Q. In your last newsletter you seemed kind of pessimistic about the economic outlook even though we've seen a 50% rise in the stock market since March. Why?
A. The reason that the stock market is up is due to firm's cutting costs or selling off assets which temporarily enhance the bottom line, not because of increased sales or a resurgence of consumer demand. The stock market is ordinarily a leading indicator of where the economy is headed, usually by about 9-12 months. But, my sense is that U.S. consumers are nowhere near as ebullient as Wall Street has been. Consumers haven*t returned to the market place and consumers are responsible for 70% of Gross Domestic Product (GDP). (The one exception was the auto industry's Cash for Clunkers program, but even that was fore-shortened and was not truly consumer driven; it was a government subsidized program).
GDP fell by 3.9% last year and while it is improving, the rebound isn't very strong. Though the stock market is up, consumers are also up to their necks in debt and U.S. consumer credit shows the steepest contraction in over 5 decades. What this suggests is that a new paradigm of savings, asset liquidation and debt repayment is being ushered in, one that will put a firm ceiling on overall demand growth for some time to come.
Commercial bank lending in July showed a record contraction of $64 billion, which is the equivalent of a 12% annualized decline. This was the third month in a row of declining bank credit to households and businesses and totaling some $149 billion. I*m not sure a recovery can be sustained without credit creation.
U.S. wholesalers stocks plummeted 1.7% in June, the 10th straight month of decline and twice as much as expected. What this suggests is that businesses were cutting inventories sharply because they remain skeptical about a return in demand.
With the real estate and financial markets having been in the dumps the past few years and my being in real estate, I grant you I may have a more jaundiced view of the recovery but, I firmly believe that Wall Street does not appreciate the magnitude of how much overhang in the form of troubled and toxic assets that remains on banks balance sheets which is why I view the recent stock rally as premature.
As for home building and manufacturing, two other possible growth engines, I do not expect a traditional rebound in these sectors, largely because of the overhang of unused capacity remains enormous. As for commercial real estate, it isn't expected to hit bottom for three more years. Delinquency rates on commercial loans have doubled in the past year to 7% as more companies downsize and retailers close their doors, according to the Federal Reserve. The commercial real estate market's fortunes are tied closely to the economy, especially unemployment, which registered 9.4 percent last month. As people lose their jobs, or have their hours reduced, they cut back on spending, which hurts retailers, they take fewer trips, affecting the hospitality industry, and so on down the road.
So, despite an up-tick in consumer saving, debt levels have only barely begun to come down. Even after the recession ends, economists expect the gradual reduction of the nation's massive consumer debt to take years.
Finally, unemployment is not expected to crest until sometime next year or possibly 2011. Consequently, I foresee a limping economic recovery with a demand curve weakened by rising unemployment and underutilized capacity.
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