Finance To You

Recovery around the corner ?

Real GDP contacts in 2009 with a forecast of negative 6.5% and both consumer and business spending being slowed down considerably, combined with a sharp pull back in trade flows and reduced productivity. Though there has been some positive news with unprecedented government spending worth mentioning. Figures for the first quarter shows some respite and forecast some recovery momentum in days to come. The mix of fiscal and monetary policy coupled with market comeback will help the economy to stability be the end of fiscal year 2009.

Predicting the financial market Crisis:

There is no doubt that there has been a phenomenal up gradation in coding and decoding of the financial information in the last couple of decades. As a result, we have been able to understand and quantify risk (to some extent). This was a breather to the market analyst as they thought it would be their days to price stocks evenly, based on risk analysis. The interrelationship of all the complex financial markets is convoluted even for the best brains. There are so many activitie and changes taking place that even the regulators have no clue which ends to tie.

Though-out the history, financial market are notoriously poor in spotting the most evident financial crisis. Be it in 1994 for Mexico or 1997 for Thailand or stock market crash of 1987. Models are built with all sorts of complex algorithm to make them real life simulators but it seems that there is a missing component that is yet to be adjusted. There crisis are events triggered by a pool of events and it’s a complex equation with larger number of variables like economic, political and psychological factors. As a result the outcome is far from satisfaction. These models are based on historical data and do justify them well, but when it comes to future they have no clue how to set the variables and degree of changes that would be experienced. Well, not to discount the credit of hard work in designing these complex models, if followed well, they can at least be a good broad indicator of any such events. These early warning systems are a way to start and contain significant information and can be used to produce the probability of crisis.

What is expected in 2009?

Developed economy is expected to slow down considerably
Emerging markets are expected to outperform the advanced economy though the growth rate may be slower than earlier years
There is a less likeliness of inflation in this economy due to lower production and decreased commodity prices.
There has been unprecedented support from all the government agencies to arrest these recessionary factors and to bring economy on tract.
US have lower imports from China in the last four quarters and the overall exports for china have decreased.
There is more than a trillion dollar stimulus package from Obama administration.
Lowered fed fund rates is helping the economy to ensure lower cost of capital and easing credit ease.
Unemployment numbers still look dismal, with more than 8.5% jobless claims.
Government bailout does not seem to help the ailing auto industry, it needs a shook up and would expect some giant companies file bankruptcy.
Expected recovery is by the November and December.

Economic Outlook 2009

There is no doubt that we are in recession and so then next big question is how long we will be in this state and when do we see dawn after this darker moments. During this period we have experienced dramatic slowdown in economic activity, higher than expected jobless claims, and constant higher volatility. At the core of this resilient economy lies the ailing housing market. Given these low mortgage rates and high housing affordability, housing demand has strengthened a bit in recent months. Conventional mortgage applications both for refinancing and for home purchases increased. Since the end of February, applications for home purchases are up about 22 percent and for refinancing up nearly 129 percent, according to the MBA. So we can expect some turnaround if we believe the numbers.

Recent unemployment data show that nonfarm jobs have declined for 14 months in a row and the unemployment rate rose from 8.1 to 8.5 percent, as reported by the Bureau of Labor Statistics of the U.S. Department of Labor. Some 3.6 million jobs have been lost. With respect to wealth, the combined impact of falling equity and household prices has been staggering. Household wealth has declined by an estimated $10 trillion. Negative factors far out-weight the boost of economic spending from the sharp decline in energy prices and government stimulus.

In the first half of 2009, economic growth seems to contract as inventory of unsold goods has piled up, and it's going to take a while to work down the excess supply. GDP for the calendar year will contract by 2.3%[1] as conditions may improve later in the year, thanks to the government's stimulus package and Treasury's efforts to end the banking crisis, not to mention the Federal Reserve's massive pumping of liquidity into the financial markets. There are some hopeful signs that consumer spending is leveling off after a big decline during the second half of last year. At some point, consumer confidence will begin to turn around, and consumer spending will start to rebound. But the gains will be very modest this year.

The Federal Reserve is taking extraordinary measures to restore lending to consumers and businesses. Its latest action is to announce that it will buy up to $300 billion in longer-term Treasuries and up to $750 billion in mortgage backed debt from Fannie Mae and other federal agencies[2]. It signifies a reversal from the Fed's traditional long-term policymaking view toward a shorter-term strategy of fighting a deepening recession amid a growing danger that a deflation mentality will take hold. The unusual actions are needed because the Fed has cut about all it can, with the federal funds rate, the rate that banks charge each other on overnight loans, at a range of zero to 0.25%. The Fed will hold the fed funds rate there for the rest of this year.

Low rates by themselves aren't having much impact because the big problem in credit markets isn't the cost of borrowing but the desire and ability to borrow and lend. Banks are seeing many companies with falling sales and profits, and consumers who aren't spending because they fear losing their jobs as the recession drags on. Banks are wary of making fresh loans, and this isn't a climate in which banks compete for making loans by lowering their prime rate, which stands at 3.25% and likely will remain there for the rest of this year.

Personal income and spending will play an important role in the timing and rate of recovery in the economy. Recently, on the back of a sober outlook for the labor market, growth in personal disposable income and spending has slumped to nearly flat levels.[3] However, the personal consumption expenditures price index is showing signs of stabilizing, though still at a much lower rate than seen just last summer. With the PCE inflation rate at 1% for the year through this past February, and core PCE actually advancing at 1.8% in February versus 1.7% for January, the pricing trend appears to be forming a bottom.[4] (Release of March data expected April 30, may update given time)

Somehow even less predictable than the markets, the government’s response to the recession remains a primary concern going forward. With recent developments involving an unparalleled government spending bill, and assertions from President Obama that the administration will continue to have an active role in guiding the economy back from the brink, considerations for future government actions must be made. Yet to be fully defined, we are at least privy to the general intentions of the administration. These efforts will include steps to stabilize the housing market, jumpstart securitization markets for auto, student and small business loans, clean up bank balance sheets by creating markets for legacy assets, and provide banks with a capital cushion to withstand a more severe economic downturn.[5]

Indicating a special interest in the future viability of banks, the administration has undertaken what have come to be known as the “stress tests.” Currently being conducted on the country’s 19 largest banks, the tests are intended to determine whether certain banks will need more capital to continue lending if the recession intensifies over the next two years. It is expected that regulators will direct several banks to raise additional capital once the tests are completed by the end of April. Officials have indicated that public money will be invested in banks unable to raise capital through private investors. One issue we are mindful of is the fact that the tests could be undermined by public perception of the results. Instead of building confidence in the banking system as intended, the results may portray some institutions as very healthy while others as very weak, precipitating an investor run on certain banks.

Given these factors we remain confident that our previous forecast of an economic turnaround in September of 2009 is correct. Building off of that we see the markets beginning their recovery in the second quarter of this year, with more stable growth returning as early as June. Unemployment by the end of 2009 will remain slightly higher than originally forecasted, at 6.5%, but will be trending down. With inflation retaining its capacity to bubble up at any point over the next several years, The Federal Reserve will seek to increase the target rate gradually as inflation and spending trends reveal themselves. We maintain our expectation that by the end of 2009 the S&P 500 will have risen to 1200 from current levels, with small-cap stocks, energy, and financials being the strongest performing sectors of the U.S. economy in 2009.

[1] http://www.bea.gov/national/index.htm#gdp

[2] http://www.federalreserve.gov/newsevents/press/monetary/20090318a.htm

[3]http://bea.gov/newsreleases/national/pi/2009/txt/pi0209.txt, Bureau of Economic Analysis, Personal Income and Outlays: February 2009.

[4] http://bea.gov/newsreleases/national/pi/2009/txt/pi0209.txt, Bureau of Economic Analysis, Personal Income and Outlays: February 2009

[5] http://online.wsj.com/article/SB123932365076007259.html, Economic Meeting Sets Stage for More Aggressive Action, The Wall Street Journal, April 9, 2009.