Global No Confidence Vote: The Next Wave

The Dow has come roaring back 20% in the last three weeks and economic data on home sales, durable goods, consumer spending and retail sales have gotten better rather than worse. More than a few prognosticators believe March 2009 now represents the bottom of this recession, and that from here on out it's slow recovery...but recovery nonetheless.

Most analysts now agree, however, that there are some encouraging shafts of light after months of pitch-black news.

"The best news now is that despite the worst . . . daily litany of horrible news, the strongest renewed bank fears, despite all of that, we've got stocks today essentially where they were in October," said James Paulsen, chief investment strategist for Wells Capital Management, owned by the giant bank Wells Fargo.

In October, all three asset classes — stocks, bonds and commodities such as oil and farm products — were in freefall. Today, stocks are up roughly 20 percent in the past two weeks, the biggest such short-term rally since 1938.

"Despite some of the worst news, stocks have stopped deteriorating and have put in what I think is a relatively strong bottom," Paulsen said.

He's not alone in spying a glimmer of hope.

"I think the worst is behind us," said James Dunigan, the managing director of investment for PNC Wealth Management in Pittsburgh.

Dunigan points to recent better-than-expected data on retail sales, which bumped up in January and held in February, as well as an unexpected February increase in sales of existing homes. New data this week showed a 3.4 percent February increase in orders of durable goods — big-ticket expenditures — which added a dose of feel-good.

"You are starting to get some whiffs of that in some of the indicators that are starting to come out. . . . All of the news isn't as consistently bad as we saw," Dunigan said. "I don't think we need to get a lot of good news. We need to get some consistently less-bad news."

If you're willing to go with that theory, then good luck to you. All this month represents is a pause before the next phase of the storm: commercial real estate.

With loan defaults rising, analysts say the struggling commercial real estate industry is poised to fall into the worst crisis since the last great property bust of the early 1990s.

Delinquency rates on loans for hotels, offices, retail and industrial buildings have risen sharply in recent months and are likely to soar through the end of 2010 as companies lay off workers, downsize or shut their doors.

This is the true heart of the problem. The residential real estate crash has triggered massive unemployment and a commercial real estate crash, giving us another roller coaster to ride downwards over the next two years. Banks and retailers damaged by the current economy most likely will not survive this second phase, especially since the residential market has another 15-20% drop in prices to go. The commercial real estate crash will only be the second tidal wave to hit America just as we've struggled to the surface for oxygen.

Deutsche Bank's Richard Parkus projects delinquency rates will keep soaring to more than 3.5 percent by year-end and as high as 6 percent by late 2010. He says the industry's woes will be "at least of a similar magnitude as those that the commercial real estate faced in the early 1990s."

Drops in property values of 45 percent from a peak in late 2007 are possible, Parkus said, exceeding those of the early 1990s, as demand for office, retail and other commercial space plummets amid a worsening economy.

Adding credence to those gloomy predictions, the government said Thursday that the U.S. economy shrank at a 6.3 percent annual pace at the end of 2008, the worst showing in a quarter-century.

Funding for commercial loans virtually shut down last year as the financial system unraveled.

There was $12.2 billion in commercial mortgage debt issued last year, the lowest figure since 1991 and down 95 percent from 2007, according to a report by Reis.

Making matters worse, about $216 billion in loans are coming due through 2012.

When the companies can't make those payments anymore, they'll get foreclosed on too, driving values down for the rest of the country's offices, factories, hotels and strip malls. More and more companies will go under. This second crash will finish off a great many businesses already on the edge...and truly put us into a depressionary scenario. Seven states are now facing double-digit unemployment, and U-6 "real" unemployment estimates ranging from 18-21%. A great many local and state economies are already so weakened by the current situation that another wave will absolutely capsize them. The banks will take another mortal blow as they lose billions on commercial real estate, throttling any nascent recovery for the financial sector in its crib. That means more bailouts, more spending, more legislation, more pain.

And the real problem is that the local banks that have kept their noses clean on subprimes are the ones that will be rocked the hardest by the global commercial real estate collapse. They're the ones that invested in the strip malls and hotels and business parks because at the time they were safe bets. Now, they'll be cutting back on loans and dealing with foreclosures just like the big boys just when the country needs those loans the most to restart the economy. The disease will be spreading. The results will be devastating. Solid banks now will become weakened. Weakened banks now will become insolvent. Insolvent zombie banks now will become more multi-billion dollar albatrosses around our necks.

The bottom? We're going to wish that March 2009 was the bottom here very, very shortly. Alas, nothing could be further from the truth. Any chance we had at recovery is about to get hit by a tsunami of commercial real estate foreclosures, skyrocketing unemployment, and a long-term depression.

Buckle in kids. As bad as it's been, it will absolutely get worse from here.

Be prepared.