Signs of the End of the Recession - Maybe
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. The Latest Economic Reports – Mostly Negative
2. Latest Wall Street Journal Survey of Economists
3. Fed’s Latest “Beige Book” Outlook is Bleak
4. Conclusions – What To Believe?
We have clients calling us every day to ask if we believe the economy and the stock markets have seen the bottom. We don’t know for sure, of course, but it may be reasonable to assume that the 4Q of last year and the 1Q of this year will mark the worst two quarters of this severe recession. We won’t see the government’s first estimate of 1Q GDP until next Wednesday, April 29, and it is expected to be about as bad as the 4Q decline of 6.3% (annual rate).
Economic reports over the last few weeks have been mixed to negative. I will highlight those reports as we go along. To get a better idea where we stand in the recession, we will also review the latest Federal Reserve “Beige Book” released on April 15, which analyzes the national economy in greater detail. Overall, it was quite negative and reinforced my view that we will be in negative economic growth territory for all of this year.
The stock markets bottomed in early March, and we have seen an impressive rally since then. The Dow Jones rebounded almost 25% from the lows in early March. There is historical evidence that the stock markets are often an early indicator of a change in the economic indicators, and tend to lead the economy by an average of six months. More and more analysts are calling the March lows the bottom, but this assumes there will be no more major negative surprises.
The stock market recovery and signs that the credit markets are unfreezing just a bit prompted some rather optimistic predictions (overall) in a recent Wall Street Journal survey of 53 economists and market analysts. On average, the 53 forecasters predicted an end to the recession by September of this year. I am not so optimistic, and the combined WSJ survey results are not nearly as positive as the September end-of-recession conclusion suggests. More on this later.
As I wrote in my April 7 E-Letter, many of the largest insurance companies are in financial trouble, so I believe it is still too early to assume that there will not be more major negative surprises. Although, as I noted in last week’s letter, it appears that the Treasury Department will allow most major insurers access to TARP bailout monies, assuming the companies are willing to submit themselves to government controls.
As we go along, I will direct you to a weekly economic publication I follow that is produced by the Wachovia Economics Group (Wachovia bank was purchased by Wells Fargo bank in December of 2008). While the analysts at Wachovia are considerably more optimistic than I am about the recession ending later this year, they do a decent job of forecasting and analyzing the various economic reports that are released each week, and it’s free of charge. I’ll tell you how to access it later on in this letter. Let’s get started.
The Latest Economic Reports – Mostly Negative
At the end of March, the Commerce Department released its final estimate of 4Q GDP, showing that the economy fell at an annual rate of 6.3%, the worst quarterly drop in 25 years. Personal consumption spending plunged 4.3% year-over-year in the 4Q. As noted above, the first estimate of 1Q GDP will not be released until next Wednesday, April 29. Pre-report estimates vary from down 4-5% to down 7-8%. My guess is that 1Q GDP will be down slightly more than the -6.3% in the 4Q of last year.
We have recently seen a few encouraging signs that the worst of the recession and the credit crisis may be behind us, such as improving profit numbers from several of the big banks that took TARP money. At the same time, there are persistent rumors that several of the major banks have failed their so-called “stress tests” being conducted by the Treasury Department. For a host of reasons, I believe that the recession will drag on for the rest of the year.
Most importantly, every week we continue to hear of mounting job losses. The unemployment rate jumped to 8.5% in March, up from 8.1% a month earlier. The Labor Department announced last Thursday that the number of Americans receiving unemployment benefits topped six million for the first time in US history. Initial unemployment claims have been above 600,000 for the last four weeks running. Most of my trusted sources believe that the unemployment rate will hit at least 10% by the end of the year, another suggestion that the recession will drag on for at least another 2-3 quarters.
Consumer confidence remains in the tank. The latest report for March had the Consumer Confidence Index at 26.0, down from 60 just last September. Lynn Franco, Director of The Conference Board Consumer Research Center noted:
With consumer confidence so depressed, it should not have surprised anyone that retail sales for March were worse than expected, falling 1.1%. It was the biggest decline in three months and a much weaker showing than the 0.3% decline that analysts expected. A big drop in auto sales led the overall slump in demand. Sales also plunged at clothing stores, appliance outlets and furniture stores, just to mention a few.
Along with the slowdown in consumer spending, we are seeing credit card delinquencies continue to soar. It was recently reported that banks and credit card companies wrote off a record $21 billion in unpaid credit card debt in 2008. Such credit card write-offs are estimated to balloon to a whopping $41 billion this year. This will mean more bad news for the major banks.
The Conference Board reported yesterday that the Index of Leading Economic Indicators (LEI) fell 0.3% in March, following a decline of 0.4% in February. The chart below illustrates the severity of the economic downturn and does not suggest that the recession has bottomed out yet.
The ISM manufacturing index was essentially unchanged in March at 36.3, up fractionally from February’s 35.8. Any reading in the ISM index below 50 indicates that the economy is contracting. The March decline was the 14th consecutive month that the index was below 50. A spokesperson for the ISM noted, however, that the March reading of 36.3 marked the third consecutive month that the index was in the mid-30s, suggesting that the decline may be stabilizing. We will see.
Industrial production contracted by 1.5% in March after a similar decline in February. Analysts estimate that industrial production fell at an annualized rate of 20% in the 1Q. If correct, that would mean the 1Q would be the largest drop since the 1Q of 1975. With the exception of utilities, all major industrial sectors registered declines. Capacity utilization (the factory operating rate) fell to 69.3% in March, which is the lowest on record, down from near 80% a year ago.
On the housing front, March brought more bad news following the brief respite the month before. Housing starts plunged 10.8% in March to a seasonally adjusted annual rate of 510,000 units. That was the second lowest home construction pace in records that go back 50 years. The decline was worse than economists had expected, and February activity also was revised lower. Applications for building permits fell 9% in March to a record low of 513,000 units. Some would argue that the declines noted above are a good thing since there are still far too many unsold homes on the market.
Unfortunately, the home foreclosure rate jumped by 24% in the first three months of this year and is poised to rise further as major lenders restart foreclosures after a temporary break, according to data released last Thursday. Nationwide, nearly 804,000 homes received at least one foreclosure-related notice from January through March, up from about 650,000 in the same time period a year earlier, according to RealtyTrac Inc., a foreclosure listing firm.
The big unknown for the coming months, however, is President Obama’s supposed plan to help up to nine million borrowers avoid foreclosure through refinanced mortgages or modified loans. The Obama administration expects its plans to make a big dent in the foreclosure crisis. But it hasn’t happened yet, and it remains to be seen whether the lending industry will fully embrace it, despite $75 billion in potential incentive payments.
Predictions of a Recovery in the Economy
As noted in the Introduction, the analysts at Wachovia Economics Group are considerably more optimistic than I am about the second half of this year. As you can see in the chart below, the Wachovia Group expects 1Q GDP to come in around -6%, and they could be correct. In any event, the 1Q GDP number will almost certainly be one of the worst in decades.
Latest Wall Street Journal Survey of Economists
As noted in the Introduction, the latest Wall Street Journal (WSJ) survey of 53 economists and market analysts yielded some (emphasize some) surprisingly positive suggestions, despite the continued drumbeat of negative economic news. The WSJ survey was taken in early April. On average, the 53 economists and analysts surveyed predicted that the recession would end by September of this year.
While the average forecast among the 53 economists suggests that the recession will end late in the 3Q, there were a number of the economists surveyed that were not so optimistic. I agree. Here are some highlights from the latest WSJ economic survey. Pay special attention to the unemployment forecasts. Those, to me, tell us more than anything about when the recession will end.
Many market analysts around the world follow the WSJ economist surveys, and they are always insightful. But this one published earlier this month raises more questions than answers. How likely is it that the recession will end in September when the consensus among the economists is that the unemployment rate will continue to ratchet up until at least mid-2010? I don’t get it.
My conclusion is that the recession may well hit bottom by September of this year, but we won’t be back to positive economic growth until sometime in 2010. And that assumes we are not looking at major insurance company bankruptcies (and/or major bailouts) if we see a bad hurricane season this summer or fall (as discussed in my April 7 E-Letter).
Fed’s Latest “Beige Book” Outlook is Bleak
The Federal Reserve issues a very insightful economic publication entitled the “Beige Book” eight times per year, essentially every month and a half. Each of the 12 Federal Reserve Banks gathers information on current economic and financial conditions in their district, and this information goes into the Beige Book report every 45 days or so. The latest Beige Book economic summary released this month is perhaps the most negative I have ever read. Here is the summary and highlighted remarks:
This summary of the latest Beige Book report sounds rather benign. But keep in mind that the Fed hates to come across sounding too negative. The report continues as follows:
I could go on and on with quotes from the April Federal Reserve Beige Book, but you get the picture. This is the most negative Beige Book assessment of the economy that I can ever remember reading over many years.
Notice how many references the Fed makes to the weakness in the commercial real estate markets. Some analysts believe that commercial real estate markets may be the next shoe to drop in the recession (along with insurance companies, as I warned two weeks ago). This does not suggest an economy that is about to rebound from a recession anytime soon.
Have the Stock Markets Bottomed?
The major market indexes rebounded 20-25% since the recent lows in early March, and investors around the world are wondering if we’ve finally seen the bottom. The latest recovery has indeed been impressive, but we need to keep it in perspective. As you can see in the S&P 500 monthly chart below, the market was extremely oversold by the end of February.
Given that the S&P 500 had plunged almost 45% from the peak in late 2007, the market was overdue for a significant rebound. Over the last couple of weeks, there have been plenty of analysts and financial writers who have proclaimed that we’ve seen the bottom. But many of these same analysts are always bullish. Others, of course, maintain that this is just a bear market rally.
No one knows which camp will ultimately be proven correct. Here are a few observations as to how things may play out. First, if Wachovia and the majority of economists surveyed by the WSJ are correct that the recession will end and the economy will improve significantly in the second half of this year, then I would bet that the bottom is in.
It is also very helpful that several of the major banks have been reporting good news for the 1Q, and the credit markets are starting to unfreeze a bit. Several of the big banks that had TARP money shoved down their throats are now begging to give it back, which is also good, and is encouraging to the equity markets and investors in general. But keep in mind that we have yet to see the results of the stress tests, and some fear this news will not be good. We’ll see.
Also, keep in mind my ongoing concerns about the insurance industry where the 1Q financial reports are expected to be very ugly. Also, as discussed above, the commercial real estate markets are turning down as we speak. So, I will not be surprised if we see at least a retest of the March lows in the major indexes. Whether we’ve seen the bottom or not may depend on how much concern develops for the insurance industry and commercial real estate just ahead.
Several of the professional money managers I recommend have moved back on the long side of the market, but most are not fully invested (i.e., they still have some money on the sidelines). And if their systems indicate that this rally is fizzling, they won’t hesitate to move back to cash and/or hedge their long positions.
Conclusions – What To Believe?
At the end of the day, the question is whether or not this recession will end before this year is over, or will it drag on into 2010? This, of course, depends on one’s definition of recession. If we are to believe that the recession is over when negative economic growth bottoms out, but has not yet improved to positive territory, then I would tend to agree that the recession will end later this year.
But if we agree that the recession has ended only when the economy returns to positive growth, then I believe the recession will not end until sometime in 2010. I hope I am wrong. The economists at Wachovia Group believe the recession will end in the second half of this year, as does a consensus of Wall Street Journal economists based on an April survey.
I sincerely hope they are correct, but I fear they are not, especially if it is confirmed over the coming weeks that the big insurance companies are in financial trouble. It’s a lot to think about, especially as it pertains to your investment accounts, your retirement portfolios and meeting your financial goals.
Time will tell which camp is correct. In the meantime, I continue to recommend that you use this market rally to move to more defensive (alternative) portfolio strategies that have the potential to protect you from major market downturns.
Wishing you profits,
Gary D. Halbert
A Backdoor Nationalization of the Banks (read this)
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.