Archive for June, 2010

Alpha Bits

Alan Reynolds has an op-ed out this morning in the Wall Street Journal chastising those who believe poor job growth is driving us into a double dip recession–the so-called “W” pattern.  It seems Reynolds would have us believe that our economy is more like a “U” (or, dare I suggest, a “V”?).   And that as a result Keynesian efforts to keep supporting the economy are not needed.

It’s well researched and well written, and argues persuasively that–properly interpreted–recent jobs numbers aren’t all that bad, amounting to a net gain this year of roughly 100,000  private sector jobs per month.  (It’s about double that if you add in government jobs, some of which are temporary).  I even agree we need to be careful with the fiscal magic wand, at least absent a long-term strategy for handling the deficit, as Bernanke suggested yesterday.

However, for all his hair-splitting, Reynolds seems to miss the point.

Recent estimates indicate more than 8 million jobs were lost during the panic and Great Recession.  In a nice, steady expansion (3-5% annual GDP growth), let’s say the economy adds maybe 300-350,000 jobs per month.  At that rate it will take 24 months just to get back to where we were beforehand, employment-wise.  And at only 100,000 jobs per month this year, we haven’t really started the clock yet.

Imagine.  Two years just to catch up.

Even worse, we’re not counting the growth in the labor force since 2008 (young people coming of age minus those retiring).  Plus fewer than expected can afford to retire now, given how their savings have been decimated in recent years.

Then there’s the economy.  Yes, there have been impressive gains over the last year or so.  Always stated breathlessly by the popular and financial press, in terms of double-digit percentage growth.  Little mention of the drastically low base that growth is from.  In fact, frightfully few actual numbers at all.  Just growth percentages.  No indication of how far we still are from the level of economic prosperity we enjoyed in 2006 or 2007.

[Some of that growth, by the way, has come from temporary fixes–namely government stimulus.  The rest has been due to industry overproducing to rebuild inventories, after running the pipeline dry when few were buying.  In the old days we called that stuffing the channel.  Now we refer to it as a rebounding economy.]

Further, there are all the references to growing corporate profits.  Sure, if you lay off lots of people and lower costs, then even with falling sales you can engineer rising profits.  But that can’t last without an increase in demand.  And that requires workers with salaries, as well as currently employed people with rising incomes.

What we’ve seen so far has been more akin to a relief rally in sales than a true demand increase.  People who had been holding their breath finally buying that refrigerator or car once they realize they won’t be losing their job.  But flooding the economy with cheap money, as the government has done, is ineffective in an environment of low demand and fear over jobs and savings.

It’s like pushing a rope.

Until there is unequivocal evidence that people feel confident enough to really start buying again, small businesses–the engine of job creation–won’t hire.  Nor will banks lend to them.  It doesn’t matter how cheap money is, no one will risk lending to a business that can’t demonstrate demand.  Despite the rise in the market over the last year, banks aren’t lending, which shows you what they really think.

Bottom line, with vastly lower employment, lower (and slowly rising) housing prices, a drop in equity wealth, a rise in the savings rate, and massive consumer deleveraging, its difficult to conceive of a way we can get our economy back to pre 2008 levels in anything less than 4 or 5 years, perhaps more.  If we do, it will only be because consumers are going into debt again, simply postponing the inevitable.  Or as I’ve discussed before, re-inflating the bubble.

So is the economy headed for a double dip (“W”)?  Perhaps, but not likely.  Frankly, I suspect it’s more like a “square root” symbol–sharp fall, then a small rise, then flat.  But no matter which you believe, what is clear, and most relevant,  is that the recovery is not a “V” or even a “U”.

Yet that’s exactly what the market has priced in over the last year.

There’s no doubt we’ve had an impressive bull run in the market since March 2009.  However, the cracks are showing.  It’s been clear to me for some time that the market has gotten ahead of itself, and that this is one of those times where the market and economy have become disassociated.  Until recently, the pundits have all been saying that we can’t be at a market top, because there’s still too much money on the sidelines, and we don’t have a top until all that money rushes in.

They underestimate the uncertainty that still grips many on Main Street.  People have been keeping a lot of their funds in cash or safe bonds because they no longer trust the market.

Really, what I think was happening up until the “flash crash” is that money managers have been talking their book.  Waiting for the suckers to come in at the last minute so they could sell at the top.  Except the suckers didn’t come, and with all the new fear and volatility introduced by Europe’s problems, they aren’t going to.  Which is why there’s been so much selling lately, and why I believe this is more than a simple correction in a continuing bull market.

We’ve been in a secular (long-term) bear market since 2000, and there’s no sign we’ll be out of it soon.  Not until we get the economy back to prior levels–which as we’ve seen will take awhile.  We may be at the end of the cyclical bull market that began last March, and could experience one or more short-term bears and bulls before we finally pull out of all this.

In fact, in hindsight it appears as if the rapid rise in the market from March 2009 to July 2009 was the “relief rally” that compensated for the panic of late ’08, while the rise since last July was the real “bull” market.  If so, there’s even a small chance we’ll be revisiting those July lows before we see another sustained rise.

In any case, the part of the alphabet we assign to the economy isn’t the real issue right now.  It’s the “W” in the stock market that we ought to be worrying about.

Disclosure: I hold no position, either long or short, in any stocks mentioned here.

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June 10, 2010 at 10:46 am 2 comments

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