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Economic Update – Green shoots don’t equal a bumper crop

Posted At : June 25, 2009 10:16 AM

Of late, there has been a tendency for analysts to see numbers or statistics that are “less bad” and interpret them as signs that we are in recovery or at least almost there. They glance back at previous recoveries and say, “Doesn’t this look like the last time? When such and such happens it means that recovery is on the way. We should therefore buy stocks” (or whatever). Well folks, to expect a normal recovery cycle, whether it is corporate profits or lending or consumer spending or capital investment or (pick a category) is just not reasonable.

First, we are at the end of a huge cycle of increasing private debt that ended in an overleveraged society. The process of reducing debt and unwinding leverage is going to take a rather long time. It will not be the typical one or two years and then things get back to an ever-higher normal. In our new world, we will not need as many malls or factories or stores or new-car plants or car dealerships or show stores (sorry ladies) or any number of other things to satisfy our new world consumer desires. As an example, and jumping ahead to a statistic for one minute, capacity utilization is now approaching 65%. Anything under 80% is anemic. Does anyone really think that businesses (in general) are going to invest more money in expanding capacity, in the face of the lowest level of production relative to potential since the 1930s?

The demographics of our population are aging rapidly, going from net spenders to net savers. The savings rate has shot up from zero to 6% already. It used to be 12%. It would not be all that unusual historically for savings to go to 9% or more in a few years. That means that consumer spending will drop by 9%. Since consumer spending was 70% of GDP, that new lower level will become our new world. And of course, due to population growth and hopefully increasing incomes, consumer spending will once again grow from whatever that new normal will be. But it is going to take some time for spending to reach the level of our productive capacity of a few years ago. We are going to have to shutter a few factories and businesses. This is going to affect corporate profits, especially for companies that depend on consumer spending. Investors who expect corporate profits to rebound in 2010 are dreaming.

Housing: the housing market is going to take at least 2 or 3 more years to truly recover. Looking at one month’s data that shows housing starts up a few thousand as a sign of recovery in the housing market is pretty silly. Housing starts are anemic and the inventory of unsold homes is still at all-time highs (an 11th month supply) with more and more homes coming onto the market through foreclosure. Just in Sacramento alone, there are an estimated 22,000 foreclosed upon homes the banks are sitting on that will overwhelm the market, with more to come. Just wait until the prime loans, the people with money, start walking away from their loans because a bad credit score is more desirable than losing hundreds of thousands of dollars. However, housing construction was once about 5% of GDP. Obviously, the collapse of housing construction has had a rather negative impact on recent GDP numbers. But housing is probably close to, if not at, a bottom. Even if it dropped by another 20%, it would have far less of an impact on GDP at the much-reduced level where it is now.

Regards – Keith Springer

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