Stocks Slump In Second Quarter: Worst To Come?

One of my favorite financial guys, Lou Scatigna gets it right again

Stocks Slump In Second Quarter: Worst To Come?
by Lou Scatigna

July 3, 2010


After an astounding 80% bear market rally from March 2009-April 2010, stocks market investors came to their senses and realized the economic situation is beginning to deteriorate and a double dip recession (or worse) is looming on the horizon.


The Dow Jones Industrial Average lost 9.4%, the S&P 500 lost 11.4% for the quarter. For the year the Dow is down 5.84% and the S&P 500 is down 7.38%.


It is my opinion that we have entered the second phase of the financial crisis, one that will be severe and long-lived.


Consider the negative factors:


Persistent Unemployment:


The U.S. economy lost 125,000 jobs in May according to the Bureau of Labor Statistics. They also announced that the unemployment rate dropped from 9.7% to 9.5%. How can the unemployment rate drop when 122,000 jobs were lost you ask? Well let’s look a bit deeper into the report. The decline in payroll employment reflected a decrease (-225,000) in the number of temporary employees working on Census 2010. Private-sector payroll employment edged up by 83,000.


Ok, so how does the unemployment rate drop when 225,000 lose census jobs and only 83,000 jobs are created in the private sector? Simple. You just decide to decrease the workforce by 652,000 people for the month. Presto, a decrease in the unemployment rate. These supposed “discouraged” job seekers somehow don’t count as unemployed as far as the Labor Department is concerned. Ask these people if they are feel unemployed or not.


Now let’s look at another way they fudge the job numbers, The Birth/Death Model. This is the BLS estimate of how many jobs were created by the start (birth) or loss do to closure (death) of small businesses. It is a number that is entirely made up since there is no way of measuring it. So lets examine the May B/D number. Hmmm a total of 147,000 new jobs were created in May by new businesses opening shop to take advantage of the robust economic landscape, ahem. Looking deeper, here is some fiction for you, 24,000 construction jobs were created during a month that saw an historic drop in new home sales according to B/D. Another interesting number is 80,000 new jobs were suppossedly created in hospitality, meaning travel and hotels even as families cut back on vacation costs. If we take out the fictional B/D figures the economy lost 272,000 jobs.


There is no way we can have economic recovery without job growth at a rate of 200,000 per month at a minimum. Millions of unemployed workers will be losing their unemployment benefits starting this month. People with no income usually do not spend much money in Target which will only add the economy’s headwind. First time claims for unemployment benefits have been stubbornly above 450,000 a week, not a number indicating what Joe Biden calls “The summer of recovery”.


Weak Housing


After a short period of housing price stability, housing sales have dropped off a cliff. After tax credit incentives to buy a home expired April 30th, both new and existing home sales plummeted over 30% in May, the biggest drop on record. All the tax credit did was rob from future months. Who in their right mind would buy a home in May, June or July when they could get a free $8,000 check from the government if you bought by April 30th?


Foreclosures are hovering at record levels and bank owned properties will further depress an already weak market. If an $8,000 tax credit and record low mortgage rates have not stimulated the housing market then nothing will (until inflation hits). Housing was the main cause of the financial crisis and will need to heal before there can be any hope of a sustainable economic rebound.


Insolvent States


Almost 80% of U.S. states are on the verge of insolvency. Think of Greece times a hundred. Tax revenues are plummeting while spending is rising due to generous union contracts that are difficult to break. Property taxes are rising in many states as will income taxes, further depressing consumer spending. Municipal bond defaults are a certainty in the near future and when the first major municipal bond defaults the entire muni market will freeze up making it difficult for states to raise capital. The federal government will have no choice but to bailout any state that is facing default further widening the country’s already huge budget deficit and increasing the nations debt.


The Oil Spill


The BP oil spill is having devastating environmental effect on the region but is also creating a huge economic downturn in the Gulf states. The uncertainty as to when they will stop the spill or what will happen if the oil comes ashore in a big way is only adding to the economic fear. The economic and environmental effects of the worst oil spill in history will be felt for many years, not only in the Gulf states but throughout the entire country.



Geopolitical


Preparations for war in the Middle East are ongoing and it looks like hostilities can start at anytime. There is no way that Israel will allow Iran to acquire nuclear weapons, period. Iran, through Syria has moved thousands of missiles into Lebanon for attacks against Israel. Iran has moved radar systems into Syria this week and U.S. Naval assets have been positioned in the Red Sea. Hostilities in the Mid East could quickly become World War III as the U.S., Russia, China and Egypt take strategic sides. Any military action in the region will cause oil prices to rise violently. Gasoline and heating oil costs would escalate adding another mighty drag on the world economy.



Europe



Europe is a basket case economically. The experiment that is the European Union is starting to fall apart as southern European countries battle huge budget deficits and debt. The European Central Bank has stated they will buy as much as $1 trillion in soveriegn bonds to ease the situation, but that will not stop the default of one or more countries in the E.U. A collapse of the Euro will drag down the entire world economy.



Other Factors



There are many other factors that could adversly effect the financial markets including: a failed U.S. bond auction, a runaway gold price signalling inflation is coming, a failure of a major financial institution, a major terrorist attack, and a hostile political environment heading into November’s mid-term election just to name a few.



I would not be surprised if we test the March 2009 lows on the stock market by year end. The historic bear market rally is over and the resumption of the bear trend has begun. The stock market’s second quarter drubbing may be the prelude to much more serious decline on the horizon. Protect yourselves accordingly.

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