Glimmers Of Hope For The Economy

Economists agree that the current U.S. recession began in December 2007. Industrial production is down 13.3% since that point in time, the largest percentage decline since the end of World War II, when production of military equipment came to a halt and brought the nations industrial output down 35%. Without question this recession is expected to be the longest and deepest since the Great Depression.

As a backdrop to 2009 there are a number of developments that we need to take note of in assessing the economic outlook. The U.S. budget deficit should exceed $1 trillion annually during each of the next two years which will be the largest deficit on record. Inflation pressures will most likely be minimal in 2009 after what was essentially no change in consumer prices during 2008. The unemployment rate, recognized as a lagging indicator for the economy, will most likely reach or even exceed 9% at some point this year. The Federal Reserve is expected to leave its short term interest rate near 0.25% for most of 2009 which is the lowest level on record.

Additionally, thirty year fixed rate mortgages could possibly come down to 4.5% in the next few months as the Federal Reserve buys long term mortgage backed bonds and mortgage debt. The global economy appears likely to remain in recession during much of the year. For the first time since WWII, the U.S., Japan, and Europe are all in recession at the same time. Oil prices are anticipated to remain in a range of $30-$65 as global demand will probably remain weak.

So, despite the ominous outlook highlighted above, there are a number of factors that have the potential to enhance economic growth toward the end of 2009 or early 2010. At the head of the list is the $787 billion stimulus bill signed by President Obama in February. The second half of the Troubled Asset Relief Program (TARP) amounting to $350 billion will be available to strengthen the banking system. Also, the Term-Backed Securities Loan Facility (TALF), of as much as $1 trillion, will be able to provide funding for the sale of securitized loans including those backed by commercial real estate. Complementing these programs are the numerous actions implemented by the Federal Reserve to open up the credit markets.

Signs that some improvement may be taking hold surfaced in the mid April release of its Beige Book account of the economy. Certainly the overall economic activity contracted further or remained weak. However, five of the twelve districts noted a moderation in the pace of the decline. The economy had declined at a 6.3% annual pace in the fourth quarter of 2008. For the first quarter of 2009 it is expected to be negative 5% and for the second quarter negative 2%.

Realistically, a quick economic recovery remains hampered by issues surrounding the housing market. While homes are more affordable in terms of price and interest rates, potential buyers are burdened by insecurity at their jobs and with their income. Also the possibility exists that prices could go lower if they wait to buy. Consequently, the economy continues to deal with the fluid state of the housing market.

History has shown that the stock market will typically begin a recovery before the economy begins its rebound. Consequently, the question arises as to whether the recent market run up is a bear market rally or a sustainable market upturn. There is no clear cut answer to that question. An argument can be made for both the bulls and the bears. Certainly, to endorse the bull point of view one must make the assumption that the actions taken by the country’s leadership have solved the financial and economic crisis and that this heavily indebted economy can return to growth by the end of this year or early 2010.

As we have pointed out earlier in the article, the pace of the decline in economic activity appears to be slowing. Accordingly we need to watch signs that can support the view that the market movement can indeed be sustainable. This would include such things as a narrowing of the interest rate spread between corporate credit and treasury securities. Also an extension of any market rally needs to be reflected across a broad group of industry sectors along with a decline in measures of volatility.

Key to the answer regarding any question concerning recovery to both the economy and the investment market is whether the consumer can finally begin to exhale a bit. Clearly, last year saw the consumer nearly stop breathing as the fourth quarter of 2008 marked the worst quarter for the U.S. economy since the 1930s. Let’s hope that some early signs are indicating that we are going to see a gradual shift from pessimism to optimism!