Howard's End: US Economy Cools

In my September 19th column I warned our readers that a looming recession was in store for the American economy. Now, General Motors, Unisys Corp, Motorola, Whirlpool, Aetna, and Gillette are laying off thousands of their US workers. John Howard writes.

The latest to join a growing list of US companies laying off staff are Aetna and Gillette who, on Monday, said they will pare 5,000 and 2,700 jobs respectively, from their payrolls, just before the holidays.

The redundancy notices are the first sign, at least in America, that the nation's white-hot economy and job market is cooling significantly.

Because of the huge volume of debt held by Americans, the largest in history, the writing has been on the wall for at least 12 months.

What makes this latest news worse is that Asian countries rely on the US for up to 40% of their exports. Australia and New Zealand have export claims on the American economy as well and Australian growth is also starting to slow. So this is serious.

Many of the US staff layoffs in recent years were as a result of mergers and aquisitions and unemployment was minimised because other growing companies picked up the slack. But that doesn't appear to be happening now.

Most of the layoffs are now happening because companies are looking for ways to pay for higher energy prices and raw material commodities without raising their prices to consumers.

Retail sales fell by 0.4% during November led by a 2.2% drop in vehicle sales. Sales are projected to be even weaker when the December figures are released.

This development suggests the US Federal Reserve may need to cut the federal funds rate sooner rather than later.

Such a move would certainly please the incoming administration. Remember, Fed Chairman Alan Greenspan is a Republican, and he was criticised for not lowering interest rates soon enough in 1992 which some say lost that election for George Bush Snr.

Some analysts are now suggesting that the Fed will try and avert a recession by lowering interest rates but investors will need to be convinced that credit problems will not worsen for financial institutions. The Fed easing interest rates will also help ease those concerns.

As at the December 15 close, the Fed's stock valuation model shows that the S&P 500 was only 12.4% overvalued, down dramatically from a record 70% overvaluation reading at the start of the year.

Now, earnings forecasts are falling but yields also continue to decline. Historically, there is a tendency for the markets to go from one extreme to the other with some American analysts forecasting a recession by the middle of next year.

A 5% treasury yield implies that the fair market value P/E (price/earnings ratio) for the S&P 500 should be 20. The actual P/E (using 12 month forward earnings) is down to 21 - almost at fair value.

Valuation is in the eyes of the beholder and it would now seem the overall US market is finally valued fairly - but there are still valuation extremes.

I remain deeply concerned with rising prices, high debt levels in the corporate and individual sector and non-performing and bad loans. The downturn is likely to inflame the US bad loans scenario.

In my September column I predicted a controlled US recession - a controlled releasing of the bubble and that's now started, but I wonder if it will stay controlled.

Therefore, because of the US scenario, I simply don't accept the latest New Zealand financial forecasts for the coming year can be as optimistic as they are now painted to be. But, I'm hoping like hell that I'm wrong. Meanwhile, I'm getting out of debt and cutting back on my budget as quickly as I can.

© Scoop Media