Corporate Earnings …
Why the Earnings Forecast Is Upbeat: With productivity skyrocketing and labor costs plunging, profits will post strong growth in coming quarters now (Oct 2009) that demand is beginning to turn up
It's earnings season, and as companies roll out their third-quarter 2009 reports, investors are sure to take a long, hard look at the results. Profits in the first and second quarters 2009, while down from the previous year (2008), managed to beat expectations, helping the Standard & Poor's 500-stock index to ascend more than 50% from its low point on Mar. 9 2009. Amid ongoing worries about the strength and sustainability of the recovery, which were heightened by the weaker-than-expected jobs report for September 2009, investors want to see if earnings will validate this year (2009)'s big market run-up.
The signs look good, and last month (Sept 2009)'s employment data are part of the reason. Through the third quarter 2009, businesses continued to slash labor costs at rates not usually seen even in past severe recessions. In fact, for the past six quarters (March 2009 – Aug 2009), companies have cut employees' overall hours worked by far more than they have pared output. The result: a striking 2.8% annual rate of growth in productivity, a rare pace during a recession. Productivity gains averaged only 0.8% annually during the previous nine downturns.
Of course, these are not long-run productivity gains: Businesses cannot slash and burn their way to prosperity. However, they can soften the recession's blow to their bottom lines and put themselves in a position to reap the benefits of the recovery as demand picks up. That's what's happening right now (Oct 2009), and that's why third-quarter 2009 earnings are likely once again to surprise on the upside.
The September 2009 payroll numbers showed that overall hours worked in the third quarter 2009 fell at a 3% annual rate from the second quarter 2009. If economists are correct in expecting about 3% growth in real gross domestic product for the quarter, then productivity may well post its second consecutive quarterly advance of about 6%. That would mean unit labor costs, or pay adjusted for productivity, are set to plunge for the third quarter 2009 in a row. In fact, unit labor costs, which are a key factor in determining profit margins, appear to have posted the largest three-quarter decline since quarterly data began in 1947.
As company reports begin to trickle in, analysts expect third-quarter 2009 earnings per share for the S&P 500 companies to decline 24.8% from a year ago (2008), smaller than the losses in each of the three previous quarters (Oct 2008 – June 2009).
However, as in previous quarters (2Q2009), investors will be focused on how companies perform relative to expectations. One key benchmark will be the number of firms that beat current estimates.
The earnings punch from recent productivity gains should be especially evident in the Commerce Dept.'s economy-wide roundup of corporate profits, due on Nov. 24 2009. These numbers cover thousands of firms and are seasonally adjusted to allow tracking from quarter to quarter. They show that the upturn in earnings actually began in the first quarter 2009. Profits in both the first and second quarters 2009 rose from the previous quarter, even though sales fell in both periods. What is different in the third quarter 2009 is that overall demand is now (Oct 2009) rising amid an ever more favorable cost structure.
As last (Sept 2009) month's job data showed, the downside of companies' aggressive commitment to productivity and profits will be very slow improvement in the job markets. However, as demand strengthens, solid earnings will help to drive corporate expansion, the foundation of a sustainable recovery.
The Credit & Loan Growth …
Banks are still skittish about offering credit, and households and companies remain reluctant to borrow, creating drags on the recovery.
In his detailed analysis of the events of the past year (2008), presented by Federal Reserve Chairman Ben Bernanke noted the substantial progress markets have made in healing the wounds from the financial crisis. But, as he was quick to add, the patient is far from healthy. "Strains persist" in many markets, he said. Institutions face "significant additional losses," and consumers and business still have "considerable difficulty" getting credit.
The bottom line: Credit is not yet flowing sufficiently to assure a strong and sustainable recovery.
The latest data from the banking sector highlight that point. Through mid-August 2009, overall bank lending to consumers and businesses continued to contract. Over the past six months (March – July 2009) all loans and leases have declined at a record annual rate of 8%, with no hint of an upturn despite the Fed's massive efforts to get credit flowing again.
What's becoming clear is the two-sided nature of the problem that won't be resolved anytime soon. One side is the reduced willingness of banks to lend in a risky economic climate amid record loan delinquencies and charge-offs. The other is the subdued desire to borrow. Households are already saddled with enormous debt, and companies are hesitant to invest in expanding their operations. The Fed has done its best to lead the horse to water, as they say, but that's about it.
This dichotomy was evident in the Fed's latest survey of bank loan officers. The July 2009 survey continued to show that more banks had tightened their lending standards than had eased them, although the stringency was not as widespread as in the Fed's April 2009 survey and significantly less so than in January. A few banks actually eased terms and conditions in July 2009, whereas none had done so in April 2009. At the same time, the Fed said, loan demand, outside of prime mortgages, continued to weaken across all major categories.
The double whammy against credit growth is why the Fed will most likely keep its target interest rate near zero for a long time and why its flood of funds into the banking system will not spark inflation in the near future. The Fed's monetary fuel is meaningless until banks are willing to lend and people want to borrow. Right now (Aug 2009), households are more interested in shedding debt amid lost wealth and sagging incomes, and banks want to invest in only the safest assets. Since February 2009, bank holdings of Treasury and government agency securities have soared by $200 billion, while loans have shrunk by $295 billion.
Banks are sure to remain skittish. Many say their lending standards will not return to normal for some time. For commercial and industrial loans to investment-grade companies, more than a third of banks said terms would stay tighter than average until the second half of 2010. For prime residential and commercial mortgages, some 40% of banks said standards would be tougher than normal "for the foreseeable future."
Lenders are more cautious partly because they must increasingly hold on to the loans they make instead of packaging and selling them as asset-backed securities (ABSs). Thanks to the Fed's Term Asset-Backed Securities Loan Facility, securitization, which affects many types of consumer loans, is stirring again after a shutdown late last year (2008). But ABS issuance in the second quarter 2009 remained 23% below the year before and 72% below two years ago (2007).
The good news is that bank loans account for only about 30% of debt held by households and nonfinancial businesses. In the broader financial markets, credit flows have improved notably in recent months (Till Aug 2009), especially corporate borrowing. Corporate bond issuance, for both investment-grade and high-yield bonds, is running well ahead of last year (2008).
As Bernanke, now (Aug 2009) nominated for a second term, has pointed out, the drag from the credit crunch is diminishing. But credit growth is a dance for two, and right now (Aug 2009) lenders and borrowers are still far apart.
The Labor Market …
Fewer Layoffs Won't Mean More Jobs: Companies, still wary of weak consumer demand, aren't doing much hiring. The trend could keep unemployment high for the next year (2010).
The news from the job front continues to be "less bad." Payroll losses in August 2009, totaling 216,000, were the least in a year, continuing the trend of progressively smaller declines. Now (Sept 2009), with an economic recovery apparently under way, some key questions are cropping up: When will payrolls start growing again? How strong will job growth be? And when will the jobless rate begin to come down?
If monthly job losses continue to ebb at the rate of the past several months (Before Sept 2009), the drop in payrolls, which has eliminated 6.9 million jobs over 20 months, would come to a halt in December 2009. That seems likely if improving expectations for second-half 2009 economic growth are on the mark. Many forecasters are upping their projections into the 3%-to-4% range, a pace historically consistent with rising payrolls.
But then what? One concern is that poor job growth has been the norm during the last two recoveries. To some extent, that pattern reflects the tendency of mild recessions to be followed by weak recoveries. In the first year after the mild 1990-91 downturn, growth in real gross domestic product was only 2.6%, and payrolls did not turn up until three quarters after the recession ended. The economy grew only 1.9% after the 2001 downturn, which is barely visible in the GDP data, and jobs didn't pick up for seven quarters afterward.
On the flip side, deep recessions like this one have tended to be followed by strong recoveries. However, job growth in the current (March – Aug 2009) upturn will face a special set of headwinds, as lingering credit constraints and debt-burdened consumers limit growth. After the severe 1973-75 and 1981-82 recessions, first-year GDP growth shot up 6.2% and 7.7%, respectively, and payrolls grew 3.1% and 3.5%. If job growth were to match that pace in the coming year (2009 & Beyond), monthly gains would average more than 350,000, which seems highly unlikely.
For one thing, job losses in this recession (2008 – 2009) have much more frequently been the result of hiring cuts rather than layoffs. Monthly payroll losses, averaging about 300,000 in recent months, indicate a net result of about 3.7 million total hires per month and about 4 million job separations of all types. In the 12 months ending January 2009, as payroll declines became progressively worse, the rate of separations held about steady, but the rate of hiring plunged.
Economists note that in the jobless recoveries after the last two recessions, the rate of firing subsided, as in previous recoveries, but businesses did not pick up their hiring rates until far into the upturn. Unfortunately, the same pattern may be shaping up this time. Although monthly payroll losses have been getting smaller since January 2009, that easing has been the result of sharply fewer separations, while the hiring rate has continued to fall.
Businesses will remain hesitant to hire as long as overall demand remains subdued, and that is almost certain to be the case in the coming year (2009 & Beyond). Spending in the U.S. and elsewhere stabilized last quarter (2Q2009), but the lion's share of growth in the second half 2009 will come from companies replenishing their depleted inventories rather than from a resurgence in demand. Plus, businesses remain keen on cutting costs and keeping productivity high. Productivity, measured as output per hour worked, soared at a revised 6.6% annual rate last quarter (2Q2009), and another big gain is on tap for this quarter (3Q2009).
How might all this figure into the unemployment rate? Economic growth of 3% or better would be consistent with a topping out in the jobless rate, perhaps in the next few months. That growth rate would generate more than the 100,000 to 150,000 jobs per month needed to prevent joblessness from rising further.
However, based on past trends, a one-percentage-point drop in the jobless rate would require payroll gains of about 350,000 per month for a full year. Even at that clip, unemployment would still be about 9% at the end of 2010. That means the first year of recovery could be a tough one for both politicians and policymakers.
US Households Wealth …
Household wealth in the U.S. increased by $2 trillion in the second quarter 2009, bringing an end to the biggest slump on record.
Net worth for households and non-profit groups climbed to $53.1 trillion from $51.1 trillion in the first quarter 2009, marking the first gain since the third quarter of 2007. The government began keeping quarterly records in 1952.
The advance reflected the biggest quarterly jump in stock prices since 1998 and the first increase in home values in more than two years. Together with increased savings and less debt, the gain in wealth is part of the mending process consumers will undergo in coming years (2009 & Beyond) before spending can gain speed.
Households are less willing to use credit and it will be a long slog to rebuild the wealth” lost during the recession.
Supplemented by federal stimulus measures such as the cash- for-clunkers program, tax credits and extended jobless benefits, consumer spending this quarter (3Q2009) has started to improve following the biggest slump since 1980. Retail sales rose 2.7 percent in August 2009, the most in three years, showing unexpected strength that extended beyond auto purchase.
The drop in net worth that ended last quarter (2Q2009) began in the last three months of 2007, the longest stretch of decreases since recordkeeping began in 1952. Wealth dropped by a record $13 trillion during that time. Americans were constrained by plunging home and stock prices, tight credit and rising unemployment. Joblessness is forecast to rise to 10 percent by the end of this year (2009).
Latest (2009) report showed household net worth in corporate equities and mutual funds increased by $1.36 trillion in the second quarter. Real-estate-related household assets grew by $139 billion, the first gain since the last quarter of 2006.
Americans are taking on less debt to repair their tattered balance sheets, pushing the savings rate up to 6 percent of disposable income in May 2009, the highest level since 1998. While the jump in savings was boosted by an increase in incomes linked to the fiscal stimulus plan, some economists are forecasting savings will continue to rise as consumers hold back on spending.
Balance Of Payments …
The ending of the recession is reviving global trade, increasing U.S. imports by a record amount in July 2009 and boosting foreign demand for American goods for a third straight month.
While the job market remains a long way from recovering, first-time claims for unemployment benefits fell more than expected in Aug 2009, offering some cause for optimism.
The jump in imports could be a sign that U.S. consumer spending is recovering. That's good news because such spending accounts for 70 percent of economic activity. Domestic demand has picked up now (Sept 2009) that US have shifted from recession to recovery!!!
The Obama administration is increasingly citing its $787 billion stimulus package as a critical reason the economy is turning around, even as officials acknowledge that jobs remain scarce.
The unemployment rate is still rising and jumped to 9.7 percent in August 2009, the highest in 26 years, from 9.4 percent the previous month.
The trade deficit rose 16.3 percent to $32 billion in July 2009. Economists expected an imbalance of $27.4 billion. Imports rose 4.7 percent to $159.6 billion, the largest monthly advance on records that date to 1992 and the second consecutive gain after 10 straight declines.
The rebound reflected a 21.5 percent spike in imports of autos and auto parts, partly due to increased production at U.S. auto plants owned by General Motors and Chrysler that had been slowed when the companies were struggling to emerge from bankruptcy protection.
Exports edged up 2.2 percent to $127.6 billion. It marked the third straight monthly increase, but left exports well below their record level of $164.4 billion set in July 2008. The export gains reflected big increases in shipments of civilian aircraft, computers, industrial machinery and medical equipment.
Some economists saw the increased imports as a sign that retailers and manufacturers are rebuilding their inventories, which could lead to greater production. Eventually the factories have to come back online to restock the shelves.
American companies have been hampered by a drop in demand at home and overseas as the recession that began in the U.S. spread worldwide. However, economists hope that a rebound in global economies and further weakening in the value of the dollar will boost exports in coming months (Sept 2009 & Beyond). A weaker dollar makes U.S. products less expensive overseas.
So far this year (2009), the deficit is running at an annual rate of $355.5 billion, about half of last year's total. Economists believe the deficit will keep rising in the months ahead (Sept 2009 & Beyond), reflecting stronger growth in the U.S. and rising oil prices.
Rebalancing Of The Global Economy …
How the Global Economy Is Rebalancing: This time Asia, the Americas , and Europe are all accelerating together. This synchronized rebound will lift trade broadly, to the benefit of U.S. exports
Looking back, it seems so clear: The wildly lopsided global economy was headed for trouble. By 2006 the U.S. trade deficit had ballooned to 6% of gross domestic product, a gap comparable to those of some Third World countries, except that the U.S. accounts for 21% of world GDP. Imports flooded ashore and dollars rushed abroad, greatly inflating trade surpluses overseas. In return, foreign currencies poured in, providing the capital America needed to finance its credit boom and devil-may-care consumption.
The worst U.S. recession since the 1930s has been a cruel way to rebalance the world economy, but it's working. Through the second quarter 2009 the trade deficit had fallen to 2.4% of GDP, and America had cut its need for foreign capital by 56%.
Now (Sept 2009) comes the hard part: holding on to or maybe extending that progress as a U.S. and global recovery takes hold.
The July 2009 trade report was good news for the near-term outlook, but it also suggested the road to rebalance will not be easy. A third consecutive monthly rise in exports showed the global recovery was gaining steam, and the second month of higher imports implied firmer U.S. demand. But the monthly deficit widened by $4.5 billion, the most in a year, to $32 billion, as a jump in imports overtook a strong gain in exports.
So, here US go again? Not necessarily. In the past, the trade deficit has typically widened sharply in a recovery, as the U.S. turned up in advance of other economies, causing imports to run ahead of exports. This time—with the global stimulus efforts kicking in and the financial markets healing—Asia, the Americas , and Europe are all accelerating together. A synchronized rebound will lift world trade broadly, much to the benefit of U.S. exports. At the same time the rebound in U.S. spending will be muted by tight credit and heavy consumer debt, limiting import growth and restraining the trade gap.
The global recovery is already starting to power U.S. exports. Shipments of goods, adjusted for inflation, rose at a 14% annual rate in the three months through July 2009, after collapsing last autumn. Exports of industrial materials and capital goods, especially to emerging markets, account for the lion's share of the recent growth.
Export strength should broaden as developed economies—including Europe and Canada , which buy a third of U.S. exports—shift from recession to recovery. Growth of key U.S. trading partners picked up to about a 4% annual rate last quarter, and they expect that pace to continue in the second half 2009. The August 2009 index of export orders from the Institute for Supply Management surged to a level indicating further solid gains.
In addition to global growth, the dollar continues to do its part in the rebalancing act. The greenback's long-term decline, which makes U.S. goods more competitive, totaled 26% against all currencies from 2002 to 2008. That slide stopped temporarily last year (2008) as a flight to safety lifted the dollar, but the greenback is now (Sept 2009) retreating, and the decline should continue. The Federal Reserve's aim to keep U.S. interest rates exceptionally low compared with rates abroad makes dollar-denominated assets relatively less attractive.
One fear is that foreign investors will stop buying U.S. debt, just as Washington needs to borrow more. Such a turn could lead to a dollar collapse, causing spikes in long-term rates and inflation. But although Uncle Sam may be borrowing more, consumer credit has plunged, sharply reducing the U.S. 's need for foreign capital. The balance-of-payments deficit, which is essentially foreign lending to the U.S., shrank to $98.8 billion in the second quarter 2009, from a peak of $214.8 billion nearly three years ago (2007).
The less the U.S. needs to borrow from abroad, the less downward pressure on the dollar—and the greater the balance in the global economy. Maintaining a better balance in the long run will be difficult, however. Export-intensive nations, such as China , must boost their domestic demand, and the U.S. must hold its hunger for imports in check while exporting more. Unfortunately, old habits die hard.
