Two recent articles, one from Bloomberg and one from the New York Times, when taken together imply that a near-term pop for the U.S. economy is likely to be followed by a years-long period of stagnation. What this means for traders is fairly simple; ride the wave thatâ€™s likely to continue for at least the next several months (if not longer)while keeping your finger firmly on the button as you avoid complacency.
The Bloomberg article highlights comments made by former Fed Chairman Allan Greenspan, who, despite continuing to be a (rightful) target of blame for the credit crisis remains as always a superb economist.
â€œA lot of pieces are falling into place for recovery,â€ Greenspan said in a speech in New York on Wednesday. He predicted â€œa fairly pronounced recovery not only in the U.S.,â€ but globally. â€œSurprises are on the upside.â€
Helped by â€œremarkable growthâ€ in productivity, Greenspan expects to see U.S. GDP growing by 2.5% (annualized) in the current quarter. Productivity is a measure of worker output; the more produced in less time, the higher the rate of productivity (and corporate profits). Greenspan has often highlighted the fact that the enormous growth in computing power was a major factor in increased productivity over the last 20 years. Of course, thereâ€™s a second, but no less important benefit to be gained as productivity increases because as the cost of production goes down, inflation remains contained.
â€œComeback will be acceleratedâ€ by â€œremarkable growth in output per hour,â€ he said. Businesses have waged a â€œhuge cost- cutting programâ€ that has bolstered profits.
This is a very important factoid which points the way to a continued strong recovery in equity markets (and therefore, downward pressure on the dollar). Remember that early in the rally, some argued that firms could not simply lay-off workers as a means to sustained profitability. This idea is proving to be wrong however because the facts are that as companies trim the fat and get leaner, theyâ€™re producing goods and services more efficiently.
Here then is explained why employment is a lagging indicator of economic recovery and why smart investors basically ignore the employment figures at this stage of the business cycle. Simply put, cutting out the blubber is a good thing notwithstanding the difficulty of those whose job depended on the ability of firms to carry the weight of excess workers.
The future doesnâ€™t look all that bright for those who lost jobs either. Unfortunately, the unemployment rate will stay elevated with no â€œsubstantialâ€ recovery in jobs until at least next year, Greenspan said. But what you as a trader needs to know is that the economy â€œis going to grow very significantly prior to the actual unemployment rate falling.â€
On To The Longer-Term Picture
According to the New York Times, citing figures from the real estate information company First American CoreLogic, there are 2.8 million active interest-only home loans in the U.S. worth a combined total of $908 billion. In the next 12 months $71 billion of interest-only loans will reset, with $100 billion to follow after mid-2011 and another $400 billion more after mid 2012.
The problem of course is that once borrowers have to begin paying the principle, monthly payments will become unaffordable as they jump by as much as 75%. And when you combine that with the fact that probably all of these homeowners are in negative equity ( where the homes are worth less than whatâ€™s owned on the mortgage) it points to a situation of rising defaults over much of the next decade as these interest-only loans mature.
A 30 year loan that is interest-only for its first 10 years means the entire house has to be paid off in the next 20. Taking out a loan like this made sense in the boom years, because it got the borrower into a bigger house than they normally could afford and because as home values rose, the loans could be refinanced after the interest-only period expired (sometimes even with cash out to the borrower)!
Of course, after the collapse, this â€œtradeâ€ has turned into a huge loser not only for the borrower but for the banks which hold them, implying that new lending will be restricted for years to come.Â Experts predict a steady drumbeat of defaults over much of the next decade as these interest-only loans mature. Auctioned off at low prices, those foreclosed houses could help brake any revival in home prices.
At the same time, thereâ€™s a multi-trillion dollar crisis brewing in commercial mortgages as well. This type of loan, even while not being interest only, is usually written with 10 year terms over 30 year amortization periods, meaning that they have to be refinanced (or a balloon payment has to be made) once the loan matures.
The problem is that values in commercial property have fallen dramatically across the country. Thatâ€™s going to make refinancing more difficult and expensive to do while often leaving the owner in a negative equity situation. And because rents have fallen while vacancy rates increased, an owner may not be left with enough income to service the new debt, making borrowing impossible.