The year progresses with more challenges ahead

March 15, 2010
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Last year it was the banks, this year it is countries. The economic crisis, which seemed to have eased off in the latter part of 2009, is once again simmering as the threat of sovereign default looms. The primary issue facing financial markets is the strength of the economic recovery as the year evolves. We see global economics growing moderately this year and corporations generating healthy revenue and earnings gains in 2010. While economic news should be better, it’s not clear how the financial markets will respond.

Major challenges for 2010 and beyond remain the concern about the size of the U.S. budget deficit and the accompanying implications for future income tax rates and inflation, even though the economy is still fighting off substantial deflationary pressures currently.

Our 2010 forecast for Real GDP is +2.2 percent. As the new year evolves, the economy is perking along. The data continues to indicate that the economy has moved from recession to recovery. We see a slow economic rebound unfolding in 2010 and, most likely, a stronger rebound will occur in many international markets, especially in developing markets.

With the stability in home prices as well as the floor in consumer confidence (despite the drop in February) and business confidence holding, the recovery is likely to be sustainable. However, there is no sign of a sharp recovery. The credit market has improved some, but small businesses are still facing tight credit.

The U.S. Consumer Confidence Index is an indicator designed to measure consumer confidence, which is defined as the degree of optimism on the state of the economy. The CCI was started in 1967 and is benchmarked to 1985 = 100. In simple terms, an increase in consumer confidence indicates economic growth in which consumers are spending money, translating into higher consumption. Decreasing consumer confidence implies slowing economic growth, and so consumers are likely to decrease their spending. Each month the Conference Board surveys 5,000 U.S. households.

The February Conference Board consumer confidence report was certainly disappointing at 46.0, but the measure of consumer confidence remained well above its recent low. The disappointing report most likely foreshadows a weak February employment report (especially with the February storms set to subtract roughly 100,000 from U.S. payrolls).

The employment picture has improved significantly compared to the large job cuts during 2009. Although the U.S. unemployment rate fell to 9.7 percent in January (the lowest level since August) from 10 percent the prior month, payrolls fell by 20,000. Employment will most likely be influenced by the February storms, which could subtract 100,000 from monthly payroll numbers. Unemployment has typically been a lagging indicator, though government could help boost employment in 2010 through Census hiring and additional “job bills.” The unemployment rate, which averaged 10 percent in the fourth quarter 2009, is projected by consensus estimates to run 9.8 percent by the fourth quarter of this year, and to be at a still high 8.9 percent by fourth quarter 2011.

We continue to see deterioration in the state of Michigan. The state held on to the highest unemployment rate in the nation during the month of December at 14.6 percent.

Housing rates rose +2.8 percent month-over-month in January to 519,000, continuing their sideways trend. The seasonally adjusted annual rate of previously occupied homes sold jumped 13.9 percent from the third quarter. The national median rose 2.9 percent. Distressed properties, either bank owned or those sold by homeowners who could not make their payments, accounted for 32 percent of all transactions in the fourth quarter, a decline of 37 percent from a year earlier. The surge in home sales was driven by buyers responding to the tax credits combined with record low mortgage rates. Given the continued declining inventory levels, housing conditions should improve.

The 30-year fixed rate mortgage fell 5 percent. Mortgage rates averaged 4.97 percent for the most recent week down from 5.16 percent a year ago. Fifteen-year fixed rate mortgages also fell, averaging 4.34 percent, down from 4.81 percent a year ago. The Mortgage Bankers Association reported that more than two out of three mortgage applications were for refinance transactions over the first six weeks of 2010 — a good sign as consumers deleverage.

In a surprise showing for a notoriously slow month, shoppers turned out in January, spending carefully but sufficiently to help retailers post solid sales gains. Retail sales were up a solid 0.5 percent in January 2010 from the previous month and 4.7 percent from January 2009. Shoppers, however, are still not spending freely as they continue to worry about their jobs, mortgages and credit.

For a sustainable recovery, corporations have to make capital expenditures and increase employment. Companies have defended their profits by cutting costs. The year 2009 went out with a bang. Let’s hope for no whimpers through 2010 and 2011.

Robert C. Boylen is a partner/portfolio manager with Norris, Perné & French LLP.

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