I have been writing about a double-dip recession or a W-shaped recovery. Friday's unemployment figure may support my thesis. A W-shaped recovery basically shows the way of economic recovery. The first leg of the recovery is not sustainable and may fall back to a recession. Then a "real" sustainable economic growth comes on the second leg. But that growth is due to genuine organic growth based upon a stronger economic foundation, like a stronger U.S. dollar. I believe we are not even at the first leg of the recovery yet.
Friday morning's June unemployment report showed a loss of 467,000 jobs, which is far worse than expected a loss of 363,000 jobs. The unemployment rate rose to 9.5% from 9.4% in May. The stock market reacted by losing 223.32 in the Dow (2.6%). The S&P 500 fell 26.92 (2.9%). Basically there was no where to hide as the NYSE has 2,885 declining issues vs only 754 advancing issues. Thus, Friday was a broad based selling day.
So, why did the market drop so much? The market has been expecting a V-shaped recovery. Some commentators even expect the economy will be in full recovery by the beginning of next year. There are signs that the housing market is stabilizing and companies have been rebuilding inventories to generate some growth. But I believe the stock market is over-optimistic.
When the U.S. started its recession, companies cut costs by laying off employees and cutting down inventories. So, once they have sold off their inventories, they have to restock their shelves. This may give investors a false alarm about economic growth. Friday's unemployment figure continues to show more people are out of work. Consumers cannot buy things when they do not have jobs. So, the restocked inventories may stay in the stores for a while.
Also, hitting a housing bottom does not mean a recovery. We may be at the bottom for a while. As consumers continue to worry about their jobs, they will not spend. After Friday's report, we all will have been talking about job concerns over the holiday BBQ. Furthermore, consumers continue to de-leverage. So, if consumers have extra cash on hand, they will pay down their debts rather than spending the cash. Some economists have been expecting the current tax cut would help consumers to spend. But when consumers know these tax cuts are only temporary, they would use any tax refund to pay down debts.
Making things even worse, on Thursday, CNBC discussed Citigroup (C) raising interest rate on millions of credit card holders. This is actually nothing new. Most of the credit card issuers have been cutting down credit limits but now they are also raising interest rates. With lower credit limit and higher interest costs, consumers are not in the position to spend.
I expect the economic recovery to be slow and most of the growth from fiscal stimulus. We all know the U.S. government has been printing billions of dollars to support the economy. The billions in stimulus money will eventually trickle down to consumers and they will spend cautiously. This is why the recovery will be slow and gradual.
When the economy actually shows sign of recovery, the Federal Reserve will need to mop up the excess liquidity in the financial system. Otherwise, we will have significant inflation. This is why the dollar has been weak-- because investors have been worrying about future inflation. I am not too worried about future inflation as I assume the Fed will remove the excess liquidity. However, if the Fed takes action too late, then we will have high inflation.
Let me assume for a moment that the Fed will do the right thing when the time has come: The liquidity removal may cause the economy to fall back into slower growth and even into a mild recession again. But the next recovery will be sustainable as investors will have confidence in the U.S. dollar with organic growth .
What is the investment theme? Do not rush to buy stocks when you see the first sign of economic recovery. Oil and gold will continue to do well until the Fed removes excess liquidity. Remember, China is diversifying its foreign reserves by buying commodities, and China has not been buying much U.S. dollars lately. You may consider buying Australian dollar ETF (FXA) and China ETF (FXI). With the China government continues to support alternative energy along with Obama's energy plan, you may consider investing in a global solar ETF (TAN) and a continuing growth ETF for the Brazilian economy (EWZ).