Posts tagged ‘Recovery’
Metamorphosis of a Bear into Bull
Picture Source: The Wall Street Journal (Mick Coulas)
James Grant, a self-admitted, “glass half-full kind of fellow,” recently contributed a Wall Street Journal article predicting the economic recovery will be a “bit of a barn burner.” Traditionally a pessimist, he recently experienced the metamorphosis from a bear to a bull. James Grant is a multi-book author who has written for the Interest Rate Observer for more than 25 years with thoughtful observations on economics and interest rates. With a value-tilted investment philosophy, Mr. Grant prides himself as a contrarian and anti-CNBC advocate.
Current Environment
Markets have transitioned from sheer panic (what Grant calls the “bomb shelter”) to a manageable utter fear – meaning a lot of investors still have cash stuffed under the mattress in low yielding money market and CD (Certificates of Deposit) accounts. This bed cash will ultimately act as dry powder to ignite the market higher, should earnings and macroeconomic variables continue to improve. Despite the approximate 60% index bounce from the March 2009 lows, the S&P 500 still remains more than 30% below the late 2007 highs.
Glass Half Empty Crowd
Skeptics of the market advance generally fall into one of the following buckets:
1) Armageddon is coming, just wait. Our country is choking on too much debt.
2) The stock market advance is merely a bear market rally within a secular bear market.
3) Rally fueled by temporary stimulus, which once it dries up will lead to another recession and bear market.
4) Earnings results that are coming in better than expected are merely coming from unsustainable cost-cutting.
Grant’s Rose-Colored Glasses
James Grant has a different view of the unfolding recovery in light of historical cycle patterns:
“Growth snapped back following the depressions of 1893-94, 1907-08, 1920-21 and 1929-33. If ugly downturns made for torpid recoveries, as today’s economists suggest, the economic history of this country would have to be rewritten.”
Consistent with Mr. Grant’s views, Michael T. Darda, chief economist of MKM Partners stated “The most important determinant of the strength of an economy recovery is the depth of the downturn that preceded it. There are no exceptions to this rule, including the 1929-1939 period.” Grant goes on to compare the current recession with the 1981-82 variety:
“[During] the first three months of 1982, real GDP shrank at an annual rate of 6.4%, matching the steepest drop of the current recession, which was registered in the first quarter of 2009. Yet the Reagan recovery, starting in the first quarter of 1983, rushed along at quarterly growth rates (expressed as annual rates of change) over the next six quarters of 5.1%, 9.3%, 8.1%, 8.5%, 8.0% and 7.1%. Not until the third quarter of 1984 did real quarterly GDP growth drop below 5%.”
Further support for a stronger than anticipated recovery is provided via data supplied by the Economic Cycle Research Institute:
“The institute’s long leading index of the U.S. economy, along with supporting sub-indices, are making 26-year highs and point to the strongest bounce-back since 1983. A second nonconformist, the previously cited Mr. Darda, notes that the last time a recession ravaged the labor market as badly as this one has, the years were 1957-58 —after which, payrolls climbed by a hefty 4.5% in the first year of an ensuing 24-month expansion.”
Mr. Grant does not promise as large a recovery implied by Mr. Darda, but historical standards point in that direction, especially when you factor in vast pools of cash and cautious prognosticators and economists such as Ben Bernanke, Warren Buffett, and Paul Volcker. These financial “giants” have not deterred Mr. Grant’s metamorphosis from a bear to a bull.
Click Here to Read Full Grant WSJ Article
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
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Tortuous Path to Productivity
There is a silver lining to the deep, tortuous job cuts in this severe recession and it is called “productivity.” Those fortunate enough to retain their jobs are forced to become more productive. In layman’s terms, productivity simply is output divided by hours worked.
Unemployment dropped to 9.4% in July, thanks in part to a decline in the job losses to -247,000 from a peak in January of -741,000 job losses. During this period of job-loss cratering, we managed to sustain a decline of a mere -1% in Q2 Gross Domestic Product (GDP). How could we lose more than 6 million jobs since the beginning of 2008 and still be on a path to recovery? A large contributor is our friend, productivity, which came in at a whopping +6.4% in Q2 – the highest in six years.
Productivity increased in part because of a slashing of work-hours by employers. Employees that have maintained employment are therefore forced to produce more output (goods and services) per unit hour of employment. In this severe recession that we are pulling out of, the American worker is being stretched like a rubber band. At some point, the “Law of Diminishing Returns” kicks in and employers are forced to hire new employees to meet demand levels, or the rubber band will snap.
The prime ways of increasing productivity are raising the amount of capital per worker (capital intensity) and also elevating the workers’ average level of skill, education, and training (labor quality).
Not only are the surviving U.S. workers toiling harder, they are not getting pay increases large enough to offset inflation. For example, Q2 hourly compensation increased +0.2%, but after accounting for inflation, real hourly compensation was actually down -1.1%.
As the MarketWatch article points out:
The early stages of recovery are typically the best for productivity: Output is rising, but cost-cutting plans are still being implemented… Productivity gains are the key to higher living standards, higher wages, increased profits and low inflation… Productivity averaged about 2.7% annually from 1948 to 1970, then slowed to 1.6% from 1971 to 1995. Since then, productivity has grown about 2.5% annually. In 2008, productivity increased 1.8%.
Productivity allows the U.S. to produce more goods and services with fewer workers. For instance, the MarketWatch article also highlights the U.S. is producing 20% more output relative to a decade ago, yet employment has not changed at all over that time period.
We are certainly not out of the woods when it comes to the recession, and for those lucky enough to maintain employment, they are being asked (forced) to work more for less pay. These productivity improvements feel like torture to the survivors, however this pain will eventually lead to economic gain.
Wade W. Slome, CFA, CFP
Plan. Invest. Prosper.
Steepening Yield Curve – Disaster or Recovery?
Various Treasury Maturities in 2006 Highlighting Inversion
Wait a second, aren’t we suffering from the worst financial crisis in some seven decades; our GDP (Gross Domestic Product) is imploding; real estate prices are cratering; and we are hemorrhaging jobs faster than we can say “bail-out”? We hear it every day – our economy is going to hell in a hand basket.
If Armageddon is indeed upon us, then why in the heck is the yield-curve steepening more than a Jonny Moseley downhill ski run? Bears typically point to one or all of the following reasons for the rise in long-term rates:
- Printing Press: The ever-busy, government “Printing Press” is working overtime and jacking up inflation expectations.
- Debt Glut: Our exploding debt burden and widening budget and trade deficits are rendering our dollar worthless.
- Foreign “Nervous Nellies”: Foreign Treasury debt buyers (the funders of our excessive spending) are now demanding higher yields for their lending services, particularly the Chinese.
- Yada, Yada, Yada: Other frantic explanations coming from nervous critics hiding in their bunkers.
All these explanations certainly hold water; however, weren’t these reasons still in place 3, 6, or even 9 months ago? If so, perhaps there are some other causes explaining steepening yield curve.
One plausible explanation for expanding long-term rates stems from the idea that the bond market actually does integrate future expectations and is anticipating a recovery. Let us not forget the “inverted yield curve” we experienced in 2006 (see Chart ABOVE) that accurately predicted the looming recession in late 2007. Historically, when short-term rates have exceeded long-term rates, this dynamic has been a useful tool for determining the future direction of the economy. Now we are arguably observing the reverse take place – the foundations for recovery are forming.
Treasury Yield Curve (June 2009)
Alternatively, perhaps the trend we are currently examining is merely a reversal of the panic rotation out of equities last fall. If Japanese style deflation is less of a concern, it makes sense that we would see a rebound in rates. The appetite for risk was non-existent last year, and now there have been some rays of sunlight that have glimmered through the dark economic clouds. Therefore, the selling of government guaranteed securities, which pushed prices down and yields upward, is a logical development. This trend doesn’t mean the equity markets are off to the races, but merely reflects investors’ willingness to rotate a toe (or two) back into stocks.
Investing Caffeine 
