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Tuesday, January 09, 2007

Uh-Oh

Oil went below $55 this morning. The hedge funds are now potentially in play; if during the next two weeks it manages to go through a closing/opening cycle at $53 this may get rough quickly. Regardless, there is ice on the road ahead for equities (as I have warned before).

Yesterday's consumer credit report showed very high borrowing for November, and it was in revolving debt (most credit cards). The significance of this is that it confirms the MEW theory, which claimed that consumers have been financing spending by borrowing against home equity, and that this source of funds would dry up and force a consumer spending slowdown. The reason why consumers simply cannot shift borrowing to credit cards is that the "affordability" mortgages were offering consumers a way not to repay credit at all in some cases, and to repay it at extremely low interest rates in others. Credit cards carry higher repayment obligations than mortgages, thus less spending can be financed off them.

Consumers have been tapped out and have extremely high debt levels. A great deal of consumer spending has been financed through mortgage equity extraction, and yesterday's G.19 confirmed that it is coming to an end. DSR/FOR for the third quarter also showed the early signs. Defaults and chargeoffs at banks are also showing some elevation. The credit contraction is also occurring in the form of tightened lending terms for riskier loans; this will continue to reduce demand for housing in 2007 by at least 8%. However, this will cause further defaults, forced sales and foreclosures, which in turn will force prices lower and probably require further tightening of lending standards, which will then also constrain demand. Housing will continue to drop, although the rate of decline in 2007 will be slower than it was in 2006.

Relatively weak retail sales in the holiday season will cause the Street to watch corporate profits closely, and it will react strongly to any suggestion of weakness. This will cause electronics stocks to be very volatile, and will force these companies to tighten employment and control spending in an attempt to keep profits steadily high. The same has already happened in retail....

Whether it's a slow slide or a fast slide, we are seeing the first signs of a consumer-led recession in 2007, and it is going to impact the stock market and employment more rapidly than most have been willing to concede. The hedge funds are an unknown, unquantifiable danger.

Calculated Risk has written extensively on MEW and other developing economic trends.

Bro, I hope you sold that Motorola!

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