Morgan Stanley Expects a Long, Slow Consumer-Led Recovery

The events of mid-March probably marked a peak in the financial firestorm, according to Richard Berner and David Greenlaw, writing in Morgan Stanley's latest Global Economic Forum. Now comes the economic fallout: The mild recession is apparently underway, as output and employment have begun to contract, capital spending is under pressure, and the consumer is fading. Though downside risks still predominate, Morgan Stanley has not revised its forecast downgrade from last month. Its forecasts remain:

Measured on a Q4/Q4 basis, we now expect real growth of 0.5% in 2008 compared with 0.7% last month, and we continue to project 2.9% growth in 2009 (the new year-over-year forecasts are 1.0% and 2.0%, vs. 1.1% and 2.2% previously; compare “A Darker US Outlook”, Global Economic Forum, March 10, 2008).

Apart from the credit crunch, it is the American consumer that Berner and Greenlaw believe will play a central role in shaping the outcome, and they face formidable headwinds:

• Job losses
• Higher energy and food quotes
• Declining home prices
• Tighter lending standards.

For these reasons, the Morgan Stanley analysts expect the coming economic recovery to be one of the weakest on record. Housing prices and wealth will have a significant effect on how much income consumers will spend. Real home prices declined by 2.8% last year, and Morgan Stanley expects a further fall of 12%. Admittedly, housing affordability soared close to 2003 peaks, reflecting declining prices, lower interest rates and growing incomes, but stocks of unsold homes remain high, foreclosures are worsening, and down-payment requirements are tightening.

Berner and Greenlaw do see several consumer tailwinds to offset the storm:

• Fiscal stimulus is on the way. Even assuming, conservatively, that consumers will spend 20 cents of each rebate dollar, this will provide a pickup.
• The Fed’s efforts to head off an ‘adverse feedback loop’ are bearing fruit.
• The feared pain of mortgage resets will likely be small.
• The intensity of the housing downturn and the pace of home price declines may diminish by late this year if builders aggressively cut housing activity as we expect.

Though these cyclical factors are important, Berner and Greenlaw argue that the longer-term outlook for U.S. consumers may be more significant. And as a muted overall recovery will probably limit job and income gains, this will result in a long period of slow growth for the U.S. economy.

In conclusion:

To be sure, downside risks to the economic outlook remain. The credit crunch could yet intensify, depressing credit-sensitive areas of domestic demand. Spillovers abroad — especially through financial conditions and via the earnings channel — could aggravate the coming slowdown in overseas growth (see “Downside Risks for Corporate Profits”, Global Economic Forum, March 17, 2008). From a market perspective, however, it’s helpful to recall that much of this bad news has been in the price. That’s a primary reason why both credit and equities have recently rallied strongly. We agree with our strategy teams that these are bear-market rallies; lasting improvement probably awaits signs that the recession is ending.

Comments

[galewhitaker]

Higher energy prices have caused the truckers to block the Parkway in protest. I'm not sure what they hope to accomplish. Do they think that blocking the Parkway is going to force OPEC to pump more oil? These truckers have not read King Hubbert's theory about peak oil. If they had read it they would scrap their trucks and get a job on the railroad. Anyway consumer spending is going the way of the VCR. Consumers are going to need all their money to buy gas for their SUV's. I think it may be a long time before they can buy an electric car and get back to the mall.