Aug 8

The Recession is Dead, Long Live the Recession?

With the latest slight improvement in that most political economic lagging indicator called the US unemployment rate, economic pundits are forced to take one or both sides of the argument.
Resolved, the US recession is over.
Though you may never see a formal debate format as indicated by such resolution, the issue here is real.
If the recession is over (defined as positive real GDP growth in Q3), hold onto your hats. Most of the previously approved stimulus funds will be spent in the months ahead and that will serve to further improve GDP growth. And that may cause much stronger GDP growth than the consensus of economic pundits expect. The most likely results – a continuing flight from quality, which means improving equity prices, continued tightening of credit spreads and upward pressure on commodity prices. Eventually, we would even start hearing more about when and how the Fed should ‘unwind’ its programs and even start raising rates.
But, if the recession is really in a Pythonesque ‘not dead yet’ mode, the upcoming stimulus spending will have some heavy lifting to do. Remember that the average consumer will continue to deleverage (and I have yet to find the average US consumer, though I see the parodied version nearly everywhere I look) . That means continued increases in savings, paying down debt, and holding back on spending. And, when 80+% of GDP is being held back, how can GDP grow very much, if at all?
The most likely case, though, is probably something that most economists are not contemplating – primarily because the consensus, from which they seldom depart very far, has not been discussing it.
As low inventories are getting replaced, the economy will undoubtedly find its way out of recession either this quarter or Q4. However, how long can GDP growth last if the aforementioned average consumer is holding back spending? Will inventory replacement require job gains at some point, which will make consumers more sanguine?
And, therein lays the rub. GDP growth is undoubtedly on the way, but its level of sustainability is questionable.  And, for investors, this means things may continue to get better in the short run, as the flight from quality continues. However, there are mighty big mountains to climb, as the ‘Greatest Deleveraging in the History of the World’ will continue.
Helping the economy climb those mountains will continue to be bailouts in several guises. As stated in our blog posting of November 30, 2008 (“Two Key Questions about the Great Re-Leveraging AKA Bailouts”), the US government (that would be ‘we the people’) is attempting to offset this great deleveraging. And, as we all have seen, success in doing so has produced uneven and politically controversial results. Alas, we can expect more political posturing to impact future bailout moves using existing or previously unannounced activities.
The bottom line for investors: It is likely that the flight from quality will continue (subject to an unknown geo-political event temporarily reversing that flight), but whether it will continue past the next few quarters remains a huge question.
As my colleague John Davidson always reminds me, by the time you see you were correct about the economy, market prices already reflect your correct opinion.
Thus, the question of what happens AFTER we see positive GDP growth is a discussion insurers should be having with their investment managers today.