Under the cover of an exuberant stock market the real economy continues to scrape along the bottom despite unprecedented monetary and fiscal stimulation provided by the Fed and the administration. Today's release of September chain store sales is a case in point. A tiny year-over-year increase of 0.1% was widely hailed as a return of consumer spending despite the advent of easier comparisons with the prior year and a late Labor Day holiday that shifted some back-to-school spending into September. Since the economy began plunging about a year ago comparisons will be easier, although this does not indicate that sales are really strong.
Consumers will continue to struggle as a result of record debts, declining employment, lower real wages, flat-to-declining hours and tight credit. The National Retail Federation forecast that year-to-year holiday sales will drop by about 1% despite weak sales a year ago. Consumer credit outstanding dropped by $12 billion in August, despite the cash for clunkers program that was largely financed by credit. Consumer credit outstanding has now fallen for 11 of the last 12 months, and the year-to-year decline is the most in more than 60 years. We expect credit outstanding to continue to shrink in the period ahead as consumers act to restore their balance sheets and banks maintain restrictive lending policies.
Housing, too, is not out of the woods as current sales of new and existing homes are almost completely dependent on various government programs, some of which are due to end soon. The $8,000 tax credit for first-time home buyers expires on November 30th, although there is some pressure to extend it in some form. It is estimated that 40% of recent house sales were to first-time buyers, mostly induced by the credit. In addition two major programs have acted to keep mortgage rates low. The Treasury program to purchase $1.25 trillion of MBS is being wound down and ends on March 31st. The direct purchase of $300 billion of Treasury securities by the Fed is mostly complete, and, in any event, ends on October 31st. In addition the FHA, a big guarantor of mortgages with down payments of as low as 3.5%, has suffered from a slew of defaults that has brought its reserves down to a point where it threatens to go below its congressional limit. The agency may therefore be forced to cut back on its guarantees or seek a federal bailout.
Adding to housing's woes is the massive hidden inventory overhang that threatens to put continued pressure on home prices. A large number of potential foreclosures have been delayed, but are due to be processed in coming months. In addition another wave of foreclosures is likely in prime mortgages as a result of coming resets of adjustable rate and interest-only mortgages. A fact that is not well known is that 13.1% of all mortgages are either past due or in foreclosure.
Lack of credit is another key factor holding back the economy. Banks are still stuck with loads of toxic assets and are facing a potential crisis in commercial real estate loans. They are therefore holding back on new lending and attempting to repair their badly damaged balance sheets. Commercial and industrial loans have declined about 15% (not annualized) in the last six months. While large companies can get funding from the bond markets, small and medium sized business are largely dependent on bank credit, and are having a hard time getting loans. Since small to medium sized firms account for about 50% of employment, this has negative implications for the labor market as well.
The tight credit situation is reflected in the monetary figures as well. Despite all of the money poured into the economy by the Fed, M2 is down 2.2% annualized over the last three months and MZM is down 1.9%. More and more, this is looking like the classic case of "pushing on a string". Chairman Bernanke has been highly critical of the early 1930s Fed for letting the money supply shrink, and now it seems that he's having the same problem.
With all of the problems in the real economy, the market continues to soar. One reason is the belief by many investors that we are undergoing a typical post-war V-type recovery. However, as is evident by watching financial TV recently, there seems to be an equally large group that doesn't believe in the "V" recovery, but see no choice but to join the herd. In our view that is almost always an indication of an impending market top.
