No Double-Dip Recession In Sight, Just Slow(er) Growth

As highlighted in LPL Group’s excellent report: “Mid-Year Outlook for 2010“, the economy is moving from ‘recovery’ mode to ‘expansion’ mode, which is very different from moving from ‘recovery’ back to ‘recession’  – a prediction made by many attention-seeking alarmists these days. We are still growing, just not as fast. That is because, during ‘recovery’, our federal government (White House, Congress and the Federal Reserve) made sure (via increases in gov’t spending, stimulus packages, low interest rates and the purchases of bad debt from banks) we grew fast to make up for lost ground. Their efforts paid off: GDP has surpassed its pre-recession peak as have Consumer Spending (which accounts for more than 70% of GDP) and government spending. Adding to the success of our recovery is the fact that nearly every major industrialize nation in the world followed the lead of our federal government – so most of the developed world recovered in unison.

The math is simple: now that we have made up for lost ground, there is just not that much growth left. We switch from recovery to ‘sustainable growth’ mode. And this is where it gets tricky: if the government primes the pump of ‘sustainable growth’ too much, then the growth will not be sustainable because it was artificially induced by the exogenous force of government intervention. Our federal government must keep a delicate balance stimulating economic growth and overheating the economy. The point is that they can no longer keep the economy in recovery mode without risk of ruining the transition to sustainable growth mode.

The Good News: exports have been strong in the first half of 2010 which led to inventory restocking and business capital spending, which we hope will translate into continued job growth. As mentioned above, GDP has surpassed pre-recession levels.

The Bad News: The Institute of Supply Management’s (ISM) Purchasing Managers Index has peaked – which presages a slow-down in economic growth. We can expect a a volatile pattern of growth for the foreseeable future.

Biggest Risks and Challenges:

  1. Fiscal problems in Europe lead to a post Lehman-like freeze of global liquidity and trade: I consider this an unlikely outcome as the European Union and International Monetary Fund committed nearly $1 trillion to support European Sovereign debt markets. $1 trillion covers all of the maturing bonds of Spain, Italy, Greece, Portugal and Ireland for nearly three years. In other words, none of these troubled counties will have to raise new debt from the public markets over the next three years. In addition, Greece and Spain have successfully implemented fiscal austerity measures and Greece’s debt reduction is running ahead of schedule.
  2. Job Growth Stalls: this is perhaps the biggest risk as job growth faces some challenges in the form of (a) potential layoffs at the state and local government levels, best case is no layoffs; (b) oil-drilling moratorium in the Gulf costs as many as 166,000 jobs, perhaps, some of this loss if offset by hiring of clean-up workers; (c) lack of confidence by business, which results in hold-backs in spending and hiring.

Positive Forces:

  1. Very low interest rates for the foreseeable future. The Fed and other central banks in developed countries plan to keep monetary policy accomodative.
  2. Low inflation helped by low commodity prices.
  3. About half of the $787 billion Tarp package has still not been spent and could be put to use – though downside of increased federal deficit weighs heavily on this option.
  4. Corporate profits should remain strong – low cost of labor, low input prices, low (for now) taxes and, at least, a little economic growth set the table for business to continue to fill their coffers.
  5. Corporate cash reserves are high- business have been storing cash flows for some time. Combined with the low leverage of most businesses, the high cash holdings mean that Corporate America is poised for lots of growth when confidence returns.

In summary, I think we will see a tug of was between the Risks and Positive Forces. Transition to the ‘sustainable growth’ phase will be marked by lots of volatility, especially in the stock market. As Charles Gave at GaveKal Research wrote in a recent research report: “The phase of indiscriminate rises in the stock market is over.” I could not agree more and believe that we are entering an environment where skill in assessing the true economic profitability and valuation of companies will determine the success of stock-pickers. And that is exactly the type of environment that suits New Constructs best.

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