The Economic Guessing Game Has Begun

In the past weeks, several clear signs have emerged signaling that investors are shifting their focus away from the credit crisis and toward the real economy and traditional investment analysis. The first and most obvious sign is the earnings reports. The next two are less obvious, but are no less important – the rise in the 10 year US Treasury rate and the increasing number of comments in the media and from economists regarding the direction of the US economy.

The 40 basis point rise in the 10 year US Treasury rate (from 3.31% on March 17 to 3.71% *) suggests a degree of relaxation in the flight to quality panic due to the credit crisis. This modest return to normalcy apparently implies that more than a few investors buy the credit crisis end is in sight story.

The other sign that investor focus has shifted is the increasing number of real economy related stories in the media. For example, the April 12th cover story in the Economist magazine, “The Great American Slowdown”, and the FT commentary, “Road to ruin? America ponders the depth of its downturn”, explore the depth and duration of the US slowdown/recession. All this brings us to the emerging debate of the shape of US economy slowdown/recession – V, U, L, or W?

The more bullish sentiment is a V shaped decline and subsequent sharp economic recovery. Painful, yet short. The U shape crowd, on the other hand, believes the current difficulties will linger into next year when the end of 2009 comparisons show a sharp enough recovery and return to prosperity.

The L shaped advocates foresee an extended period of economic weakness a la Japan. Then there are the W shape believers, which is the camp I occupy. Things get better for a while (thanks to the stimulus package and the sustained strength of the global growth story – yes, Virginia, decoupling has worked to a meaningful degree) only to be followed by an economic decline into 2009 for a whole host of reasons, including a withdrawal from the US stimulus and a decline in US consumer spending and concurrent rise in US consumer savings (more on this in the near future).

Investment Strategy Implications

The US economy is undergoing a transformation on multiple levels that will produce major disruptions in the financial and valuation models for equities. These more thematic issues – credit crisis and its consequences, for example – will likely alter the economic landscape for years to come thereby producing substantial opportunities and risks. One outcome will almost certainly be a redistribution of economic growth in the US away from a US consumer dominated economy and toward a more export driven model.

That said, it is advisable to cover the traditional bases. Therefore, whatever shape your US economic doughnut might be (despite the fact that the credit crisis is likely to be far from over), the time has arrived for investors to form their view on the future direction of the US economy.

Comments

[iThinkBig]

I am with you on the W shaped camp. These recent bailouts and stimulus done now and in the immediate future will be paid for by taxpayers. That bill will come due heavy in 2010 when the tax cuts expire, and new taxes are added on top.

The other reality is the U.S. has exported several major markets overseas and these nations have simply reverse engineered. So while multinational companies made out big in the short term, and will still make out for awhile, America as a whole offers less to the world of what it really needs. There will be massive shifts of how our economy operates, with many service jobs (80% of America) becoming laborer jobs. Indeed export will help America out in the long haul but these jobs, created by foreigners will barely provide a living and without benefits. A recent example is the Airbus contract going to the EU (the skilled high paying jobs) while the assembly plant for the final product will be in Alabama. Say hello to $10 an hour with little or no benefits.

To fix this economy, the key is energy independence and creating a massive global investment opportunity in America. This of course would begin deflating the commodities bubble, fix the banking system, create millions of decent paying jobs and restore global investor confidence in one fell swoop. However, I don't work in Washington and see challenges with conflicts of interest with our politicians whom get phenominal inside information and own energy stocks (both Dems and Republicans). It will probably take citizens demanding heades on pikes before laws are passed that prevent politicians/family from investing in energy during there terms or not be elected if they own energy stocks. This is the real reason no group of politicians have ever passed meaningful energy legislation.

[tom kern]

interesting concept to understand unfolding in the u.s. with low monetary value u.s. products would seem to be revered worldwide.this looks good for the future of the dollar value or benefit from investment. the big question is how will this unfold? let's hope it benefits usa too.

[sivere]

The real economy is still somewhat functioning. It is being impacted by high fuel prices and commodities. People still go to work, give bitrth, eat food, live in [lower valued] hosues, etc. Life goes on.

The problem is the $500+trillion derivatives bubble that may pop at any time. This will impact the real economy if farmers cannot get loans to keep running there farms if people cannot get loans to finance their homes, if producers of stuff that people need cannot finance the machines and supplies they need to make the stuff.

This is all the fault of the Fed and its policies of the last 20 years (at least). As the derivative bubble was inflated the Fed stood by, even encouraged it with glee. In fact it is the fault of congress who have the constitutional responsibility to administer and maintain a currency and system of credits. Therefor, we need to

TakBackTheFed.com

We need to do it NOW. Let's not sit around and wait fo the crash, open our wallets, and pay for it (not that what is in our wallets will necassarily be woth much). Let's take action now, and save our nation!

[sorgmot]

We believe that the long term 21year decline in USA interest rates hit bottom in 2001 and will be in an up trend ( with pauses ) until 2050.

The down trend in real estate prices will continue until then.

P/E multiples on bonds and stocks will rise until 2050 causing bear markets with some rallies until then. Earnings per share will rise so that stock market prices will rise on balance.

The exchange rates for the USA dollar will stop falling and then rise and there will be more exports and fewer imports, but only if the USA Government stops wasting money.