The News is Bad but Not All Bad
There really is some good news out there. First, the price of a barrel of oil has dropped from $147 to $63, (this morning) its lowest level since June 2007. In fact, the price of gasoline is now no higher now than it was just a year ago. This favorable trend will act like a tax cut to consumers, putting real money in their pockets. Moreover, consumers can face the upcoming winter with far less trepidation and can take comfort in the fact that as things stand now, their heating bills will likely be more like last year’s.
On the banking front, there are emerging signs that banks may be increasing credit availability. LIBOR rates are slowly coming down, indicating that credit spreads are narrowing and that capital is at least flowing better between banks. If the banks really do use their capital infusions to facilitate lending, other credit spreads will narrow and we will look back on this time as a uniquely opportune moment for buying bonds. There are lots of highly rated publicly traded fixed income securities with yields to maturity similar to long term returns for equities, i.e. between 8% and 10%, but with obviously lower volatility.
That having been said, credit is still not available to many sound and growing companies who need it and have until now been able to rely on it. Deals similar to the one made by Warren Buffet with Goldman Sachs are being replicated many times by private equity investors who have had to become bankers of last resort for entrepreneurs.
The U.S. economy has almost certainly entered into a recession and the economies of many industrialized and emerging economies are likely to join us. While that may not be new information, there is reason to believe that this recession will be both deeper and longer than either of the two we experienced in the last 20 years. That is because the housing crisis this time is far worse than the one that hit the U.S. in the late 1980’s and because credit has been so severely curtailed that businesses have been stopped dead in their own tracks.
We are currently in “earnings season”, as public companies announce their earnings for the most recent quarter. However, we must be careful not to extrapolate some positive earnings results (remember, those earnings mostly came before the bankruptcy of Lehman Brothers and the concomitant freeze in the capital markets) into an expectation for good fourth quarter earnings. Starkly put, earnings for the next several quarters are likely to be horrible.
Housing prices continue to fall. Until they stabilize and the supply demand characteristics for the housing sector improve, consumers will rightfully be very nervous and likely unwilling or unable to increase their spending.
Economic growth for the last decade or more has been achieved in large measure with borrowed money which has been in the form or mortgages, equity lines of credit and/or credit card debt. Now it is crunch time – credit is no longer readily (or at all) available, and consumers are being forced to curtail their addiction to debt. The net result can only be negative for economic growth, as consumers will be forced to use their paychecks to reduce their existing debt rather than to make new purchases. The $64 trillion question is: “How long will it take for the debt overhang to be cleaned up?” The enigmatic answer will determine the timing and strength of the economic recovery.