Buffett says economic and credit woes linger

Warren Buffett's comments on the investment outlook usually resonate, and those over the weekend were no exception: Panic in financial markets may be through, but that doesn't means it's the end of the economic and credit woes.

Buffett's assessment is a wakeup call to investors who have been pushing stock prices higher and are warming up to owning risky debt again, both big bets that the worst of the credit crisis is over.

Feeding that shift in sentiment has been better-than-expected economic and financial news, which at a glance does look good. It's when you dig a little deeper that it's evident why it's not.

Buffett spoke over the weekend during events surrounding the annual meeting in Omaha of his company, Berkshire Hathaway Inc. He said the Federal Reserve's bailout of Bear Stearns in March likely averted a broad crisis, which could have spurred a run on investment banks and crippled the financial system.

The "idea of financial panic" has largely been "fairly well taken care of," he said, but he predicted the pain is far from over for financial institutions. Buffett also said the U.S. economy is in a recession by his definition — when most people and businesses are not doing as well as they were three, six or nine months ago.

That contrasts with the upbeat view embraced by investors in recent weeks. Just look at the turnaround in the Standard & Poor's 500 stock index: After tumbling more than 13 percent from the start of 2008 through the Bear Stearns mess on March 17, it has gained more than 10 percent.

Among the data points feeding such gains was the May 1 report from the Commerce Department showing a surprising 0.6 percent growth in gross domestic product during the first quarter. To many investors, it was proof that the economy isn't in a recession.

That, however, glosses over some land mines in the report — which Merrill Lynch chief North American economist David Rosenberg says are indicative of a "recession beneath the veneer." He points to the 0.4 percent annual decline in real final sales of domestic purchasers, which is considered a solid measure of economic health since it is essentially real GDP without inventories or net foreign trade. It dropped from a 1.3 percent annual growth rate in the fourth quarter and a 2.5 percent pace in the third quarter of last year.

The latest figures on the job market released Friday also came in above expectations. Instead of falling by 75,000 as economists had estimated, payroll employment dropped just 20,000, according to the Labor Department. The unemployment rate fell to 5 percent from 5.1.

But as economists at Goldman Sachs point out, that is hardly good news for an economy that needs at least 125,000 new jobs per month to keep pace with labor force growth. It warned clients to dig beneath the "not-so-dire headline data" to find out where contraction in the housing market is eating away at the economy.

While subprime loans — those to borrowers with risky credit profiles — were what fed the first leg of this mess, the next could be caused by a deterioration in prime lending. CreditSights advises to keep tabs on prime default rates.

Others are sounding the same warnings as Buffett. But his often are the ones that are heard.