Now the Democrat controlled CBO agrees with me!
Interestingly, Obama has routinely criticized George W. Bush for out-of-control spending, which is a well-deserved criticism. In Bush’s eight years, he – with the help of Congress – added almost $5 trillion to the national debt. Obama’s budgets would add almost twice that amount - $9 trillion - according to the CBO.
I think most people reading this would agree that a 2010 budget deficit of $2.3 trillion is simply way too much, even in this economic and financial crisis. While Obama says his budget is necessary to get the economy out of the ditch, it could make things worse by ruining America’s credit standing in the world. Unfortunately, it looks like he has the votes to get most of his budget passed.
Conclusions, Market Implications & What To Do Now
The 20% bounce in the stock markets and the latest smattering of good news on the economy have led some analysts to conclude that the worst of the recession and the credit crisis are behind us. That could be, but the forecasters I respect believe we will see at least another 1-2 quarters when GDP will fall 6-7% or possibly more. So, I am not convinced we’ve seen the worst of the recession or the credit crisis. I hope I am wrong.
The good news (if we can call it that) is that the US was the first major economy to go into recession; it has suffered a more severe contraction than most other sizable economies, with the notable exception of Japan; and it would therefore be reasonable to assume the US will be one of the first major economies to turn the corner.
Yet in many ways, calling the bottom in the recession misses the point. Unlike past recessions that were followed by a strong recovery, I believe (and my best sources agree) that we face at least a couple of years of very slow growth when this recession ends. Yes, the government and the Fed are spending trillions like drunken sailors, but this economic and financial crisis is likely to put a damper on growth for at least several more years.
With that backdrop, investors have to consider the likelihood (or unlikelihood) that the US equity markets bottomed in early March. With the major market indexes having plunged over 50% from their peak in late 2007 to early March, it is easy to assume that we’ve seen the bottom. I, on the other hand, am not so convinced.
But that, too, misses the point in my opinion. Whether the bottom is in or not, I fully expect the equity markets to at least retest the lows seen early this month when the Dow fell to 6,500 and the S&P 500 fell to 675. And there is no guarantee that those lows will hold. Therefore, if you are looking to exit failed buy-and-hold positions in stocks, and move to more defensive strategies, I would suggest doing so now.
My greatest concern at this point is that the new Public-Private Investment Program may not work. As I have written in several recent letters, it is clear that relatively little of Obama’s $787 billion stimulus plan will be spent this year when it is needed most. Thus, that means that it is even more critical that the PPIP get started quickly and that it succeeds. As noted earlier, there is no assurance that it will get up and running quickly, or that it will succeed (or if President Obama is fully behind it).
If you have been considering alternatives to the buy-and-hold strategy for a portion of your equity portfolio, such as the active management programs I recommend – which can move to cash and/or hedge long positions - now may the time to get such strategies in place.
Remember, it does not matter where you live; we have hundreds of clients all across America.
Finally, we hosted our second Webinar with Scotia Partners on March 25. I’m very pleased to report that almost 300 of you registered for this opportunity to learn more about Scotia’s very successful investment program. If you missed it, you can watch and listen to the full Webinar discussion (including all charts) at www.halbertwealth.com.
Hoping we can help you in these tough times,
Gary D. Halbert
Obama Budget - $9.3 Trillion in Deficits says CBO
Obama Sticker Shock (more CBO budget analysis)
Uncle Sam’s Hedge Fund (the Geithner bank bailout plan)
Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.