Hitting Bottom Is Inevitable, Subsequent Growth Is the Real Concern

Given the length and depth of the current recession, it is natural for analysts to start looking for a bottom. In such an environment, bad news will be ignored while the seemingly good news is overblown. For example, the most recent initial unemployment claims report indicates that labor markets continue to deteriorate; we have yet to see a turning point consistent with improved conditions. Likewise, the durable goods report was heralded as a positive sign, but the jump in this volatile series needs to be taken in context of the severe drop the previous month. The chart of nonair/nondefense new orders is not particularly encouraging (click to enlarge):

That said, things will eventually get less worse, if only because some sectors, such as new residential housing, will hit a bottom. And that bottom is not likely to be zero, and, I suspect, that bottom will be late this year or, at worst, early next year. That should not, however, be confused with an optimistic outlook, as the durability and strength of the eventual recovery is in doubt. I am confident that the economy will not spiral downward endlessly; I am more worried that we will be left at a suboptimal equilibrium chiefly characterized by low growth and persistently high unemployment.

San Francisco Fed President Janet Yellen outlined the "optimistic" case in a speech Wednesday:

However, I am well aware that my views are strikingly more optimistic than those I hear from the vast majority of my business contacts. They tend to see conditions as dire and getting worse. In fact, many of them can’t believe I would even suggest what they see as such a patently rosy scenario! So why is it that so many of us who prepare forecasts seem to be more optimistic than many others? I think there are several reasons. First, as forecasters, we distinguish between growth rates and levels....Second, it takes less than many people think for real GDP growth rates to turn positive. Just the elimination of drags on growth can do it. For example, residential construction has been declining for several years, subtracting about 1 percentage point from real GDP growth. Even if this spending were only to stabilize at today’s very low levels—not a robust performance at all—a 1 percentage point subtraction from growth would convert into a zero, boosting overall growth by 1 percentage point...

The key point, often lost to the general public, is that data patterns can quickly reverse when the economy hits bottom. Still, job growth can remain largely nonexistent, similar to the 2001-2003 period. Next:

Third, policies are in place that could jump-start the economy, including the fiscal stimulus package, the Administration’s housing program, and a growing list of Federal Reserve and Treasury credit programs that aim to improve financial market function and the flow of credit.

A significant amount of stimulus will be flowing into the economy, and while it is not enough to fill the output and credit gaps, it is not negligible. Finally:

Finally, at some point, negative feedback loops can turn positive. For example, if federal government and Federal Reserve policies were to jump-start the economy, credit losses of financial institutions could diminish and lenders might increase the supply of credit available to finance spending. More credit, and better consumer and business confidence, could further boost the economy and employment, which would feed back positively on credit conditions. In other words, the negative feedback loop that is currently in play could be replaced by self-reinforcing positive dynamics.

I am less optimistic that negative feedback loops will soon turn positive. Again, while the amount of stimulus flowing into the economy is significant, credit worthiness looks to be deteriorating at a faster rate. As noted early, the employment picture is not yet turning rosier (Yellen expects unemployment to rise into 2010), households are already choking on debt, and, as reported in the Wall Street Journal, commercial real estate loan delinquencies are rising. I suspect that Richmond Fed President Jeffrey Lacker is close to the mark when he said yesterday:

One popular notion is that the credit market disruptions we have seen over the last year or so impede the financial sector's ability and willingness to extend credit to households and business firms, thereby creating an additional drag on spending. But causation can flow in the opposite direction as well. When overall economic activity seems poised to contract, the outlook for household income and business revenues deteriorates as well, and borrowers become less creditworthy, all else constant. Moreover, consumer and business demand for lending declines when they cut back on discretionary outlays. My reading of current conditions is that the economy is holding back credit markets much more than credit markets are holding back the economy.

The lack of creditworthy borrowers, especially considering more reasonable underwriting standards, strikes me as a significant impediment to the Fed's plans for restarting securitization markets via TALF. (Lacker also looks for positive signs, notably the recent retail sales data, and appears more optimistic, but like Yellen highlights downside risks). That said, the willingness of monetary and fiscal authorities to pump massive amounts of money into the financial sector has staved off a collapse - and thus created another sort of bottom.

Still, despite the prospects for bottoming, the key in my mind remains the subsequent path of activity. On that Yellen says:

...for some time to come, disinflation, and even deflation, will represent greater risks than inflation. With economic activity weakening, economic slack is likely to be substantial for several more years. We need to be sure that we avoid the kind of deflation that Japan experienced during its lost decade. While I don’t think such an outcome is likely, it should be on our list of concerns.

Likewise, I am not optimistic on the longer term. The US economy is suffering the aftereffects of a credit bubble, and this will have lingering effects on the growth path. This is especially the case given the depth and breath of the global downturn; indeed, few others are pursuing stimulus as aggressively as the US, promising to prolong US weakness with continued pressure on exports.

In short, analysts should be looking for the bottom, and it would not be a surprise to get a strong bounce in the data soon after hitting the bottom. But I think sustaining that bounce will be difficult. Expectations of a rapid return to sustainable, high growth path are likely to be met with disappointment. Hitting the bottom is inevitable. It is the subsequent pace of growth that should be the focus of concern.

Comments

[CautiousInv...:]

A very informative article that places recent market activity in perspective.

The November lows and recent March lows were speared by fear of financial Amrmageddon...........and the subsequent rallies resulted from relief that these scenarios had been averted.

Looking forward, I am not so sure the market has focused upon or has a handle on longer term earnings in a structurally changed economy in which changes in regulatory oversight and reform of the tax code will impose additional weight upon corporate earnings. All of this, of course, is layered upon a retrenching consumer, falling home prices and new pockets of troubled assets.

After we reach an economic bottom, I think we are looking forward to a muddle through economy characterized by low economic growth and marginal corporate earnings. Should interest rates begin to creep up, the market will assign lower earnings multipliers to the reduceds earning that begin to distinguish the new financial landscape.

Mar 27 07:46 AM

[SteadfastMason:]

Your statement, below, interests me. Could you offer more info and perhaps a hypothetical example or two to support the rationale behind your belief that increased employment / more and better paying jobs in America are an unnecessary and irrelevant component for America's economic recovery?

Perhaps you are thinking the GNP will be derrived b government and big business...by outsourcing at lower pay rates and then exporting to or selling in those countries. It could also include a policy to systemic devalue their own currency...compared to those of other major trading partners. We know China has, so far, been successfull as an export-centric economy by controling an unusually low wage rate for their citizens, manipulating their currency exchange rates, etc.... Clearly, employment is a very big concern and factor driving the economic and trade policies of the Chinese government.

Is this what you envision as an acceptable and likely future for America? If not, I must admit, I just don't understand how you arrive at your position.

Lastly, assuming you are right and Americans can all stop worring about needing to work for the economy to prosper....I should perhaps focus on spending my remaining 50+ years of life nature-walking. And while I am out on a leisurely stroll....who might you envision I will be able to trasnfer responsibility to purchase my weekly bag of groceries, fund my son's college, cover my medical bills, pay my utilities, phone, auto loan, and mortgage?

Kind Regards,

SteadfastMason

On Mar 27 05:30 AM Cetin Hakimoglu wrote:

> You mentioned jobs your article. To be blunt, jobs just don't matter
> that much. The era of regimented, payroll labor is slowly coming
> to an end due to outsourcing, insourcing, and crowdsourcing. Jobless
> recoveries are now inevitable for all future recessions, including
> this one like it or not. The bull market lasted for 5 years despite
> elevated unemployment in 2003. Rising jobless claims and high unemployment
> just isn't a big deal.

Mar 27 08:43 AM

[pacman1947:]

Tim,
I agree with your conclusions. A bottom will be found somewhere. The recovery and rebuilding process may be long, slow, and painful. The markets most likely will continue to unwind the enormous credit bubble that caused the crash and the ensuing bubble-headed response by the government which will enhance the crash farther. We may have a three-year nose dive like that between '29 and '32 due to ineffective government interference. It took another decade to dig out then, and may forecast the same kind of recovery this time.

There may be a few bear market rallies to play with for the next few years, but a bull run will depend on building on a foundation of real wealth creation and value. Education, rebuilding infrastructure, and re-establishing manufacturing industries producing innovative and disruptive products will be that foundation.

We have a long way to go before that happens.

Mar 27 09:03 AM

[prudentinve...:]

Tim, It is a challenge to be a realist in the midst of a euphoric party, but I agree entirely with your message and with Cautiousinvestor and pacman1947.

I believe we have some years ahead to recover from the drunken party that Greenspan started. My main concern is that the policymakers are still inclined to slake the hangover's thirst with more booze, making the recovery weaker and longer than it needs to be.

Mar 27 09:17 AM

[kelm:]

Interesting article. I recognize that Yellen's speech was not completely included here but it is a concern that I see nothing on the deficit and the dollar and the likely impact the results of our massive monetary expansion will have on our future growth rates. The total US debt is a major headwind on the economy and it is getting bigger due to the approach we are taking to bailouts and liquidity/capital injections. It would seem that alone could take a few points off of growth.

Mar 27 09:32 AM

[mrmillergd:]

Agree with all so far. Growth of the past 20 years in our country has been driven by real productivity increases due to the expansion of the Internet and other cheap forms of communications along with expansion of government. In the last 7-8 years we have had "faux growth" driven by legacy industries that were propped up or directly tied to the credit bubble - e.g. fin svcs, autos, retail, housing.

I don't think we've yet identified where new forms of growth will come from. What are the "blue collar" jobs of tomorrow?

The only reason I am optimistic long term is that if there are new high growth industries you can guarantee the American entrepreneur will dive in head first.

Mar 27 09:38 AM

[Lilguy:]

Cetin said, "Rising jobless claims and high unemployment just isn't a big deal."

In a consumption-driven economy such as ours where C >2/3GDP, it is difficult to see how significant economic growth can occur when 10% or more of the workers/consumers are unemployed/underemployed. Suddenly, we have lost 10% of our PCE and 6-8% of GDP.

...and I do think it will take years to return to nominal full employment.

Mar 27 09:39 AM

[Lilguy:]

I think Tim has hit the mark. More importantly, it is a strong argument that the current economic policies followed by the Administration and Fed are (a) not going to have the projected economic resusciatory effect next year and (b) will require even much larger federal debt to staunch the slowdown and resume even modest growth.

Without repeating what I've said here before in great detail, the Administration needs to change the focus of its economic policies from Wall Street to Main Street if it expects to turn this economy around in a reasonably timely and cost-effective way. Right now, we're just throwing taxpayer money down a manhole.

Mar 27 09:43 AM

[TeresaE:]

"Jobless Recovery"

Are you freakin' kidding me?

Those aren't "jobs" they are your CUSTOMERS.

Can't I make this any clearer to the "experts" in this world. We offshored our BEST CUSTOMERS, made up for it with free & cheap credit and housing and now there is nothing left.

There is no "jobless recovery" unless Congress repeals the 2005 credit laws and forces banks back into reckless abandon with cheap, easy credit. And liar loans become the norm again.

Utopian idealists that believe sucking trillions of dollars away from the "overpaid American middle class" changing it into low level, nearly slave Chinese & third world labor and expecting that the loss of purchasing dollars is somehow POSITIVE for America are the ones that started this train wreck.

We are never going to "recover" if you think the world will look like it did in the late 90s or 2005.

Overeducated fools and idiots refuse to see the empty businesses popping up around them.

They don't represented just "lost jobs", they represent lost customers.

And you will NEVER have a "recovery" without CUSTOMERS.


On Mar 27 05:30 AM Cetin Hakimoglu wrote:

> You mentioned jobs your article. To be blunt, jobs just don't matter
> that much. The era of regimented, payroll labor is slowly coming
> to an end due to outsourcing, insourcing, and crowdsourcing. Jobless
> recoveries are now inevitable for all future recessions, including
> this one like it or not. The bull market lasted for 5 years despite
> elevated unemployment in 2003. Rising jobless claims and high unemployment
> just isn't a big deal.

Mar 27 12:28 PM

[TeresaE:]

Amen.

But 10% is a pipe dream.

The true number of unemployed/under-employed is far greater than 10%. Paycuts, hour cuts, benefit cuts are not counted in that figure yet are 100% realized at the cash register.

Now realize that credit is being called on nearly every small business (employers) in America, which will only continue to stop the purchasing machine.




On Mar 27 09:39 AM Lilguy wrote:

> Cetin said, "Rising jobless claims and high unemployment just isn't
> a big deal."
>
> In a consumption-driven economy such as ours where C >2/3GDP, it
> is difficult to see how significant economic growth can occur when
> 10% or more of the workers/consumers are unemployed/underemployed.
> Suddenly, we have lost 10% of our PCE and 6-8% of GDP.
>
> ...and I do think it will take years to return to nominal full employment.

Mar 27 12:31 PM

[mattjh:]

I tend to think " a muddle through economy" is what we call a sustainable economy.


On Mar 27 07:46 AM CautiousInvestor wrote:

> A very informative article that places recent market activity in
> perspective.
>
> The November lows and recent March lows were speared by fear of financial
> Amrmageddon...........and the subsequent rallies resulted from relief
> that these scenarios had been averted.
>
> Looking forward, I am not so sure the market has focused upon or
> has a handle on longer term earnings in a structurally changed economy
> in which changes in regulatory oversight and reform of the tax code
> will impose additional weight upon corporate earnings. All of this,
> of course, is layered upon a retrenching consumer, falling home prices
> and new pockets of troubled assets.
>
> After we reach an economic bottom, I think we are looking forward
> to a muddle through economy characterized by low economic growth
> and marginal corporate earnings. Should interest rates begin to creep
> up, the market will assign lower earnings multipliers to the reduceds
> earning that begin to distinguish the new financial landscape.<br/>
>

Mar 27 02:18 PM

[Fighting Yoda:]

We have been a credit bubble phony economy for last two decades. The party is over, time to puke and cleanup. Yes of course the bottom will be reached, but only after all avenues – helicopter Ben , have been exhausted. It would be a slow and painful process. The tragic part would be we will stay at the bottom for a long time, jobless recovery.

So gear up for the pain, and don’t buy into these euphoric stock rallies. Await the G20 fireworks.

Mar 27 02:26 PM

[Fred Voetsch:]

They used to say, "Remember the Alamo" now I imagine we should start saying, "Remember Japan."

America is much more dynamic than Japan but we are really dugging ourselves a hole with all of these bailouts.

Mar 27 02:50 PM

[Chris B:]

1) Unemployment may not improve until a year or more post-recovery. See the 2000-2004 period.

2) The decline in durable goods orders will never predict the end of the recession. In June of 2002, you might have concluded that the chart was "not particularly encouraging" - right before the recession ended and it shot upward.

3) "The US economy is suffering the aftereffects of a credit bubble, and this will have lingering effects on the growth path." Those aftereffects also include tens of millions of 15-30 year mortgages and business loans at multi-decade low interest rates. My 5.5% 30 year loan is the envy of the older generations and my rock-bottom payments will allow me to spend and save more for another couple of decades. The same is true of businesses started, or expanded, in this era. Interest expenses are huge, and a lot of savy people have locked in low rates.

4) "Hitting the bottom is inevitable. It is the subsequent pace of growth that should be the focus of concern." I agree 100% that this is the more important question. Throughout the history of the world, the fastest growing nations have emphasized good governance, education, technology, science, and infrastructure. To the extent that the US returns to this universal path of success, we will be successful. My key recommendations:

-separate investment & commercial banking, restore Glass-Steagal
-adequately fund education for all kids, not just a few
-adequately fund law enforcement
-invest in tech and science
-build the infrastructure to reduce oil dependency (and the associated economic crisises that result - 1974, 1981, 2008,...).
-do something to reduce the influence of lobbyists

Mar 27 03:13 PM

[Jason S.:]

I agree with the bears. A fundamental change occurred late last year with the consumer: rather than spend extra cash on on ipod, stereo, tv; the extra cash will instead be used to pay off debt or save. This is very different than the last decade. Demand (which is determined by wealth --- not debt (like the last decade)) is still unknown for assets and therefore price is still unknown. The drama between China and the US on dollar value will be an interesting one.

Mar 27 04:53 PM

[pacman1947:]

TheresaE has made another astute observation: "Overeducated fools and idiots refuse to see the empty businesses popping up around them...They don't represent just 'lost jobs', they represent lost customers."

Without a strong middle class of consumers, no lasting recovery (or for that matter a sustainable economy) will be possible.

The American Dream has evaporated into an atmosphere of toxic gasses steaming from mountain of debt.

Many of the commenters here get it. We're not going to survive if we don't change our ways.

Mar 27 05:54 PM

[E.D. Hart:]

Positive and negative feedback loops are commonly misunderstood to mean exactly the opposite of what they actually mean.

A negative feedback loop results in stasis, or relative stability--like a thermostat--(there is small variation around a stable range of values) . The law of supply and demand is classic negative feedback dynamics when simplified.

A positive feedback loop is a cascading event where each step feeds into and intensifies the overall effect--like global warming--heat melts permafrost, which releases more Carbon dioxide, which traps more heat, which melts ice/snow, which results in less light radiated back to space, and greater heating of the earths atmosphere...and so on..until a new range of values is reached which may or may not lead into a new Negative feedback loop.

We are in a vicious positive feedback loop with deleveraging and the global credit crisis where each successive step intensifies the overall effect and results in a cascade of negative consequences.

Mar 27 06:58 PM

[dw57:]

depends. if you want a recovery or not.
the last time the jobless recovery was less of an issue because of credit. but that leg is gone. so a jobless recovery dooms us to stay the way we are now


On Mar 27 05:30 AM Cetin Hakimoglu wrote:

> You mentioned jobs your article. To be blunt, jobs just don't matter
> that much. The era of regimented, payroll labor is slowly coming
> to an end due to outsourcing, insourcing, and crowdsourcing. Jobless
> recoveries are now inevitable for all future recessions, including
> this one like it or not. The bull market lasted for 5 years despite
> elevated unemployment in 2003. Rising jobless claims and high unemployment
> just isn't a big deal.

Mar 27 08:49 PM

[Lin:]

Re
TeresaE- You are spot on ! Chris - More money on Law enforcement " cops" , Go to Alachua county , Gainesville , Florida , where employed + retired " cops" Drive Hummers + have 5-6 fat horses , while the rest live in poverty , paying the " property taxes " for their salaries + pensions . Funny , I've NEVER seen nurses drive hummers ! Cops ?
They wonder why folks are leaving Florida in droves !

Mar 27 09:58 PM

[aarc:]

The United States is still looking inwards and trying to find more trash hidden under the carpets and behind closet doors.

Why don't we take a little LOOK OUT the window.

Let's see how China goes.

Shanghai and Szensen Indeces are now in the full blast rally mode of a 1-2-3-4-5 pattern. We Elliott Waves practioners call it the Impulsive Wave and the first high probability indication that the current downturn has already ended and the final bottom has already been set.

The next pullback after this impulsive rally will be the "opportunity of the century" among China investors to buy with a very high degree of confidence.

United States and Europe are still in the quagmire but are already at the last stages of this more than 8 years of corrective process that has started in year 2000. Projected target is Q4 2009 to Q1 2010 as the time frame for the final bottom to be reached.

China markets have been going up and up since late Oct 2008 while that of the US, Germany, France, and England were digging further into the unknown abyss. Japan's Nikkei was able to prevent a lower low and is now in a holding pattern.

Taiwan, Hongkong, Korea, India, and even the Philippines are enthusiastically following the lead of China by not going down since Oct 2008! Australia made a small dip but was expected to follow where the US goes. They followed alright, but reluctantly.

It feels like the decoupling theory is now in full blast-off mode from the launchpad.

Stock market is the barometer of a nation's economic health.

Will the Americans simply stand-by or go further down this nightmarishly labyrinthian hellhole - while China is starting to succesfully overcome their own economic problems well ahead of the United States? They are even starting to "usurp" the US role in the IMF.

These days, a nation's strength is no longer being measured by it's military dominance nor it's technological prowess to reach the moon first.

It is how it's economy is performing in the Global Marketplace which is the ARENA of the present and into the future.

Wake UP America!

Mar 28 03:05 AM

[dcb:]

Game works like this. Large fiscal stimulus works for a short enough time to allow the financial industry to avoid the regulation it needs. Note difference approach in Europe. Reform the system so it is stable. You have to understand the two pronged approach of our government is designed to protect industry. Without the stimulus the banks would be forced to reform. We get screwed two ways. Talf, stimulus, and I'll wager 10K no real reform. Just what the financial industry ordered.

Mar 28 10:18 AM

[Alphameister:]

The article nicely summarizes my view also, and the comment by aarc even more closely coincides with my thoughts on how to find both impressive growth and great value in today's investment world. This is a time to buy China for big gains over any time frames.

Mar 28 03:04 PM

[Robert Mcdo...:]

There is a parsimonious view that bottoms are false bottoms if they have a lot of federal sponge padding. But, padding helps to make hitting the floor comfortable plus adding a little spongiform bounce. Until now the focus has been to restore confidence in the banks in terms of their capital reserves and finance for their 'funding gaps'. But, while that should start restoring some weight to banks' share values, there is a big fear that banks' own internal confidence has been so shot to pieces they wouldn't know when to respond positively to the economy turning round and heading north.
Banks historically overshoot the recession cliff - like the cartoon characters running off the cliff who only fall the second after they look down. They are also several quarters late traditionally in responding with new loan growth to economic upturn. They spend the first 2-3 quarters of recovery taking profit in deleveraging, almost like assuming recovery is just a dead cat bounce. If government doesn't nationalize it can at least try and force the banks to be anit-cyclical right now and be immediately pro-cyclical once recovery is happening. How do we know when that is?
Well, let's assume recovery as it zigzags forward as usual is here when the next lows start being higher than the last lows and the next highs exceed the last highs.

Mar 28 04:43 PM

[Poor Man's ...:]

No matter if we are at bottom now, or in the near future, for the long term(5-10 years), the return on strong stocks purchased now should yield a nice return.

Mar 29 01:47 PM