Signs of the End of the Recession

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
April 21, 2009

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?

Introduction

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:

“Consumer Confidence was relatively unchanged in March, after reaching an all-time low in February (Index began in 1967). The Present Situation Index suggests that the overall state of the economy remains weak and that more job losses are on the horizon. Apprehension about the outlook for the economy, the labor market and earnings continues to weigh heavily on consumers' attitudes. Looking ahead, consumers remain extremely pessimistic about the short-term future and do not foresee a turnaround in economic conditions over the coming six months.”

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 Conference Board Leading Economic Indicators

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.

U.S. Department of Commerce Real GDP Chart

The Wachovia Group believes that economic growth will recover in the 2Q and 3Q with GDP registering only a negative 1-2%. And they currently forecast that GDP will improve into mildly positive territory in the 4Q. I believe Wachovia’s prediction of an end to the recession by the 4Q is too optimistic, as do several of my most trusted sources for economic forecasts.

If you would like to read Wachovia’s latest weekly economic analysis released on Friday, click on the following link:
http://www.realclearmarkets.com/articles/WeeklyEconomicFinancialCommentaryApril172009.pdf

If you would like to subscribe to Wachovia’s weekly economic commentaries, click on the following link – the service is free of charge:
http://www.wachovia.com/economicsemail

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.

“Economists in the latest Wall Street Journal forecasting survey expect the recession to end in September, though most say it won’t be until the second half of 2010 that the economy recovers enough to bring down unemployment.

Gross domestic product was predicted to contract in the first and second quarters of this year by 5.0% and 1.8%, respectively, on a seasonally adjusted annualized rate. A return to growth -- a modest 0.4% -- isn’t expected until the third quarter.

Indeed, economists’ prospects for the labor market remain bleak. Just 12% of the economists expect the unemployment rate to fall some time this year. More than a third of respondents expect the jobless rate to peak in the first half of 2010, while about half don’t see unemployment declining until the second half of 2010. By December of this year, the economists on average expect the unemployment rate to reach 9.5%, up from the 8.5% reported for March...

Meanwhile, asked to name the biggest risk to their forecasts, economists singled out problems in the credit markets. ‘Once the virtuous cycle starts, the chief headwind will be credit availability,’ said Kurt Karl of Swiss Re. The possibilities of a failure of a major financial institution and persistent reluctance of consumers to spend, both related to the credit markets, were tied for second place in the list of concerns.”

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:

“Reports from the Federal Reserve Banks indicate that overall economic activity contracted further or remained weak. However, five of the twelve Districts noted a moderation in the pace of decline, and several saw signs that activity in some sectors was stabilizing at a low level.

Manufacturing activity weakened across a broad range of industries in most Districts, with only a few exceptions. Nonfinancial service activity continued to contract across Districts. Retail spending remained sluggish, although some Districts noted a slight improvement in sales compared with the previous reporting period. Residential real estate markets continued to be weak.

Home prices and construction were still falling in most areas, but better-than-expected buyer traffic led to a scattered pickup in sales in a number of Districts. Nonresidential real estate conditions continued to deteriorate. Difficulty obtaining commercial real estate financing was constraining construction and investment activity. Spending on business travel declined as corporations cut back. Reports on tourism were mixed. Bankers reported tight credit conditions, rising delinquencies, and some deterioration of loan quality.

Agricultural conditions were generally favorable across Districts, although drought conditions persisted in the Dallas and San Francisco Districts. The Districts reporting on energy said reduced demand, high inventories, and lower prices led to steep cutbacks in oil and natural gas drilling and production activity. The Minneapolis, Kansas City, and Dallas Districts noted declines in employment in the oil and gas extraction industry.

Downward pressure on prices was reported across Districts. Wage and salary pressures eased as labor markets weakened in all Districts, and many contacts continued to report job cuts and wage and hiring freezes. Employment continued to decline across a range of industries, with only scattered reports of hiring.”

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:

“Manufacturing activity continued to decline in most Districts and across a wide range of industries… Orders and shipments of capital goods, autos, paper, and construction-related equipment and products such as metals, wood products, lumber and electrical machinery remained mostly sluggish and below year-ago levels…

Districts that report on nonfinancial business services said demand continued to fall across most industries. Providers of health-care services noted further declines in activity, and contacts in several Districts noted demand for professional services, such as architecture, business consulting and legal services, remained weak. Auto dealers continued to struggle, and overall vehicle sales were sluggish in all reporting Districts as weak demand and tight credit continued to limit sales…

Travel and tourism activity contracted further in several reporting Districts, as households and businesses continued to scale back on discretionary and travel spending. Tourist spending in the New York, Minneapolis, and San Francisco Districts saw double-digit declines compared with the prior year. Airlines in the Dallas District and hotel contacts in the Kansas City District reported weakening demand for business travel, while the Atlanta District noted convention cancellations. Restaurants continued to see sluggish activity in the Kansas City and San Francisco Districts, which prompted further layoffs and closures in the latter region.

Housing markets remained depressed overall, but there were some signs that conditions may be stabilizing… New home construction activity fell further, however, as inventories remained elevated. Home prices continued to decline in most Districts, although a few reports noted that prices were unchanged or that the pace of decline had eased… Nonresidential real estate conditions continued to deteriorate over the past six weeks. Demand for office, industrial and retail space continued to fall, and there were reports of increases in sublease space.

[Commercial] property values moved lower as reality ‘set in…’ Commercial real estate investment activity weakened further. Contacts said a decline in credit availability and markdowns on commercial property were keeping buyers and sellers on the sidelines.

… Demand for commercial and industrial loans was weak, and there were several reports that business borrowers were postponing capital expenditures. Commercial real estate lending continued to decline. Credit availability generally remained very tight across regions. A number of Districts reported deteriorating loan quality and rising delinquencies for all types of loan categories. In particular, several reports noted more stringent requirements for commercial real estate loans due to worries of worsening loan quality in the sector.

Labor market conditions were weak and reports of layoffs, reductions in work hours, temporary factory shutdowns, branch closures and hiring freezes remained widespread across Districts. Staffing firms in the New York, Cleveland, Richmond, Chicago, and Dallas Districts reported that demand for workers remained sluggish.

… Continuing layoffs, furloughs and hiring freezes kept wage pressures minimal. Contacts from a broad range of industries reported pay freezes, with some noting salary reductions. The Minneapolis District reported that unionized faculty at Minnesota's technical and community colleges had tentatively accepted a two-year pay freeze. Contacts in the Boston, Philadelphia, Richmond, Chicago, and San Francisco Districts reported cuts in certain non-wage employment benefits, including cuts in bonuses, elimination or suspension of employer contributions to employee retirement programs, and increases in copayments on employer sponsored healthcare plans.

… Consumer spending remained generally weak. Travel and tourism activity contracted further in several reporting Districts, as households and businesses continued to scale back on discretionary and travel spending… Retailers kept inventories lean, in line with the slow pace of sales, and most expect demand to stay at current low levels over the next few months… Auto dealers continued to struggle, and overall vehicle sales were sluggish in all reporting Districts as weak demand and tight credit continued to limit sales.”

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.

S&P 500 Chart

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

SPECIAL ARTICLES:

A Backdoor Nationalization of the Banks (read this)
http://online.wsj.com/article/SB124027165661037073.html

Big-Spending Conservative
http://www.nytimes.com/2009/04/21/opinion/21brooks.html?_r=2&ref=opinion

Tea Party Economics
http://www.forbes.com/2009/04/20/tea-party-taxes-opinions-columnists-ear-marks.html