4 reasons why the US is headed for recession

There are significant headwinds building for the US economy. Many of these were obvious a while back to those who had bothered to take a look. Now that they are starting to appear more obvious even some of the Wall Street lemmings are taking notice, although denial still seems to be the predominant view. Below are a few of the more obvious signs that the US economy is headed for recession in 2008.


Housing

Not even the most optimistic of bulls can be optimistic about the outlook for Housing except maybe for NAR chief chucklehead Lawrence Yun. Below is a couple of graphs from the Federal Reserve Bank of Dallas Economic Newsletter in Novemeber. The first graph shows the deterioration of Subprime as well as Prime mortgages. Don't expect Fed cutting rates to 1% this time around to have same effect they did back in 2002. The lines on this chart are headed higher regardless of what the Fed does.


Considering the collapse in housing construction and home prices the chart below is particularly disturbing as it shows the majority of resets on adjustable rate mortgages are yet to come.



But don't take my word for it, listen to what the Fed's own Randall Kroszner said yesterday:

... conditions for subprime borrowers will get worse before they get better. First, the bulk of the first interest rate resets for adjustable-rate subprime mortgages are yet to come. On average, from now until the end of 2008, nearly 450,000 subprime mortgages per quarter are scheduled to undergo their first reset, eventually causing a typical monthly payment to rise about $350, or 25 percent. Second, the weakness in house prices and the resulting limit on the build-up of home equity will hinder the ability of subprime borrowers to refinance out of their mortgages into less expensive loans; as a result, more borrowers will be left with a mortgage balance that exceeds the value of the house.

The likely consequences of these two factors--imminent interest rate resets and the difficulty of refinancing--will be yet higher rates of delinquencies and foreclosures over the next several quarters and, in turn, additional downward pressure on house prices. The overhang of unsold homes also will weigh heavily on the prices of newly built and existing homes. ...

Also don't forget the now observable downturn in Commercial Real Estate. Of course we all know that Housing is only 5% of the economy and can't on its own cause a recession. However, despite the chorus of lemmings on Wall Street that claim there has been next to no spillover to the the broader economy anyone with a modicum of common sense knows that housing busts don't occur in a vacuum.



Slowing Economic Output

Signs are everywhere of this but I just want to point out a couple. The ISM survey for manufacturing is sitting precariously on the fence that separates expansion from contraction. On Thursday the Philly Fed manufacturing index was a surprisingly robust 8.2 however the real news was in the forecasts. The index of future activity in the Philadelphia region fell sharply to 20.5 from 43.5 in October. The outlook index in New York fell to an all-time low of 30.5.

Yesterday Industrial production reported a -0.5% fall in October and capacity utilization fell 0.5 of a percentage point to stand at 81.7% in October marking the first decline since May. As John Hussman of Hussman Funds noted on Monday

from above 80% to below 80% has generally accompanied the beginning of recessions.

Downward Earnings revisions and Forecasts

This is obviously related to the previous point. Whilst there is nothing startling about downward earnings revisions it's the types of companies that they are coming from that is of interest here.


Federal Express (FDX)

FedEx cuts its quarterly outlook on rising fuel prices

Shares of FedEx Corp. struck a 21-month low on Friday after the country's second-largest packaging transporter lowered its fiscal second-quarter forecast due to rising fuel costs.

For the November quarter, the Memphis, Tenn.-based shipping company lowered its earnings outlook to $1.45 to $1.55 per share from $1.60 to $1.75. The company also dropped its full-year earnings estimate to $6.40 to $6.70 per share from previous guidance of $6.70 to $7.10.

I previously spoke about transport companies being good proxies for the health of the economy. However to put FDX's woes down to rising fuel costs would be oversimplifying. As the company itself states:

In addition, less-than-truckload freight trends in the FedEx Freight segment remain weak, which appears to mirror the decline in U.S. industrial production.

Also remember that the earnings downgrade from Fedex is a downgrade of a downgrade. Fedex slashed previous estimates back in September.


JC Penney (JCP)

J.C. Penney cuts outlook, adding to holiday jitters


J.C. Penney Co. reported Thursday a 9.1% drop in third-quarter profit, hurt by sweeping discounts to clear unsold merchandise. The department-store operator cut forecasts for the fourth quarter and the full year, citing macroeconomic concerns....

"We have to be realistic about our expectations for the balance of the year," he said, adding that "2008 is going to continue to be a difficult environment. We are planning 2008 very conservatively on expenses."

Kohl's (KSS)

Kohl's reports profit drops 14%, lowers outlook


Kohl's Corp. said Thursday third-quarter profit dropped 14%. The retailer, like its rival J.C. Penney Co., also lowered its forecast for the rest of the year, adding to retail jitters about the holiday outlook....

Assuming comparable sales of flat to 2% lower, Kohl's said per-share profit would be $1.45 to $1.51 for the fourth quarter and $3.52 to $3.58 for the year. Kohl's had previously forecast profit of $3.77 to $3.87 for the year....

Starbucks (SBUX)

Starbucks shares slip on trimmed forecast.

In a conference call Thursday, Starbucks Chief Executive Jim Donald said the company faces sluggish traffic at its U.S. stores and outlined plans to attract more consumers, including the company's first-ever nationwide TV ad campaign. The company also scaled backed its expansion plans to match current economic conditions.

"It is apparent that our customers are feeling the impact of the economic slowdown," Donald said. "We believe the combination of this slowdown and the price increases we implemented in 2007 to help mitigate significant cost pressures ... have impacted the frequency of customer visits to our stores."

Some fairly somber forecasts from the nations biggest transport company and some major retailers. Just so you don't think I'm picking on retailers:

Applied Materials (AMAT)

Applied Materials' income falls 6%; shares volatile

Applied Materials (AMAT) reported a 6% drop in earnings and said first-quarter revenue would also decline sequentially by 13% to 18%.

"It's a dynamic environment and caution signals from customers reflect uncertainty," he said on a conference call with analysts.

He (CEO Michael Splinter) said he expected chip capital expenditures to decline 5% to 15% in the coming year. He said he also expected investments in DRAM to "pull back" while investments by flash memory makers to continue to be strong

George Davis, the company's chief financial officer, said the first quarter of Applied's fiscal 2008 "reflects the softening in the semiconductor-equipment markets for orders and revenue."

This outlook squares with that of Cisco last week and shows that it is not just retailers, homebuilders, financials and transports that are feeling the pinch.

The broader picture of earnings going forward is what I've been saying for some time. Forecasts for 4Q07 and FY08 are too rosy and will have to come down. Analysts failed to predict negative growth this quarter but that's what we now have with almost all the S&P500 companies having reported this earnings season. I mentioned a while back that we were close to the end of this earnings expansion and now that has also become reality.



An ailing consumer

Despite the fanfare surrounding Walmart's 8% rise in earnings all is not well with consumers. The fact that the market gets excited by an 8% rise in earnings should tell you something about the type of environment we are currently in. The reports from retailers above should be evidence enough that there is a slowdown in retail spending.

The tepid retail sales number for October and plunging consumer confidence are also ominous signs. Tying in with the first point on housing, mortgage equity withdrawals (MEW's), which have have been one of the drivers behind consumer spending in the last few years is drying up as housing prices decline. Credit is harder to get and the consumer is feeling the pinch of higher gas, food and energy prices.

All this adds up to a simple conclusion, the US economy is headed for recession in 2008. As for the stockmarket, I'll give the last word to Mervyn King, governor of the Bank of England. From The Guardian:

Bank's grim warning over UK economy

The governor of the Bank of England issued a stark warning yesterday of a looming economic slowdown as he signalled that the next year will be the toughest for Britain in a decade.

Putting investors on high alert for a sharp fall in share prices, Mervyn King said the period ahead would be marked by slower growth, rising inflation, a weakening housing market and a falling pound. He expressed surprise that global stock markets had so-far shrugged off evidence of the slowdown.

The governor stressed that even the two quarter-point cuts in interest rates pencilled in to the Bank's forecasts would not spare consumers from a painful period of belt-tightening next year - and that the risk was that the UK economy would be even weaker than Threadneedle Street currently expects.

He said the Bank's "central outlook for the UK economy is, in the near term, one of slowing growth and rising inflation. But further ahead that outlook is for a return of growth to its average rate and inflation to target."

King stressed that the period of financial market turmoil that led to the run on Northern Rock was far from over and would be intensified by a tumble in share prices.

"It's very striking that despite developments we've seen in the last three months, equity prices are on average higher now than they were in August. This is true around the world and in emerging markets, they're 20% higher," King said.