First the good news. Although it wasn’t exactly a popular view in the early going, we’ve been saying for some time that the recession ended early in the summer (our money is on the recession’s official end point being either June or July). And while it is dangerous to pat yourself on the back in this business, it is indeed nice to see that the vast majority of economists, including Mr. Ben Bernanke, now agree that the recession has technically ended. In fact, even the majority of the economists surveyed by the Wall Street Journal believe that the economy is now on the mend.
After the longest (18 months) and deepest (-3.8%) recession in the post-war period, the 48 economists surveyed this week by the Journal expect the economy to show a growth rate of 3.1% during the third quarter of this year. And it is for this reason that the stock market has enjoyed such a strong run since the beginning of July.
However, that is where the good news ends. It is positive that the WSJ’s survey of economists says the expansion in the economy will continue. But, the economists polled are quick to point out that the current rate of growth is likely to slow going forward and they don’t really want to make any projections much past mid-year 2010.
The problem is we are most likely entering something called a “jobless recovery.” As the Journal says, “The worst recession since the Great Depression has left a scorched landscape that will weigh on the labor market and the broader economy for years to come.” And it is for this reason that we aren’t likely to see a “V” shaped recovery in the economy.
Given that the world’s manufacturing base is now located in the Far East, the Gross Domestic Product of the U.S. is now mostly driven by the consumer. And as such, it is tough to get too excited about the potential for a robust rebound in the economy given the state of the jobs market. Although this week’s initial jobless claims report was the best of the year and triggered a rally in stocks, we should keep in mind that another 521,000 people headed to the unemployment line last week alone and that 6.04 million people continue to collect unemployment insurance.
The fact that the jobs picture continues to be weak won’t make the evening news these days and shouldn’t surprise any investor that has been paying attention. However, when you are trying to look ahead six months or so, the state of the jobs market makes the picture murky at best.
According to Allen Sinai, “Never before has business shed so many workers so fast, so many people failed to find work who are looking for work, and so many dropped out of the labor force as in the current circumstance.” And lest we forget, the current rate of unemployment nationwide is 9.8%.
The problem here is that the unemployment rate is expected to rise for the next five or six months. The Journal’s survey of economists suggests that the unemployment rate will peak out at 10.2% next February.
Since people have been talking endlessly about the employment picture lately, this concept shouldn’t surprise anyone to any great degree. But the fact that job growth isn’t expected to pick up any time soon just might. Diane Swonk of Mesirow Financial said this week, “It could take until 2014-2015 before we see a 5% handle on unemployment again.”
Putting a pencil to the numbers, assuming we see an “average recovery” and the pace of job growth also comes in at an average rate, the Journal reports it would take 86 months for the economy to recovery the more than 1million jobs lost since the recession began. And for those of you keeping score at home, that means it could be Christmas 2016 before the economy recovers the jobs cut during the credit crisis.
With unemployment likely to continue to be a big problem, it is hard to see how the consumer is going to do much more in the way of discretionary spending than they are doing right now.
To put this into perspective, think about how you and your friends have reacted over the past year. In October 2008, the economy stopped on a dime as the credit crisis hit with a vengeance. In short, everybody stopped doing everything from a consumption standpoint. Nobody bought anything. Nobody went on vacation. And just about everybody decided it was probably time to start paying down some of those credit card balances.
However, when it became obvious that the banking system wasn’t going belly up and that we weren’t going to enter The Great Depression II, consumers began to breathe a sigh of relief. So nowadays, you are likely going out to eat again. You may be buying some things at the mall again. And you may even be planning a vacation for the holidays this year.
Yet it is a safe bet that you are spending less money now on all of those discretionary items than you did in 2007. And it is also pretty safe to say that you aren’t planning on increasing discretionary spending anytime soon. Thus, from an economic standpoint, the question becomes: After the initial recovery, what will drive the economy’s growth?
One way to push things forward is via government spending. But with the public up in arms about the massive amount of money currently being spent and the mind-boggling deficits being run up, the option for more government spending in the future does not appear to be on the table.
So, with the unemployment rate likely to continue to rise into next year, the consumer isn’t likely to start spending willy-nilly again. Then there’s Corporate America. Companies have done a good job of cost cutting (hence the unemployment problem) and are currently in the process of “rebuilding inventories.” But unless things pick up, companies may not see “top line” growth (i.e. an increase in sales) anytime soon. And then with the government having already spent close to a trillion dollars and the political climate not good for additional spending, the shape of the economic recovery might look more like a square root sign than anything else.
Which brings us back to the stock market. Stocks are currently busy discounting the improvement in the economy and the fact that most companies will be able to once again exceed the expectations in terms of earnings estimates. (Remember, if you place the “expectations bar” on the ground – or in some cases, in a trench – most companies will find a way not to trip over it, and thus can continue to exceed expectations!)
But at some point in the future, this “discounting” of better days ahead will be completed and traders will begin looking for that top-line growth everyone is talking about. Thus, it is safe to say that the current game of “betting on the future” will have to end. And if the economic improvement and/or earnings growth doesn’t show up as expected, well… disappointment might set in and things could get ugly.
Trying to figure out “how much is enough” in terms of discounting the future is indeed a tricky business. So, we’ll continue to watch valuations in the market. And we can argue that there may be room to the upside on this front. But if the S&P climbs above the 1200(ish) level, unless we start to see some improvement in sales – meaning the consumer returns to the malls – stocks will likely become overvalued. And in short, we might need to dig out those risk management strategies again.
If you are getting the impression that we are either donning or frantically searching for our bear hats, you are wrong. We believe our heroes in horns can continue their run for the roses for some time yet. However, the big point this weekend is to remember that this is unlikely to be the start of a new multi-year bull market where you can simply “set it and forget it.”
No, we are of the opinion that we have not seen the last of the bears and that the “jobless recovery” might just be the bears’ raison d’être.
Wishing you all the best for a profitable week ahead,
David D. Moenning
Positions in Stocks Mentioned: None