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Market Comment

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Less Bad is not Good Enough

Fri, Jun 5 2009, 06:56 GMT
by Comstock Partners Team

Comstock Partners Inc.

Survival is not Recovery

Although the pace of economic decline has slowed, the economy is still falling-and merely "less bad" is not good enough to justify the robust stock market rally of the last few months. When the massive fiscal and monetary stimulus started last fall, we stated in our comments that the program would probably prevent a systemic collapse of the global financial and economic system, but would not prevent a long and deep recession. In our view that is turning out to be the case.

While the fiscal and monetary stimulus is on a scale never before seen, it is likely to be offset by the debt deleveraging of consumers, the still deteriorating housing situation and credit problems in non-housing areas.
Consumers are still up to their eyeballs in debt at the same time that unemployment is rising, wages are stagnating, net worth has plunged and mortgage equity withdrawals have dwindled away to nothing from an annualized rate of $1.1 trillion.

During the boom years consumers cut their savings rate to zero and used the increase in stocks and houses to fund their lavish spending habits. With those sources of funds no longer available consumers have cut back spending and lifted their savings rate to 5.8%. In the period ahead it is probable that households will keep increasing their savings rate to a more normal 10% by keeping their spending mostly confined to essentials and a generally less lavish living style. While this is advantageous for the economy on a long-term basis, it is negative for the economy in the period ahead. Although consumer confidence has increased from extremely low levels, consumer spending is still declining. Since consumer spending still accounts for about 70% of GDP, continued restraint will also reduce production, employment, incomes and capital expenditures.

Adding to the problems, we think it's unlikely that the housing slump is over. Inventories of homes for sale are still rising while a third wave of foreclosures is now underway-this time in prime mortgages. Nationwide, 12% of first mortgages are overdue including 5.7% in prime and 49% in subprime. Typically, a high percentage of overdue mortgages end up in foreclosure within a few months. In addition as we pointed out in last week's comment the ratio of median family income to home prices is still substantially above the long-term average. This means that housing prices will continue to decline.   Thelatest Case/Shiller numbers show that home prices have declined 19%year-over-year and 32% from the peak. This will put more homeownersunder water on their houses and add to current inventories.   Wealso note that official inventory numbers are probably understated as aresult of both banks and individual homeowners temporarily keepinghomes off the market.

Thereare other important credit problems as well in credit cards, autoloans, home equity loans, other consumer loans and commercial realestate loans.   Together with continued distressfor housing, these problems will lead to further write-offs for bankloans and a continuing reluctance to lend.

Published on  Fri, Jun 5 2009, 09:18 GMT