Monday, August 03, 2009

A recovery that feels like a recession

You will hear a pretty consistent refrain from many optimists in the coming months - the recession has ended and the recovery has begun!

Let's talk about these facts for a moment. The National Bureau of Economic Research officially labels recessions based on GDP reports. As of the second quarter, GDP was still contracting but the rate of decline has slowed meaningfully thanks to substantial increases in government spending (excluding government spending the second quarter GDP decline was essentially flat vs the first quarter).

As a result of further stimulus spending and the cash-for-clunkers program it is safe to assume that the economy will "grow" again by the second half of 2009. However, most of this growth is essentially like training wheels on a 3 year-old's bike. When the stimulus programs stop will there be sufficient activity from the private sector to maintain the growth story or will we slide back into recession?

L, W or V?

What type of recovery do you expect? Almost all of our recent experience with recessions have ended with sharp V shaped recoveries. Unfortunately, recent history tends to have a greater weight when people make their forecasts and thus, many expect a sharp recovery once we turn the corner. I'm not in that camp.

I think we have about an equal probability of an L or W shaped "recovery". In an L shaped recovery growth would remain muted and we would remain stuck with an economy that is bouncing along the bottom - not getting worse, but certainly not getting much better.

The W shaped recovery would be the most painful and also the hardest to predict. Under this scenario we would oscillate in and out of recession for the next 5-10 years. Given that the vast majority of companies are still cutting costs and not forecasting any improvement in their revenue line I think this is a real possibility.


Many have asked about the stock markets continued strength and there are a couple of factors at play...

1) The continued decline of the US dollar. On a basic level, the stock market is a commodity index just like oil or gold. The decline in the value of the dollar means that it takes more dollars to buy assets like oil or gold or stocks. Eventually, this connection starts to breakdown between stocks and US dollar moves, but I think it's played a role in the move over the past 3 weeks.

2) The stock market has really lost it's ability to be a forecaster of economic activity. The stock markets focus on near-term moves and the huge computer trading operations have turned the stock market into an economic generator rather than an economic predictor.

I tend to think that people buying stocks at these levels were probably buying townhouses in Las Vegas and Phoenix in 2006:)

One final note on some data that will be coming out soon - unemployment. There are currently 2.6 million people receiving unemployment benefits beyond the normal maximum 26 week period. These people or the "extendees" as they've been labeled, have struggled to find new work in the economy. The number of extendees has jumped from just 100k a year ago to more than 2.6 million in a year. While that number is daunting, consider that without another round of benefit extensions (there are talks to extend benefits) up to 1.5 million "extendees" will be come "exhaustees" as they exhaust the last of their unemployment benefits.

So while we could theoretically see a drop in the number of "unemployed" persons in coming months, much of the drop could be a result of people just dropping out of the system as their benefits are used up.


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