Morgan Stanley Sees V-Shaped Recovery: I See W-Shaped Recession

Dick Berner, Chief North American Economist at Morgan Stanley, thinks we are in for a sizable uptick in GDP for Q3.

I must be honest; I am sceptical about this, but Berner is a well-regarded economist whose views can’t be dismissed out of hand. He says:

Incoming data… confirm that the deepest and longest post-war recession is now ending. And it’s ending with a roar: A temporary surge in vehicle production is likely to pace a much stronger rebound from recession than we thought only a month ago, so GDP may rise 3-4% annualized in 3Q. The recession and recovery are starting to look more ‘V’-shaped: Revised data now show that the economy declined by 3.7% since the recession began in 4Q07, making it the deepest post-war downturn. But significant economic headwinds mean that the 3Q surge is unlikely to spill over into a stronger overall recovery. And with inflation declining, a tighter monetary policy is unlikely soon. We continue to think that the Fed will remain on hold until mid-2010.

Ingredients for a rebound. There’s no mistaking the ingredients for a sharp summer rebound, including a classic inventory snapback and modest improvements in some components of final demand. Aggressive vehicle production cuts (a 46%, seven-quarter plunge in motor vehicle output, with the first half down at a 36.3% annual rate) have brought motor vehicle inventories in line with sales. Indeed, the cuts in output overshot, pushing annualized US production 2-3 million units below the pace of domestic sales in the past three months. Just to catch up, vehicle production surged about 60% in July over June, and seems likely to rise further through the summer. As a result, motor vehicle output likely will add about 4 percentage points, or roughly double our estimate last month, to overall GDP.

A reduced pace of inventory liquidation elsewhere in the economy will probably also contribute to growth. Apart from motor vehicles, companies liquidated about US$100 billion in real inventories in 2Q, bringing the level of inventories in relation to sales down somewhat from its 4Q08 peak. And even if companies are still liquidating stocks, a slower pace of liquidation (which means that the change in the change in inventories is positive) will likely add more to growth in output than we expected last month. Indications of stronger orders and production in July’s ISM report suggest that manufacturing outside of motor vehicles is beginning to bottom.

Better-than-expected gains in housing and construction will probably add another half point to 3Q output. Despite the obvious headwinds that still face housing, imbalances are smaller, and activity is starting to improve by more than we thought previously. The vacancy rate in one-family housing, now 2.5%, has fallen 40bp from its 4Q08 peak. And modest improvements in sales and continued declines in inventories have brought inventories of new, one-family homes down to 8.8 months’ supply -from 12.4 months in January. The 2.4% June surge in one-family construction outlays signals that activity began to turn at the end of 2Q. With financial conditions gradually improving, despite lenders requiring higher downpayments, further gradual improvements in demand seem likely, and housing construction is also likely to improve further. Moreover, thanks to the funding from the American Recovery and Reinvestment Act (ARRA), it appears that state and local infrastructure outlays are starting to pick up a bit sooner than we expected a month ago.

Limited ‘payback’. This 3-4% 3Q surge in GDP growth is not sustainable, but neither a significant ‘payback’ nor a double dip is likely. Vehicle sales illustrate the point. The blowout response to the ‘cash-for-clunkers’ incentive program has been far stronger than we expected. With the initial US$1 billion in funding used up in a few days (even if some of the deals were booked at dealers in anticipation of the July 24 initiation date), this fiscal stimulus is getting a lot of bang for the buck. It is timely, targeted and temporary: The incentives have an immediate effect; combined with matching dealer incentives, consumers are getting a 30-40% discount off the sticker price, and consumers must use them or lose them. The deals will run out soon even if the Senate approves the US$2 billion in additional funding voted by the House before they recessed last week. If each billion in funding spurs an extra 250,000 vehicle sales, as seems possible, the annual selling rate in August may climb past the 12 million we expect for July. While the sales pace will slip back in the following months, manufacturers likely won’t have to trim inventories at all in 4Q. Beyond the spillover from the vehicle rebound, improving global growth, the growing impact of fiscal stimulus and looser financial conditions may also limit the slippage in 4Q, by sustaining exports, factory output, infrastructure and housing.

So, to recap, we have the Fed on hold at zero percent rates, a huge uptick in autos, government stimulus coming online, and a robust inventory cycle coming into place. This does sound very bullish regarding Q3.

But, there are some major problems to contend with longer-term.

Four headwinds still indicate a moderate recovery, in our view. First, financial conditions are still restrictive, reflecting the gradual improvement in bank balance sheets and securitization markets. The combination of reduced access to credit and falling home prices will keep consumers cautious and promote further deleveraging and increased saving out of current income. Second, absent a sustained pick-up in vehicle sales, the inventory-related production bounce in motor vehicles won’t last. More broadly, inventories elsewhere in the economy aren’t yet lean in relation to sales. Third, despite the infrastructure pick-up, stressed state and local governments are cutting current services and furloughing workers. Fourth, ‘core’ consumer incomes (real, after-tax wages and salaries) are now falling again, following several one-time boosts to real after-tax income earlier this year (e.g., declines in energy prices, stepped-up tax refunds, a cut in withholding rates on April 1, and one-time checks to Social Security and SSI beneficiaries in May and June). Measured by the employment cost index, private industry wages and salaries rose just 1.5% in the year ended June, a record low. With continued pressure on wages and payrolls, and the bulk of the ARRA tax cuts likely to hit incomes only in spring 2010, real spendable income should be flat to down in 2H09.

Exactly right. Don’t forget the fact that jobs are still being cut and personal income is at 2007 levels as a result. Not exactly the stuff of sustainable recoveries. Berner goes on to suggest that declining inflation will keep the Fed on hold for some time to come and ends his analysis there.

I would add the comment that this sounds bullish over the short-term but not necessarily sustainable. Auto demand is being pulled forward artificially and the inventory cycle and government stimulus are both temporary.

The only variable which is supportive of this V-shaped scenario over the longer-term is interest rates – and that is only because of the threat of deflation. I see this as further confirmation that a W-shaped recession is a very real possibility.

Source: Roaring Out of Recession in 3Q – Richard Berner, Morgan Stanley

Comments

[Donald Ingram:]

NEWS FLASH! RECESSION OVER!!
Depression has now begun.
U.S.of A. Bankrupt.
All debt will be paid. Either by the debtor or by the lender.
Either with dollars worth pennies or pennies worth dollars.

Aug 06 12:02 PM

[thiazole:]

Yeah, and some of the hottest days of the year happen in late spring and some of the coldest happen in late fall because seasons aren't determined by temperature. By the same token, recessions aren't determined by pain. The most painful time during a recession is usually right at the end, and the pain takes quite a while to heal. A recession means things are getting worse, and they stop getting worse at the bottom, when the pain is the greatest.


On Aug 06 09:23 AM John Galt wrote:

> So what happens if the GDP turns positive for a quarter?
>
> 371,000 people are still losing their job each month but you are
> going to tell them that we are in "recovery"? Our last recession
> basically lasted 9 months, and the 18 following months had no job
> creation.
>
> So what happens when GDP goes up a tiny tiny bit, but people keep
> losing jobs for months and months and months? The Morgan Stanley
> economists, CNBC, and everybody else is screaming recovery, while
> millions of people are still hurting and are left behind.
>
> Also, so what happens when our economy gets knocked way way down,
> and then shows an inch of improvement? Is that good? Do you want
> to be down there? We aren't even talking about getting back to where
> we used to be, we are talking about stopping the bleeding here.<br/>
>
> Yeah you might stop the bleeding in Q3, but it sure as heck is still
> going to hurt!

Aug 06 12:37 PM

[Moon Kil Woong:]

Has anyone noticed the 30,000 unemployment improvements from prior uptrends magically get erased a few months after they are reported. Of course, that's understandable since they often fall into the statistical margin of error (meaning nothing should have been made of them in the first place). I'm just saying, one ought not call an end to a recession on data that's likely to be corrected in the future (when hasn't the number beeen readjusted)?

As for GDP, considering they made the prior quarter worse to make this quarter better plus all the government spending additions, I reading it it close to divining the future with tea leaves (that may not even be tea leaves).

For a real market turn I'll stick to seeing when corporate quarterly earnings actually show signsa of revenue growth (higher earnings on revenue contractions are not real signs of a market recovery).

Aug 06 12:49 PM

[John Galt:]

Fair enough and a good point.

But when the bleeding stops, and things move up and inch ( who is to say we won't have further GDP declines) or slow or flat growth ( New normal)...

Even the most bullish people predict " a jobless recovery" and an unemployment rate that creeps up next year. So they predict positive GDP, followed by quarters of more job loss. That's the bulls mind you.

Who is going to tell all those people still losing jobs, still not finding work that (take a gulp of Kool Aid) that we are in... RECOVERY!

Do you think those people own stocks? Do you think they know what the DJIA is? Do you think that means anything to them other than the bald crazy guy on CNBC is going to jump around with an extra giddy up and a tent pitched in his pants?


On Aug 06 12:37 PM thiazole wrote:

> Yeah, and some of the hottest days of the year happen in late spring
> and some of the coldest happen in late fall because seasons aren't
> determined by temperature. By the same token, recessions aren't determined
> by pain. The most painful time during a recession is usually right
> at the end, and the pain takes quite a while to heal. A recession
> means things are getting worse, and they stop getting worse at the
> bottom, when the pain is the greatest.

Aug 06 02:02 PM

[thiazole:]

Perhaps they are being revised worse, but it doesn't change the clear and obvious trends:

www.briefing.com/Commo...

www.briefing.com/Commo...


On Aug 06 12:49 PM Moon Kil Woong wrote:

> Has anyone noticed the 30,000 unemployment improvements from prior
> uptrends magically get erased a few months after they are reported.
> Of course, that's understandable since they often fall into the statistical
> margin of error (meaning nothing should have been made of them in
> the first place).

Aug 06 02:06 PM

[Stone Fox C...:]

don't expect those jobs to continue to be cut in the face on this recovery. Its always a mistake to base your thesis on a lagging indicator. Name one recovery that took place without still losing jobs for a while?

Aug 06 02:06 PM

[JCC:]

Well Edward, it is not only Morgan Stanley, but others are now predicting 3% growth for the second half of this year. Goldman Sachs, The Federal Reserve, Morgan Stanley and others recently came out with similar predictions. Furthermore the market appears to be accepting this conclusion.

In a week or so we will see what Roubini and Krugman think.

I don't know how long this will last, but right now, the green shoots are growing rapidly. It is even being noticed by many small businesss owners. In some cases like in banking we even have green trees.

Suffice it to say that It is way early to predict a W shaped recession.

Aug 06 02:25 PM

[Donald Ingram:]

Ah yup. And I got me some ocean front property in Arizona that I'd like to talk to ya about!


On Aug 06 02:42 PM Notary wrote:

> I will not say it is over but yes we have recovered to some extent

Aug 06 03:21 PM

[Clarence th...:]

Think of this economy as your last blind date:
A V-shaped recovery would mean that she digs you, and
the W-shaped retraction has you back home on the couch.

And the giggling you hear are the waiters making fun of your hair.
She's not in to you, and you are always the last to know.

Keep Hope alive. Arkansans have to live somewhere.

Aug 06 03:23 PM

[LeoTheDog:]

Or, for that matter, a recovery. Numbers that show that things are getting worse, but worse more slowly than before, are not particularly strong evidence of a recovery. It isn't even clear that things are getting better, only that they aren't getting worse as fast as before.

Moreover, even when we can see improvement it should be remembered that "improvement" does not equate to "recovery".


On Aug 06 02:25 PM JCC wrote:


> Suffice it to say that It is way early to predict a W shaped recession.

Aug 06 03:42 PM

[thiazole:]

I don't think they read SA, either. That is really a political issue, not an issue for this thread. I'll applaud you for standing up for the little guy, but I just don't see how it relates in determining when the recession ends and what shape the recovery takes on. Even in the most V shaped recovery, it would take a solid year before the average guy on the street looking for work believed it. That doesn't mean it didn't happen. It took most the average folks until the fall or even winter of 2009 before they "felt" this recession. That doesn't mean it didn't begin much earlier. I guess that is the irony of a recession. They almost always begin when things are really good and end when things are really bad. It seems backward, but that is just the way a recession is defined.

On Aug 06 02:02 PM John Galt wrote:


> Do you think those people own stocks? Do you think they know what
> the DJIA is? Do you think that means anything to them other than
> the bald crazy guy on CNBC is going to jump around with an extra
> giddy up and a tent pitched in his pants?

Aug 06 04:06 PM

[Tony Petroski:]

I continue my call of an ampersand-shaped recovery: &

Aug 06 04:34 PM

[Ricard:]

"I would add the comment that this sounds bullish over the short-term but not necessarily sustainable. Auto demand is being pulled forward artificially and the inventory cycle and government stimulus are both temporary.

The only variable which is supportive of this V-shaped scenario over the longer-term is interest rates – and that is only because of the threat of deflation. I see this as further confirmation that a W-shaped recession is a very real possibility."

I completely agree with the author's conclusion. It's undeniable that the CARS program will provide a temporary lift until it runs its course, after which something else will have to fill that void. Christmas sales? Please...

I've begun hedging my bets, just in case. I think this October will prove to be the beginning of a nasty winter:

seekingalpha.com/artic...

Aug 06 10:31 PM

[RoadtoSerfdom:]

I neither majored in, or work in, the field of economics so perhaps I am mistaken on some salient points. Feel free to educate me.

The recession/recovery is measured by GDP (particularly, this is the metric used in this article.) The government told us they were going to borrow and print huge sums of money, use that to offset declining GDP, and that it would end the recession.

Assuming this is true (and it certainly seems so) why would anyone argue with the predictions of recovery (as defined in the context of the GDP metric)? Obviously, there are reasons to be skeptical re: the sustainability of the recovery; but it seems counterproductive to argue that GDP will not turn around when the government is clearly making sure that it will (methods be damned!)

But in this case, how useful is GDP as a determinant for the end of the real economic woes facing our country (or the world)? What did we fix (besides the books of some "too-big-to-fail companies")? Have we increased our manufacturing capacity? Have we changed our vendor-financed debt consumptive economy? Have we improved our personal debts? The government's debts or unfunded obligations?

But hey, GDP is improving! Thanks to a (hopefully) temporary Keynesian stimulus policy. Once these effects wear off after FY2010, where will we be? Will all these roads and bridges built generate enough revenues to continue paying the salaries of those that built them, plus enough revenues to cover maintenance costs, plus enough revenues to pay back the money spent (plus interest) that was borrowed to build them?

My neighborhood is getting a $2M Senior Citizens center with the initial funding to staff workers paid for out of stimulus funds. When the stimulus funds cease, will my bankrupt state be able to continue paying these workers as well as the additional costs of the center, or are all of these types of employees getting temp work whether they realize it or not? Won't this be the case for the overwhelming majority of "paychecks-- not jobs" created by "stimulus" in every one of our states?

What about all the people that couldn't afford to pay their mortgages (when we were in the "boom" part of the boom-bust cycle we so dearly embrace these days)? Just because the government said they could not be foreclosed, and must be refi'd does not mean they will be able to pay off their mortgages in an even slower economy. Quite the contrary, common sense would indicate. Commercial real estate..?

I see no reason to think that recovery is not here (from the arbitrary GDP metric) and even less reasons to think this won't end up worse than where it started. Count me in the "double-dip" crowd-- I just don't think it will happen until after 2010 (barring some unforseen event.)

Hell, W was very proud of the way he fought off the dotcom/911 recession. Are we not doing many of the same ignorant things, on an exponentially larger scale? If I can't afford health insurance, at least I can trade in my paid-for car and drive home in a Prius. Of course, if I can't afford health insurance, how the heck can I afford a new car? Oh yeah, in America we can vote to spend Chinese renminbis...

"All the king's horses and all the king's men..."

Aug 07 12:30 AM

[imex68:]

By the way the Etymology of the word ampersand is

a corruption of the phrase "and per se and", meaning "and [the symbol which] by itself [is] and".[1] The Scots and Scottish English name for & is epershand, derived from "et per se and", with the same meaning.

Corrupt economy ? Banksters ? Gvmnt ?

8-)


On Aug 06 04:34 PM Tony Petroski wrote:

> I continue my call of an ampersand-shaped recovery: &amp;

Aug 07 06:40 AM

[Stockpickin...:]

very well said MGA_1, it will be slow and steady, but I believe will happen.

Aug 07 08:05 AM

[upgrayed:]

"Morgan Stanley Sees V-Shaped Recovery: I See W-Shaped Recession" I have no problem with the headline, just replace the word "See" with "am Guessing" and you will be all set.

Aug 07 09:13 AM

[Maxe Paul:]

If a guy named "Dick" says it's a V shaped recovery, then it's a W for sure!

Nice article Ed.

I was going to make a "Dick", "Ed" joke but i will refrain myself!

Aug 07 10:05 AM

[Edward Harr...:]

Maxe: As long as it's not a Dick/Mr. Ed joke!


On Aug 07 10:05 AM Maxe Paul wrote:

> If a guy named "Dick" says it's a V shaped recovery, then it's a
> W for sure!
>
> Nice article Ed.
>
> I was going to make a "Dick", "Ed" joke but i will refrain myself!

Aug 07 04:09 PM

[RE Broker:]

I don't think that "buying" green shoots can continue forever as this is all borrowed money and the public is getting nervous about it. I agree Edward, it will be a w unless things really go badly and the economy flatlines for a long time.

Aug 07 09:13 PM