Tuesday, July 21, 2009

American Recession is Over (Or, We Have Hit Rock Bottom)

Bernanke has added his voice to the growing concensus view, that the Recession is over.  This is one week after Daniel Gross's article on some leading economic indicators.

So this means that we have hit rock bottom, low enough that the economy will not shrink anymore, for a little bit longer.  You can kind of see this in the stock market as well, where the SP500 hit the bottom back in March, and has recovered quite a bit of its value since then.

However, the question now is, what's next?  The current "recovery" is primarily the result of fear easing and hitting bottom.  Back in the first quarter of this year, the credit market locked up, and businesses went into survival mode, hoarding cash and minimizing expenses.  Now, the commercial papers market has returned to somewhat normal, meaning businesses can stop hoarding cash.  Businesses cannot slash any more expenses without impeding their operations.  And productivity is up, as they fire many of the lazier employees.

American companies are earning some money from the economies of China and India (and Brazil and other developing countries), which gives you that small rise in earnings you are seeing in the Second Quarter reports.  However, the American consumers are not spending, so there is little domestic driver for corporate earnings this year.

There are three scenarios going forward:

1.) Optimistic: The Obama stimulus finally hits the economy.  The Adjustable Rate Mortgages stop being a drain on banks (because they already wrote down the mortgage sector, hopefully).  We can't see a consumption-driven recovery, but we can see Investment from a new technology, as yet unknown.  Rich people the world over start going on vacation again to luxury destinations.  Inflation stays under control.  These little things add up to start dragging the world economy out of the slump. 

This would depend on all of these little things happening, and so far, it looks highly unlikely, short of a World War III-driven economic recovery.

2.) Neutral: Stimulus hits, but the ARM write down (from all the 2007 homebuyers losing their homes, or a Federally-forced "mortgage protection" settlement) largely cancels out the stimulus.  Consumption stays the same.  Investment stays low.  Inflation stays middle.  Rich people are afraid to visibly spend on luxuries, keeping them at home.  We enter a Japanese style economic ennui.

This scenario is very likely, because the ARM write down has yet to happen.  As Gross said in his article, we cannot foresee a technology compelling enough to start an Investment-driven recovery, in the style of the 90's Internet Boom.

3.) Pessimistic: The ARM writedown overwhelms the Obama stimulus.  Inflation on the Supply inputs (a bad corn harvest, rise in fertiliser cost, Nigerian MEND terrorism, et al) pushes companies and households into bankruptcies.  The stock market takes a second nosedive.

This scenario is somewhat likely.  If it does happen, it will be a long, bad stretch for the world.

The above analysis does not account for several wildcards.  For example, the Cap and Trade regime and other environmental initiatives could severely curtail corporate investment and bankrupt small companies.  A bad H1N1 outbreak in the northern hemisphere could drive 2009 back into negative growth territory.

So for those of you looking to invest in the stock market: Yes, you have missed the bus, once again.

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