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  Posted on: Thursday, September 25, 2008
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Market Problems Far From Over

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Although earlier in the day there seemed to be an agreement in principle by Congressional leaders to pass a bailout plan, the agreement appears to be falling apart as we write.  Whatever happens, though, we believe we are in a severe bear market with major declines still ahead.  If the plan fails to pass within a reasonable time the results can be as disastrous as described by Secretary Paulson and Chairman Bernanke in their Congressional testimony.  But even if a bailout bill passes within the next week (which is still the probable outcome) the most it can accomplish is to prevent an imminent collapse of the global financial system and give us some breathing room.  While this is a worthwhile accomplishment, major financial and economic problems will still remain.  In particular, as detailed below, the economy has lately started to decline at a greater rate and is likely to remain in major recession until well into 2009.

The labor market is weakening significantly.  Employment was down 84,000 in August and down 600,000 for the year to date.  Unemployment reached 6.1%, the highest level in five years. Jobless claims for the week ended September 20 was up 32,000 to 493,000, the highest since early 2001.  While part of the latest rise was due to the hurricanes, the overall level is still high, and layoff announcements by corporations are accelerating rapidly.

New orders for durable goods in August were down 4.5% and were broad based throughout industry.  This reflects an inability of many businesses to borrow as well as widespread weakness in consumer spending. The results were confirmed by a sharp downturn in factory production and weakness in the various regional manufacturing surveys.  The downturn in new orders makes it likely that capital spending will also decline in the period ahead.  Industrial production was down 1.1% in August and is likely to weaken further as a result of tight credit, rising unemployment, a decline in capital spending plans and slower global growth.

The consumer remains in a precarious position, hit by the credit crisis, rising unemployment, lower wage growth, declining wealth and more restrictive consumer lending standards. August retail sales were down for the second straight month following the end of the rebate effect.  Chain store sales have declined for the last three weeks.  A leading retail group has forecast that sales for November and December will rise only 1.5%, the lowest gain since 1991. It is likely that consumer spending will decline in the third quarter.

The Conference Board index of leading indicators dropped 0.5% in August after a decline of 0.7% in July.  The index is at its lowest level in four years.  It is now off 3.7% from its peak, surpassing the peak-to-trough decline in the last recession.  We believe the index is pointing to continued downward pressure on the economy.

The housing industry also remains in weak shape.  August new home sales were off 11.5% for the month and 34.5% year-over-year.  New home sales have not been this low since 1990.  Inventories amount to a 10.9 months supply, up from 10.3 in July. New homes for sale now remain on the market for nine months compared to 5.7 months a year earlier.  Existing home sales have been bouncing within a relatively narrow range for the past few months.  Remember, however, that foreclosure sales account for a significant part of this market.  The weakened consumer condition will continue to impact housing in the period ahead.

We have long argued that the global economy has not decoupled from the U.S., and that appears to be confirmed.  The economies of Europe and Japan have turned down sharply and are rapidly slipping into recession.  The global PMI for August was below 50% for the first time in five years while EU auto sales have plunged to the lowest level in ten years.  The OECD recently declared that the UK was already in recession.  In Japan property values have once again stated to drop after five years of relative stability.

Despite the credit crisis and the economy, the stock market has still not capitulated.  From peak to trough the S&P 500 declined 28% as compared to an average of about 30% in postwar bear markets.  Since the credit problems first became evident the market has consistently been in a state of denial, always believing that the Fed would come to the rescue.  The downturns were always mitigated by expectation of a Fed bailout, and the successive bailouts, in turn, were greeted by vigorous rallies, although each rally topped out at a lower level than the previous one.  At the same time a large number of economists and strategists have denied that we are in a recession.  We believe the current bailout will not solve the underlying problems, and that the poor economic numbers coming out over the next few months will be so obvious that even the most rabid bulls will not be able to deny them. With the S&P 500 still at 21 times reported earnings (where estimates are dropping weekly), a major market decline seems to be in store.


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