Comstock Partners, Inc.August 27, 2009
Economy Built on Quicksand
The widely hailed economic recovery is built on a foundation of quicksand. The impending rise in third quarter GDP is based on massive government spending, a slowdown in the inventory deceleration, the cash for clunkers program and some misleading housing numbers. At the same time the most important drivers of a sustained recovery such as robust consumer spending, rising real wages and a real housing recovery, the necessary drivers of an economic upturn, are all missing from the recipe.
Consumer spending, which accounts for 70% of GDP, is likely to remain in the doldrums for some time to come. With household debt still near record highs, deleveraging will be a feature of the economy for an extended period. Household savings rates that previously averaged about 9% of disposable income is still at a paltry 4.2% after falling to zero in the previous boom. Since household net worth has collapsed, the need to replenish savings will continue to suppress spending. At the same time payroll employment continues to decline, unemployment is rising, hours are being cut and large numbers of workers are being forced into part-time work when they prefer to work full-time. Moreover, since corprate revenues are still in a nose dive as evidenced by second quarter reports, corporations will continue to cut their labor costs, thereby reducing household income even further. Adding to the pressure, credit conditions are still tight and only the most financially secure consumers have access to loans. All of these factors mean that consumer spending and income will remain under pressure and prevent any true recovery from gaining momentum.
At the same time recent housing numbers are giving a misleading picture of strength in housing. July existing home sales were up 7.2%, but inventories of unsold homes rose by 7.3%. A recent national surevey of real estate agents indicated that only 36% of home sales were made to buyers not under stress. The remaining sales all invlolved either foreclosures, short sales by banks or by sellers not in default but in financial trouble as a result of unemployment, illness or family problems. In addition 30% of sales were to first-time home buyers taking advantage of the $8,000 tax credit that expires at the end of November. New home sales were also up in July, reaching an annualized 433,000 units. However, this compares to full-year numbers of 776,000 for 2007 and 485,000 for 2008. Remember, too, that annualized monthly new home sales peaked at about 1.4 million in 2007. Ominously, a wave of new forclosures is likely in the period ahead. A recent Deutche Bank study shows that 26% of all homes with a mortgage are worth less than the amount of the mortgage and that this will rise to 48% by the first quarter of 2011. This will lead to more foreclosures and lower prices as well as more bad loans on the books of financial instititutions that carry the loans. Adding to the negative picture, another wave of resets of adjustable rate mortgages will exacerbate the situation even further.
All in all the chances for a V-type recovery are exceedingly slim, and it is more likely that after a quarter or two of rising GDP, the economy will continue to sink into further recession. This would be typical economic behavior following a major credit crisis. After a 55% rise since the bottom, the stock market is discounting a far rosier scenario, and will probably be exceedingly disappointed as events unfold in the period ahead.