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Investor’s CornerBy John Gudritz CFA
Principal
Front Street Investment Management LLC
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The recent revisions to quarterly GDP numbers show that the Great Recession was even “greater” than originally thought and that the recovery has been weaker. To add still more to investor anxiety, the global economy is slowing, especially in the U.S. and Europe, and the health of the banking system in Europe is in question. The stock market decline is finally reflecting this new reality. That has me feeling more bullish long-term.
My long time readers know that I have been questioning the sustainability of the U.S. economic recovery since it began two years ago. That is because history has shown that recessions caused by financial crises take many years from which to recover. Economic growth is more subdued and vulnerable to slowdowns and more frequent recessions during a post-crises recovery. I did not believe that the huge stock market rally reflected that economic truth. As we see from this correction, it did not.
The Bureau of Economic Analysis’ (BEA) revisions for the U.S. Gross Domestic Product (GDP) from 2007 through the second quarter of 2011 showed that the recession and the recovery have been worse than what was previously thought. In fact, the numbers now show that the U.S. has not yet fully recovered from the recession.
Specifically, the BEA revised the real contraction in the economy during the recession from down 2.8 percent to down 3.5 percent. The big surprise was the revision of the first quarter of 2011 from 1.9 percent to only 0.4 percent. That is, what we thought was slow growth turned out to be virtually no growth.
While real GDP growth did pick up in the second quarter, it only bounced to 1.3 percent due to better exports and business investment. Consumer spending (personal consumption expenditures) sharply decelerated to only 0.1 percent.
Year-over-year real GDP only grew at 1.6 percent as of June, which is a little worrisome. Since 1948 any time that the economy’s year-over-year real growth rate fell below 2 percent it meant a recession was just around the corner.
With this “recovery” being as tepid as it has been it is no wonder that consumer confidence indicators have been languishing at recessionary levels since the recovery began in the summer of 2009. Despite the tremendous resurgence in the stock market from March 2009 to May 2011, the average person on the street was not feeling much better about their financial future. High unemployment, stagnant wage growth and the continued decline in home prices probably had something to do with that pessimism.
Adding to consumers’ concerns this year were the higher gas and food prices that were partly caused by the Federal Reserve’s second quantitative easing (QE2) by way of the weaker dollar. This only further pinched budgets for families not invested in the stock market.
In addition, the recent political spectacle in Washington DC over the debt ceiling debate was not confidence building. Neither was the downgrade from AAA to AA+ of U.S. Treasury debt by Standard and Poor’s rating agency. I have never heard so many people actually worried that the federal government would default on its debts. It is no wonder that Congress’s approval rating is in the low teens.
While we have our economic challenges on this side of the Atlantic, Europe is in the midst of another financial crisis due to sovereign debt. I fully expect this unfortunate situation to be worked out with the Euro Monetary Union left intact. I also expect that no European bank will be allowed to fail. Programs will be instituted by the European Central Bank and various governments to shore up the capital of the banks.
If all of this wasn’t enough to make investors want to sell their stocks and run for the hills, there is also the slowing growth in emerging countries that have been the growth engines in this recovery. China, India and Brazil and others have been raising interest rates to slow their economies to reduce inflationary pressures. How can the global economy grow without these countries leading the way?
No doubt, investors are facing what seems to be an insurmountable “wall of worry” that includes numerous risks to the global economy. With that being the case, I am actually feeling more optimistic about future investment returns in the stock market in relation to the amount of risk that must be accepted by my clients to achieve them. Why do I feel better about future potential returns for stocks?
It is because the stock market (S&P 500) recently fell to the 1100 level where it was in October 2009. Despite this slowdown, the U.S. economy is actually in better shape today than it was in 2009. Lower stock prices plus a healthier economy equals higher future returns over the next 10 years. With investors’ expectations finally reflecting the new reality of slower growth in this post financial crisis economy, risk of disappointment is greatly reduced and that makes me more confident about investing in the market.