Market Update
Dwight Johnston
Vice President, Economic & Market Research
Bad News Is the New Good News
During the last week of April, we read the following headlines: "Chrysler Files Chapter 11", "First Quarter GDP Plummets by 6.1%", "Swine Flu Threatens Global Economy." In last month's Words from WesCorp, I mentioned how market psychology has changed dramatically, and the market was taking "less bad" news as good news. That positive market psychology reached a new extreme last week when those grim headlines resulted in stocks closing higher on the week. Bad news is now the new good news.
It's easy to dismiss the swine flu news as media mania. We certainly hope that is the case. But the other news should not be dismissed so easily. The 6.1 percent decline in GDP was the second consecutive quarter in which GDP has declined by more than six percent. That hasn't happened since the 1930s. The market rallied on the news as market pundits and some economists pointed to certain negative elements in the report that might indicate that improvement in the economy can be expected in the second quarter on a rebound from depressed levels. But this has been said for the past three quarters, and there was nothing compelling in the overall composition of this complex economic number that was particularly reassuring. At some point, GDP will simply have to turn slightly positive. It's just a matter of a mathematical calculation from a low base. But a rebound in GDP is irrelevant if the job market does not rebound and the consumer remains in a shell. And this is where the Chrysler news comes in.
The market shrugged at the Chrysler announcement. This was "old" news. Everyone knew this was coming. In thirty days or less, we'll see the same thing or something close happen to GM. Again, this will be "old" news. Market pundits and most economists are already relegating the automakers' saga to the history section. But, in fact, we're only at the starting point in realizing some of the negative economic impacts that these restructurings will bring. At a minimum, we'll see 300,000 - 400,000 jobs be lost at the auto companies, dealers and related industries. Not only will some of those folks be unable to find jobs, but also those who do will likely be looking at much lower compensation. This will be a drag on spending. Cuts to retirement benefits can also impact consumer spending. The fact is that unless the economy starts to magically improve soon, the automakers' changes will add to the economic downdraft starting later in the year.
The markets are also trying to dismiss the banking story as "old news." Conventional wisdom is that the banks will convert enough preferred equity into common equity to meet future capital requirements, and that improved bank earnings will offset future loan losses that will hit their balance sheets.
In the first quarter of the year, the markets seemed to come to grips that we really didn't know how the economic issues would play out in 2009 or what the future held for the financial landscape. In less than one month, market psychology completely reversed to one in which it is assumed that the economy was no longer in danger and the banking industry would easily overcome any future losses. All bad news is presumed to be the basis for future good news. But hard evidence of a great turnaround is simply not there. The turnaround that has happened is one of attitude---hope vs. despair. It's good to have hope. Hope and optimism can influence outcomes. But let's be realistic in the uncertainties ahead. The U.S. has not faced the economic and financial challenges we're facing since the 1930s. Nothing in the last seventy years compares in breadth and scope. We're still at square one regarding the automakers, probably no further than halfway through the banking problems, and at DEFCON I in job market. I continue to place the most importance on the job market. I'll be happy to join the hope crowd when we see verifiable improvement in the job market. Until that happens, bad news is still bad news.
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