- Technical Analysis -

February 24, 2010 (FinancialWire) — Editor’s Note: Look for Dr. Duarte’s follow-up FinancialWire(tm) commentary on this article in the coming days (via http://www.financialwire.net/?s=djdrtregflp).

The Dow Jones Industrial Average fell over 100 points on Tuesday, despite good earnings from Home Depot (NYSE: HD) and upscale retailer JW Nordstrom (NYSE: JWN).

At the top of the news was a big drop in consumer confidence for the latest month. The Conference Board’s consumer sentiment index fell 10 points. A look around the world, suggests that there are plenty of reasons for consumers to be glum.

The economic weakness in Europe continues to show no signs of abating. In the latest episode, Fiat is idling all of its plants in Italy for two weeks, due to weak demand. The news cycle has been heavy on Greece’s use of currency swaps and derivatives to make its books look better over the years in order to meet the criteria for entering and remaining in the European Union. But, to some degree the thought of derivatives, swaps, and cloak and dagger transactions by high stakes brokers and government officials gives that story an ethereal quality. To be sure, the effects have been anything but ethereal, given the fall in the euro and the potential repercussions.

Yet, nothing is more tangible than being out of work because there is no demand for the product that you make. And that’s what’s happening to Fiat, which happens to be the majority stakeholder of the third largest automaker in the U.S., Chrysler. In fact Fiat has idled all of its Italian auto-manufacturing plants for two weeks to compensate for weaker demand as the European versions of the “cash-for-clunker” programs have run out. The plants will remain closed until the first week of March, furloughing about one third of all of Fiat’s employees in Italy. What makes this closure significant is that, according to a company spokesman, this is the first time that all Fiat plants in Italy will be closed simultaneously.

The European issues, according to a company spokesman are not linked “whatsoever” to Fiat’s Chrysler operations, although it is widely accepted that 2010 will be a difficult year for the auto industry. If you look at the auto industry as a microcosm of how the lack of government support may affect the rest of the global economy, you can see what’s coming–a potential contraction as government stimulus fades away and private industry fails to pick up the slack. It’s already happening to state and local governments in the U.S. where teachers may start to lose their jobs as the $48 billion worth of stimulus money for education starts to fade away.

In fact, instead of making things better, it’s plausible to consider that federal aid–and the potential lack of or reduction of it in the next twelve months–may accelerate the demise of state and local governments as money starts to run out in a big way on Main Street.

And Europe is not alone. A report in The New York Times highlights the problems faced by state coffers, where tax revenues have fallen for five straight quarters, the first time this has happened since the Great Depression. Citing data from the Nelson A. Rockefeller Institute for Government, the Times reported that “state tax collections fell to $134.5 billion in the last quarter of 2009, a 4.1 percent drop from the $140.2 billion collected during the same period a year earlier.” The Times notes that the rate of fall in tax revenues has decreased, with the record fall of 16.% being recorded in the spring of 2008, the fact that it continues is what’s the most worrisome. And that makes sense, since it means that there is little sign that it’s going to stop any time soon.

If you’re looking for a scenario that could accelerate things toward the negative, look to commercial real estate and the potential fallout if that market’s decline accelerates. There are over a trillion dollars worth of commercial real estate mortgages, many of them still on the books of community banks, that are due to reset within the next three years. Many of them, just as in the case of many individual mortgages, are under water, which means that the potential for default is higher than normal. If businesses continue to experience weakness and can’t pay their rent, we could see the beginning of that highly predicted, but not quite visible double dip recession scenario taking shape.

And there are some pockets of significant weakness across the U.S. According to The Washington Post: “In Washington, the number of troubled properties has multiplied at a phenomenal rate, with the value growing from only $13 million in 2007 to $40 billion now, according to CoStar Group, a Bethesda real estate research company. The region trails only South Florida and metropolitan New York in the per capita value of commercial real estate assets in foreclosure, default or delinquency, according to the research group Real Capital Analytics.”

One expert told the Post that “half of commercial real estate mortgages will be underwater by the beginning of 2011,” compared to one fifth of the residential mortgages that are in place now, that are glutting the marketplace.

The major problem is the way commercial loans are structured. Unlike residential mortgages that are set up for 15 or 30 years the majority of the time, commercial mortgages are most often set up as five-year loans that are then restructured. Many of the loans that were set up in the last five years are coming due, at a time when business isn’t generally doing well.

So if you’re looking for reasons to have the stock market show some weakness, even if it’s over the short term, you can think of consumer confidence as a place where many things come together.

[Go to http://www.financialwire.net/?s=joe+duarte to see more commentaries by Dr. Joe Duarte.]

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