But we’re not…yet.

Classic economic theory says that money supply can be used to stimulate the economy and our central bankers seem to agree. That’s why they’ve pumped more than $1 trillion dollars into the economy, engineered countless bailout bonanzas for zombie institutions, put Detroit on life support, and delivered a bunch of financial Band-Aids to the trauma ward — all in a desperate bid to make Americans feel better about the global financial crisis.

To their way of thinking, the trillions of dollars have been a success. That’s why any meeting of the Group of Eight (G8) nations looks more like a mutual affection society with central bankers anxious to claim credit and backslap each other in congratulations for having avoided the “Great Depression II.”

But by taking the Federal balance sheet to more than $2 trillion from $928 billion 2008, they’ve created a situation that should have resulted in an epic inflationary spike to accompany the 137% increase in liabilities.

Yet that hasn’t quite happened.

Core inflation — which denotes consumer prices without food and energy costs — has actually decreased from 2.5% in 2008 to 1.5% presently. And that has many investors who have heard the siren call of the doom, gloom and boom crowd wondering if they’re worried about nothing.

So what gives?

Well, there are four reasons we haven’t yet seen hyperinflation:

Click here to continue reading Mr. Fitzgerald’s article.

What’s he talking about? Today, we take a look and invest right alongside his idea. And it should start to pay off with the arrival of the first swallows of spring in 2010. It’s also timely now — in this weak-kneed economy — because it has traditionally held up well even in when the economy is on the ropes. Even the Great Depression couldn’t put this thing down.

We start with simple truths. The world’s population has more than doubled since 1950 — from about 2.5 billion to 6.7 billion. By 2050, there will be more than 9 billion people on the planet. Almost all of this growth will come from undeveloped markets such as China and India. And they will all be doing one thing, for sure — eating.

Now, hang on. I know that is a banal insight by itself, but this story has layers like a tiramisu. The second layer is the mix of food eaten, which is important. These undeveloped economies are getting richer. Predictably, as people everywhere have done and continue to do when they have a little more money in their pockets, they change their diets. They spend more on food. The average Chinese spends 40 cents of every additional dollar earned on food. In India, it’s about 70 cents of every additional dollar. What do they buy?

Read the rest of the story at PennySleuth.com.

Martin Wolf, speaking, gravely, for the world’s intelligentsia in The Financial Times last week, proclaimed that: “the only thing worse than rescuing the system would have been not rescuing it.” But he is wrong; of all the many blessings economists may bestow upon a grateful people, improving the economy is not one of them. An economy is a natural thing. It can be improved by the striving of entrepreneurs, the prudence of bankers, and the sweating of field hands. But when it comes to the macro-economic policy, forbearance is the quality that pays. Any initiative on the feds’ part inevitably makes things worse.

The Bubble Era, like the Great Depression, was largely –but not completely – the result of government initiative. Artificially low interest rates – intended to counter the modest downturn of 2001 – sent the wrong message. Consumers – notably those in Britain and America – bought things they couldn’t afford. Producers – notably those in Asia – made things for which there was no real market. Debt piled up. Mountains of it.

As consumers bought more and producers made more the economy grew. But much of the economic “growth” of the 2001-2007 period was fraudulent. It was based on debt spending, not on genuine increases in purchasing power. Debt pretends to be real money. It looks like the real thing, but it is not. It stimulates the economy like counterfeit money. It causes production and consumption, but of the wrong sort. Former Reagan era Office of Management and Budget director David Stockman estimates the level of “counterfeit GDP” at $4 trillion in the US alone.

The fraud was discovered, though misunderstood, when sub-prime debt began to implode.

Finish reading the complete article at The Daily Reckoning.

Who’s back? Harry Dent, the self-styled “economic futurist,” who presumes to tell us about the great economic booms and busts that lie ahead.

How can he possibly know these things?

According to Dent, an analysis of the “highly predictable” nature of consumer spending based on demographic trends – increasing spending during child-rearing years, peak spending as the kids leave home and slower spending during late work and retirement – reveals what lies ahead for the economy and the stock market…

Harry Dent: Dow 44,000 & Other Flimsy Forecasts

Harry Dent is a man worth listening to. After all, he has a near perfect track record – as a contrary indicator…

For example:

• With less than auspicious timing, Dent brought out The Roaring 2000s Investor in 1999, confidently predicting that the Dow would hit 44,000 by 2008. With the luxury of hindsight, we now know he was off by 30,000 points or so.
• At the time, Dent also argued forcefully for NASDAQ stocks, predicting, “The technology revolution will favor Internet-oriented companies.” Within three years, the NASDAQ lost three quarters of its value and the leading index of Internet stocks plummeted 89%.

And Dent didn’t confine his market predictions to the U.S. He further forecast that Argentina would see “moderate growth until 2015 and then stronger growth into 2025.”

No, Argentina would suffer a currency collapse and financial crisis followed by rioting, social unrest and years of economic stagnation.

It’s obvious now just how wrong Dent was. But 10 years ago, plenty of brokers and investors agreed with him. He sold hundreds of thousands of books and raked in millions as an advisor to top Wall Street firms, including Morgan Stanley (NYSE: MS).

Harry Dent’s Next Bold Prediction: The Great Depression Ahead

Five years later, bloodied but unbroken, and using his same demographic trends theory, Dent published The Next Great Bubble Boom: How to Profit from the Greatest Boom in History: 2006-2010.

Well, no. That period encapsulated the biggest bust since the Great Depression. As for his revised forecast of Dow 40,000 in 2009, it looks like he’s off by 30,000 or so points again.

With a track record like this, you might imagine Mr. Dent would shy away from economic prognostication.

Yet he’s promoting a new book. And if you’re looking for a reason to be optimistic about the market, you’ll find it in his chosen title: The Great Depression Ahead.

Within weeks of the book’s publication, the Dow began a 48% ascent, one of the six biggest rallies in the last 100 years.

Look, I’m not entirely unsympathetic to Mr. Dent. Anyone in the investment prophecy business needs the skin of a rhino and a Ph.D. in humility. No one gets it right all the time.

Moreover, Mr. Dent has made hundreds of predictions in his long career, so I’m sure he can point to a few successes. (Of course, so can an orangutan heaving darts at the stock pages.)

It’s just that Dent has made millions in book sales and investment advisory fees peddling this mumbo-jumbo.

(Poor advice does have its consequences, however. His AIM Dent Demographic Trends fund severely underperformed the market and was quickly folded into another fund. His name was quietly dropped.)

Yet Mr. Dent is still out there, offering dubious investment advice based on faulty premises.

The truth, of course, is this…

Forget Harry Dent… Listen to This Advice Instead

While anyone can make a good call from time to time, no one can consistently predict the economy or the stock market.

If you don’t accept this – a fundamental investment tenet with great investors from Benjamin Graham and Warren Buffett, to Peter Lynch and John Templeton – your chances of long-term success are slim.

Yet Mr. Dent clings to his demographic theories and economic futurism. And that’s unfortunate.

Someone really ought to let him in on one of the great secrets of investing: Your only real mistakes are the ones you don’t learn from.

Good investing,

Alex

Source: Harry Dent: Bold Predictions of the Great Depression Ahead

Life expectancy in 1935, in the United States, for example, was 76.9 for men. Workers relying on the plan for retirement would not receive much each month and were not expected to live long enough to drain the system.

When Social Security was founded, the typical US worker at age 65 could expect to live another 11.9 years. But if today’s official projections are right, by the year 2040 the typical 65-year-old worker can expect to live at least another 19.2 years. If the normal retirement age had been indexed to longevity since 1935, today’s worker would be waiting until age 73 to receive full benefits and tomorrow’s workers even longer.

In a report called “Demographics and Capital Markets Returns,” Robert Arnott and Anne Casscells argue that the crisis is not in Social Security, but in demographics. “When an entire society ages,” suggest Arnott and Casscells, “…the thing that matters most is the ratio between the workers to retirees. Unfortunately, the aging of the baby boom generation, which is a significant bulge in population, will cause a dramatic increase in the ratio between workers to retirees, one that will put enormous strain on society and cause friction between generations.”

In the United States, as in other developed countries, the unfunded benefit liability for public pensions amounts to 100 percent to 250 percent of GDP. It is a ” hidden debt ” far greater than official public debt. Unlike in the private sector, these debts are not amortized as expenses over 30 to 40 years. And it may be worth pointing out that under normal conditions economies do not run such crushing deficits. They only do so in crisis mode.

The annual cost of Social Security benefits represented 4.4 percent of GDP in 2008 and is projected to increase to 6.2 percent of GDP in 2034, and then decline to about 5.8 percent of GDP by 2050 and remain at about that level.

And to the retiring boomers’ other doubts and insecurities, we might add that US health care costs are expected to rise by 7 percent of GDP over the next 40 years – a rate that is more than twice as fast as other developing nations. The “old old,” – those aged 80 and over – are predicted to rise sharply through 2050 and will dramatically increase long – term care costs as well as disability, dependence, and health care expenses.

In fact, by official projections, in 2030, the US government will be spending more on nursing homes than it spends on Social Security today. “Although people justifiably worry about Social Security,” says Victor Fuchs, an economist who studies the health care industry, “paying for old folks’ health care is the real 800-pound gorilla facing the US economy.” Adding projections for Medicare and Medicaid ’s expenditures to those of Social Security could raise the total cost to more than 50 percent of payroll taxes.

The fiscal kickers of health cost inflation and political demand for more long-term care benefits threaten to raise public spending dramatically in the United States. Between 2005 and the fall of 2008, we spent two and a half years chronicling the efforts of David Walker, the former comptroller general of the United States, and Bob Bixby, executive director of the Concord Coalition, to reign in reform and shore up the Social Security and Medicare systems. The project yielded a feature length documentary film, which earned us a trip to the Sundance Film Festival in January of 2008 and another to the Critic’s Choice Awards in Los Angeles a year later. We published a best-selling companion book of the same title in late 2008. You’re encouraged to delve into the numbers we presented in the film and book. They’re truly mindboggling. But in many ways the project was dated the moment we released it to the public.

The credit crisis that reached a fever pitch developed in 2008 pushed the date of insolvency of these programs ever closer. On May 13, 2009, the Medicare Trustees warned that the fund they tap to pay for beneficiaries’ hospital care will be insolvent by 2017 – two years earlier than trustees had predicted the year before. The program has been paying out more than it collects in taxes and interest since last year, in part due to a recession well underway. Medicare would have to deposit $ 13.4 trillion – $ 1 trillion higher than last year’s estimate – into an interest-earning account today in order for the hospital fund to pay its scheduled benefits over the next 75 years. The program’s total unfunded obligation, which includes doctor and prescription drug benefits, is $37.8 trillion. The trustees estimated that in coming years, Medicare spending will rise faster than workers’ earnings or the economy as a whole.

Trustees say that while the financial standing of Social Security decreased more sharply than Medicare last year, the health program remains at greater risk of insolvency. The financial difficulties facing Social Security and Medicare pose serious challenges, the report concluded.

For Social Security, the reform options are relatively well understood but the choices are difficult. Medicare is a bigger challenge. Its cost growth can be contained without sacrificing quality of care only if health care cost growth more generally is contained. But despite the difficulties – indeed, because of the difficulties – it is essential that action be taken soon, particularly to control health care costs.

After the revised Social Security and Medicare announcement the world began to wonder: Can the US hold onto its AAA credit rating?

“The US government has had a triple-A credit rating since 1917,” David Walker, now president and CEO of the Peterson G. Peterson Foundation, commented in the Financial Time s following the release of the Trustees report, ” but it is unclear how long this will continue to be the case. In my view, either one of two developments could be enough to cause us to lose our top rating.

“First, while comprehensive health care reform is needed, it must not further harm our nation ‘ s financial condition. Doing so would send a signal that fiscal prudence is being ignored in the drive to meet societal wants, further mortgaging the country’s future.

“Second, failure by the federal government to create a process that would enable tough spending, tax and budget control choices to be made after we turn the corner on the economy would send a signal that our political system is not up to the task of addressing the large, known and growing structural imbalances confronting us.”

Of course, we must note that the whole credit rating biz is…well…corrupt. The agencies that are responsible for dishing out sovereign credit ratings (S&P, Fitch, and Moody’s) are the same ones that left us all out to dry in 2007. (Of course, mortgage – backed securities get a AAA…housing prices never fall!) Rest assured, if Wall Street can buy its way into AAA, Uncle Sam surely can, too.

But even Moody’s is starting to hedge their bets. They’ve since created three subdivisions within their AAA rating: resistant, resilient, and vulnerable…a corporate way of saying the good, the bad, and the ugly. While the United States isn’t in the worst of the bunch, it’s certainly not the best.

Source: Social Security? Not Exactly

All we know, dear reader, is that following great crashes we get great bear market rallies. And these euphoric rushes of blood to the head have a nasty habit of suckering overoptimistic investors. As resource investing legend Doug Casey put it in yesterday’s Casey’s Daily Dispatch, there were eight such rallies during the Great Depression. These rallies lasted an average of 11.3 weeks, during which time the average increase was 52.6%.

Simple math will tell you that this rally has lasted almost twice as long as the average bear market rally during the Great Depression.

Doug reckons what he calls the “wonder rally” on Wall Street won’t survive the September. He points out that options traders are now betting that the VIX – the volatility index – will increase 13% in the next five weeks, according to data compiled by Bloomberg.

That’s the biggest spread since August 2008 – just before the S&P 500 saw its worst two-month plunge in 21 years. See, these two indexes – the VIX and the S&P 500 – have moved in opposite direction 81% of the time over the last five years.

As Doug says, however, it’s critical that underground investors keep an open mind regarding equities right now. The reason is simple. The government is pumping phenomenal amounts of funny money into the economy. And equities are extremely sensitive to this kind of fiscal policy (more sensitive, that is, than the wider economy, which tends to react slower to stimulus).

This is a big wild card. And in our humble opinion it’s a big reason behind why stocks are doing so well right now. Long suffering readers will recall that here at Notes we believe traders and investors are betting on the government’s ability to backstop the market rather than on the market itself.  There is also a strong likelihood that Washington’s fiscal and monetary stimulus will trigger an inflationary cycle, which would also benefit stocks in the short-term.

Common sense isn’t exactly fashionable these days. But take a moment to think about just how extraordinary a 49% rally stocks is over just five months. As our favorite underground analyst, David Rosenberg, points out, this is “unprecedented back to the 1930s.”

In the last cycle, it didn’t happen until February 2004 – 18 months into that bull phase where again there was tremendous policy stimulus and an oversold low to climb out of. In addition, household credit was expanding rapidly. Even coming into what was a secular bull market in 1982, it took a good seven months to rally 49% – and that was with the benefit of a V-shaped economic recovery. Going back to 1950, it has taken an average of around 18 months for the market to rebound 49% from a recession trough, not five months as has been the case thus far.

That stocks have climbed out of their recent recession trough over three times as fast as after the average recession sets serious alarm bells ringing here at Notes HQ. As we’ve said before, if you have money in stocks right now, you better be sure that money is nimble.

The first public retirement pension scheme was created by Otto von Bismarck in 1880 Germany. Fifty years later, during the Great Depression, Franklin Roosevelt followed suit in the United States. As we’ve seen, the number of people expected to reach the retirement age of 65 was not considered to pose a threat to future funding. Life expectancy in 1935, in the United States, for example, was 76.9 for men. Workers relying on the plan for retirement would not receive much each month and were not expected to live long enough to drain the system.

When Social Security was founded, the typical U.S. worker at age 65 could expect to live another 11.9 years. But if today’s official projections are right, by the year 2040 the typical 65-year-old worker can expect to live at least another 19.2 years. If the normal retirement age had been indexed to longevity since 1935, today’s worker would be waiting until age 73 to receive full benefits and tomorrow’s workers even longer.

In a report called “Demographics and Capital Markets Returns,” Robert Arnott and Anne Casscells argue that the crisis is not in Social Security, but in demographics. “When an entire society ages,” suggest Arnott and Casscells, “…the thing that matters most is the ratio between the workers to retirees. Unfortunately, the aging of the baby boom generation, which is a significant bulge in population, will cause a dramatic increase in the ratio between workers to retirees, one that will put enormous strain on society and cause friction between generations.”

In the United States, as in other developed countries, the unfunded benefit liability for public pensions amounts to 100 percent to 250 percent of GDP. It is a “ hidden debt ” far greater than official public debt. Unlike in the private sector, these debts are not amortized as expenses over 30 to 40 years. 21 And it may be worth pointing out that under normal conditions economies do not run such crushing deficits. They only do so in crisis mode.

The annual cost of Social Security benefits represented 4.4 percent of GDP in 2008 and is projected to increase to 6.2 percent of GDP in 2034, and then decline to about 5.8 percent of GDP by 2050 and remain at about that level.

A Bubble in Health Care

And to the retiring boomers’ other doubts and insecurities, we might add that U.S. health care costs are expected to rise by 7 percent of GDP over the next 40 years—a rate that is more than twice as fast as other developing nations. The “old old,”—those aged 80 and over—are predicted to rise sharply through 2050 and will dramatically increase long – term care costs as well as disability, dependence, and health care expenses.

In fact, by official projections, in 2030, the U.S. government will be spending more on nursing homes than it spends on Social Security today. “Although people justifiably worry about Social Security,” says Victor Fuchs, an economist who studies the health care industry, “paying for old folks’ health care is the real 800-pound gorilla facing the U.S. economy.” 23 Adding projections for Medicare and Medicaid ’s expenditures to those of Social Security could raise the total cost to more than 50 percent of payroll taxes.

The fiscal kickers of health cost inflation and political demand for more long-term care benefits threaten to raise public spending dramatically in the United States. Between 2005 and the fall of 2008, we spent two and a half years chronicling the efforts of David Walker, the former comptroller general of the United States, and Bob Bixby, executive director of the Concord Coalition, to reign in reform and shore up the Social Security and Medicare systems. The project yielded a feature length documentary film, which earned us a trip to the Sundance Film Festival in January of 2008 and another to the Critic’s Choice Awards in Los Angeles a year later. We published a best-selling companion book of the same title in late 2008. You’re encouraged to delve into the numbers we presented in the film and book. They’re truly mindboggling. But in many ways the project was dated the moment we released it to the public.

The credit crisis that reached a fever pitch developed in 2008 pushed the date of insolvency of these programs ever closer. On May 13, 2009, the Medicare Trustees warned that the fund they tap to pay for beneficiaries’ hospital care will be insolvent by 2017—two years earlier than trustees had predicted the year before. The program has been paying out more than it collects in taxes and interest since last year, in part due to a recession well underway. 25 Medicare would have to deposit $ 13.4 trillion—$ 1 trillion higher than last year’s estimate—into an interest-earning account today in order for the hospital fund to pay its scheduled benefits over the next 75 years. The program’s total unfunded obligation, which includes doctor and prescription drug benefits, is $37.8 trillion. The trustees estimated that in coming years, Medicare spending will rise faster than workers’earnings or the economy as a whole.

Trustees say that while the financial standing of Social Security decreased more sharply than Medicare last year, the health program remains at greater risk of insolvency. The financial difficulties facing Social Security and Medicare pose serious challenges, the report concluded.

For Social Security, the reform options are relatively well understood but the choices are difficult. Medicare is a bigger challenge. Its cost growth can be contained without sacrificing quality of care only if health care cost growth more generally is contained. But despite the difficulties—indeed, because of the difficulties—it is essential that action be taken soon, particularly to control health care costs.

After the revised Social Security and Medicare announcement the world began to wonder: Can the U.S. hold onto its AAA credit rating?

“The U.S. government has had a triple-A credit rating since 1917,” David Walker, now president and CEO of the Peterson G. Peterson Foundation, commented in the Financial Time s following the release of the Trustees report, “ but it is unclear how long this will continue to be the case. In my view, either one of two developments could be enough to cause us to lose our top rating.

“First, while comprehensive health care reform is needed, it must not further harm our nation ’ s financial condition. Doing so would send a signal that fiscal prudence is being ignored in the drive to meet societal wants, further mortgaging the country’s future.

“Second, failure by the federal government to create a process that would enable tough spending, tax and budget control choices to be made after we turn the corner on the economy would send a signal that our political system is not up to the task of addressing the large, known and growing structural imbalances confronting us.”

Of course, we must note that the whole credit rating biz is…well…corrupt. The agencies that are responsible for dishing out sovereign credit ratings (S & P, Fitch, and Moody’s) are the same ones that left us all out to dry in 2007. (Of course, mortgage – backed securities get a AAA…housing prices never fall!) Rest assured, if Wall Street can buy its way into AAA, Uncle Sam surely can, too.

But even Moody’s is starting to hedge their bets. They’ve since created three subdivisions within their AAA rating: resistant, resilient, and vulnerable…a corporate way of saying the good, the bad, and the ugly. While the United States isn’t in the worst of the bunch, it’s certainly not the best.

Regards,
Bill Bonner and Addison Wiggin

Source: Excerpt from ‘The Hard Math of Demography’

Since the Great Depression, a period marked by widespread runs on banks, the FDIC has done a good job of fulfilling its mandate. So how are they doing in this crisis?

In a nutshell, they are in trouble.

The FDIC insures 8,246 institutions, with $13.5 trillion in assets. Not all of them are going bankrupt, of course. Yet as of late July, a disturbing 64 banks had gone belly up this year – the most since 1992 – costing the FDIC $12.5 billion. At the end of Q1, the agency was already asking for emergency funding.

And worse, much worse, is likely yet to come. The following chart shows the total assets on the books of the FDIC’s list of 305 troubled banks. The list doesn’t include the biggest banks that are considered too big to fail, as they are being separately supported with bailouts. By contrast, if the banks on this list fail, the FDIC is on the hook to have to step in and take them over and, of course, make depositors whole.

Other measures of how serious the losses at banks are becoming can be seen in the chart below, which shows charge-offs and non-current loans at all banks. You can see that the Net Charge-offs remain stubbornly high, with banks charging off almost $40 billion in bad loans in the last two quarters alone. And the number of non-current loans – loans where payments are not being kept up – is soaring.

Together, these measures indicate the potential for more big failures and more big bailouts coming down the pike.

Into the battle against bank insolvency the Fed brings a level of reserves that can best be described as paper-thin. From almost $60 billion last fall, the FDIC’s reserves have been drawn down to only about $13 billion today, a 16-year low. A quick look at the FDIC’s own data shows us how inadequate those reserves are compared to the deposits they are now insuring.

The chart below says it all:

As you can see, the Federal Deposit Insurance Corporation currently covers each dollar on deposit with a trivial 2/10ths of a penny.

And even that understates the seriousness of the situation: the $4.8 trillion in deposits the FDIC is providing coverage on doesn’t include the expansion that now extends insurance coverage from $100,000 to $250,000 for normal bank accounts. That likely brings the exposure of the FDIC closer to $6 trillion. But that’s pretty inconsequential at this point: using any reasonable accounting method, the FDIC is already bankrupt and will require hundreds of billions of dollars in government bailouts just to keep the doors open.

So, given the dire shape of its finances, what measures is the FDIC taking, you know, to batten down the hatches and all that?

For starters, they are expanding their mandate by guaranteeing bank loans – $350 billion and counting at this point. And the government has tapped the FDIC to play a pivotal role in guaranteeing the loans issued to buy toxic waste through the government’s highly problematic and fraud-prone new Private Public Investment Partnership (PPIP). The FDIC’s commitment to the PPIP is and may become limited based on its resources.

It is hard to draw any other conclusion but that hundreds of billions in new funding will be required to keep the FDIC operating. Given the catastrophic consequences of the FDIC failing, starting with a bank run of biblical proportions, there’s no question it will get whatever funding it needs. By loading the new loan guarantee responsibilities and the PPIP onto the FDIC’s back, the administration will go back to Congress and ask for the next large bailout.

Of course, in the end, all of this falls on the taxpayer, either directly in the form of more taxes or indirectly via the destruction of the dollar’s purchasing power. Another bale of straw on the camel’s back, and another reason to be concerned about holding paper dollars for the long term.

Regards,

Bud Conrad

Source: The FDIC is in Trouble

With data like this? C’mon:

The U.S. economy shrank at 1% annualized rate in the second quarter, the Commerce Department estimates today. Since that’s better than the 1.5% contraction the Street had predicted, we see headlines of “The Pain Is Easing,” and “Recession Easing” left and right. True, the latest GDP number is better than that of previous quarters, but here are some of the stats that really got our attention:

• The U.S. economy has now contracted four quarters in a row, the worst streak since the Great Depression
• GDP has contracted 3.9% in the last year, the worst fall since at least 1947, when the Commerce Department started keeping track
• First quarter GDP was revised down heavily, from a 5.5% to 6.4% — the biggest quarterly GDP drop in almost 30 years
• The Commerce Department revised 2008 down too, from a 0.4% annual contraction to a 1% decline
• Consumer spending, 70% of U.S. GDP, contracted 1.2%. The retrenchment was largely replaced by government spending, up 10.9%
• Employment compensation rose by just 1.8% over the last 12 months, the slowest rate on books that go back to 1982.

But as you’d expect, the market has clung to the expectations-beating, lower-than-usual headline GDP. Thus stocks are currently holding onto yesterday’s gains and hovering around break-even.

“The modest bounce in consumer confidence last spring is fading already,” writes Eric Fry, “and that’s not a good sign for the stock market. As the chart below illustrates, consumer sentiment trends tend to lead stock market trends.

“Throughout 2007, consumer confidence flat-lined while share prices rallied. This divergence between sentiment and share prices became particularly extreme in late 2007, as share prices soared to new highs while consumer confidence plummeted. Just a few months later, share prices were plummeting also.

“The lesson is clear: If consumers lack confidence, so should investors. During the last two months, share prices have diverged once again from consumer confidence readings. This is not a promising sign.

“And yet, despite this warning sign, lots of hopeful investors have persuaded themselves that the mirage of economic rejuvenation is the real thing. We’re not drinking that sand.”

Source: Irrational Exuberance Continues

But don’t expect that to last. A slump in consumer spending and soaring unemployment could both pose a significant threat to retailers going into the 2009 holiday season.

The U.S. unemployment rate hit 9.5% in June and could eclipse 10% by the end of the year, sending the economy into a “jobless recovery.”

In a speech to Congress on May 9, Federal Reserve Chairman Ben Bernanke cited a lack of consumer spending could serve as a constraint on hiring. This could create a paradoxical effect as employment obviously plays a key role in consumers’ spending habits.

Even for the employed, the lessons learned from the worst economic downturn since the Great Depression will resonate with consumers. That has already been evidenced by the U.S. savings rate, which has climbed above 4% for the first time in more than a decade.

In addition to taking money out of the hands of potential customers, soaring unemployment could lead to higher lending standards. As unemployment rises, so too will credit defaults and the cost of credit will increase accordingly.

In the past, consumers have counted on attractive financing promotions for the purchase of big-ticket items such as high-definition televisions and kitchen appliances. But that won’t be the case with tighter credit

“Consumers were also able to spend more because of the easy availability of credit, most notably through mortgage equity withdrawal and they responded by buying more items,” said Deloitte Strategic Advisor Richard Hyman.  “These conditions underpinned retail growth for the past 10 years but have now disappeared. However, it’s worse than that. They will clearly not return once the recession is over.”

Of course, tighter credit isn’t just a problem for consumers.

A Brick & Mortar Inventory Crunch for the Holidays?

The potential bankruptcy of commercial lender CIT Group Inc. (NYSE:CIT) could be a major tipping point for businesses that rely heavily on credit. Vendors for retail giants such as Wal-Mart Stores Inc. (NYSE:WMT) and Target Corp. (NYSE: TGT) rely on CIT for factoring – an old form of finance in which the lender pays the vendor for its accounts receivable. If the retailer fails to pay for the goods, the lender assumes the responsibility to pay the vendor.

“Right now our industry is preparing for the fall and winter season,” Kevin M. Burke, president and chief executive of the American Apparel and Footwear Association told The New York Times. “A lot of these orders are going to come to a grinding halt if there is no capital.”
A CIT bankruptcy would be a “double whammy” to stores whose suppliers have already cut the amount of merchandise they are making to better align inventory with the drop in consumer spending, said Burke. If those suppliers lose their sole source of capital, what little merchandise retailers originally ordered might never arrive.
The timing of CIT’s woes is “terrible,” Al Ferrara, a partner in retail and consumer products business of consulting firm BDO Seidman LLC said in a Reuters interview. “Retailers now are basically gearing up for the back-to-school and the fall season.”
An inventory crunch at brick & mortar retailers would give a competitive advantage to online retailers, which have more flexibility and already account for about a third of holiday retail sales.

For brick & mortar retail businesses, managing inventories during the holiday season is a delicate balancing act in which managers must walk a fine line between over- and under-ordering stock.

If retailers overstock, they will be forced to offer even steeper post-holiday discounts than they would like in a desperate bid to unload inventory. But if they don’t stock enough merchandise to meet demand they risk not only missing out on sales, but driving potential customers to online retailers, such as Amazon.com Inc. (Nasdaq: AMZN) whose warehouses are not restricted by the display racks and checkout counters found in brick & mortar stores.

This doesn’t mean brick & mortar retailers will sit idly by this holiday season as Amazon siphons off customers via the Internet. All of the nation’s biggest retail players have their own websites too, but the gap between Amazon and the No. 2 online retailer, Staples Inc. (Nasdaq:SPLS) is huge: Amazon generated $19.2 billion in online revenue in 2008, while Staples generated less than half of that in the same year: $7.7 billion.

While half of the top 10 online revenue generators came from traditional stores, notably absent were brick & mortar discount giants Wal-Mart and Target.

And even Best Buy Co. Inc. (NYSE: BBY), which displays in-store signage promoting an “expanded assortment” of products online for consumers who did not find what they were looking for in the store, came in at just No. 10 on the list.

Shopping for a Silver Lining

While a continued slump in consumer spending would benefit no one, certain retailers are better positioned than others, and could ultimately use adverse economic conditions to turn a profit.

For instance, the aforementioned Amazon.com, which is the world’s largest online retailer, could see a sizeable boost in its web traffic as consumers comb the Internet for bargains.

Companies that have a consumer-friendly economical brand, such as Wal-Mart, will also benefit.

Wal-Mart’s “Save Money, Live Better” slogan is already resonating with consumers, and The No. 1 retailer in the world has gone to great lengths to cement its reputation as the affordable choice for shoppers.

The company has set up a “Save Money, Live Better” website (complete with testimonials of what people are doing with the money they save by shopping at Wal-Mart) and a “Live Better Index,” which includes an interactive map of the United States to show how much money people have saved in each state by shopping at Wal-Mart.

The result of Wal-Mart’s efforts? Holiday sales grew 7% last year, according to the Advertising Research Foundation.

Similarly, same-store sales are consistently rising at discount houses such as Family Dollar Stores Inc. (NYSE: FDO), and Ross Stores Inc. (Nasdaq: ROST), the latter of which has the “Dress for Less” sloganright under its name at every store. On the flip side, stores like Macy’s Inc. (NYSE: M) and Saks Inc. (NYSE: SKS) have reported consistent declines in same-store sales over the past few quarters.

“Needs-driven spending will gravitate towards retailers able to tick the most important consumer boxes like price and convenience,” said Deloitte’s Hyman. “Although it will remain the engine of retail growth, wants-driven spending will slow and consumers will be much more choosy.”

Source: Retail Sector Faces Uphill Climb in 2009