No “green shoots” in the jobs market

April 23, 2009 — Mitul Kotecha

 

Over recent weeks various officials have highlighted signs of stabilisation in economic conditions.  Indeed, economic data have been coming in less bad than feared. Nonetheless, one indicator is likely to take a considerably longer time than others to turnaround.  The jobs market is set to continue to deteriorate globally for many months after other economic indicators stabilise.  In the US the pace of lay offs has been dramatic, with 5.1 million jobs lost since December 2007 and 2/3 of these registered in the last five months alone.
 

The US unemployment rate currently at 8.5% is set to move to potentially as high as 10%, with the change in the rate from its cycle low already greater than any time since WW2.  The contraction in the economy points to much further job losses in the months ahead.  The good news is that a smaller pace of economic contraction ought to result in smaller declines in payrolls over the coming quarters and this implies a decline from the Q1 monthly average of 685,000 job losses.  Nonetheless, this doesn’t mean there will be a quick improvement either. 

 

There are several other implications of rising unemployment.  If the unemployment rate does reach 10% it would match the worst case scenario visualized in the Fed’s stress tests for US banks.  Rising unemployment would imply not only less consumer spending, but more loan defaults, more writedowns and more pressure on bank balance sheets.  Just look at the massive provisions that some US banks have built into their forecasts for the months ahead.  The likely slower pace of economic recovery compared to past recessions suggests that any improvement in the labour market will also be more gradual. 

 

Another dimension to the deterioration in the jobs market underway at present is the growing number of temporary and/or contract workers that are being layed off.  A broad US government definition estimates that such workers account for around 31% of the labour market.   If the losses in these jobs are accounted for the unemployment rate could be as high as 15.6% according to the US Bureau of Labour Statistics.   This suggests that the economic impact of rising job losses may be much more severe than predicted.

 

And finally the effect of rising unemployment on wage pressures should not be ignored.   Many employers are not only shedding staff but also cutting wages.  Moreover, a looser labour market in general plays negatively for wages as the demand for labour decreases.   Easing wage pressures is good for dampening inflation pressures but in the current environment it could fuel further fears about deflation, which in turn could be extremely negative for the economy. In the worst case scenario it could even end up as a 1990s Japanese scenario of a downward deflationary spiral which ultimately crippled the economy for a whole decade.   Let’s hope not.

Posted in Economics, Financial crisis, US. Tags: , , , , , , , , . 2 Comments »

Nervousness sets in

April 20, 2009 — Mitul Kotecha

Over recent days a number of banks including Citigroup, JP Morgan Chase, Goldman Sachs, and Wells Fargo and most recently BoA have revealed a return to profitability in Q1.   In Citigroup’s case it has been reported that earnings were helped by an accounting change that allowed it to post a one off gain of $2.5 billion.   However, it’s stock price was unlikely to have been helped by the announcement of a delay to the planned sale of a stake of 36% to the US authorities until the results of the bank stress tests are known. 

There is no doubt that US banks are being helped by strengthening mortgage demand due to low interest rates, improved liquidity in markets and the huge amounts of money that the government is pumping into banks.   High volatility has also helped boost trading revenues.   Nonetheless, uncertainty about the outlook in the months ahead continues to grow due to the risks from corporate loan defaults, a slide in the commercial real estate market and rising consumer loan delinquencies. 

This suggests it will be difficult for markets to get too bullish even if banks continue to report decent Q1 earnings.   Perhaps demonstrating this, even Citigroup’s better than expected earnings failed to prevent its shares falling on the day of its earnings announcement.   This was followed by a fall in BoA’s shares today in pre-market trading despite revealing that profits tripled in Q1.

Indeed, there are appears to be a degree of nervousness creeping back into markets, indicating that the improvement in risk appetite over recent weeks could be stalling as uncertainty about what lies ahead intensifies.  BoA’s increase in provisions for credit losses in Q1 highlights where this nervousness is coming from.   The results of US bank stress tests is the next hurdle for markets and if anything this could lead to more market tensions, especially if some of the banks are found to be requiring additional capital which looks increasingly likely to be the case.

Posted in bank rescue, Economics, equity markets, Financial crisis, US, US administration. Tags: , , , . Leave a Comment »

10 questions to ask…

April 14, 2009 — Mitul Kotecha

…before you return to the stockmarket.

Equity markets have undergone their biggest 5-week rally since the great depression but there are several questions that should be considered to determine whether the gains will last.

1) Why is the rally in equities broad based? On the face of it a broad based rally should come as good news but it also appears indiscriminate with investors rushing to buy any stocks regardless of the underlying factors. This suggests investors are jumping in without looking where they will land.

2) Why are financial stocks rebounding so strongly? Surely all the problems have not been resolved so quickly. Even if the removal of toxic assets are starting to gain traction markets are unlikely to have anticipated the likely problems coming from a new wave of credit card defaults, and comsumer and corporate loan delinquencies as economic conditions deteriorate and unemployment rises.

3) Have markets factored in the outcome of the results of the stress tests on US banks? These results will be known in about three weeks. Although no bank can fail the tests from a technical perspective, there is every chance that some will be found to be in bad shape and in need of more capital.

4) What effect will the impact of accounting changes have? The relaxation of industry accounting standards in the US mean that it will be difficult to gauge losses on a variety of debt. This could add to the uncertainty surrounding valuations rather than help to end it.

5) How will tensions between banks and the administration impact stocks? There appears to be growing tensions between the US administration and banks over repayment of bailout money and the speed at which banks are removing toxic assets from balance sheets. Many banks in the US are reluctant to announce further writedowns despite pressure to do so.

6) How long will positive data surprises continue? Clearly expectations for economic data had become overly bearish over recent months. Data releases have actually come in better than forecast recently as reality has not been as bad as expectations. This in turn, has helped give more fuel to the market rally. Once expectations become more realistic markets will find little support from positive data surprises.

7) Are markets full pricing in the depth and breadth of the recession? It appears that markets are looking at the current economic downturn as if it was the same as past cyclical downturns. This is unlikely to prove correct as economic conditions will not improve anywhere near as quickly as experienced in recent recessions. Moreover, the jobs market is likely to continue to worsen for many months to come. At best, economic recovery is unlikely until early 2010 and even this may be optimistic whilst any recovery is likely to be slow and mild relative to past recoveries.

8)How compelling are valuations? Although the price side of the P/E ratio has dropped sharply the earnings outlook continues to be negative. Analysts have forecast Q1 earnings to drop by around 37% but as the economy worsens and unemployment rises the earnings outlook could like quite bad for some time to come.

9) Are stocks rallying too quickly? Historically equity markets do not rally so rapidly following such a shock on the downside. Any rally is usually slower.

10) Are stocks rallying too early? Stocks rally around 5-6 months ahead of an upturn in economic conditions but as noted above any recovery in the economy is unlikely before early next year, which suggests the stock rally is premature.

Posted in bank rescue, Economics, equity markets, Financial crisis, US, US administration. Tags: , , , , , . 1 Comment »

Q1 earnings in focus

April 10, 2009 — Mitul Kotecha

Equity markets have continued their ascent albeit with continuing volatility around the Q1 earnings season. Other indicators of market stress have also improved whilst bond yields haved edged higher. Next week will test the markets optimism with a plethora of banks set to release their results for the past quarter. Wells Fargo provided a boost to financials today with its earnings report. Banks will benefit from the changes to mark to market accounting regulations allowing banks more flexibility in valuing their dodgy assets. Although I am somewhat concerned about the political push for the change in these accounting rules it will no doubt ease some of the pressure on banks and their estimates of writedowns.

Meanwhile the economic news continues to be less negative as the bigger than expected narrowing in the US trade deficit reveals. This adds to the run of better than expected numbers over recent weeks that is perhaps showing that the pace of economic deterioration globally is easing. The economic news has also contributed to the better tone to equities and improvement in risk appetite.

Action to prevent the economic and financial crisis from deepening is also creating a floor under markets. The Bank of England left interest rates unchanged but maintained its commitment to conduct asset purchases having done around 1/3 of the planned GBP 75 billion so far, with the remainder to be undertaken over the next couple of months. Elsewhere Japan will provide further fiscal stimulus to boost its flagging economy although the unstable political situation could yet derail such plans. Nonetheless, the picture is clear as policy makers continue their battle to boost sentiment and thaw credit markets.

If markets can get through Q1 earnings without a major set back there maybe hope that the rally really has got legs. I still think there is a whiff of a bear market rally going on but I would happy to be proved wrong.

Posted in Bond markets, central banks, Currencies, Economics, equity markets, Financial crisis, UK, US. Tags: , , , , , , . 1 Comment »
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