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How is the economy going to rebound when food and gas are so expensive and credit is so tight?

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April 04, 2008 – Comments (3)

There has been a lot of optimism in the stock market lately, which I obviously welcome as someone who rarely shorts things in real life and who is usually fully invested in some sector of the market.  However, I just can't shake this pessimistic feeling that I have about things.  I'm trying to figure out why I am so down on the economy right now.  Part of if might stem from the fact that I work in a field that is related to the auto industry and that my wife first worked for a now defunct mortgage company and currently works in the corporate office of a major real estate company.  These industries are in rough shape.  An analyst who I highly respect, Dr. Stephen Leeb is very bullish on things right now (Market Update) and the Federal Reserve has injected an unprecedented amount of liquidity into the system.  Still, I can't shake the feeling that we are going to re-test the lows in the market before things are all said in done.

Consumer spending is the engine that drives the U.S. economy.  We are a nation of consumers, not producers.   There are two things that I believe are going to have a major negative impact upon consumer spending.  They are banks tightening their lending standards and inflation. 

For a number of reasons that I have touched upon in past posts inflation is out of control right now, despite what the CPI says when the government reports it.  Food prices are skyrocketing and gas prices are at all time highs.  These are things that everyone has to buy and the more expensive they are, the less money people have to spend on other things.  See the links below for a few examples of what I am talking about.

Gas Sets Second Straight Record High

Rice Jumps to Record, Corn Near High as Demand Outpaces Supply

Corn Hits $6 a Bushel on Tight Supplies

In addition to being hammered by raging inflation, the credit crunch is preventing consumers from seeing the full impact of the dramatic rate cuts that the Federal Reserve has made over the past six months.  Despite the fact that the Fed has lowered its target rate to 2.25%, according to bankrate.com the average 30 year mortgage rate still sits at 5.81%.  This isn't high, but it is nowhere near as low as it would have been with this sort of Federal Funds rate in the past.  Not only are the real rates that consumers are able to get rates not dropping as quickly as they have in the past, but banks are becoming much more risk averse and selective about who they extend credit to.  Add in the fact that consumers cannot tap the equity that they have in their homes like they had been and these factors will have an adverse impact upon consumer spending as well.

Lenders Ease the Throttle on Car Loans

Late payments on consumer loans at 16-year high

Well, there are my optimistic thoughts for the morning.  Despite all of the enthusiasm in the markets right now, I personally can't shake the feeling that there is more pain to come.  I am just trying to figure out if I am being unnecessarily pessimistic or if this is the way things really are.

On tap for today is the March employment report.   It will be interesting to see what it looks like, even though I have said in the past that I am often skeptical of the numbers that the government reports.  Hopefully yesterday's rough jobless claims number isn't a harbinger of what it will look like.

Jobless Claims Highest Since Sept. 2005

Have a great weekend everyone,

Deej

3 Comments – Post Your Own

#1) On April 04, 2008 at 10:05 AM, TDRH (99.75) wrote:

Deej,

     IMHO the malaise you are sensing is a credit hangover.   Consumers have too much debt and servicing that debt is getting harder and harder, all the while the cost of living keeps rising.  Consumer spending represents between 70-75% of GNP, and they overextended their lifestyles by borrowing against the equity that they had in their largest asset, their homes. 

     Your family is in the middle of the storm and is probably being very conservative in its purchasing decisions.    I am not in as precarious a position, but the thing that makes me feel more confident and secure is to be debt free and semi liquid.   As asset prices (homes) fall I have heard many analysts say that there is the potential that they could overshoot the low, just as they overshoot the high and there will be significant buying opportunities in the future.    Do not listen to a real estate agent that says "you will not know the bottom until it is already back and running."   Those days are over with tighter lending standards and the decoupling of the fed rate and long term interest rates.   

Sorry to add to your sense of  darkness.

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#2) On April 04, 2008 at 10:26 AM, TMFDeej (99.45) wrote:

Thanks for cheering me up, TDRH :).  I do have a mortgage, but who on Earth could afford to buy a decent home here in the NY area without one.  Other than that my family is in pretty good shape.  We have significant savings both in a regular investment account and in IRAs / 401Ks as well as zero credit card debt, other than what we pay off every month.  I feel extremely sad for those who are being impacted by the current problems that the U.S. is experiencing, but I look at them as more of an investment opportunity than something that gets me down...as long as my wife and I still have jobs.  I still think that long term the dollar will continue to fall and inflation will be a major problem.  If so, one can profit by purchasing solid foreign companies, U.S. companies that export goods, oil plays, and ag plays.

Deej

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#3) On April 04, 2008 at 3:00 PM, nuf2bdangrus (< 20) wrote:

I have been a perennial bear who has been cyclycally suckered to give up my bearish picks on the rallies....a mistake I will make no more.  As a banker, I know what kind of loans we wrote, and we're a conservative bunch, the shadow banking system built around us was downright fraudulent.  By mistakingly using 'subprime" as the name of the crisis, we are missing the jist.  It is Alt A where the real trouble is....too many credit worthy speculators stuck holding the bag.I think the market is rising on relieve, technicals, and the expectation that the credit crisis is over.  Investing is about "trading the trader", something I am just learning..  But sentiment never trumps fundamentals in the long run, just as common sense knew that real estate couldn't appreciate at 15% per year for every, as neitehr could the NASDAQ, as both would be hyperinflationary.  And indeed, they both corrected...the difference being, as you note, that the real estate boom created consumption, which is unsustainable, and has to be serviced.  Servicing past consumption, coupled with higher core costs, and less available credit ( early talk about the massive layoffs to come in financials, as there is incredible oversupply) all will drastically reduce consumption.  It has to, unless we inflate, which we shouldn't.  I am also very suspicious of "meddling" in equitities by those who have huge stakes in maintaining a rich equity market, as we have had to have eitehr housing or equities high to keep the spending party on.  But I can tell you, that only lasts so long.  The Fed is in a great gamble of its time, to try to steady the slowdown of the assett deflation crash....

 

Honestly, look around you, consumers are stretched, delinquencies are rising, auto sales are slowing with "no end in sight".  The market believes that the resession will be mild, and that growth will return.  The wisest and quietest voices are saying we haven't yet come to grips with a cycle if abnormally high corporate earnings, which will correct.  When the expectations come down, it will be reflected in an adjustment to stock prices.  

 

Disclosure, I am heavily short....I don;t like to be, but I just believe the party was way to heavy and way too long.  The last 10 years have been assett bubbles, but organic income growth does not exixt the way it needs to in our economy.  When it corrects, I will go long outside of energy and gold. 

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