No Moderation of Economic Decline..posted 2/27/09

Some observers had sensed in recent weeks that the economic decline was moderating.  After all, the preliminary 4Q GDP numbers didn’t look all that bad, and the leading economic Indicators had risen for two months. But all the evidence I look at today indicates that any moderation in the rate of decline is wishful thinking.


The revised 4Q GDP numbers released today (-6.2% annual rate) confirm what many of us felt: that the economy was declining much more rapidly through December than the first estimates (-3.80%) suggested.


But more important than the past quarter is what is happening now and through the next couple of quarters. Job losses are continuing at a rapid rate, with initial unemployment insurance claims climbing to a new high.  It now looks as if we have at least 2-3 months ahead of job losses in excess of 500,000.


Economic activity in the rest of the world, with the possible exception of China (and I’m not even sure about China) is falling more rapidly than here.  Mexico, Southeast Asian economies, Taiwan, Japan, the U.K., eastern Europe, Russia, are registering either double digit rates of decline or close to it.  Our exports, a pillar of strength during much of 2008, have been declining more rapidly than our imports, and have thus been a negative for our GDP .


Most worrisome, in my judgment, is what is happening to Consumer Net Worth, a metric that tends to lead actual consumption by 6-9 months. Over the past two years Consumer Net Worth is down almost 25%.  I don’t need to tell readers what has happened to stock prices.  Every further percentage point decline probably has more negative effect than the previous one.  Savings for education and retirement have been very badly wounded. To top that is the continuing erosion of home prices.  Indications are that the housing price decline may have actually accelerated into early 2009, although that’s not a certainty.


I, therefore, expect no letup in the contraction of consumer spending, at least in the few months ahead. While I do no actual economic modeling myself, I study the models of many others, and believe that we are now in the midst of a quarter that will prove in most respects to be almost as bad as the 4Q of 2008, or an annualized decline of -5.3 to -6.0%.


In 2Q I expect some moderation, but a continued slide.  By the 3Q, a combination of the first effects of the stimulus package and monetary expansion (M2 has expanded at an annual rate of over 16% over the past six months)  beginning to provide some traction we may see a 1-2% decline.  Then it’s sort of even money as to whether we get a slightly positive result in 4Q.


There are many earnings estimates that still must be cut, although recent market action following earnings disappointments suggests that actual investors had already downgraded their expectations below analysts’ estimates.


I remain extremely concerned about the banking system, mainly because I think many bank assets have not yet seen their peak troubles.  Commercial real estate loans, the leveraged buyout loans of 2006-2007, credit card debt, and plain old business loans have a bad year ahead, in my opinion.  I believe that evidence that the erosion of bank asset quality is ending is necessary before the stock market can register anything more than range-bound rallies.


Meanwhile, the most encouraging thing I can say about stock prices is that their decline has brought them to a valuation level that is interesting if not outright cheap. If I were 41 instead of 81, I might even get enthusiastic!


Shiller’s PE is at “Interesting” Level

Readers know that for some years I have paid close attention to Robert Shiller’s Price-Earnings Ratio (Shiller PE).  You can see a chart and description of the Shiller PE in my February Musings.  Since I wrote that piece the continued market decline has brought the Shiller PE from over 15 to under 13, compared to a long-term mean of over 16.  It has been significantly lower only thrice before:  during the Great Depression, in the early post-war years when investors still suffered from depression psychosis, and in the mid to late 1970’s when inflation and interest rates were both sky-high.


Like many investors, I have large cash holdings, mostly raised before September last. Also, like many others, I don’t want to step up and catch a falling knife.  Therefore, despite my doubts about the value of technical tools, I think they can be useful at times like these. Currently these tools are telling me to stay out, and be skeptical of any rallies.  But that can change very fast.  I’ll do my best to let you know when they do.




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