Weekly Economic and Financial Commentary

Poor Momentum Going into 2009

Mon, Feb 2 2009, 06:56 GMT
by Wachovia Research Team - Wells Fargo Investments, LLC | View company's profile

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U.S. Review

Poor Momentum Going into 2009

U.S. real GDP declined at an annualized rate of 3.8 percent in the fourth quarter. Although the decline was the largest contraction since the first quarter of 1982, it was not nearly as bad as the 5.5 percent plunge the consensus expected. The real surprise was the unexpected increase in real inventories, which rose $6.2 billion in the fourth quarter following a $30 billion drawdown in the third quarter. Inventories made a positive contribution to GDP growth equal to 1.3 percentage points in the fourth quarter. Consumer spending plunged at a 3.5 percent pace in the quarter as spending on big-ticket items like motor vehicles and home electronics plummeted. Businesses also cut back on new plant and equipment outlays. Within fixed investment spending, purchases of equipment and software plunged nearly 28 percent -- the sharpest quarterly decline in fifty years. As if to rub salt in the wound, gross exports plunged nearly 20 percent, a by-product of recession in most foreign countries. However, gross imports also tanked (down nearly 16 percent), so there was little overall effect on GDP from net exports.

Economic Weakness Has Carried Over Into The First Part of 2009

Nominal GDP essentially reflects revenue growth for the overall economy. The shortfall in nominal GDP matches up with the top line revenue figures reported by many major corporations and helps explain why so many firms have been slashing payrolls. Businesses simply do not have the money coming in to continue operating the way they were previously.

Layoff announcements moved to the forefront once again this week, as a number of firms including Caterpillar, Home Depot, Pfizer and Starbucks announced cutbacks this week. Most were made in conjunction with earnings of merger announcements and in some cases the cutbacks were simply rehashing or enlarging previously announced moves. Earnings have largely come in on the low side of expectations and many firms have reduced expectations or stated that they had less visibility of future sales and earnings trends.

Economic weakness has clearly carried over into the first part of 2009. Weekly first-time claims for unemployment insurance rose an additional 3,000 in the latest week, bringing the figure up to 588,000. The small increase confirms last week’s larger bounce back and removes any doubts that earlier reported declines in unemployment claims simply reflected holiday timing distortions.

Consumer Confidence also weakened in January. There was some hope that the inauguration of President Obama might generate a slight bump. Instead, the overall figures fell 0.3 points to a record low 37.7, as consumers continue to express worries about the current state of the economy. The employment component of the series actually improved slightly, with the proportion of consumers expressing optimism about employment prospects rising 0.7 percentage points to 7.2 percent and those stating that “jobs are hard to get” falling 0.4 percentage points to 41.1 percent.

Despite the improvement, the employment component of the Consumer Confidence Index remains consistent with a further increase in the unemployment rate. Our forecast calls for the jobless rate to rise 0.3 percentage points to 7.5 percent. We expect nonfarm employment fell by another 575,000 jobs in January, continuing the carnage seen in the fourth quarter.

Another key report out this week showed new home sales plummeting 14.7 percent to a paltry 331,000 unit rate. That is the lowest sales figure for the series, which dates back to 1963. One possible contributing factor is that many potential first-time homebuyers are awaiting the more favorable incentives that are included in the economic stimulus package.

Global Review

Deep Recession in Japan

Data released this week suggest that the Japanese economy, which had already contracted in the previous two quarters, fell off a cliff in the fourth quarter. It seems likely that Japan is mired in its deepest recession since the end of the Second World War.

Industrial production, which had dropped 8.5 percent in November relative to the previous month, fell another 9.6 percent in December. On a year-over-year basis, IP plunged more than 20 percent in December, surpassing the previous record decline of 18 percent set during the deep recession that followed the first oil price shock in the mid-1970s.

Net exports have been an important driver of Japanese economic growth over the past few years, and Japan is clearly feeling the effects of the global downturn. As shown in the top chart on page 4, the volume of Japanese exports nosedived by roughly 25 percent in December. Japan is an important supplier of capital goods to other Asian countries, and data show that Japanese exports to its Asian trading partners have cratered in recent months. Little wonder that Japanese industrial production has imploded.

But there are other factors as well behind the downturn in Japan. The value of retail sales fell 1.4 percent in the fourth quarter relative to the previous quarter. With inflation near zero percent in Japan, the drop in the value of retail sales probably translates into an outright decline in real consumer spending in the fourth quarter. And with the unemployment rate up sharply in recent months–- it jumped from 3.7 percent in October to 4.4 percent in December –- a near-term turnaround in consumer spending does not seem credible. In addition, survey data suggest that businesses plan deep cuts in fixed investment spending. The 28 percent drop in “core” machinery orders since last summer shows that the downturn in capital spending is well underway.

Unfortunately, the ability of Japanese policymakers to stimulate the economy is rather limited. The Bank of Japan has cut its policy rate to only 10 bps, and massive fiscal stimulus is constrained by the government debt-to-GDP ratio that has risen to 170 percent, the highest ratio by far in the developed world. Therefore, Japan will need the engine of stronger growth in the rest of the world to pull its own economy up. It may be waiting quite a while.

So if the Japanese economy is on its knees and its outlook is grim why is the yen so strong? (See middle chart.) For starters, Japan has a large current account surplus (see bottom chart). That is, Japan is a net lender to the rest of the world. When investors turn risk averse, as they have done over the past year or so, international capital flows tend to weaken. Countries with current account surpluses naturally feel upward pressure on their currencies.

Astute readers will note that China also has a large current account surplus, yet its currency has been stable versus the dollar since last summer. The difference between China and Japan is that policymakers in the former intervene in the foreign exchange market to keep their currency stable. In contrast, Japanese officials generally allow their currency to fluctuate freely. Until risk aversion subsides, the yen likely will remain strong.

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Published On Tue, Feb 10 2009, 13:28 GMT

About this Report

Wells Fargo Investments, LLC

https://www.wellsfargo.com/

sam.bullard@wachovia.com

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The Moderate Economic Recovery is Still Underway
Fri, Feb 10 2012, 19:23 GMT
Off to a Good Start for the Year in US; Europe Agrees on Fiscal Pact; Manufacturing Improves
Fri, Feb 3 2012, 20:08 GMT
Less Strength Than Meets The Eye
Mon, Jan 30 2012, 05:24 GMT
Good News on Manufacturing, Inflation and Housing
Fri, Jan 20 2012, 20:12 GMT
Week Two Brings a Little Less Enthusiasm
Mon, Jan 16 2012, 06:17 GMT

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The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. 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