Delos Smith: The Economy Will Stall Until Consumers Recover

Includes: DIA, SPY
by: Harlan Levy

Delos Smith is senior economist for The Security Executive Council, a Fordham University economics professor, and president and chief economist for Delos Smith & Associates. Previously, he was senior business analyst with The Conference Board, issuer of a monthly consumer confidence survey.

Harlan Levy is a business reporter and consumer columnist at the Connecticut daily newspaper The Journal Inquirer.

H.L.: Weak earnings from General Electric (NYSE:GE) and Bank of America’s (NYSE:BAC) big earnings loss sent the stock market down on Friday, eclipsing the Dow Jones Industrial Average’s Thursday rise over 10,000. The the Dow almost hit 100 yesterday. So, are we in a bull market that will get back on track or will the bears dominate?

D.S.: I think it’s still a bull market for the investment world. Again, I see the positives in the earnings reports. Goldman Sachs’ (NYSE:GS) report was very positive, and Citigroup’s (NYSE:C) was better than what we were expecting. In fact, most of the earnings have beaten estimates. So, in the future the market is positive, although it could be quite sluggish.

H.L.: The fact that the dollar is weak is either bad or good, depending on which analyst you listen to. What’s your opinion?

D.S.: The dollar is where we want it to be, because the Treasury has made no interventions at all. So this relatively low dollar, relative to other currencies, is positive from the U.S. government’s point of view.

If it gets too low, we can strengthen the dollar by intervening in the currency markets and buying dollars and have it organized so that a lot of other countries would do the same. So I’m not worried about the dollar.

Remember, the Chinese pegs its currency with us, so there really has been no change for them. They consider it very positive as their export business is starting to get much better.

But a weak dollar is not the big issue at this moment. It’s not even close to it.

H.L.: What’s the big issue?

D.S.: The consumer. The consumer represents close to 70 percent of the economy, and the consumer is still very, very troubled and needs a lot more healing.

One major indicator is the consumer confidence measures put out by The Conference Board and the University of Michigan. On Friday we had the preliminary report from Michigan, and consumer confidence actually slipped, which is not a good sign. The Conference Board’s consumer confidence index has been in the 55 area overall, which is very low. Normal is 90. If you look at how consumers consider the present, as opposed to expectations for the future, the present is 25, and the future is 73. So the present situation is dreadfully low and has not changed since the recession. The bottom was at 23, so we’re at the bottom.

Another key factor is consumer credit. The last month it was down $12 billion and has been down for the last seven months. Consumers have lowered its debt by over $100 billion, which means the consumer is still saving and healing and deeply concerned about what is happening in this economy. And this economy is not going to go anyplace until the consumer feels better.

H.L.: Job losses are coming down, but we still had 514,000 initial jobless claims in the week before last. Will the recovery stumble because of job losses?

D.S.: The job picture is always a laggard, but the claims number is still relatively high. It should be about 450,000 if the economy was really starting to heal. The non-farm employment had a setback last month, and the unemployment rate is still going up and will soon be over 10 percent, so the consumer is still very nervous.

It certainly is true that the financial markets are feeling much better. The inventory situation is in very good shape. That is probably the most positive factor in the economy. There is virtually no inventory overhang at all. In fact, inventories are so low that you’re going to have to have some rebuilding of inventories, and this is why some of the production measures look so much better, especially the two Institute of Supply Management numbers for manufacturing and non-manufacturing.

But this inventory increase and production increase is not going to last until the consumer gets back into the game.

H.L.: What’s happening in housing?

D.S.: The housing sector has improved very steadily. We will have numbers later this week for new and existing home sales. The key numbers will be inventories. For both, inventory levels are getting close to normal levels. This is a very key factor. Getting the inventory levels down is key for the healing of the consumer, because housing is so important to consumers.

H.L.: What do you think of the financial sector?

D.S.: The financial sector is our best and strongest area, showing the most rapid recovery. But you have to remember that the financial sector is part of a global financial system and is not dependent on nation states. At this moment it is doing very, very well and will be most helpful for getting the consumer to start feeling a little better.

H.L.: What do you think of the Obama administration’s goal of stricter regulation of the financial industry?

D.S.: It is needed very badly. It’s going to be very difficult to pass, but it’s an area that needs to be regulated, because we don’t a repeat of what created the problems that sunk the economy and the financial world.

But the main problem is that there has to be global governance, and global governance is going to be extremely difficult. At this moment it means that the nation state central banks have to work very well together.

We also have to make sure that the rating agencies are up to speed. They need to understand the new financial instruments, which they didn’t know. So many of their ratings were very wrong and misleading.

We love sports, but every sport has umpires and referees. If we didn’t, sporting events would be chaos. With the incredible financial technology available in the financial markets, the need for regulation and understanding what’s going on has never been greater. Therefore our referees and umpires must understand the financial markets, which they did not just a little while ago and which they let go out of control.

H.L.: How do you see the economy in 2010?

D.S.: If we have good management, cooperation and coordination among nations, and good luck, the economy should start to heal, and we will again have positive numbers. And there’s a good chance we will. If we don’t, the global economy will be sluggish, but because of the sluggishness there will be a lot of pressure to have good regulation and good understanding of what’s going on.