drsohn.com..."Economy: Double-Dip for Consumers?"
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>>>Dr. Sung Won Sohn
Chief Economic Officer
Wells Fargo & Co.
(612) 667-7498
February 18, 2002
FINANCIAL MARKET STRATEGIES
Economy: Double-Dip for Consumers?
· Despite the incredible performance of consumers in supporting economic growth, a "double dip" recession scenario, where consumer spending falters, has not gone away. There are four major concerns. One, mounting layoffs will sap consumers' buying power and confidence. Two, the balance sheet is highly leveraged under the mountain of debt. Three, the boom in the stock market, which helped consumers' spending spree, has turned into headwinds for consumers. Four, there is little pent-up demand to sustain consumer spending. The first concern on jobs should diminish. The sharp fall in initial claims for unemployment insurance and the increase in new orders for capital goods by businesses signal that the worst of corporate retrenchment is over. Furthermore, inventories are at rock bottom, encouraging businesses to increase production and hire people. Manufacturing, which has shed well over one million jobs, has hit the bottom.
· To be sure, consumer debt relative to income is at record high, but about 70 percent of the debt is in mortgages (chart 2). House prices continue to rise, allowing consumers to tap their home equity through refinancing. More importantly, consumer debt-service in relation to income has peaked (chart 1). The negative wealth effect from the setback in the stock market has been overblown. For the vast majority of consumers, home equity is much larger than stock equity. As of 1998, government data show that the average home equity was $100,000, compared to $25, 000 for stock equity. In addition, two thirds of household’s own homes, compared to less than half for stocks, including both direct and indirect. The top quintile of households owns 83 percent of all the equity outstanding. It is true that there isn't much pent-up demand, but consumers will open up their wallets if enough incentives are given. The lack of pent-up demand is an argument for moderate growth in consumer spending, not a double-dip. Consumers' financial position is sound overall.
Bonds: Buying a Straw Hat in Winter
· The antidote for "Enron-itis" has not worked yet. The flight-to-quality has kept Treasury yields below where they should be and the credit spreads have widened (chart 4). Without the fears of more landmines in accounting irregularities, the beginning of economic recovery, the prospect of tighter monetary policy and the reemergence of budget deficits should have raised Treasury bond yields. The adjustment process will take place later.
· Investors have flocked to mortgage-backed securities as another safe haven. Because of guarantees and collateral, there is very little credit risk in mortgages. Since mortgage rates are expected to trend up, there is little prepayment or "convexity" risk in mortgages. However, investors could pick up about 200 basis points in yield by switching to Baa Corporates. This is a buying opportunity for Corporates.
Stocks: Liquidity-driven to Earnings-driven Market
· Generally, the liquidity-driven market moves fast and is broadly based. Since liquidity, not earnings, has been the primary driver of the market, the price-earnings ratio rose. In the earnings-driven market, however, earnings drive prices. Therefore, the price-earnings ratio may not change much. The key in detecting the transition from liquidity- to earnings-driven market is not earnings, but monetary policy.
· Abstracting from the accounting scandal, earnings should take over from liquidity sometime around mid-year. Economic recovery has begun. Corporate earnings should rise at a double-digit rate during the second half of the year. Monetary policy will tighten around the time as well.
THESE ARE NOT INVESTMENT RECOMMENDATIONS. CONSULT YOUR FINANCIAL ADVISORS.<<< |
