This week’s economic news pretty well sums up what we already knew, or at least suspected: the economy is in bad shape and no one is sure how much worse it may get or when it will recover. Continued uncertainty assures more volatility in the stock markets and, after the current rally fizzles out, perhaps new lows. Before we discuss the market though, let’s get through the economic numbers first:
GDP
On Thursday, Oct. 30, 2008, the Commerce Department reported that third-quarter gross domestic product (GDP) declined .3 percent. GDP measures the total production of all goods and services in the United States. The third-quarter decline marked the worst contraction for the economy since the same quarter in 2001 (fourth-quarter 2007 GDP was revised, after an initial report of an increase, to a slight contraction). On average, economists expected a GDP decline of .5 for the third-quarter 2008, so the actual number was better than expected.
Still, the economy is in decline, mostly due to weak consumer spending and a contraction in business equipment orders. Severe weakness in consumer spending contributed to a 2.25-percentage point deduction from GDP. So what made up the difference to make the drop only .3 percent? You guessed it, government spending. Federal government spending increased 13.8 percent. State and local government expenditures rose 1.4 percent.
Among the biggest factors in the recession is the decline in real estate prices. The more the value of homes drops, the less consumers will spend. In fact, according to a joint study by senior researchers at USC and UCLA, housing wealth has a significant impact on GDP. The study suggests that every 10 percent decline in national housing prices creates a 1 percentage point decline in GDP. What this means in the short-term is that we are probably going to see some wicked bad GDP numbers for fourth-quarter 2008 and first-quarter 2009. The stock market is probably not going to like that. Thus, take advantage of the current rally, because it is not likely to last, and what comes after may be worse than what we have already seen. If anyone is interested in more about the joint study, please click on this link to HousingWire.com.
Jobless Claims Unchanged, But More Reports of Job Cuts
In a weekly report from the Department of Labor, initial claims for jobless benefits held at the same level of 479,000. This figure remains well within territory typically associated with recessions, as if any of us need more confirmation that we’re in one.
On top of that report came an announcement from American Express that it is laying off 7,000 workers, or nearly 10 percent of its workforce as part of an effort to save $1.8 billion in 2009. Thus, as the credit crisis continues to creep into every part of the economy, credit card issuers are feeling the sting. Elsewhere, The Wall Street Journal, examines possible job losses in the wake of an expected merger between General Motors and Chrysler.
Someday, I hope to have good news to report. Unfortunately, for now, layoffs appear to be spreading throughout the economy. For more, please follow this link to a CNBC.com article.
Federal Reserve Cuts Rates
At an unscheduled meeting held on October 8, 2008, the members of the Federal Open Market Committee (FOMC) unanimously voted to lower the target for the federal funds rate by .50 percent. Then, at the FOMC’s regularly scheduled meeting on October 29, 2008, the committee members unanimously voted to lower the federal funds rate target by another .50 percent, for a total rate reduction for the month of October of 1 percent. The federal funds rate –the rate that banks charge each other for overnight and other short term loans –now stands at 1.00 percent. The discount rate –the rate at which banks in sound financial condition may borrow from the Federal Reserve Board’s discount window –simultaneously was decreased by the same amount to 1.25 percent.
In the statement accompanying the October 8 decrease, the Fed noted that the move was part of a coordinated effort by central banks of several countries to deal with the ongoing credit crisis in the financial industry. Joining in reducing their respective lending rates were the central banks of Canada, England, Europe, Sweden and Switzerland. The Fed’s statement cited evidence of an economic slowdown and concern that “the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit” as the driving forces behind the surprise rate cut. The Fed further noted that it would continue to monitor economic conditions and “act as needed to promote sustainable economic growth and price stability.”
The Fed’s statement following the October 29 decrease noted that economic activity had “slowed markedly, owing importantly to a decline in consumer expenditures.” The statement also pointed to weakness in business equipment spending, industrial production and foreign demand for U.S. exports as factors behind the economic decline. Further, the Fed noted that it expects inflation to remain in check due to the continued fall in commodities and energy prices.
This is the most honest assessment I have seen from the Fed in some time. I only wish the Fed had taken such a sobering view of the economy back in January.
Stock Market Update
Bespoke Investment Group LLC has compiled a price matrix for the S&P 500 that shows that the market is most likely fairly priced for lowered earnings expectations in 2009.
Even though we’re in the midst of earnings season, most investors really have no idea where earnings are going to be in the future. While the consensus forecast for 2009 is currently around $95, there probably isn’t a person on the planet who thinks earnings will be anywhere near that high. But how much further below $95 will earnings be, and what multiple do those earnings deserve?
With that in mind, we created a matrix to show where the S&P 500 would trade based on different combinations of earnings and multiples. Boxes highlighted in red indicate levels within 5% of where the S&P 500 is currently trading. As shown, if (and we realize there is really no chance of this happening) the consensus for 2009 EPS forecasts proves to be accurate, the S&P would currently be trading at about 10 times next year’s earnings.
So where are earnings likely to come in next year? One of the more bearish forecasts making the rounds is that earnings for the S&P 500 will come in at $60 per share next year. If that forecast proves to be accurate, that would bring the current multiple of the S&P 500 to about 15.5 times next year’s earnings. While a multiple of 15 is by no means extremely cheap on a historical basis, it is hardly expensive either.
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Gregg D. Killoren
victoria1014
Economic Roundup: Gross Domestic Product Drops; Unemployment Unchanged; Fed Reduces Rates
This week’s economic news pretty well sums up what we already knew, or at least suspected: the economy is in bad shape and no one is sure how much worse it may get or when it will recover. Continued uncertainty assures more volatility in the stock markets and, after the current rally fizzles out, perhaps new lows. Before we discuss the market though, let’s get through the economic numbers first:
GDP
On Thursday, Oct. 30, 2008, the Commerce Department reported that third-quarter gross domestic product (GDP) declined .3 percent. GDP measures the total production of all goods and services in the United States. The third-quarter decline marked the worst contraction for the economy since the same quarter in 2001 (fourth-quarter 2007 GDP was revised, after an initial report of an increase, to a slight contraction). On average, economists expected a GDP decline of .5 for the third-quarter 2008, so the actual number was better than expected.
Still, the economy is in decline, mostly due to weak consumer spending and a contraction in business equipment orders. Severe weakness in consumer spending contributed to a 2.25-percentage point deduction from GDP. So what made up the difference to make the drop only .3 percent? You guessed it, government spending. Federal government spending increased 13.8 percent. State and local government expenditures rose 1.4 percent.
Among the biggest factors in the recession is the decline in real estate prices. The more the value of homes drops, the less consumers will spend. In fact, according to a joint study by senior researchers at USC and UCLA, housing wealth has a significant impact on GDP. The study suggests that every 10 percent decline in national housing prices creates a 1 percentage point decline in GDP. What this means in the short-term is that we are probably going to see some wicked bad GDP numbers for fourth-quarter 2008 and first-quarter 2009. The stock market is probably not going to like that. Thus, take advantage of the current rally, because it is not likely to last, and what comes after may be worse than what we have already seen. If anyone is interested in more about the joint study, please click on this link to HousingWire.com.
Jobless Claims Unchanged, But More Reports of Job Cuts
In a weekly report from the Department of Labor, initial claims for jobless benefits held at the same level of 479,000. This figure remains well within territory typically associated with recessions, as if any of us need more confirmation that we’re in one.
On top of that report came an announcement from American Express that it is laying off 7,000 workers, or nearly 10 percent of its workforce as part of an effort to save $1.8 billion in 2009. Thus, as the credit crisis continues to creep into every part of the economy, credit card issuers are feeling the sting. Elsewhere, The Wall Street Journal, examines possible job losses in the wake of an expected merger between General Motors and Chrysler.
Someday, I hope to have good news to report. Unfortunately, for now, layoffs appear to be spreading throughout the economy. For more, please follow this link to a CNBC.com article.
Federal Reserve Cuts Rates
At an unscheduled meeting held on October 8, 2008, the members of the Federal Open Market Committee (FOMC) unanimously voted to lower the target for the federal funds rate by .50 percent. Then, at the FOMC’s regularly scheduled meeting on October 29, 2008, the committee members unanimously voted to lower the federal funds rate target by another .50 percent, for a total rate reduction for the month of October of 1 percent. The federal funds rate –the rate that banks charge each other for overnight and other short term loans –now stands at 1.00 percent. The discount rate –the rate at which banks in sound financial condition may borrow from the Federal Reserve Board’s discount window –simultaneously was decreased by the same amount to 1.25 percent.
In the statement accompanying the October 8 decrease, the Fed noted that the move was part of a coordinated effort by central banks of several countries to deal with the ongoing credit crisis in the financial industry. Joining in reducing their respective lending rates were the central banks of Canada, England, Europe, Sweden and Switzerland. The Fed’s statement cited evidence of an economic slowdown and concern that “the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit” as the driving forces behind the surprise rate cut. The Fed further noted that it would continue to monitor economic conditions and “act as needed to promote sustainable economic growth and price stability.”
The Fed’s statement following the October 29 decrease noted that economic activity had “slowed markedly, owing importantly to a decline in consumer expenditures.” The statement also pointed to weakness in business equipment spending, industrial production and foreign demand for U.S. exports as factors behind the economic decline. Further, the Fed noted that it expects inflation to remain in check due to the continued fall in commodities and energy prices.
This is the most honest assessment I have seen from the Fed in some time. I only wish the Fed had taken such a sobering view of the economy back in January.
Stock Market Update
Bespoke Investment Group LLC has compiled a price matrix for the S&P 500 that shows that the market is most likely fairly priced for lowered earnings expectations in 2009.
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