Near-Term Recovery Is Impossible

Kristin Graham
  OCT 12, 2009 10:20 AM

Cleansing the economy is creating a vicious circle that will be hard to break.

 


I love bull markets. I like to have faith in the future of our economy. And I’m tired of all the pessimism tied to the recession.

Apparently, the entire market feels the same way. Since hitting year lows in March, the S&P 500 has been on a tear, rising nearly 60%.

The Depressing Truth

But as optimistic as I want to be about a rebounding economy, and as much as I want to see the market continue to recover, I also have to face reality. And the reality is that a fully recuperated economy is nowhere in sight.

Granted, the market is a leading indicator and valuations are based on future expectations. Therefore, emerging signs of stabilization do warrant price appreciation.

The problem is that stabilization is as far as we’re going to get in the near future. The economy is just beginning to claw its way out of a deep recession and a long road to restoration lies before us.

There are certainly signs of improvement -- the financial system is no longer on the brink of failure and the housing collapse has significantly moderated. But antsy investors have gotten ahead of themselves in anticipation of full out recovery as the ever-important unemployment rate is expected to linger at high levels for some time and ultimately prohibit economic growth.

A Country-Wide Cleaning Binge

Our economy has been forced to rid itself of excessive waste, ranging from toxic assets to unsustainable debt levels to over-staffed offices. While we continue to “clean house,” more jobs will be lost as companies tidy up organizational structures and implement tighter expense control. Of course, this de-leveraging process is starting to slow, but purging the excess was the easy part.

Now, we’re tasked with rebuilding a leaner and more efficient economy. This will take significant time as we adapt to a fundamental shift that has occurred in our economy and will leave large portions of the economy jobless for an extended period of time.

Depending on the Consumer

This is problematic for economic growth because the economy heavily relies on consumer spending to propel growth. Accounting for nearly 70% of GDP, consumer spending plays an integral part of recovery. Consumers must increase their spending levels before economic recovery can really be achieved.

But how can this happen when unemployment is continuing to increase to record levels and isn’t expected to return to normal for an extended period of time? Many jobs that were lost will never be recreated. Excess capacity is making companies reluctant to start hiring again until demand catches up with supply. And increasing levels of cheap outsourcing from companies like Infosys (INFY) and Wipro (WIT) are providing further incentives to not hire in the US. According to HIS Global Insight, it could take a decade for our economy to return to the 5% equilibrium level of unemployment.

High Unemployment = No Spending = No Growth

As long as unemployment is high, consumers are incapable of spending to stimulate the economy. In addition, the inability to use debt and new frugal mentality instilled by the credit bubble is adding to the reluctance to spend.

Investors, giddy over the September retail sales data, nonsensically bid retailers like American Eagle (AEO), Pacific Sunwear (PSUN), and Talbots (TLB) up by double-digit percentages over the past few days because of signs of slightly improving sales figures.

While sales declines are being tempered, it will still be many, many years before we come close to reaching the consumption level we had at the height of the bubble.

On one hand, this is a good thing, as both consumers and businesses had overextended their use of debt and spent capital frivolously, which ultimately led to unsustainable growth rates. We needed something to slow us down.

On the other hand, the process of returning to economic equilibrium is going to be a drawn out process. Right now, recovery actually entails reducing jobs to further clean out the excess that had built up. Thus, a period of net job creation can’t be expected in the near future.

Bottom Line

Global economic recuperation is starting to materialize in countries like Germany and China. However, with a strong dependence on consumption, the combination of prolonged unemployment and an emerging trend of conservative spending habits makes near-term recovery impossible in the US.

Investors should be cautious with the over-exuberance being priced into the market. It simply isn’t possible to return to a healthy state until the workforce begins to grow again, and I think the market is underestimating the dire situation we’re currently facing.

Given our country’s current unemployment status and the projections experts are expecting, we are a long ways away from being anything more than “stabilizing”.

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