It’s now
been a year since the dark days of early March 2009, when, although no one
knew it at the time, the stock market hit rock bottom. From there, all of the
indexes went on a tear through the rest of the year, moving almost
uninterruptedly higher before easing slightly in the first two months of
2010. At this writing (March 5), the Dow is still up 60%, the S&P 500
68%, and the NASDAQ 83%.
Virtually no one
was calling for this kind of rally a year ago. But it happened. So investors
are either seeing the “green shoots” supposedly sprouting from
the moribund economy or believe that they’re about to break ground any
day now. That sentiment is continually reinforced by government officials and
media talking heads who almost universally proclaim that “the worst is
past,” “we’re back from the brink,” or other words to
that effect.
It’s often
said that stock market action is a leading indicator, reflecting what
investors think the economy will be like six or nine months down the road.
Are they right?
Will good times soon be here again? Or is this just a big dead-cat bounce?
Jobs: Now here,
we’ve clearly turned the corner. Everyone says so. For evidence, all we
need do is look at the declining rate of job loss in the country. Uh-huh.
Perhaps
it’s rude of us to point this out, but a declining rate of job loss is
still a job loss. It is not the same as job creation.
The hard reality
behind February’s “encouraging” numbers is that 14.9
million people remained out of work. 8.4 million jobs now have been lost
since the start of the recession. In addition, there is a net need for
100,000 new jobs a month, just to keep up with first-time entrants to the workforce.
Even if the
economy were suddenly to start churning out new jobs at the robust rate of a
half-million a month – and the chances of that range from zero to none
– it would still take nearly two years to return just to pre-recession
employment levels.
(Near-term
employment figures may blip up, as the government hires one and a half
million people – who knew we needed so many? – to help take the
census. That could lead to a classic false dawn.)
Anyone looking to
the housing market to lead the recovery, as it often does, had better find a
magnifying glass. January marked the third consecutive monthly drop in new
home sales, and it was a whopping 11.2% tumble. Mortgage applications fell to
the lowest level in 13 years. There was even a decline of 6.1% from January
of 2009, itself a very dark month. Congress’s extension of home
buyers’ tax credits is proving to be of increasingly little consequence.
New home sales
are very important, since they cause a cascade effect down through the entire
supply chain, from architects to building contractors, to sawmills, to
sheetrock manufacturers, to carpenters, plumbers, and electricians. But sales
of existing homes are also relevant, and there, too, the figures are grim.
After piggybacking on federal subsidies through the fall, sales absorbed the
worst pummeling on record in December, down 16.2%. January was a little
better, only off 7.2%.
One number that
is unfortunately growing is this: distressed sales, such as foreclosures,
accounted for 38% of sales in January, up from about 32% in December. People
are losing their homes at an increasing rate, with few buyers stepping up to
the plate.
But hey, maybe
there is a huge pent-up housing demand out there. We doubt it, but if there
is, it doesn’t matter. Because lenders are ignoring it. In 2009, U.S.
banks posted their sharpest decline in lending since 1942. One reason is that
many are too cash-strapped themselves to deal with borrowers. According to
the FDIC, at year’s end its “problem” list of U.S. banks at
risk of failing hit a 16-year high at 702 (or nearly one in eleven),
rocketing up from 552 at the end of September and 416 at the end of June. And
little wonder. More than 5% of all outstanding loans are now at least three
months past due, the highest level recorded in the 26 years the data have
been collected.
Then
there’s those that can’t lend because they’re no longer
with us. 140 banks went belly-up in 2009, and 2010’s total will be
worse than that if January’s 15 failures prove representative. The FDIC
is bankrupt after reporting a $20.9 billion loss in the fourth quarter of
2009 in its Deposit Insurance Fund.
However, never
let it be said that the government won’t try to squeeze some lemonade
out of its bag of lemons. To wit, the FDIC’s own financial woes
haven’t prevented it from opening a huge new satellite office in the
Chicago area. The facility will be dedicated to managing receiverships and
liquidating assets from failed Midwest banks, and will occupy seven floors of
an 11-story building. The office space being leased is well over 100,000
square feet and will employ approximately 500 temporary employees and
contractors.
Does the FDIC
know something we don’t? We can’t say for sure, but the fact is
that the agency has already opened similar offices in Irvine, California, and
Jacksonville, Florida. Each time, the number of bank failures in
those states spiked dramatically after the FDIC set up shop.
Elsewhere,
consumer confidence is flagging and, since the economy is 75%
consumer-driven, that doesn’t bode well. The Conference Board’s
index took a swan dive in February, to its lowest point since last April. The
index plunged to 46 from January’s reading of 56.5, stifling the
previous three months’ uptrend. As a measure of how bleak the public
mood is, the economy is considered stable only when the consumer confidence
reading exceeds 90. We’re barely halfway there.
And finally, we
don’t want to lose sight of the 800-pound gorilla in the room, the
federal debt. How bad is it? Well, the Bank for International Settlements
recently released a very frightening figure. In order just stabilize debt
at pre-crisis levels, the BIS says the U.S. government must run a budget surplus
of 4.3% of GDP. Every year. For ten years.
For an in-depth
look, try Harvard economist Kenneth Rogoff’s new book, This Time is
Different: Eight Centuries of Financial Folly (co-authored with Carmen
Reinhart of the University of Maryland), the first comprehensive survey of
past financial crises around the world.
Dr. Rogoff, who
may be the country’s leading expert on the historical record, concludes
that a banking crisis often leads a country into default, because
government’s response is usually to try to prop up the financial system
with yet more debt.
If that sounds
familiar and disconcerting, it should. Even more so because Rogoff has
identified a clear tipping point, beyond which there is little hope of
recovery. When a government’s debt grows to equal annual GDP, the game
is essentially over.
Where we are now:
We have $12.5 trillion in gross debt, growing at $2 trillion per year, on a
GDP of $14.3 trillion. Next year, it will be $12.5T + $2T = $14.5 trillion on
a projected $14.5T of GDP. Or 100%. A level we cannot survive for long.
That means
it’s likely, in the not-too-distant-future, that the government will be
confronted with a very stark choice between defaulting on the debt or trying
to inflate its way out. The former would kill off economic growth and likely
launch a worldwide depression of epic proportions.
Disastrous as
that would be, if the alternative is chosen and Washington’s printing
presses beget hyperinflation, that would probably be worse. In a serious
deflation, those who have saved for a rainy day can make it through okay. In
hyperinflation, which unconstrained further spending could easily bring on, everyone
loses.
The truly prudent
prepare, as best they can, for either eventuality.
How to prepare
for the worsening crisis… how best to diversify your portfolio and protect
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Doug Hornig
Senior
Editor, Casey Research
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