The ponderous and sluggish wheels of government despite all the revisions and adjustments to economic statistics have finally been forced to admit that the U.S. economy has entered a recession and that it started in March 2001.
Manufacturing output has been falling for 15 consecutive months, the longest period in history and they failed to notice. Real earnings of corporate America have been falling for the past twelve months. It simply makes one wonder if the politicians and bureaucrats who reside inside the Washington Beltway have any clue as to what is happening in the real world. The odds are that the 4th Quarter earnings reports will be much worse than even the disaster of the 3rd quarter.
Politics has edged aside common sense. The economic stimulus packages proposed by either the House or Senate are full of pork barrel spending that will increase taxes or the deficit to finance. About the only reason for either approach is to be seen as doing something. With the War on Terrorism forcing spending to higher levels, has anyone sat down and said here are programs that must be cut to enable our country to maintain a surplus? Not hardly! By the time, the bickering stops and any bill is sent to President Bush for signature, it will be doubtful whether the economic stimulus will make the situation better. The delay in getting any stimulus package into the economy almost guarantees that it will not provide the effect envisioned.
Consumer spending is off slightly and the politicians are urging consumers to spend, spend, and spend. With consumer debt service at 22% of disposable income, how much higher do politicians think that consumers should go. When Wal-Mart used massive discounts to lure customers into their stores on the weekend after Thanksgiving, every one was certain that the consumer was going to make this Christmas season a bright spot. However, one Wal-Mart executive probably admitted the truth when he said, "We better get the consumer's dollars before someone else does." A look at the sales breakdown showed that low-end retailers fared significantly better than their high-end competitors.
In many areas, sales of pre-owned residential real estate are slowing significantly and prices are dropping. Despite low interest rates on mortgages (and even these are edging upwards), sales of homes over $250,000 are in trouble. Vacancy rates in commercial and office properties are rising and effective rental rates are under severe pressure. In the Dallas metropolitan area, over 8,000,000 sq ft of office & commercial space is available or about 24%. Yesterday, we heard of one property that was leased for three years with 18 months free rent and a free buildout. The owner had to have a certain percentage of his building leased by December 31, or the buildings loan would be called.
Apartment rental rates are also under pressure. The housing boom has been largely tied to the low-down buyer market for the past six months. If you want to really get scared, check out the past due loans at the government agencies that finance these homes. The defaults could make the Savings & Loan crisis look like nothing. Prices for residential real estate in California are 25% below last year's prices in many areas. The pressure on Freddie Mac must be enormous.
The Enron disaster appears about to become the largest bankruptcy in US financial history. Insiders have sold almost $100 million of stock in the last 15 months while refusing to allow the employees pension plan and 401(k) plans to sell any stock. The company is now stating that their previous earnings might be overstated by $500 million and that the liabilities might be understated by a substantial amount.
Playing in the derivative markets can hide profits and losses for even the most knowledgeable. Does anyone remember the century old English bank, Barclay's, that was destroyed by a small derivative player in Singapore just a few years ago. That should have been the tipoff but the derivative exposures of many financial institutions and corporations has increased exponentially since then.
Enron is a classic example of providing financial statements that are "forward-looking" or pro-forma. Less than six weeks ago, despite falling from almost $90 per share in August 2000, many Wall Street firms were touting Enron as an example of a great company.
The exposure of lenders in the Enron debacle, e.g., JP Morgan Chase, and Goldman Sachs among others, is huge. Moreover, the entire financial derivative mess could be triggered by the Enron disaster. If that happens, the Federal Reserve bailout of LTCM a couple of years ago will seem like nothing.
Enron's auditors, Anderson & Company, will probably only receive a minor slap on the wrist from the SEC for the audited reports that failed to disclose the Enron problems. But then, how many CPA firms and even Wall Street firms really understand the potential liabilities confronting their clients from the derivative markets?
I recently received the following quotation in an e-mail --- "much of the US economic data is now just propaganda" - - - and upon looking into the actual numbers and the hedonic adjustments and revisions that are issued almost routinely, one should be very careful about any month-to-month or year-to-year comparisons.
This is true with unemployment numbers, productivity numbers, capacity utilization numbers, personal income, gross disposable income, balance of trade numbers, M1, M2, M3, and the list goes on and on. The fog of economics is being purposely increased to hide the true facts of this economy.
While the stock market has increased significantly from the post 9-11 lows, the trend seems to be up despite the actual economic performance. If one decides to reenter the market, you should be aware that the 4th Quarter results for most companies will be worse than the dismal 3rd Quarter results. A market that is emotion driven can go in the opposite direction quickly.
While we have increase our equity exposure somewhat, we are maintaining very tight exit position strategies. When the current euphoria runs out, the drop in market values to more realistic levels for price/earning ratios could be substantial. Unlike some economists and market guru's, we do not seem a substantial recovery taking place in the second half of 2002.
Several factors could prevent a recovery from happening in 2002. The financial derivative disaster could spread. The disaster facing Argentina could impact upon many other Central and South American countries. If the Taliban and al Qa'ida are able to retain significant forces to wage guerrilla warfare or to execute additional terrorist strikes in the US, the market emotion could be changed.
The expansion of the terrorist war outside of Afghanistan to either Somalia, Syria, Palestine, Malaysia, the Philippines, Pakistan or Iraq brings additional risks and will require additional resources. Those resources can only be provided by increased taxation or increased debt. The Federal debt is already up against the national debt limit and President Bush will be required to ask for an increase within the next 90 days. We are already hearing about foreign companies and investment firms moving money out of the United States and into the Euro. The effect an increase in our federal debt coupled with the already huge increase in the money supply will have on our dollar is probably not positive.
As the extent of the unemployment problem in the US increases home foreclosures and the disaster of credit card delinquencies flows through the economy, the psyche of the American consumer to continue to spend will probably change to paying off debt and increasing savings. This change will reduce growth further and result in a further slowing of the recovery.
So take advantage of the current upward market momentum but be very careful because it could change quickly. And, of course, it might even turn into a depression, God forbid!
But then - 'Tis Only My Opinion!
Fred Richards
December 2001
Corruptisima republica plurimae leges. [The more corrupt a republic, the more laws.] -- Tacitus, Annals III 27
This issue of 'Tis Only My Opinion was copyrighted by Adrich
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Last updated - July 3, 2008