What to expect before an Economic Recovery

20 Feb, 2009

What to expect before an Economic Recovery

Posted by: earlhines In: Investing| Markets

Earl Hines

No one knows the future, but there are a few signs to watch for

The current recession has already been the longest post World War II, and is expected to be the deepest global economic downturn since the 1930s. Many economists now expect no clear signs of recovery until 2010. If history serves as a model, financial markets will try to predict this turn-around and begin to recover 4 to 6 months in advance. Bottoms are difficult to predict, and time and time again it has been proven that you can’t time the market. As such, I wanted to offer a few thoughts on what we can expect to see before the economy recovers.

1. Housing Market Must Stabilize: New housing starts in January were down 17%, an all time low, signaling that housing is still in the doldrums. Though this is very bad news for the construction industry, it may eventually lead to improvements in existing home sales where inventories are at record levels and housing prices continue to plummet. According to the National Association of Realtors, the national median home price has fallen 15.3 percent during the last year. Finally, before we see any meaningful economic recovery, the tide of foreclosures sweeping the country must be reduced. Not only do foreclosures result in families being homeless, it dramatically impacts the balance sheets of the mortgage holders, putting additional pressure on the beleaguered banking industry. Major portions of President Obama’s recent stimulus package are designed to reduce foreclosures and allow for loan modification to keep more people in their homes, and more importantly, to keep payments flowing to mortgage holders. If this plan succeeds we should begin to see mortgage defaults decline and home prices stabilize.

2. Job Market Must Improve: The US lost 2.6 million jobs in 2008, and so far this year, another whopping 600,000, the steepest decline in employment in over 34 years. Unemployment is now at 7.6% and many leading economists predict it will rise to 8.5 or 9.0% before the economy begins to recover. The causes of job reductions are coming from a variety of places, including, small businesses who can no longer access sufficient credit to meet payroll or pre-pay for inventory; reduced demand because consumers are refusing to buy in favor of saving, or who themselves have been put out of work; and, businesses who are delaying business spending in hopes they can weather the current economic storm. In my opinion, this trend will be the most difficult to turn around. The government’s stimulus plan includes a variety of tax cuts for businesses and individuals, and incentives to create new jobs in the construction of infrastructure and alternative energy. However, job creation programs are slow, and we will not likely see any impact until 2010. There is also no guarantee that tax cuts will automatically flow back into the economy in the short-term, as many companies are simply trying to get their own balance sheets in order.

3. Credit Markets Must Normalize: Banks have to start lending again. Current rates on conforming loans are at historic lows, making more money available for mortgage lending. But business credit needs to open up dramatically at reasonable rates to ensure that businesses can access capital so that they can invest again. To date, many of the banks that have been bailed out by the US tax payer, have been doing their best to fix their own balance sheets, and have been somewhat tight-fisted with the cash. Rates have to stay reasonably low, and the banks have to lend.

4. Consumers and Businesses Have to Start Spending Again: If the current economic crisis has led to anything positive, it’s that many Americans are now saving more money and doing their best to reduce debt. This is very positive in the long run, but paradoxically, in the short-term, it thwarts efforts to get the economy going again. Nearly two-thirds of America’s gross domestic product comes from consumer spending. Unfortunately, many consumers and businesses are currently either flat broke, or doing everything possible to stay financially solvent. It is for this reason that the US government is doing unprecedented spending (and unprecedented borrowing) in an effort to get money flowing throughout the system. The belief is that once consumers see that their homes are not plummeting in value, and their jobs are not in jeopardy, they’ll begin to spend again. As they do, businesses will begin to invest again, in expectation of competing for the consumer’s dollars with new innovative products and services.

And the economic wheels start spinning again from there.

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Tags: Investing, Markets

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What to expect before an Economic Recovery

No one knows the future, but there are a few signs to watch for

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