As the markets are on a bullish trend these days, many people are asking (again) whether the economy is back on track. Markets observers are pointing to positive news on the economic front: U.S. consumer spending, consumer sentiment, housing sales and durable goods are all showing encouraging signs and unemployment claims have stop climbing. But the glass is only half full as the data is so bad to begin with that a slowing in the pace of deterioration is hardly good news.
Here is the reality: U.S. Housing prices have not finished their descent. The fact that more houses are being sold is the result of lower prices. Quantity demanded went up with falling prices but the demand curve has not shifted up. The housing market is still pretty depressed. U.K. and European house prices are also declining as the recession there deepens and unemployment is rising. Ireland is particularly affected as it is expected that the economy will have shrunk by as much as 12 percent before the end of 2010 as a construction slump deepens and unemployment surges.
The demand for commodities worlwide is also still dropping. Many mining and resources companies are thus suspending indefinitively their investment projects after the price of commodities slumped significantly between September and April. The recent resurgence in prices means nothing and is only normal after such a deep tumble. In a particular bearish news, Potash said at the end of May that it will further decrease output by 400,000 metric tons due to weak demand. True, eventually this is going to alleviate negative price pressure. But not yet!
All this should not be a suprise to anyone as the motor of economic growth during the last decade is choking. Asian economies contracted at an unprecedented pace last quarter as exports fell and consumers and businesses cut spending. Yes, Singapore’s economy shrank less than expected last quarter but the nation is struggling with its worst recession in its 44-year history. South America, in particular Mexico, has also fallen on hard times and the recovery will be long and painful. Eastern Europe is at the brink of a depression.
On the bond side, Chairman Alan Greenspan warned in late May that the financial crisis is not over and argued that American banks must still raise significant capital. Even Federal Reserve officials, who are recognizing that there are some signs of “stabilization” in the U.S. economy, are not convinced those improvements will persist. Remember that last month, after S&P cut the outlook on U.K.'s AAA bonds to “negative”, U.K. corporate bonds fell dramatically and the cost of hedging against losses on government debt jumped.
Finally, global corporate profits are not to going to improve any time soon. Companies are going to have to deal with very unfavorable and jittery credit markets for a while. Many corporations will also have to make significant pension contributions to address the deteriorating of their pension liabilities. In Europe, especially, while profits were above analysts’ estimates, earnings will likely continue falling further before they recover.
According to Desmond Lachman, Resident Fellow at the American Enterprise Institute "... it is all too natural to be looking ... for signs of green shoots that an economic recovery might have begun. However, rather than grasping at straws, US policymakers would do better to honestly ask themselves ... whether the policy measures taken to date (are) commensurate to the enormity of the challenges posed to the US economy by the most severe asset price and credit market busts since the 1930s? ... The difficult global economic background would also seem to heighten the urgency that US policymakers refrain from wishful thinking about an early bottom to our economy."
I could not agree more.