Insights & Advice



May 8, 2009


  • Consumers, businesses, and financial markets are showing signs of improving health. The US recession will end in the second half of 2009.
  • The difference between most recessions and this one has been a dramatic and overwhelming loss of faith in the economy.
  • We are becoming more optimistic on the economy, but we remain cognizant of the strong recessionary forces that remain in place. A full recovery remains long off.
  • The odds have improved that the bear market has hits its bottom and that it will not re-test its March 2009 lows (retesting the November 2008 lows is a distinct possibility, but not a certainty).

In 2008 we wrote about the credit-crisis “morphing” into a recession. On April 22, 2009 the International Monetary Fund said that “by any measure, this downturn represents by far the deepest global recession since the Great Depression.”

Credit, while still ailing, is no longer in crisis. And the economy, while seriously impaired, will stabilize over the coming months and then recover before year’s end.

In September 2008 (pre-Lehman Brothers collapse) I attended the annual Charles Schwab Impact conference. The conference is an opportunity for us industry folks to catch up on technology improvements, corporate best-practices, and other such important manager/owner topics. For one evening during that event I was able to have a conversation with a non-industry person, but still on the topic of the economy. My wife and I were able to schedule dinner at a friend’s house, and it just so happened that President Bush was speaking that night. And while we largely avoided politics and business during dinner, while the patriarch of the household drove us back to our hotel we could not help but to comment and converse about the Presidential address. It was terrifying.

I do not wish to come across as a conspiracy theorist, but I had gotten used to our government lying to us. And here is the leader of the free world warning us about just how bad the economy is. Now, for as far back as I can remember (and as far back as the archives will allow me to remember) it is customary of our leaders to coddle us during tough times and to tell us that things are gong to be alright.

Now, this fellow driving me home is no joke in the business world. He’s about ten years my senior and is the CEO of one of the largest construction companies in the world. So when he asked me what it would take to turn the economy around, I felt a little embarrassed at the answer. Feeling small in his shadow, my fragile self-esteem was desperately searching for some sophisticated answer about capital injections for the banks, or how a 1980s style Resolution Trust Corporation would be appropriate, or something of that sort of academic magnitude.

Instead, I focused on one intangible – confidence. It likely seemed like a copout of an answer. But it sure seemed right then and, eight-months later, it seems to have been proven correct.

The difference between every recession in the last three-quarters of a century and this one has been the severe loss of confidence. Sure, businesses and consumers have turned cautious in other recessions, but there was always – at least by most – an underlying belief that the economy would again gain traction. And our leaders told us so. But this time, as far as two months into his first term, even Mr. Hope himself, President Obama, was bashing the economy. That’s just not good for confidence.

Quite frankly, aggregately speaking, there is still little confidence had by the average Jane and Joe. But, at least, there is confidence in some spots where before there was none. Banks are loaning where they did not loan before. Investors are buying corporate bonds when before there were no bids. Homebuyers are willing to buy homes now that prices and mortgage rates have gone down and government incentives have gone up.

Confidence is not restored, but it is being restored where before there simply was no trust. No trust in counter parties. No trust in stimulus efforts. No trust in the efficacy of the Fed. There was no trust at all.

And when no trust exists for the consumer or for businesses, there is only one solution – the government must drag us out of the dark and into the light. We’re all going kicking and screaming, but we’re going. For example, there have been gains in so-called core retail sales as well in different gauges for corporate purchasing managers. To be sure, we are not seeing, nor in the next few months are we expecting, robust growth. The economy is, however, experiencing distinct stabilization (an important first step) and in some cases baby-steps toward improvement. And that’s what we need to see.

We spoke to a lot of clients in August, September, and October of last year. And we discussed that going from a boom to a bust was a lot like going from day to night. The change of light is not a light switch. The light fades slowly – very slowly. Often there are signs that the light is going to go out – schools let out students and maybe streetlights go on; we get out of work and maybe we have to turn on the headlights; maybe we see the moon and the sun in the sky at the same time; maybe we go home to cook and have to turn on the oven’s overhead light to see what spices we are adding– and then suddenly we realize that it’s dark; we realize that it’s a recession.

Now we know it’s dark. At some point it doesn’t get any more dark – but what’s the difference? It’s too dark to tell anyway! But at some point the streetlights go off. At some point the crickets stop chirping and the birds start singing. And then, all of a sudden, the alarm goes off in the morning and it is light again. Well, with a recovery it is similar. Instead of a ray of sunshine here and a ray of sunshine there, we start to get glowing (or at least “less dark”) reports from our leading indicators. It’s not a light switch off and it’s not a light switch on. The process is less mechanical and more like a sunset and sunrise.

The problem right now is that it is so dark that it is difficult to be confident that our eyes are not deceiving us.

A correlative problem is that if we wait until the sun comes out then everybody knows it is daytime (i.e. out of recession). And when everybody knows it, there is no opportunity in being confident enough to make your call before everybody else. There is no opportunity to make money in the stock market.

You don’t have to be the first one to be brave enough to make the call that the sun will, once again, rise. For example, if you did that at the lows of October 2008 then you pretty much have just treaded water in the stock market for nearly seven months. And that was not a terribly fun seven months. Following the lows of October 2008, the stock market crashed in November 2008 and then again in March 2009. And it may, yet, crash again. But at least this time it will do so with the backdrop of a stabilizing (rather than a deteriorating) global economy. That allows us the confidence required to make an investment decision (rather than a sheer speculation) that the low is in for this bear market and that the sun will, indeed, rise again.

So why not leverage up on margin and get full-plus exposure to stocks? Because we’re investors – not speculators. Investors focus on probabilities and strategies. Speculators bet what they can lose.

Recessions rarely proceed in straight lines. And while we are confident in our call that the bottom (whether it is revisited or not) is in for this bear market, we are also cognizant that false dawns are common before recoveries finally take hold.

Strong recessionary forces remain in place to possibly dampen any rebound. These forces include the supply overhang in housing, limited spending on construction and capital spending, and the continued threat of fading consumer spending due to permanent losses in equity and housing wealth.

Risk management is still the name of the game. The brutal truth is that the financial system, while healing, is still far from healthy. Policy makers have eliminated the worst possible outcomes, but there is much repair that is still required and that leaves downside risks.

Some Numbers


The free fall in manufacturing is over. The severe downturn in production is beginning to abate because of the improvement in credit markets, massive inventory liquidation, and firmer consumer spending. An oft followed measure of manufacturing is the Institute of Supply Management (ISM) index. The most recent number was 40.1 for April, up from March’s 36.3. This was the fourth consecutive increase, putting the index well above its average of 35.9 for the first quarter of 2009.

The bad news is that the index is below 50, which indicates that factor output continues to contract. Other bad news is that a number below 41 suggests that the economy is still in recession. We are certainly still in recession, but the pace of the recession slowed early in the second quarter of 2009.

Further, an internal inspection of what constitutes the ISM index reveals that current inventories have plunged to their lowest levels since 1982, while new orders have risen back to August 2008 levels. The gap between the two, a proxy for future production, is getting bullish. That is not to say that further liquidation will not continue, but things are getting better.

Interest Rates

At the current level, 10-year Treasury yields (about 3.25%) are in the bullish zone for the economy. And while they have risen in recent weeks, yields are still below the 2008 average of 3.66%, which was a record low. And the day which the Federal Reserve decides to take away this economic juice is likely distant.

Too, shorter-term interest rates have been driven to zero, and mortgage rates have plummeted to a four-decade low.

Money Supply

Since last August, money supply (as measured by M2) has risen at a postwar high annualized growth rate of about twenty percent. It’s easy to get lost in geeky details on this one, so I’ll try to be jargon-less. Economic growth is, in part, a function of the velocity (or turnover) of money. The more money that is out there, the more that gets turned over. In short, this is bullish.


The labor market is still suffering, but weekly jobless claims are edging lower, pointing to a slowing layoff rate, which is a signal of a maturing recession. The four-week moving average has fallen about 35,000 from its peak, also an outcome consistent with a more moderate decline

With a Little Help from Our Friends (in China)

While the recovery is taking hold in the US, it will gain further traction if other large economies are also able to accelerate (a positive feedback loop). China is returning to a much stronger mode of strength due, in part, to massive amounts of stimulus spending that the nation easily was able to afford due its giant surplus of cash reserves. In the first three months of this year, Chinese banks had extended $660 billion of loans, more than all new bank lending in 2008. Remember the above comment on the velocity of money being bullish? Well, $660 billion of turnover (and don’t even get me started on the multiplier effect) is very bullish. (We’ll write more on China later).

Bottom Line: Asked when the economy would rebound, Larry Summers, head of the White House Economic Council, delivered perhaps the most honest assessment we have yet heard uttered. In response to that question Mr. Summers replied that there are two types of forecasters, “Those who know they don’t know, and those who don’t know they don’t know.”

It is likely of little reassurance to those reading, but we are in the camp of those who, at least, know that we don’t know. Still, we are confident that stock, bond, and commodity prices have bottomed and that the economy will follow. Developments over the past few weeks have boosted our confidence in forecasting an economic stabilization and a return to growth later in 2009.

Although the financial markets could still face additional “retests”, any move to the downside is likely to be temporary (months, not years) due to the US economy being in recovery.