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Wednesday, 6 February 2008

An Excellent and Definitive Report from ML

Courtesy of CNA Forummer - Eagle

Come across an article by the economist David Rosenberg of ML, which is a must read and one which I believe paints the economic picture accurately. Can't find on-line so I will post the major points here:-

1. We r into the 1st month of recession.

2. Average home prices can drop another 25%.This may sound dire but is nothing compared to the 130% surge fr 2000-2006.

3. Historical record shows these setbacks in the real economy (ie recession) usher in an ave 25% drop in S&P 500.

4. So we ve a situation where both house and equity prices, though already fallen decisively fr their peak, hv potential to drop another 25% fr here.

5. Model predict personal savings rate may be pushed up to 4% fr sub zero today, causing severe dent to consumption growth (ave rise in savings rate during recessions is abt 3%).

6. We r heading into the 1st consumer recession in 30 yrs that will not hv the demographic spending power support fr the baby boomers. (As bad as early 1980s, early 1990s and 2001, the boomer could still be relied upon to put a floor under the consumer).

7. Analysis factor in the end of credit cycle and the starting pt for both the household debt-service ratio and the personal saving rate. Household debt-to-income ratio is now 138% vs 100% 6 yrs ago. The starting pt right now is 14.3% for the household debt servicing ratio and -0.5% for the saving rate. Compared these to the early 1990s, these ratios were 11% and 10% respectively. (Thus huge restraint will be imposed on consumers in the near future and we r no where near the launching pad for a new bull run in consumer spending).

8. GDP for 2008 forcast to ave 0.8% and 1% for 2009.ie two full yrs of below-potential GDP growth and at end 2009, output gap is seen widening to 4%.

9. Now +0.8% GDP may not sound too dire but keep in mind this is the same growth rate posted in 2001 - a period that saw 60% slide in Nasdaq and more than 20% fall in S&P 500.

10. In terms of quarterly pattern, we see a 3 quarter recession ahead.; starting in 1Q -0.4% (the same as 1Q2001 when the last recession began) By 4Q, growth shld flatten and the downturn ovr, but will be followed by elongated U shaped jobless recoveries, as in the prev two asset bubbles (recall 1992 and 2002).

11. Transition to next economic expansion will take yrs to flush out the excesses of the multi yr leveraged boom in asset prices.

12. FED easing cycle and bull market in Treasuries is still not ovr, very likely 2003 lows in interest rate will be re-visited (note: I yet to check the FED rate in 2003 to see what the low was).

13. Since the equity market tends to bottom out roughly 60% of the way thr a recession, the timing of the beginning and the end to the downturn would imply a trough sometime in Jun-Aug period.

14. Fiscal stimulus of US$175b is built into the model. Then again Bush cut taxes by 120b in 2001 and FED had cut rate by 300 basis pts b4 9/11, and still had a recession in 2001 as nature took its course; and we still had a lacklustre recovery in 2002.

15. +0.8% GDP assume a solid export performance on the hope that the rest of the world hangs together, combined with competitiveness of the depreciating dollar and increased govt spending during election yr. Strip of export and govt sector, 2008 forcast calls for -1.3% decline in private sector demand (consumer spending + housing + non residential construction + capital expenditure). Contrast that: real private demand nvr contracted in 2001 (+1.4%) and only moderately in 1991 (-0.9%); and would on this basis, go down as the weakest yr since 1980.

16. It become clear that problems in housing and credit markets are spilling into consumer areas. Just look at the sharp loss in consumer credit quality and how lenders are bracing for much higher delinquency rate going forward (cited a no of credit card provisions/losses at JP Morgan, Wells Fargo, Citigp, Capital One etc) (Watch out this Thu Consumer Credit report)

17. As for corporate profit, see S&P 500 operating earnings at US$80 for 2008, an 8.5% decline. Again this may not look so bad on the surface coz the calculation is a smoothed 4 quarter ave. The peak to trough decline is closer to 20% which is typical of recession. Similarly to GDP, there will be an extended U shaped recovery to earnings; which we see beginning to unfold by 4Q2008.

18. Market is trading at 16.5 times PE ratio for 2008, which means that when bench marked against the current 6.5% yield fr Baa corporate bond market, the equity market is still overvalue by 10%.

19. Commercial real estate is now playing carch up to residential. Vacancy rate rose to 12.6% in 4Q, terminating 16 straight quarters of declines. Net absorption slowed dramatically to 4.4 millions fr 16.2m. Developer added more than 19 million sq ft of commercial space in 4Q - the largest supply since 2000. Shopping ctrs vacancy rate also rose to 7.5% in 4Q, highest lvl in 11 yrs.

20. Finally on labour market, expect to se job losses in the range of 2.5 million in 2008, close to what we saw in 2008. Unemployment to go up to 5.75% by end of 2008 and 6% in early 2009. To be sure this is low by historical standards, but a 6% rate in today's less regulated and more mobile economy feels much the same as the near 8% jobless rate posted in early 1990s and 10% rate we endured in the early 1980s.

Quite a lot to chew on, but one based on fact, data (both present and past) and predicted using economic model/simulation, as opposed to empty talks by some analysts with no credentials.

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