Stock Watch: Consumers to the rescue

It’s difficult at best to ignore the sanguine mood on Wall Street lately. With Ben Bernanke, President Obama and Treasury Secretary Geithner constantly touting the myriad programmes in support of the financial infrastructure, it’s no wonder the few positive developments we’ve seen seem to have such an overwhelming impact. Seemingly eons ago investor confidence was built on the tenets of proven fundamentals. Yet, in the last eight weeks, investors have gained renewed faith in their employment and income picture and are increasing their appetite to riskier financial assets.

The Fed policy makers in their statement following the 29 April meeting noted slight improvements in financial conditions. They cited stronger business and consumer confidence, and expectations for improvement in industrial production replacing the inventory liquidation in the last six quarters. This, they believe will cause the pace of economic contraction to ease. Undoubtedly an increase in confidence is positive for a recovery, but by no means are these factors the Rock of Gibraltar.

To be fair, there have been some positive signs; interest and mortgage rates are quite low and are expected to remain low for a while, companies and consumers are de-leveraging and cleaning up their balance sheets by writing down toxic assets and shoring up their capital reserves. On the job front, the severity of the declines in initial jobless claims, factory hours worked and layoff announcements seem to be abating while central banks are actively employing many innovative measures to show their commitment to win this battle. Looking at these factors one can deduce that recovery is ahead, but it’s mind boggling that the market quickly shot up in excess of 38 per cent within two months on just the mere prospects. It does not suffice that the programmes have the propensity to work, but must also spur real demand that can lead to a meaningful and sustained recovery.

The consumer remains extremely challenged on many fronts. Home prices, the largest contributor to wealth, are still in a downward spiral. Unemployment, at 9.4 per cent in May, is expected to worsen as we approach 2010 and the GM and Chrysler bankruptcies take effect. Treasury markets, the basis for mortgage rates, remain quite volatile sending 30 year rates up by 50 basis points in a single day. Coupled with a slew of regulations being proposed, unavailability of credit and the prospects of a longer recovery period, will only serve to encourage savings and temper the spending that is much needed to pull the economy out of this trough.

Businesses are facing the same fate. With economic forecasts showing depressed activity throughout 2009, one should expect continued cutbacks in capital spending and manpower until there are clear signs a recovery can be sustained. Increases in mortgage delinquencies, foreclosures and backlog of unsold properties will further reduce lenders’ earnings potential from lack of mortgage origination and refinancing opportunities. As market participants oscillate between deflation and inflation, the tightened and increased cost of business credit and the impending meltdown of the 1.3Trillion commercial real estate market, this does not present a menu of attractive possibilities that the confidence cited by the Fed will be sustained.

Notwithstanding, the consumer has historically bode well in aiding a recovery. In 2001, the tech bust resulted in a mild recession as some areas of the economy, consumer spending and housing, held up relatively well. But historical tendency is just that, tendency, and not a guarantee that past relationships will persist. With consumer spending contributing approximately seventy percent to GDP, it is no wonder the White House, Fed and Treasury are aggressively promoting and lobbying this group. What remains to be seen is if the consumer will yet again be the catalyst to pull the world economy out of what could be the deepest, longest and most dispersed post war recession on record.

Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.



Butterfield Bank’s Brendalee Scott-Novak