Are We Out of the Woods?

Since the global credit crisis began, banks and financial institutions have reported more than $1.5 trillion in credit losses and writedowns worldwide. Even though it seems like we passed the hardest economic period in decades, I strongly believe we are not out of the woods yet. To understand when we could reach that spot, I would pinpoint some key metrics that we should look at when judging the stage of the global economic revival. I hope that many of my readers would agree that the epicenter of the global financial meltdown will coincide with the place where the economic rebound is to occur first. By all means, that place is the US economy.
As many experts believe, and I subscribe to that viewpoint, the stock market dynamics should be the very first thing we should carefully pay attention on. From the March 9th low point, the S&P500 index has rebounded almost 50%. Historically speaking, the markets have behaved like a strong forward looking indicator. Moreover, it is well accepted that the equity markets pre-announce the economic growth with 6 months in advance.
Since the global financial debacle has been triggered by an unprecedented downturn in the housing markets, the recipe for fixing the current economic crisis has to be the real estate market. I do believe that there is a small probability we could witness a second wave down, especially if the current residential market gets contaminated by the commercial real estate downturn. If the real estate prices dropped by another 10 percent or more, we would see a major acceleration in foreclosures. However, the latest economic indicators signal a higher probability that we are close to stabilization. For instance, the number of contracts to buy previously owned homes in US, one of my favorite leading indicators, rose in June for a fifth straight month. Foreclosure-driven declines in home values and tax incentives are putting houses within reach of first-time buyers, helping to stabilize the real-estate market.
Objectively speaking, the economic recovery is likely to be muted as job losses and falling home values cause Americans to limit spending. Consumer spending accounts for about 70 percent of the US economy. Personally, I do not see the consumer coming back strongly. The job market continues to cloud the outlook for spending. The unemployment rate is projected to surpass 10 percent by early 2010. Excluding the effects of the stimulus plan, incomes would have dropped 0.1 percent in June after no change the prior month, according to Commerce Department. Wages and salaries decreased 0.4 percent in June, the ninth drop in 10 months. Before seeing the light at the end of the tunnel, the aggregate demand should start driving the hiring process. On the road to a higher employment, we should see strong trends of lower weekly initial unemployment claims, higher average workweeks and massive part-time jobs transition into the full-time positions.
Last but not least, we should watch the so-called Libor-OIS spread. The gauge of bank reluctance to lend has narrowed to 28 basis points from 364 basis points on October 10 2008. By historical standards, normal credit markets operate with a Libor-OIS spread south of 25 basis points.