Daily Investment Interpretations

August 1, 2010

2010-8-1:  The articles below tell an interesting story. 
    The first article, A Sin and a Shame, written by the New York Times' Bob Herbert, explains that corporate managements have used The Great Recession as an excuse to squeeze their workforce to get more and more out of them. This is why corporations are sitting on piles of cash. But I suspect that this is an object lesson in why, even with all its warts, government intervention is essential. If one corporation improves its bottom line by transferring more of its operations overseas, its competitors have to fall in line or fall behind. For the economy as a whole, this is bad because it reduces the number of employed consumers who have the money to buy the corporation's products. But individual corporations have to maximize their own profits, and leave it to someone else to regulate the system: U.S. job growth still lagging.
    The second article, The closer you look at the GDP report, the uglier it gets, points out that consumer spending rose at a slow, and slowing (throughout the quarter) pace during the second quarter. Furthermore, the principal contributors to GDP growth were inventory replacement, fiscal stimulus, and residential  investment as homebuyers hurried to take advantage of the homebuyers tax credit. In this current quarter, fiscal stimulus is no longer present, and state and local governments which, thanks to federal stimulus money, were slightly positive during the first half of 2010, are cutting back sharply now that the federal stimulus money is no longer there. Here are three more articles in the same vein: Steep decline in GDP growth raises alarms, What Today's GDP Report Says, and Double-dip feared as US economic growth loses pace.
    On the other hand, this article, Needed: Better GDP Growth, in Barron's, argues that what we're seeing is typical in this stage of a recovery. This article is no longer available without a subscription to Barron's, but here's the part that is available:

"'THE GDP REPORT MAY EASE some fears that the U.S. is heading for a double-dip recessionů.But it also confirms widespread concerns about a sharp economic slowdown,' commented The Wall Street Journal.

"That news item could have been responding to Friday's report on GDP growth in this year's second quarter. But it actually appeared in early February 2003. Widespread concerns about an economic slowdown seemed even more warranted at the time, because growth in gross domestic product had been running much slower. We know now that the sharp economic slowdown then expected turned out to be a sharp acceleration by the ... "

    I'm thinking that a highly important fact is buried in this article. It sounds to me as though the author, Gene Epstein... and by extension, Barron's, and perhaps, other fountainheads of financial interpretation such as Marketwatch and the Wall Street Journal... have forgotten to mention that  this recession differs not only in degree but in kind from any previous recession since World War II. Last year, the Fed fired its last conventional bullet against the bear, and it didn't stop the bear. (In fact, it hardly seemed to slow the bear.) This means that comparisons with previous post-WWII recessions may not be applicable. We're up against what Paul Krugman dubs the "zero lower bound". I remember well the news in early 2003. There was talk about the danger that Alan Greenspan's Fed couldn't rekindle the economy... about "pushing on a string". The question then was, as it is now, whether interest rates could be lowered far enough to revive the economy. Dr. Greenspan's Fed found it necessary to lower the Fed funds target rate to 1% and to hold it at that level for over a year. (Dr. Greenspan has been roundly criticized for holding the overnight  lending rate so low for so long, and that criticism may be well justified, but I remember the angst over whether or not he would be able to re-ignite the economy. And we now know that for all practical purposes, a 1% interest rate is about the equivalent of 0%.) 
    Of course, once "Uncle Alan" lowered interest rates, the economy rose sharply. But this time, we can't depend upon "Uncle Ben" to pull our chestnuts out of the fire. He's already tried and it didn't work.
    This isn't to criticize Gene Epstein or Barron's for comparing this recession with previous recessions. I didn't twig to this caveat when I first read Mr. Epstein's article. I should have recognized the problem the minute I read the article, but it wasn't until a few hours later that I realized that we can't compare what's happening now with what's happened in previous post-WWII recessions.
    To summarize: 
(1)  In 2003, in the midst of a recession that was milder than the current "Great Recession", the Fed fired its last conventional bullet at the bear and it worked ("bearly"?) This time, it didn't. 
(2)  Many of the prognostications being issued for the economy going forward are probably based upon the prior experiences of the prognosticators, virtually all of which is based upon Fed-controlled recessions since World War II. 
    The Barron's article is suggesting a second-half pace of GDP growth of 3.2%. It also states that a double dip seems increasingly improbable. And finally, it observes that if second-half growth is closer to 1.6% we may expect to see a rise in unemployment to, e. g., to 9.8%.
"Conventional" Fed Tools
    I'm mentioning "conventional" Fed tools because the Fed still has some (costly and untried) unconventional tools available to it which it hasn't yet chosen to try.
Bottom Line: 
    Appealing to what's happened in past recessions to chart the course of this recession doesn't appear to me to be a winning strategy. 
    There will be one more week of heavy earnings reporting and then the second-quarter earnings season will be winding down. 

    For the coming weeks,
    U.S. stock market to continue balancing act,  
    Investor sentiment rises, and   
    Emerging markets, on healing path, climb in July   
    My investment advisory service explains that the reason the markets haven't rallied on our excellent corporate earnings may be 
(1) that they're anticipating the situation 6 to 9 months out when the major gains will already be behind us, and
(2) that traders may be uncertain about the macroeconomic outlook.