How Bad Can It Get?

The stock market is down and continues to fall almost every day. As of March 7, 2008 the DJIA is down 10.3% for the year, the NASDAQ is down 16.6%, the S&P 500 is down 11.9% and the Russell 2000 is down 13.8%. Most investors are looking at their portfolios and quite unhappy. The initial problems with the mortgage market started this tumble. Will it continue to get worse and is it spilling over into other parts of the U.S. economy. So how bad can it get?

We are in a Recession

First of all, we are in a recession. Yes, we need to wait for the National Board of Economic Research (NBER) to opine on whether we have two consecutive quarters of decline in the Gross Domestic Product (GDP), but that will not happen for up to a year after the fact. Here are some of the economic factors that lead me to this conclusion:

1. The jobs outlook is deteriorating. For February the government reported that the economy lost 63,000 jobs. Actually, the private sector lost 101,000, meaning that government hiring continues to increase. Due to the way the government counts the impact of births and deaths, this factor supposedly added 135,000 new jobs. This bit of statistical chicanery probably means that the real loss in jobs was probably much larger. Moreover, the unemployment rate fell slightly to 4.8% from 4.9% due to a sharp contraction in the total number of people looking for work. This is not a good sign.

Generally, employment is a lagging indicator and is is highly unusual to see two months in a row of job losses and not experience a recession. Yes, that is right, jobs fell in January as well.

2. The U.S. dollar hit new lows against the basket of nineteen currencies, trading as low as 72.46. The dollar’s weakness is one of the reasons we are seeing the price of most commodities climb higher, since it takes more dollars to buy such commodities as oil. A falling dollar is considered good for any companies that export from the U.S. as their goods and services are less expensive each time the U.S. Dollar falls. On the other hand, a falling U.S. dollar depreciates the value of the U.S. government, so investors and countries that are holding this debt may sell part of their holdings to find higher returns. If this happens it tends to raise interest rates on this debt, which can cause the U.S. to experience higher inflation and raises the cost of our own debt. The best scenario is stability in the U.S. dollar which allows investors to have more confidence in their holdings.
3. Oil is trading around $105 a barrel. As mentioned part of this high price is due to the falling U.S. Dollar, as oil is priced in that currency. Part is due to concern that Venezuela, Ecuador and Columbia will escalate the current saber rattling and actually go to war. It looks like this risk is now over as the presidents of the countries involved have backed away from their threats and now seem to want to avoid further confrontation. But such is the story of oil. There seems to be new problems poking its head up all over the world when there are large reservoirs of oil.

And part of the higher price in oil is due to speculators buying on expectation of higher prices.  Opis Speaking of Oil by Tom Kloza provided this insight. The following is from the government report (published weekly by the Commodities Futures Trading Commission or CFTC).

The CFTC refers to speculators as non-commercial entities -- there is about $24-billion more money bet on higher crude oil, gasoline, and heating oil prices than is wagered on a lower price outcome. The typical large speculator that has bet on higher crude prices holds a position of 3,000 futures contracts, or a nice tidy clean number of 3-million bbl worth of WTI or more than $300-million worth of crude! 

There are 99 of companies that comprise this group. And as Tom said, “In the casino business, they would be known as whales.” The whales can and do move the market. Then they move on to the next thing that interests them and the market gets back to normal.

We will see when and if the price of oil falls as predicted by T. Boone Pickens.

4. The index of Leading Economic Indicators (LEI) continues to plunge, and is not far away from levels last seen in 2001. Such a drop by the LEI has always been accompanied by a recession. U.S. leading index decreased 0.1 percent which is the fourth straight month of declines.
5. Personal income for the average U.S. consumer rose by the same amount as inflation, around 0.4%, and with rising energy and food costs, it is no wonder that retail sales are down and falling. The savings rate is still negative, which means consumers are using savings to maintain their consumption.

If this doesn’t convince you then the world’s richest man, Warren Buffett recently said that any reasonable person believes the U.S. is in a recession.