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Is The Economy Turning The Corner?

Posted by Larry Doyle on April 21, 2009 7:05 AM |

Markets correct by price (both up and down) and time (extended). Despite the 3+% price declines in equity markets yesterday, the markets are up approximately 20% since the market lows seen on March 6th. Some analysts believe this upward move signals an improvement in the economy largely due to the fiscal and monetary stimulus provided by Uncle Sam. I am not in that camp.

A few emerging economies, specifically China, have improved. Can the rest of the world, including the U.S., expect those economies to be the engine for a global turnaround at this juncture? I do not think so. I still see the following issues on our domestic horizon:

1. continued deterioration in loan performance on bank books

2. a banking system woefully capital deficient

3. an automotive industry which must downsize

4. municipalities which are faced with the predicamant of capital shortfalls and underfunded pensions

5. commercial real estate just starting to experience real defaults

6. a housing market with increased foreclosures pressuring prices

7. an unemployment rate clearly headed toward double digits

Earnings reports for the first quarter have been mixed. I view the recently reported bank earnings as largely “managed” via accounting gimmicks. Meredith Whitney believes the earnings for major money center banks will turn negative in the 2nd quarter. The regional banks, without the benefit of large capital market activities but facing credit writedowns, report earnings today. Key Corp just reported a loss of $1.09 eps (earnings per share) versus an estimate of -.21. I suspect we will see losses from other regional banks of a similar magnitude.

Let’s look behind the curtain of the Leading Economic Indicators report released yesterday. Bloomberg highlights U.S. Economy: Leading Index Shows Extended Recession. This report is comprised of 10 factors. The report came in yesterday at -.3. That number in and of itself does not portend a disastrous economy, but it certainly does not predict the economy is turning the corner anytime soon. Let’s look closer:

The index of U.S. leading economic indicators fell more than forecast in March, signaling what may be the longest recession in the postwar era will extend into the second half of the year.

The Conference Board’s gauge, which points to the direction of the economy over the next three to six months, fell 0.3 percent after a 0.2 percent drop in February. The gauge hasn’t risen since June.

Rising unemployment and tight credit mean recent gains in consumer spending, the biggest part of the economy, will probably not be sustained. Stocks dropped as a report by Bank of America Corp. raised concern Americans will keep falling behind on loan payments.

“There’s no reason to think that this recession is going to end any time this spring or this summer,” Ken Goldstein, an economist at the New York-based Conference Board, said in an interview with Bloomberg Television. While “there is at least a little bit of a hint that the intensity may begin to back off over the next few months” the recession is “going to be a long slog,” he said

Some analysts believe the pace of decline is slowing, which is reason to enter the market. However, that poses the risk that losses not yet recognized will not impact future earnings. I view the market as overpriced at current levels.

Bloomberg further reveals:

Six of the 10 measures in today’s report subtracted from the index, led by a plunge in building permits and declining stock prices. Faster vendor performance — signaling a decrease in order backlogs — a decline in factory hours, rising jobless claims and a drop in bookings for capital goods also contributed to the drop.

“We are looking for a recovery that is significantly less robust than what is typically seen after deep recessions,” said Dean Maki, co-head of U.S. economic research at Barclays Capital Inc. in New York.

Thus, even if the market does not further decline in price, based on the information provided in this report, at best the market will run in place or trade in a range.

The few positives amidst the leading economic index targeted growth in the money supply, improved consumer confidence, and the shape of the yield curve (a steeper curve is typically a harbinger of an improving economy).

However, I view the growth in the money supply due largely to increased purchases of government and mortgage securities as a concern of future inflation. The yield curve has steepened due to the overwhelming fiscal deficit.

I still see a prolonged period of economic underperformance and little reason to be constructive on equities at this juncture. Turning the economy around is going to take a long time. Time, Why You Punish Me?


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