Insights & Advice


Recovery – Part II

May 18, 2009

On May 8, 2009 we posted an article on titled “Recovery”.

This weekend, among other things we spent time reviewing that article as well as the indicators which allowed us to confidently forecast an end to the recession in 2009. This article is a brief addendum to “Recovery”. We cite some of the specific indictors that make us more optimistic about the months to come.

To be sure, there are indicators that disprove our premise of a coming economic recovery (most notably, the Conference Board’s Leading Economic Index – LEI; however, the LEI will be updated this Thursday and we expect a sharp jump to the upside). And, yes, we do believe that the recession still exists. We do not argue that the recession has ended, and we do not argue that our evidence is definitive. But we do have great confidence that this recession will end in 2009. In fact, a year from now when we get the “official” declaration as to the end of the recession, we believe that the recession’s end could very well be not this autumn, but rather this summer.

Following is a brief list of the indicators that allow us to confidently forecast an end to the recession sooner, rather than later. Here’s what we are seeing:

1. Credit Spreads. This recession was triggered by the credit crisis that began out of nowhere in the summer of 2007. Developments in the credit markets are crucial for determining an end to the downturn. As the economy stabilizes and finds footing for improvement, investors tend to leave the safety of government bonds (making Treasuries a bad investment) for the higher risk/higher return of corporate bonds, which leads to a narrowing of credit spreads. We have seen a narrowing of these spreads since December 2008.

2. Nonfarm Payrolls. Make no mistake, the labor market is in a shambles and, as a lagging indicator, will continue to be a mess well into a new recovery. Like all the indicators, and for this one in particular, we are looking for not necessarily improvement in the form of “good” numbers, but rather an abating of the “bad” numbers. Job losses peaked in January and are moderating.

3. Consumer Sentiment. In the aforementioned May 8, 2009 article “Recovery”, we talked a lot about how confidence must be restored in order for any economic traction to take hold. Further, we discussed that while consumer sentiment is critical to any economic recovery, to mend the damage of this particular decline a rather substantial amount of improvement needs to be made. Per the sentiment indicators we follow, sentiment and confidence is being restored – perhaps not yet substantially, but it is being restored.

4. New Home Sales. Housing contributed enormously to the economic downturn. A recovery in new home sales, which tentatively bottomed in January, would be a welcome sign. It is important to note the use of the words “tentatively” and “would”. New home sales figures have been a very volatile number as of late. Further, the lead-time range (from the point of improvement to the point of economic recovery) is wide at two to nine months. Still, it is worth noting the improvement over the last few months as it has been coincident with other improvements.

5. Consumer Spending. There has been much ado regarding the explosive increase of the money supply. But just as we have previously written, an increase of money supply is only positive for the economy if that money gets spent. Consumer’s willingness to spend money on durable goods, which include big ticket items such as vehicles, is often coincident with improved confidence. And that coincident movement is important because often times there is a difference between what people say (sentiment) and what they actually do (spend) . Even though spending on durables is only about ten percent of the economy, it is very pro-cyclical, and thus a leading indicator. As such, the October 2008 trough and the subsequent rebound have been encouraging.

6. ISM Manufacturing Index. The manufacturing index tends to be more volatile (and hence less predictable in terms of gauging a sustained improvement) than the service sector. And while the ISM Manufacturing Index can leap and lurch both up and down, it has been steadily improving.

7. Inventory-to-Sales Ratio. Since the inventory reduction of the first quarter of 2009 was the largest ever, it is important to include this indicator in our assessment of improving conditions. The elimination of excess supply of goods allows for the increase of future production increases.

It is important for us to go through this exercise because when it is near the end of the recession then it is the end of the bear market and time to buy stocks.