America has just elected a president with leadership and vision. President Obama is expected to choose a first rate economic team: individuals such as Larry Summers and Tim Geithner may be his choices for the position of the Treasury Secretary.

Obama is fully aware of the very difficult economic and financial challenges that his country is facing and will work hard to resolve them.

But Obama will inherit an economic and financial mess worse than anything the US has faced in decades: the most severe recession in 50 years; the worst financial and banking crisis since the Great Depression; a ballooning fiscal deficit that may be as high as a trillion dollar in 2009 and 2010; a huge current account deficit; a financial system where de-leveraging is still occurring at a very rapid pace, resulting in a worsening of the credit crunch; a household sector where millions of households are insolvent and on the verge of losing their homes.

A serious risk of deflation looms large as the slack in goods, labour and commodity markets becomes deeper; a risk that end in a deflationary liquidity trap as the Fed is fast approaching the zero-bound constraint for the Fed funds rate; the risk of a severe debt deflation as the real value of nominal liabilities will rise given price deflation while the value of financial assets is still plunging. This is the bitter gift that the Bush administration has bequeathed to Obama and the Democrats.

The latest US macro news have been worse than awful: collapsing retail sales and consumption, free fall in capex spending by the corporate sector, sharply falling industrial production and employment. Home prices are bound to fall 40 per cent from the peak with simultaneously collapsing auto sales; forward looking indicators of business and consumer confidence dropping to multi-decade lows and sharp surge in corporate defaults, wrecked banking and financial systems that would have to be partially nationalised.

This is the most daunting set of economic and financial challenges that any president has had to face since the Great Depression. In the rest of the world things are also as bad: a severe recession in Europe, Japan and other advanced economies; the risk of a hard landing in many emerging markets including China; an almost certain global recession; a severe global financial crisis. It will be a long and severe and protracted two-year recession regardless of the best intentions and good policies of the new US administration. It will take a lot of hard work to clean up this mess and reduce the length and severity of this economic contraction.

And in the meanwhile the brief bear market sucker's rally in the equity market has lost its steam and US and global equities are starting to plunge again. This situation is not getting better anytime soon, consequently the bear market rallies cannot defy the laws of gravity: a slew of ugly and worse than expected macro, earnings and financial news was bound to take a toll on equities and other risky assets. And now, after a brief rally markets are starting to plunge again.

For 2009, the current consensus estimates are that S&P 500 earnings per share (EPS) will be $90 in 2009, up 15 per cent from 2008. Such estimates are delusional. If EPS fall – as most likely – to a level of $60, then with a multiple (P/E ratio) of 12 the S&P500 index could fall to 720, i.e. 20 per cent below current levels;

If the P/E declines to 10 – as possible in a severe recession, the S&P could be down to 600 or 35 per cent below current levels. And in a very severe recession one cannot exclude that the EPS could drop as low as $50 in 2009 dragging the S&P500 index to as low as 500. So, even based on fundamentals and valuations, there are significant downside risks to US equities.

So the brief sucker's rally is over and a reality check is now dawning on markets and investors. Expect this financial crisis and economic recession to get much worse in the next 12 months before it gets any better. We are nowhere near a bottom for housing, the US economy, the global economy and financial markets. The worst is ahead of us rather than behind us.