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Housing and financial services job cuts are already large and more are coming. But job losses have spread well beyond housing and finance. Manufacturing jobs will continue to be lost as consumers buy fewer domestic goods and foreigners buy fewer American-made products. Retail jobs, normally the employment of last resort for the newly unemployed, are shrinking rapidly. Retail trade employs 10% of the total, but since November 2007, accounted for a quarter of jobs lost, or 320,000, as consumers cut their spending. And another 209,000 retail employees had their full-time hours cut to part-time. Estimates are that 6,100 U.S. stores -- ranging from mom-and-pops to major chains -- will fold this year, up 25% from 2007, and followed by 14,000 stores in 2009.
Impotent Monetary Policy
Conventional monetary policy ease through central bank target interest rate cuts at present is nearly useless, i.e., pushing on a string. Qualitative easing, now actively pursued by the Fed and the Treasury and by central banks and governments abroad, will probably at best only stabilize demoralized financial structures by substituting government securities for questionable assets with little near-term rejuvenation of lending and economic activity.
Also, bear in mind that in democracies, governments are almost guaranteed to be behind the curve in dealing with financial and economic crises. That's because voters elect them to respond to their concerns, not to act in anticipation of yet-unseen problems. Politicians are responders, not planners. In 2006, neither voters nor politicians wanted to prepare for a mortgage market collapse, but voters demanded and got swift action after the crisis unfolded in 2007 and this year.
This means that any resuscitation of the global economies falls on fiscal policy and, as usual, the effects will be delayed, influencing the recovery after the recession rather than shortening its normal course. The incoming Obama Administration is, of course, talking about a sizable fiscal package, perhaps $500 billion to $700 billion, or 3.5% to 5% of GDP.
$700 Billion In Perspective
That's a lot compared to the size of post- World War II recessions (Chart 8). Notice that the 1957-1958 recession, the most severe so far, has a peak to trough decline in real GDP of 3.7%, and the long and deep 1973-1975 downturn saw a 3.1% decline. We're forecasting the most severe recession since the 1930s with a 5.0% decline. You may think that a 5% decline is not a lot, but bear in mind that recessions are more interruptions in growth than economic collapses -- growth that business, consumers, employees and government assume will continue without interruption. Similarly, the 21% decline in the Case-Shiller house price index so far (Chart 2) is small compared with the more-than-doubling during the bubble years. Still, it's very painful for those who made small downpayments at the top and those who extracted their equity when prices were still high.

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Real GDP Declines in Recessions
Even a $700 billion fiscal package would probably have limited impact on the recession, and not start to be effective until the end of 2009. And even then, the effects will probably barely offset the negative cumulative recessionary forces. Obama says his proposal will create 2.5 million jobs over two years. But as discussed earlier, payroll declines are likely to continue to run 500,000 per month, so his program would only offset five months of recessionary losses.
Phase 4
Phase 4 of the recession, its globalization, is clearly underway with almost every major country's economy falling whether or not the official recession label has yet been applied. One indicator of weakness is the 2.4% decline in global semiconductor sales in October after a 2.1% fall in September from a year earlier, reflecting softness in computer and cell phone sales. The worldwide turndown is driven by housing slumps, notably in Ireland, the U.K., Spain, Australia and China. U.S. financial woes have spread to almost all major financial institutions worldwide. And consumer spending has been weak in Europe and Japan. U.S. consumer spending accounts for 71% of GDP but less than 60% in all other G-7 countries except the U.K. Sure, much more of healthcare and education expenditures tend to come from government, not consumer pockets in those lands, but households have traditionally been more cautious spenders than Americans, especially in recent years.
And this introduces another key reason for global recession -- retrenchment of U.S. consumers, which depresses U.S. imports on which the rest of the world depends for growth. The huge U.S. trade deficit is the counterpart of the rest of the world's huge surplus.
Commodities
Obviously, the commodities boom is over (Chart 9). Prices of energy, base and precious metals and agricultural products are all down significantly from peak prices. The global recession has reversed the earlier excess of demand over supply.
Reuters/Jefferies Commodity Research Bureau Index

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Also, institutional and individual investors who earlier rushed into commodities under the belief that they are a legitimate asset class like stocks and bonds are stampeding out even faster. The financial crisis has also made investors wary of structured notes and other commoditylinked instruments -- and of the firms espousing them.
Tsunami In The Swimming Pool
As noted at the outset, the first two phases of the recession were largely financial, the residential mortgage collapse and the following Wall Street woes. Then, like a tsunami in a swimming pool, that financial tidal wave rolled to the other side and inundated the goods and services economy, with Phase 3, consumer retrenchment, and Phase 4, global slump. Now the tsunami is being reflected back to the financial side of the pool in three ways.
First, retrenching consumers will keep pushing up delinquencies on credit cards, home equity, auto and student loan debt, which will result in big writedowns for their many institutional holders. Collectively, these four categories amount to $4.4 trillion, dwarfing the $0.7 trillion in subprime loans.
Commercial real estate debt is the second problem area, and of the $3.5 trillion outstanding, $800 billion is in commercial mortgage- backed securities and $2 trillion in commercial mortgages held in regional and community banks. As vacancies rise, big writedowns will follow.
Third is nonfinancial leveraged loans and junk binds. Delinquencies have barely risen from rock bottom levels, but will as anticipated by yield spreads and 20% junk bond yields. Recession-depressed revenues here and abroad, collapsing commodity prices (Chart 9) and the leaping dollar that will turn earlier currency translation gains to losses, will all slaughter the corporate earnings of nonfinancial corporations, so far relatively untouched by the financial recession. So delinquencies and charge-offs of junk securities will leap and many investment-grade debts will be pushed into junk territory. Junk bond spreads vs. Treasurys now imply a 21% default rate, higher than in 1933 at the bottom of the Depression. Financial institutions also own a lot of the $3.7 trillion in leveraged loans and junk bonds.
If the tsunami moving from the goods and services side of the pool does considerably more damage to the financial side, it will again be reflected back and even tighter financing will devastate the real economy. Policymakers here and abroad, of course, are trying to erect baffles in the form of bailouts in the middle of the pool to dampen the waves. They are learning that they have to build those baffles bigger and stronger to prevent the waves washing over them. Their moves from Fed interest rate cuts to massive quantitative easing, described earlier, shows they're making progress.
Recession Ends When?
If policymakers succeed in containing the mortgage mess and bailing out financial crises related to consumer borrowing, commercial real estate and junk securities -- and other financial problems we haven't explained in detail -- then the recession may well end at the end of 2009 as massive fiscal stimulus begins to take hold. If not, it probably will extend well into 2010 and perhaps beyond.
To end the crisis, four developments are needed, in our view. The elimination of excess house inventories will probably continue until at least the end of 2010, as discussed earlier. The writedowns and recapitalizations of financial institutions -- at least those related mainly to mortgage-related problems that have unfolded so far -- are well along.
Subsidizing the mortgages of underwater homeowners is beginning to develop. And of course the quicker the excess house inventories are eliminated, the more limited will be further house price declines and the fewer will be the additional homeowners who will slip under water. Bailouts of bad loans and securities in the three additional areas we've identified are big unknowns in terms of cost and feasibility. Nevertheless, policymakers are gaining experience as they grope their way through the current round of bailouts and may be real pros when further big problems surface.
The Dollar
At the end of last year, we forecast that the dollar would end its seven-year slump and rally later in the year against most currencies, but not the yen. And it did, starting in July. It was obvious a year ago that far too many were negative on the greenback. As with commodities, many institutional and individual investors considered foreign currencies as an asset class, worthy of a certain percentage of their portfolio.
Much more importantly, we were forecasting a major global recession and reasoned that, as usual in times of trouble, the dollar would be the global safe haven. We didn't expect the U.S. economy to improve but that the rest of the world would join America in the tank. The greenback would be the best of a universally bad lot. We expect the dollar to keep rising for the next 5 to 7 years, continuing the long- run pattern.
Profits
With the nonfinancial sector joining financial businesses in full retreat, domestic corporate earnings will be decimated in coming quarters, as discussed earlier. And U.S.-based multinationals will also be clobbered by weak foreign revenues and the strong dollar, which will make foreign earnings worth less in dollar terms. Some 30% to 50% of revenues of consumer staple companies like PepsiCo, Sara Lee and Campbell Soup come from abroad. With our forecast of a severe recession, we look for corporate profits, as defined by the Commerce Department, to fall 48% from their peak in the third quarter 2007 to the fourth quarter 2009, and to drop 32% from 2008 to 2009.
P/Es and Stock Prices
Our forecasts imply S&P 500 operating earnings of $40 per share in 2009, down 35% from our $62 estimate for this year. That may sound extreme, but not for the most severe worldwide financial crisis and deepest global recession since the 1930s. At stock market bottoms, the S&P 500 P/E tends to be in the 10-12 range. But low interest rates normally push up P/Es and 10-year Treasury now yield 2.66%, and will probably be even lower later while 30-year Treasury bonds are now at 3.0%, our long-held target, and also a low in recent decades, but may drop further.
So a P/E of 15 at the stock bottom sounds reasonable, but would put the S&P 500 index at 600 then, down 32% from here and 61% below its record close on Oct. 9, 2007. Wow! Earlier, we warned of the number 777, not the Boeing airliner model but the low on the S&P 500 in 2002. If it were breached, we noted, then the bear market that started in early 2000 would still be intact, and all of the rally from the 777 low in October 2002 to the peak five years later would merely be a rally in a bear market. Last month, the S&P 500 fell below 777. It has since bounced, but probably not for long as new lows lie ahead.
There are other reasons to expect considerable further weakness in stocks. High dividends can support stocks at least to a degree, and dividend yields in Europe are meaningful, averaging 5.2%. But not in the U.S. where the S&P 500 yield is a miserly 2.5%. And dividend cuts are coming fast and furious. In the U.K., dividends are constrained for financial institutions getting government bailouts, while in the U.S., the financial sector is slashing dividends.
Some 36 of the S&P 500 have cut dividends 46 times this year, axing $33.8 billion, with $30.8 billion coming from financials. Among those S&P 500 firms, about 20% of dividends this year are from financials, down from 34% in 2007. Elsewhere, REITs are cutting payouts, and GM eliminated its dividend. Only 202 S&P 500 companies have initiated or raised dividends 218 times this year, representing payments of $18 billion, with only $2.4 billion being from financials. In 2007, 298 did so and only 12 reduced or suspended dividend payments.
In troubled times, investors tend to withdraw from foreign markets to concentrate on the home scene they know best. That's why bear markets tend to be uniform. U.S. investors sold a net $92 billion in foreign stocks and bonds in the July-September period, a record flight from overseas investments, while foreign investors pulled over $100 billion from stocks in Japan, South Korea and India so far this year. U.S. stocks are actually falling less than most foreign markets.
Deflation
For years, we've been forecasting that chronic deflation of 1% to 2% per year would start with the next major global recession. Well, it's here! In October, the U.S. producer price index fell 2.8% from September and the CPI dropped 1.0%, the biggest decline since before World War II. Sure, the big driver was the decline in energy costs, but even excluding food and energy, consumer prices dropped 0.1%.
The Fed worries that in deflation, offsetting monetary policy is difficult since its target rate has to stop declining when it reaches zero. Of course, the Fed has other tools as witnessed by the quantitative easing discussed earlier. Nevertheless, all these measures amount to leading the horse to water, as discussed earlier, and he may not drink. The deflation in Japan in the 1999-2005 years worried the Fed when it appeared imminent in the U.S. early in this decade, and it still does. Japan again faces chronic deflation, and the Bank of Japan forecast zero change in the CPI (ex food but not energy) for the fiscal year ending March 2010. Fed Vice Chairman Kohn said the lesson from Japan was that "we should be very aggressive in combating deflation."
Deflation encourages saving since money is worth more later. It also spawns deflationary expectations. Buyers anticipate lower prices later by waiting to buy. That sires excess inventories and capacity, which forces prices down. Buyer suspicions are confirmed so they wait even further to buy, generating a self-feeding downward price spiral, as now seen in autos and houses. Deflation also elevates the cost of debts and debt service since both remain fixed in nominal terms but the revenues and incomes used to repay them tend to fall with overall prices.
Deflation fears and other forces have also reduced reducing 30-year Treasury bond yields to our long-held target of 3.0% and completed what we dubbed in 1981, when the yield was 14.7%, "the bond rally of a lifetime." The recent financial crisis has also helped as investors abandon everything else -- stocks and fixed income alike -- in favor of Treasurys. wFhaloanrateequitymortgage O Fap E Mortgage Equity Lt 1 Loan Rate Equity Mortgage Semi-Annual U.S. Economic Outlook: Collapsing On Scheduler k Mortgage w Iphone%B9%CC%BC%FE06%2015 a a Mortgage Loan Rate Equity Mortgage eFhaloanrateequitymortgage O Fap E Mortgage Equity Lt 1 Loan Rate Equity Mortgage Semi-Annual U.S. Economic Outlook: Collapsing On Scheduley j b b Loan Rate Equity Mortgage Loan Rate Equity Mortgage Loan Rate Equity Mortgage