Ben Speaks, We Decipher

This afternoon, Ben Bernanke spoke to the National Association for Business Economics.  The full text of the speech can be found here: http://www.federalreserve.gov/newsevents/speech/bernanke20081007a.htm

Here are some key sections of the speech and my translation and interpretation.

"Considerable experience in both industrialized and emerging economies has shown that severe financial instability, together with the associated declines in asset prices and disruptions in credit markets, can take a heavy toll on the broader economy if left unchecked. For this reason, the Federal Reserve, the Treasury, and other agencies are committed to restoring market stability and are working assiduously to ensure that the financial system is able to perform its critical economic functions.

"Recent actions by the Congress have given the Treasury new tools and resources to address the stressed conditions of our financial markets and institutions. The Federal Reserve has also been granted a new authority -- the ability to pay interest on bank reserves, which will allow us to expand our lending as needed to support the system while better managing the federal funds rate. These tools will provide important additional support for the government's efforts to strengthen financial markets and the economy."

Financial freeze-ups cause damage to the real economy (a.k.a. Main Street).  Lots of damage has been done, but the Fed has some new tools to inject ever larger amounts of liquidity into the system.  However, as fast as they pump it in, it just is having no effect so far (well, hard to say just how bad the carnage would be if they had not been pumping in the liquidity, but clearly it has not been enough).

"Economic activity had shown signs of decelerating even before the recent upsurge in financial-market tensions. As has been the case for some time, the housing market continues to be a primary source of weakness in the real economy as well as in the financial markets.

"However, the slowdown in economic activity has spread outside the housing sector. Private payrolls have continued to contract, and the declines in employment, together with earlier increases in food and energy prices, have eroded the purchasing power of households. This sluggishness of real incomes, together with tighter credit and declining household wealth, is now showing through more clearly to consumer spending.

"Indeed, since May, real consumer outlays have contracted significantly. Meanwhile, in the business sector, worsening sales prospects and a heightened sense of uncertainty have begun to weigh more heavily on investment spending as well."

The economy was in bad shape even before the latest round of the credit crunch hit.  This is making it much worse.  It is not just about housing anymore, nor will the bad loans at banks only be related to mortgages.  People are getting poorer and as a result they are going to spend less.  Christmas will be cancelled (at least the secular Santa part of Christmas; the religious side is not affected).  Businesses are not going to spend money on any expansion plans if there are going to be no customers for the additional goods.

"The intensification of financial turmoil and the further impairment of the functioning of credit markets seem likely to increase the restraint on economic activity in the period ahead. Even households with good credit histories are now facing difficulties obtaining mortgage loans or home equity lines of credit. Banks are also reducing credit card limits, and denial rates on automobile loan applications reportedly are rising.

"Businesses, too, are confronting diminished access to credit. For example, disruptions in the commercial paper market and tightening of bank lending standards have made it more difficult for businesses to obtain the working capital they need to meet everyday operating expenses such as payrolls and inventories."

No soup for you!  Doesn’t matter if you have a good credit score or not, credit is going to be hard to come by, and that is going to hurt people's ability to buy goods and services.  The same is true for businesses -- they will have a hard time paying for goods like inventories and services like employment services (a.k.a. payroll).

In short, the economy is already in bad shape and getting worse.  Elsewhere in the speech he pointed out that inflation risks have seriously diminished, at least for the short- to medium-term.  The risks to growth (also known as a severe recession) are now much greater than the risks of higher inflation.  He is all but announcing that there is a rate cut coming very soon.  Not too many bullets left in that gun, but looks like he is about to shoot them.

I would stay far away from the Consumer Discretionary sector as well as the Financial sector.  It is still very much an open question in my mind if General Motors (GM) and Ford (F - Analyst Report) will make it through this storm. 

With the possible exception of Wal-Mart (WMT - Snapshot Report) and Costco (COST - Snapshot Report), retailers should be avoided.  Those two are likely to benefit from people who normally shop at places like J.C. Penney (JCP - Analyst Report), Kohl’s (KSS - Snapshot Report), Gap (GPS - Snapshot Report) and Macy’s (M - Snapshot Report) trading down.  Thus, the Wal-Marts of the world may do OK by getting a larger slice of a shrinking pie.  The Macy’ses of the world face a shrinking slice of a shrinking pie.

Read the full analyst report on GM

Read the full analyst report on F

Read the full analyst report on JCP