• The Conference Board’s sentiment index climbed to 39.2, the highest level since November, from 26.9 in March, the New York- based research group said today. The gain was the biggest since November 2005.
• Home prices stabilize: A report from S&P/Case-Shiller today showed that the slide in home prices in 20 U.S. markets slowed in February for the first time since January 2007. Prices fell 18.6 percent in February from the same month last year after dropping 19 percent the previous month.

These are welcome developments in a financial and economic world beset with bad news. These data emphasize that the dragon of recession can be slain. The programs put in place in the U.S. are beginning to take effect.

Further analysis of the Conference Board sentiment index is also illuminating. The Conference Board’s measure of present conditions rose to 23.7 from 21.9 the prior month. The gauge of expectations for the next six months surged to 49.5, the highest level since the collapse of Lehman Brothers Holdings Inc. in September of last year.

This jump in optimism is encouraging, because if and when the economic recovery begins, it must be supported by strong consumer spending. But, if consumers are pessimistic about the future, their wallets are likely to remain closed. The hunker-down syndrome is strong when the outlook is sour.

As for housing prices, recent reports show government efforts to support housing and revive lending may be starting to work. Combined purchases of new and existing houses have hovered around a 5 million annual pace since November, and sales at retailers improved in the first two months of the year.

Add to these new developments the fact that the American and many foreign equity markets are on a fairly sustained up-trend, and you get more signals that the worst may be over, and that investors and consumers are loosening their retrenchment. It looks good for an actual recovery some time this year.

But is the slight up-tick for the last week a telling indicator?  Probably not, since it could just as easily turn down next week.  One week does not make a trend.

Another stock market measure is the price/earning ratio of the market.  The market index value divided by the aggregate earnings of all the components is an important indicator of the value of equity holdings.  The chart below shows a long, historical trend of this measure:

P/E Ratios for U.S. Equities

The P/E ratio in earlier recessions was lower than it is now, but this indicates that the bottom may at least be near.  The current level of 13 is below the long term average of around 15, but it was below 10 in both the 1982 and 1930s recession.

One of the reasons business earnings (half of the P/E ratio) are so low is the inability of businesses to raise prices.  We are currently in a period of deflation, which is not promising for a strong business environment.  However, there are a couple of up-indicators for a return of rising prices: the prices of copper, corporate bonds and inflation-protected Treasury securities are higher today than they were in November.

For an Associated Press Report on the possibility of bottoming, follow the link:http://news.yahoo.com/s/ap/20090314/ap_on_bi_ge/wall_street_finding_the_bottom

The prices of homes is another indicator that many consider important to a recovery.  The graph below shows the trend in this important variable:

Prices of Homes

Home prices have come down considerably from their previous high, but they still have a way to go before reaching the long term average.  Also, home prices vary considerably within different markets.  Some of the hardest-hit regions (Las Vegas, Phoenix, Miami) have already lost about 50% of their previous high.

The one variable yet to be considered is the broken banking system that afflicts most of the developed and emerging markets world.  And on this front, there is not much encouraging news.  It is impossible to foresee an economic recovery without a healthy banking system, and that is not present just now.  The meeting of finance ministers in London over the weekend indicates they want to do something about it, but the language they chose in their press release was to “do everything possible” to correct the problem.  This is not language that instills confidence in the investing community.  It will be up to the heads of state, who meet on April 2nd to address this issue more fully.

The only encouraging statement coming out of the meeting of the finance ministers came from U.S. Treasury Secretary, Timothy Geithner, who indicated he would flesh out his proposal to strengthen American banks, “soon.”

Two other items relevant to a recovery are consumer spending, which is still falling, and the huge amount of money market and cash holdings by investors and banks.  Consumer spending needed to fall from its near 100% level just a few month ago.  An economy needs to have savers, and this country lost theirs, at least in the aggregate, for many of the last few years.  There is a recovery of savings underway, but it has a bit further to fall before stabilizing at the long-term average of 93%,

Cash holdings of investors in money market funds and banks are exceptionally high, which indicates to me that there is plenty of money poised to re-enter the equities market, once confidence is restored.  We can only hope it is soon.  Probably by the middle of April, we should see some signs of recovery of consumer confidence.  The G-20 meeting will have concluded, with some expected gains from an agreement to strengthen the IMF lending to emerging markets, better international banking regulation and some coordination of stimulus spending plans.

Plus, there are other signs that the rate of getting worse is slowing down. Unemployment figures for March will help clarify this issue, and they should be out in early April.  If we get some encouraging signs by the end of April, then we might expect a bottoming by the summer or fall quarter.

UPdate 3/16:  Chairman of the Federal Reserve, Ben Bernanke, sees end of recession in 2009.

From NYT: “We’ll see the recession coming to an end probably this year.”

With those words, Federal Reserve Chairman Ben S. Bernanke staked a marker on what he believes will be the end of the malaise that has descended upon the United States economy. And, he said on a “60 Minutes” interview that ran Sunday evening, the country will begin to recover next year — “and it will pick up steam over time.”

To watch a video of the interview on 60 minutes, follow the links below.

• 
  The Chairman Part 1 (13:23)
• 
  The Chairman Part 2 (13:13)
• 
  Behind The Scenes #1 (0:57)

To read the complete transcript of Mr. Bernanke’s inverview Follow this link to the CBS site.

The battle lines are already forming.  Republicans, as expected, will attack all elements of it, hurling labels like “socialism,” “unAmerican,” “Big Government,” etc.  Even some democrats are unhappy with cutting farm subsidies to some of their big contributors–those who take in over a half a million dollars a year.

Mr. Obama is fighting back, however.  His website has a video presentation of his weekly “radio” address in which he lays out his defense. (Click here to see it)

The vested interests, such as the medical and insurance industries, do not like it.  So we might expect a repeat of the advertising blitz that doomed the Clinton proposal in his first year in office.  This time, though, the Obama Administration knows what to expect, so I would expect orchestrated counterattacks to shore up the defenses.

There is no way to overstate the sea-change this budget represents.  It abandons the Reagan approach that defined government as the problem, and reinstates the Roosevelt approach that placed the federal government front and center of shaping American welfare.  It will be interesting to see how this looming battle plays out.  Can Mr. Obama use his popular mandate to force through this kind of change?  Stay tuned for a round-by-round accounting.

Update on Health Care initiative: (3/5/09)

Although Mrs. Hillary Rodham Clinton has not directly participated in any of the White House’s planning sessions on health care, her presence is felt in Mr. Obama’s efforts to pass his own health care reform proposals. The work she did 15 years ago, although ultimately unsuccessful, is being used as a model of what and what not to do for the current efforts.

First, the Obama plan is not being drafted in secret, and then handed over to Congress to pass. Mr. Obama’s plan is broadly defined, and Congress will be allowed to shape the details. Secondly, Mr. Obama is introducing his plan only six weeks into his Presidency. Mr. Clinton waited for 11 months to make his move. The delay, according to some, was one of the major factors in its defeat.

Another factor was the focus of the new plan, which stresses cost control, and it allows everyone to keep their current coverage if they want to. One of the things about the Clinton plan that was attacked was the fear that everyone was going to be forced into one type of access to health care.

Mr. Obama has also included at least partial funding ($635 billion) for his proposal in the first budget submitted to Congress. Mr. Clinton did not do this, choosing to focus initially on balancing the budget, which did not allow any room for health care spending. Now, however, the need for health care reform is widely seen as a necessary step to control the costs of Medicare and other federal spending that touches on health care. This means that the proposals of Mr. Obama are facing far less resistance from Congress and, oddly enough, even from the health care industry than the Clinton plan when it was introduced.

These differences may be critical in gaining passage of this most important piece of legislation. Although Mrs. Clinton may be engaged in diplomacy in foreign lands today, her efforts of a decade and a half ago are helping the new President do what he promised to do about bringing important changes to Washington. She may not get the credit for the success, and certainly Mr. Obama deserves all he will get for getting the job done, but Mrs. Clinton knows that her past efforts are providing some broad shoulders for the current Administration to stand on.

If we line up the current levels of American unemployment, GDP, budget deficits and the current account deficit, the dollar can be made to look like a pig.   The problem, though, is that a currency’s value is never a matter of absolute value.  It’s always about relative value.

Certainly the absolute picture of the American economy is gloomy.  But, then, so is almost everybody else on the world stage.  In Europe, both the developed and developing nations are worse.  Their banking crisis is similar to ours, and their exports are falling fast, as the recession strikes all parts of

Euro/Dollar–Feb 08 to Present 

the continent.  A look at the euro/dollar chart above doesn’t inspire confidence in that currency as a replacement for the dollar.  The euro has fallen about 20% since July of 2008.  For economies that are dependent on exports, their currencies are vulnerable to world demand.

Asia is also in a world of hurt.  Only China and India are reporting continuing growth, and even in these engines of growth, the growth rates have slowed dramatically.  China has had tens of thousands of export-oriented plants close down recently, and is pushing an army of millions of unemployed workers back to their rural villages, seeking to scrape a bare living from tiny farming plots of less than a tenth of an acre in size.

The Japanese Yen is the only major currency that has appreciated with respect to the dollar, as the chart below shows.

Dollar/Yen–04/07 to present

The yen, however, is not rising against almost all currencies because of the strength of the Japanese economy.  Quite the contrary.  Japan is rapidly descending into a major recession.  The reason the yen is strong now is because a decade of being the borrowed side of the carry trade means that those who are exiting the carry trade must now purchase yen to square with their brokers.  The “strong” yen is not helping Japan, it is, in fact, increasing the devastation.  A strong yen means that prices of Toyotas, Sony TVs, and everything else Japan sells to the rest of the world are increasing in price just when they need to be falling.

Since the world wide recession began, the dollar has actually risen in value.  The flight to quality phenomenon is well known, and with economies crashing all over the globe, the greenback has regained its allure as a safe place to be, relative anywhere else.

The flight to quality effect is also seen in the price curve of U.S. Treasuries .  In the chart below, the iShares ETF, IEI, shows how the price of 3-7year Treasuries has risen since the global slowdown began.

Since its low in late June of 2008, this ETF, which holds only Treasury obligations, has risen about 7.5%.  Much of this rise was because of the repatriation of dollars that had flowed to emerging market equities and debt obligations during the boom period.  But, now that the currencies of almost all the emerging markets have tanked (30-50% declines in the last year), those monies have flowed back into U.S. dollars to be used to purchase Treasuries. 

The reserve role of the dollar continues to define its resiliency as a safe haven in a turbulent market.  The dollar is not imperiled.  It is prospering, and will probably continue doing so for a long time to come.

The meeting is important because Mr. Geithner will be forced, to some degree, to put some meat on his proposal to salvage the American banking system. His proposal of a few days ago, as to how to spend the balance of the TARP funds, has not been greeted with any enthusiasm in America.

American banks are in horrid shape, especially our largest ones. Today, the market capitalization of our top banks is below $500 billion. Yet the International Monetary Fund estimates that the write-downs of their loan portfolios will rise to $2.2 trillion once a full accounting is required. When this happens, Mr. Geithner will be forced to step up to the task of rescuing them. But it is hard to imagine a scenario where the American taxpayer will pony up $2 trillion and not want a piece of the action. Yet “nationalization” of our banking system is not something he, or many others, want.

This state of affairs is understandable. America condones nationalization of the postal service, some parks, some forests and national monuments, but banks are a different matter. Our public sector has no experience running giant banks, and there is much resistance to trying it. Yet, we are going to be the capitalists of last resort to the giants that got us into this mess, so there will be a huge outcry to bite the bullet and take them over.

My own preference would be to nationalize them, and then set up an immediate procedure to denationalize them by breaking them up and selling them off in pieces. If they are too big to fail, as they are, then that are simply too big. We can get along without these behemoths. Local banks have served our economy well, and there is still room for large, internationally connected banks in our large trading cities. But we do not have to have banks as large and Bank of America and Citibank have become. At their current size, their mischief becomes a potential catastrophe for the entire world.

At any rate, Mr. Geithner will have his work cut out for himself as he faces his European and Pacific counterparts today and tomorrow. As Morris Goldstein, a policy analyst at the Peterson Institute for International Economics in Washington said: “There is a vacuum to be filled. The United States, as the largest global player, needs to lead the show.”

Most of the other ministers there will not have Mr. Geithner’s resistance to taking over their failed banks. The U.K. is well on its way there, now, and other will probably follow soon, as the shoes continue to fall in the banking crisis of the century.

3.6 million jobs have been lost.  (For an update through February, see the charts below.)

Businesses in all sectors except health care are cutting back on their payrolls. It is a major retrenchment and is still getting worse. The chart above shows the change in employment levels by month. Considering that the U.S. needs, on average, about 1.5 million new jobs each month in order to keep up with labor force growth, the effects on the economy are worse than the bar chart shows. As jobs become harder to get, as they are now, this discourages many workers from even looking for work. These “discouraged workers,” as they are called, are then no longer counted in the labor force—thus understating the unemployment levels.

If the labor force participation rate was today what it was when George W. Bush took the oath of office, today’s unemployment rate would be over 9.5%.

The chart below, which tracks the unemployment rate, has been moving almost vertically since September of 2008. This is cause of great concern. This type of rapid retrenchment can lead to a spiral of self-fulfilling behavior that is exceptionally hard to stop. This is one of the reasons President Obama has spoken so forcibly on the need for speed in getting the economy righted and job creations begun.

The next chart shows the effects on unemployment among workers with various levels of education. High school dropouts are most severely affected, seeing their unemployment rising to 12%. As a worker’s educational level improves, the percentage unemployed drops. Note that those with at least a Bachelor’s degree suffered only a 4% rate of unemployment.

There isn’t much in expectations about a recovery until July, at the earliest, and even then, the recovery is expected to be slow.

This could make our current recession the longest since the 1930s, outlasting the two record-holders, the mid-1970s and early 1980s downturns. Each of these recessions lasted 16 months. The current recession, which started in December 2007, would reach that milestone in April.

Update on Unemployment: 3/6/09

The U.S. economy continued the trend of high job losses in February. The last six months have seen 3.3 million jobs disappear, sending unemployment to 8.1%, the highest level in 25 years. The surge in unemployment in February was caused by the loss of 651,000 jobs for that month, according to the U.S. Department of Labor. Last month represented a 59-year high for job losses in one month.

Jobs Lost Date:

The only good news in this set of data is that February lost no more (actually slightly less) than January, and less than December. However, this does not constitute a trend. It is too early to make that kind of call. March could go up, down or stay the same. We just don’t know where the bottom is.

Unemployment is a lagging indicator, so once the unemployment rate turns down, the economy will have already have begun improving.

See update to this chart for late February, below.

The graphic above shows the dramatic drop in annualized GDP quarterly growth for the fourth quarter of last year. Two other points  are well demonstrated in this data:

· The effects of the stimulus rebate last year is clearly seen in the spike in the second quarter of last year. The jump from less than 1% in the first quarter to about 3% in the second is probably attributed to the checks that were sent to taxpayers in the late first quarter. It was effective, but it was simply too small to overcome the momentum that had accumulated to the downside by that time.

· The drop in the 4^th Quarter is actually more dramatic than shown. The drop in consumer spending, which is behind the GDP drop, was so steep that producers could not adapt their production fast enough to counter the fall in sales. As a result, many of the products made during the quarter simply piled up as unsold inventories. But, the production was counted in GDP, so the slowdown in GDP was lessened by this artifact. The unsold inventories, now gathering dust all around the country, is the main reason we see huge layoffs  being announced in January—pointing to an even worse drop if quarterly GDP figures for the first quarter of this year.

There is no mystery about the dramatic slowing of consumer spending. For years prior to 2008, consumer spending had been artificially propped up by home loans. Home prices were going up so fast that home owners could refinance their new-found wealth one or twice a year and spend the proceeds on home improvements, new cars and large television sets. When the housing bubble burst, the prop was pulled from consumer spending, and it fell like a stone.

I expect unemployment to continue going up as millions of workers are being given pink slips every day so far in 2009. Manufacturers have to trim their production not only to make up for the over-production of late 2008, but they must also slow production lines for the lower sales levels anticipated in the future. This spiraling effect is well understood in business and economics. It’s hard to stop, once it gets going, and it is going now with full steam.

The scary part of this scenario is that this exact same process is being repeated in Europe, Asia, Latin America and Africa. No region is immune; no country can escape its effects. The good news is that virtually all the world’s economies are generating counter-cyclical spending plans to help pull out of the nosedive we are in. Simultaneous stimulus spending will help the world’s economies recover faster than otherwise, since there can be no beggar-thy-neighbor polices when everyone is going through the same thing.

Also, keep in mind that unemployment is a lagging indicator of future production. By the time unemployment stops falling, the recovery is likely to already be underway.

UPDATE on 4thQ, 2008 GDP (2/28/09)

The Commerce Department has just revised the 4thQ GDP estimates, and the news is not good.  The top chart shows a 3.8% annualized decline.  The revised figures, show in the chart below, are much worse:

It turns out that a better estimate of the fall was 6.2%, not 3.8%.  Every major component of the economy shrank, except government spending. Economists said all signs point to a similar drop in output in the current quarter.

The revision could be traced primarily to a contraction in inventories of unsold goods, which the government had previously said had grown.  Businesses were able to trim their inventories faster than first estimated.  The good news is that the pile of unsold goods is not as large as first estimated.

But, traditionally inventories in a recessions fall much faster than they have so far.  This suggests that the worst is yet to come as far a cutbacks in production.

The final adjustment will be made next month by the Bureau of Economic Analysis.

In a sea of bad news, the water just got a little deeper, as every state in the United States reported a month over month and year over year rise in their rate of unemployment.

It is not surprising that the agricultural states in the center of the country have the lowest levels of unemployment, since so much of farm labor is supplied by the families that own the farm.  The industrial states are suffering the most, as they are most dependent on factory employment.  But, even the service industries are hurting, as California, Florida and Nevada, three states that have large service industry composition, all show unemployment of 10% or higher.

The regular employees of these banks have not been so lucky.  The same report details how there have been about 100,000 job cuts in the banking industry since the failures began.  Unfortunately, the job cuts are coming from the ranks, not from the top. 

The taxpayers, too, are not getting a fair deal for the billions they are handing over to the failed banks.  We will have no say or right to questions decisions by the same executives who misguided their corporations to bankruptcy.

In another report, the high-flying execs at Citibank caved under pressure from President Obama and decided today to abandon plans for a luxurious new $50 million corporate jet from France.  The decision came 24 hours after the banking giant, which was rescued by a $45 billion taxpayer bailout, defended buying the state-of-the-art Dassault Falcon 7-X U.S. skies — as a smart business deal.

These kinds of stories are making it impossible to generate any public support for the bailout plans.  With staggering sums being offered and no public control over their behavior, how can anyone support them.

I hope the Obama Administration will see what is wrong with this picture and make some major changes in the way the handle the second half of the funding that is working it way through Congress now.  It is much more likely, now, that there would be some support for nationalizing the failed banks, at least for a few years, and have them operated by the Federal Government until they could be broken up and sold in smaller pieces.

Compare this with an expected GDP drop in Germany or America of from 1-2% and you see how the losses in their major markets translate in a multiplier effect of around 10 times in Taiwan. They are not decoupled with America and Western Europe. They depend on demand from these regions to fuel their internal employment and growth.

On Thursday, January 22, Japan said exports fell 35 percent in December from a year earlier as the crisis hurt its main markets. Japan is being hit by a triple whammy: its economy is slowing for internal reasons, its exports are slowing because of the recessions in its major export markets of America and Europe, and the yen is rising, making the first two problems even worse.  Sony Corporation lost almost $2 Billion last year–its first loss in 14 years, much of which is attributable to the rising yen and the global recession that adversely affects its high value products.

The rise in the yen is a payback of a decade of being the borrowed currency in the carry trade.  Now that interest rates all over the world are dropping, all those who borrowed yen to invest in higher interest rate currencies are being forced to buy back the yens they borrowed.

UPDATE on Japan

On February 15th Japan announced that its real GDP  shrank at an annual rate of 12.7 percent from October to December after contracting for two previous quarters. When compared with the third quarter of 2008, Japan’s economy receded 3.3 percent.  This was the worst drop since the first three months of 1974.

“There’s no question that this is the worst recession in the postwar period,” Japan’s economic minister, Kaoru Yosano, said after the results were released.

The dismal figures also place Japan firmly among the worst-hit in the global crisis, dwarfing economic declines in the United States and Europe.  The United States GDP declined at a 3.8 percent annual rate in the fourth quarter and 1 percent when compared with the previous quarter.

This will probably thaw out the fiscal freeze that has gripped the Japanese legislative process for the past months. Prime Minister Taro Aso has promised spending worth almost 50 trillion yen ($545 billion) in two packages. But political bickering in Parliament has slowed progress.

In South Korea, industrial production is dropping at the fastest pace since record keeping began in 1975.  Only Vietnam and Bangladesh are holding up, mostly because they produce low value-added goods that are increasing in demand, such as cheap clothing.

In China, economic growth slowed sharply during the last quarter of 2008, to 6.8 percent, and to 9 percent for all of 2008, down from 13 percent growth in 2007, the Chinese National Bureau of Statistics reported. And the South Korean economy shrank 3.4 percent during October to December compared with a year earlier.

Keep in mind that the data from China is of an unknown quality. The Chinese government is the sole keeper of production, employment and monetary data, so I am always a little skeptical of the accuracy of what they publish. Compared with America and Europe, China is more closed to the inner operations of the bureaucracy that husbands their national data.

Indonesia is the least susceptible of those shown to a slowdown in the west. It has the world’s fourth largest population and can depend more on internal aggregate demand than almost any other economy in Asia. Taiwan and South Korea are the most dependent on exports to sustain their local economies.