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 Today's topic deals with the current state of affairs in our economy, and to a lesser degree, the stock market. We have seen a significant rally recently in the stock market and the overall sentiment seems to be that the worst is behind us and that we're moving back towards growth. In this edition of Financially Speaking, we'll take a look at what we feel is happening and offer some insights.
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The Waves of Uncertainty
From January 1, 2009 to its low on March 9, the S&P 500 Index dropped 25.1%. Uncertainty was at the root of that drop. In general, the economic fundamentals were not dramatically worse than what was seen at the end of 2008. Yes, unemployment was higher, but everyone expected that. I believe a questionable public interview with Tim Geithner in February and the ongoing concern about our banking system pushed the uncertainty to extreme levels. Uncertainty combined with a negative data bias can be a very painful combination. Fast forward two months and the S&P 500 has rebounded by 37.4% as of May 8, 2009. Improved leadership regarding Government intervention in the banking system, a general slowing of the pace of economic decline and some surprisingly better-than-expected corporate earnings have pushed the data bias more positive. The uncertainty remains, but now it seems more about when the recovery will start...or has it already started and "am I missing it?"
When Bad News Really is Bad
Much of the talk regarding our economy recently has focused on the slowing of the economic decline. Most analysts admit today's economic news is bad. But many say that economic or market bottoms can only be established once the decline has slowed...then turns positive. Thus, the slowing of the decline is essential to any pending recovery. While I agree with this sentiment from a purely mathematical view, I'm not particularly excited as a money manager. I feel the underlying issues associated with this recession are too pervasive to get excited about the slowing of the decline. Does the slowing rate of decline mean a recovery is imminent, or is it simply a statistical moderation of the decline rate? In this environment we feel that the news of a slowing economic decline, while encouraging, is still bad news.
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Real Estate, Tight Credit,
Consumer Spending and GDP
If we boil the current credit crisis and recession to its most basic cause, it has to be the reduction in residential real estate values. Those reduced home values caused the problems in the derivative markets, resulting in significant issues with over-leveraged balance sheets at major banking institutions, which then resulted in the tightening of credit access. These events then led to a sharp reduction of consumption based on lower personal net worth. That said, I believe a true recovery, one that provides real GDP growth, won't happen until housing prices stabilize and home-buying volume and inventory get closer to normal. While we have seen signs of efficiency within the housing market, the volume of sales and the inventory of homes for sale remain far from normal. Add to this the continued tightness of credit throughout the financial system and it becomes clear why housing won't recover quickly.
The slow recovery in housing that I'm suggesting will impact other parts of the economy as well. Looking at GDP, residential spending increased 50% from 2003 to 2006. Consumer spending, a much larger component of GDP which includes durable goods, non-durable goods and services grew by 31% between 2003 and 2007. Undoubtedly a portion of this spending was the new appliances, paint and landscaping associated with increased home ownership. It seems clear to us that the reduction in housing activity will naturally slow consumer spending and drag on GDP growth.
Beyond housing, consumers have ample reason to slow their personal spending. Consumers are seeing the light with respect to excess spending and debt. The shocking reality of net worth reductions in the wake of plummeting home values and stock markets has shifted the national saving rate steeply upward. Many recessions recover from the pent-up demand resulting from the slowdown...I don't expect it from this recession. |
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Am I Bearish?
 All of the above sounds terribly bearish, but it isn't meant to. I am suggesting that a number of negative issues remain in our economy and I believe it is premature to see the slowing of economic decline as a trend to near-term recovery. The rally we've seen recently may be a response to irrational negativity in early March, but may now have run its course. The economic headwinds described above could prevent a near-term economic recovery and may even suggest market pullbacks are likely. This is a time to be watchful of your investment portfolio.
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