Are We in the Recovery Phase?
One thing is certain about any recession we have faced in the last 150 years; we eventually recover and enter a new phase of growth and prosperity. What is not certain is which segments of the economy will lead the recovery from recession. Over the years different market segments have accounted for the climb back from unemployment, weak corporate earnings, and declines in the housing and retail sales markets. This time around there is no unanimity of conviction amongst economists or business leaders as to which segment or segments will take the lead.
I have written in previous months about the main areas to watch for signs of recovery, or signs that a recovery may be delayed. The primary indicators are: interest rates, employment levels, inflation trends, and housing prices. The combination of these four categories really comprises the whole picture on the economy. I have purposely omitted retail sales, as retail sales have been relied upon far too heavily as a driver in the US economy for the last 20 years. In my opinion, our reliance on retail sales may have accentuated the trough of this current recession. Given the excessive levels of personal debt (primarily credit card debt which has fueled retail sales for far too long), I prefer to focus on the above named indicators for a more accurate picture of economic health. The improvement in these areas will signal the time to focus on which segments will benefit, and will help to direct our personal investments.
Interest rates have been artificially pushed lower by the Federal Reserve Board for the last several years. At first, they were lowered to help sagging retail sales, as lower rates encouraged people to spend more. The lower rates especially attracted buyers to the durable goods area, where it is common to finance the purchase of major appliances and automobiles. However, the unreasonable availability of credit to just about anyone (my teenaged children regularly received free credit cards and $2000 lines of credit with no credit check), rapidly fueled the excesses which helped the economy appear to be healthy when in fact there was an underlying decay. Low interest rates share some of the blame for the housing price bubble as well. With mortgage rates so low, and credit standards lax, numerous mortgages were granted to people who had almost no chance of meeting their long term obligations. The available funds caused housing prices to be bid up unrealistically, simply because people were able to make the monthly payments. At least that was true for a while; then the first round of adjustable rate mortgages were reset and the snowball began to roll down hill.
Due to the huge amount of new debt incurred by the US Government ($2 trillion just since January), we may see interest rates begin to inch higher in order to assure the ongoing purchase of that debt by investors.
As rates move higher, the economy will surely slow as the cost of new investment in machinery, equipment, land and buildings goes up with higher rates. Therefore, we are at am impasse regarding rates and the FED has to play this market like a fine violin to avoid putting on the brakes too soon.
Of course inflation is directly impacted by interest rates. As stated earlier, lower rates encourage more spending and more spending increases demand for limited goods and services. Back to the time worn equation regarding supply and demand, and lower rates fueling greater demand pushes prices higher. Again, that is what accounted for a great deal of the real estate price bubble. Gold has long been the benchmark for inflation, and in fact was used regularly by former FED chairman Alan Greenspan as a key indicator in his analysis of where to peg interest rates. A brief look at the 10 year price chart for gold below will confirm your feeling that prices of just about everything have been going up for some time. It is difficult to accept government assurances month after month that inflation is not of great concern at this time.
To be fair, gold prices have also reflected fear of traditional investments as well as inflationary trends. The US dollar has fallen substantially in value against other global currencies over the same time period that gold has had a substantial increase in price, largely because of a fear to hold investments denominated in US dollars. The largest investment class denominated in dollars is the US Treasury bond market, which is represented by the more that $11trillion dollars in bonds and notes issued to raise those funds. Regarding inflation trends, the economy cannot fully recover until we see inflation muted as evidenced by declining prices for gold, oil, and other global commodities.
In my opinion, the most significant indicator of economic health is the employment picture. For many months, we have lost hundreds of thousands of jobs per month. Since January of 2008, we have lost more than 7 million jobs in the United States. This number is staggering even when compared on a percentage basis to the Great Depression Era and the devastating recession of 1981-83. It is apparent that if we cant put people back to work, we cant improve the total economic picture anytime soon. While employment levels are extremely important, they are not a leading indicator of economic health, as the economic picture will improve as creation of jobs is anticipated. Therefore, it is important to watch the monthly jobs data and take note as the loss of jobs begins to decrease on a monthly basis (there is some evidence that this is taking place now). The next step is to begin to see the creation of new jobs on a monthly basis. At that point I will give much more credence to those who believe we are in a recovery. As we begin to see jobs created, take note of which segments of the economy are creating jobs.
I reference housing prices in my recovery scenario because we all understand that the American dream is pegged to opportunity, freedom, and home ownership. Earlier in this article we discussed the housing price bubble and the net effect of the manipulation of supply and demand factors. The results have been devastating. The credit crunch and market melt down last fall were triggered by mortgage backed securities which contained billions of dollars worth of mortgages which were nonperforming. Many of these mortgages have been foreclosed; many more will be foreclosed in the months ahead. Housing sales were up for a couple of months in June and July, only to fall again in August.
The temporary upswing in sales may have been due to bargain hunters and to the Government stimulus package which offers an $8000 credit to first time home buyers. We need to watch home prices and the level of home sales closely, as the improvement in those indicators will confirm better employment data and stable interest rate markets. Taken all together, interest rates, inflation data, employment data, and housing prices will give you a very good perspective on our national economic health.
Ideally, this information will help us to improve our personal economic health by timing our investments and selecting market segments with the greatest potential for improvement. In short, these factors will help us to determine when we are in the recovery phase.
©Patrick J. Catania 2009 The views and opinions expressed herein are solely those of the author and do not necessarily reflect those of Baxter Credit Union, its Board of Directors, or its employees. The author is responsible for the content. Readers should consult with, and seek professional advice from their own attorneys, accountants, and financial advisors with respect to their individual financial needs and circumstances. We welcome your feedback and ideas regarding this service. To submit a comment or idea for a future article, please email us at email@example.com