Fears of financial crisis spillover into real economy mounting

US STOCKS tumbled yesterday as weak earnings from technology and commodity companies reignited fears that the spillover effects from the financial crisis would lead to a rapidly slowing economy.

Sun Microsystems and Texas Instruments, the world's second-largest semiconductor maker, both posted double-digit percentage declines after disappointing investors; giant copper producer Freeport-McMoRan Copper Gold was hit by falling demand for raw materials amid the global slowdown.

With the credit crunch now "hitting home", as Federal Reserve chairman Ben Bernanke said on Monday, markets expect corporate profits to be badly hit. Mr Bernanke warned of a "protracted slowdown", saying that the US economy was "likely to be weak for several quarters".

Despite having rejected calls for a second fiscal stimulus plan just last July, Mr Bernanke said that a "significant" stimulus now "seems appropriate".

He is also worried that credit tightening might "extend or deepen" the slowdown. Despite the US Treasury's planned injection of $250 billion into US banks, many are worried that banks will hoard the money.

"It doesn't matter how much Hank Paulson gives us," the New York Times quoted one anonymous banker as saying this week. "No one is going to lend a nickel until the economy turns."

Even if banks do offer to loosen the purse strings, many are worried that indebted consumers will just say no. The $150 billion fiscal stimulus earlier this year had a limited effect, with analysis suggesting that most of it was saved. Consumer spending accounts for more than 70 per cent of the US economy but with just 22 per cent of people saying that their personal finances have been getting better, it's not surprising that they have retrenched.

Retail sales have fallen three months in a row, the longest slump since records began in 1992. Consumer confidence fell by the most on record this month.

Between 1960 and 1990, households saved an average of 9 per cent of after-tax income. Since 1990, however, that percentage has fallen to 3.5 per cent and it fell below 1 per cent in each of the last three years. Having lived through the bursting of two asset bubbles - the dotcom boom/bust of the late 1990s and the housing bubble in more recent times - Americans are expected to start salting away their income once again.

That leaves the US economy in a tricky position. "To rebuild economic health in the United States, you need a serious recession that will last several years," investment guru Marc Faber said this week. "The patient that got drunk on credit growth needs to go into rehabilitation. To give him more alcohol, the way the Fed and the Treasury propose to do, is the wrong medicine."

Despite the increasingly grim data, analysts have remained resolutely optimistic. Analysts are predicting that SP 500 stocks will earn about $97 per share in 2009, well above an estimated $81 this year. As the Wall Street Journal this week quipped, "the best use for that forecast is to take this column and wrap a fish in it".

Analysts have been behind the curve for some time now. In the final quarter of 2007, analysts estimates were 33 per cent too high. They have spent all of 2008 lowering their forecasts while remaining much too positive on the earnings front.

Forecasts are expected to be slashed in the coming weeks and months, especially against a deteriorating economic backdrop. Deutsche Bank this week predicted a "major recession for the world economy over the year ahead, with growth in the industrial countries falling to its lowest level since the Great Depression and global growth falling to 1.2 per cent, its lowest level since the severe downturn of the early 1980s".

It all means that investors will be eagerly awaiting company earnings and guidance over the following weeks. More than 60 per cent of US companies will have reported earnings by the end of the month, with ATT, Apple, McDonald's, Yahoo and 3M all reporting this week.