This list tells you why I believe we are in the worst bear market of our collective lifetime.
10. Poor Outlook for Small Businesses – Small businesses make up more than 50% of non-farm GDP, employ about half of the nation’s private sector workforce, and create most of the nation’s new jobs according to the Small Business Administration. For the month of May, the National Federation of Independent Business reported that small business owners had a more negative outlook on job creation, capital expenditure plans, and future sales expectations. Considering that small business owners have more tenuous access to credit and are uncertain about cash outlays for healthcare and unemployment benefits, many are putting growth plans “on hold”. If 50% of GDP and employment remains “on hold”, it points to the strong possibility of a double dip recession and, in turn, another decline in the S&P 500.
9. Cash Outflows Are Trending Poorly – ICI reported that for the week ended June 16, domestic equity mutual funds saw $1.8 billion in outflows for the seventh sequential weekly outflow. Despite net activity of $5.2 billion for 2010 thus far, the first seventeen weeks of the year were comprised of $40.6 billion in inflows while the last seven weeks represented $35.4 billion in outflows. Should this trend continue, it will put managers in an awkward position of having to sell “winners” to meet redemptions due to the low levels of cash on hand. If both of these trends continue, one would have to believe it will have a negative impact on the S&P 500.
8. Tax Cut Expirations – Art Laffer, apparently not one for mincing words, wrote an excellent opinion piece in a recent The Wall Street Journal called, Tax Cuts and the 2011 Economic Collapse. While his title gets at the point rather well, briefly, in summary, Mr. Laffer made the very strong case, in my opinion, for the idea that income and production will be inflated above where it would be otherwise in 2010 since in-the-know individuals and businesses are shifting income, when possible, to 2010 in order to avoid the tax hikes that are coming in 2011. Not only did this happen in 1993 from 1992, but he believes “…this shift in income and demand is a major reason that the economy in 2010 has appeared to be as strong as it has. When we pass the tax boundary of Jan. 1, 2011, [his] best guess is that the train goes off the tracks and we get our worst case nightmare of a severe “double dip” recession.”
7. Deflation – In the most macro-terms possible, and at the risk of being repetitive, until the asset class at the eye of the financial storm – residential housing – heals via stabilized pricing, we are living in a world of deflation. This is reinforced by record low mortgage rates. In more micro-terms, over the last 12 months, the core rate of inflation has risen only 0.9% or well below the 2.0% average annual increase over the past 10 years. In addition, returning to small business owners, 28% reported making price reductions in May, an increase over April, while this price cutting contributed to a high percentage of such owners reporting declining sales. Lastly, the Fed’s extraordinary liquidity efforts of the last two years have led to stagnant money rather than monetary expansion. Should this transform into a true “liquidity trap”, stagflation is the best case scenario but outright deflation is more likely.
6. High Unemployment – 15 million Americans are out of work. Nearly half of those people lost their jobs after December 2007. Private sector hiring appears to be at a standstill with only 41,000 new jobs created in May. 46% of the unemployed have been out of work for more than 6 months or the highest percentage since this record has been kept back in 1946. The real unemployment rate, counting those who have simply stopped looking for a job, is nearly 17%. All in all, a rather bleak picture on the employment situation here in the U.S. and one that will lead consumers to remain on the spending sidelines and especially for houses.
5. Commercial Real Estate “Crash” – Various sources estimate that between $1.3 and $3.5 trillion in commercial loans is coming due in the next 5 years with more of it weighted toward 2012. This could be an ugly event. This is especially true if banks are unwilling or unable to offer new financing to the borrowers since commercial real estate owners will then be put in the awkward position of having to pay for multi-million dollar commercial real estate holdings in cash. While some will be fortunate enough to do so, there are others who will not and this will force mainly small and mid-sized banks, and insurance companies, to write down bad loans and determine what to do with portfolios of commercial real estate in a depressed market. This situation is so grave that chairperson of the Congressional Oversight panel, Elizabeth Warren, said that half of all commercial real estate loans will be underwater by the end of 2010 and the bulk of these loans are concentrated in small- and mid-sized banks. She even went so far as to say that this will devastate small-business lending and create “a downward spiral of economic contraction.”
4. Housing Double Dip – After a year of respite for the U.S. housing market due to the government’s tax credits and MBS purchases, residential housing is set to take another deep dip down. May’s non-government “owned” housing market activity was awful. Housing starts dropped by 10%, permits fell by almost 6%, mortgage applications were down, the homebuilders’ sentiment index dropped, existing home sales fell by 2.2% while new-home sales took a 33% nosedive. However, it is the combination of the S&P/Case-Shiller Index and annual housing starts that demonstrate that the housing market’s direction is down.
Source: Standard & Poor's and Fiserv
Source: U.S. Census Bureau
While this Tuesday’s CSI release may be to the positive as may be both July and August, the chart at top () shows that there is a very real chance that pricing could level off where it had been in the late 1990s while housing starts are in unchartered territory having broken multi-decade support of about 1 million starts annually. It is difficult to see how the gravity of either chart can be warded off in the next 5 to 10 years, and thus to understand how the housing market can move in any direction other than down.
3. Financial Institutions Are Tied to the Housing Market – Putting aside the potential implications of the bank-reform bill and any links between U.S. banks and both European banks and sovereign debt, financial institutions are likely to have a tough go at it again. I spoke to a banking analyst yesterday who told me that if the decline in housing is accompanied by a worsening unemployment picture “it will really flow through” to U.S. banks and insurance companies. This “flow through” will show up in two places: (1) security portfolios, and, (2) loan portfolios. Remember the “toxic assets” of 2008? They still exist to the degree that they were not sold off or written down. If the upcoming decline in housing is aggravated by unemployment, it is likely to spur another wave of delinquencies and foreclosures. This will hit the value of the security portfolios because much of the paper will become “toxic” again due to the non-performing loans layered in the various, and sometimes repackaged, tranches of debt. However, it will also hit the loan portfolios of banks, and this analyst thought this was the real danger, because banks will have to write off a new wave of bad loans and figure out to unload houses in a truly distressed housing market. All of this is why I continue to believe that until the asset class at the eye of the financial crisis heals – housing – we can be assured that the crisis itself is not over.
2. The World’s Unsustainable Borrowing Binge of the Last 30 Years – While not nearly as powerful as Mr. Laffer’s title, it does speak for itself. The private sector, and financial institutions in particular, borrowed in what proved to be an unsustainable manner between 1980 and 2007. “Unsustainable” because active borrowing as measured by the Federal Reserve collapsed in 2009 to -$611 billion from its annual peak of $4.6 trillion in 2007. That is a huge, almost incomprehensible decline in borrowing to have occurred in two years. The U.S. government has attempted to shoulder some of that load by borrowing about $2.9 trillion in the last two years, but it is a nearly impossible task. Should it prove to be more than the U.S.’s balance sheet can handle, it will result in foreign creditors demanding a higher rate of return on Treasurys as is happening in Greece today. This will devastate banks because their fixed-rate assets will be underwater, but more frighteningly, the U.S. dollar will become severely devalued if not collapsed.
1. The Ugliest Chart of All Time – Unless there is an act of God between now and 4 pm EDT this coming Wednesday, the chart of the S&P 500 will be forever altered for the worse. This chart is, of course, the basis for all of my work, or what I have called the Twin Peaks, or the S&P 500’s severe double top with a technical target that is far, far below where the index is today.
And there you have it, the Top Ten Reasons To Be Bearish and why I believe we are in the worst bear market of our collective lifetime.
Disclosure: No positions.