 here
is the sense that a strong near-term rebound is headed for the U.S.,
with positive spillover in non-Japan Asia. However, it may not have
legs. Headwinds could weaken and shorten the U.S. rebound while foreign
economies are still in the process of finding a bottom.
Rather than
a synchronized global expansion, we're more likely experiencing
somewhat of a ragged bottoming process - a bowl-shape trajectory
with the bottom of the bowl extending into 2002. This has disappointing
implications for 2002 corporate earnings and positive implications
for bonds in the
U.S. and Europe. Just as the decline into recession was somewhat
gradual, moving sector by sector, the recovery should also be gradual,
with early strength in technology demand but only gradual follow-through
into other sectors.
One can expect
the Fed to be accommodative during this period and the European
Central Bank to cut interest rates early in 2002. The sharp rise
in bond yields in the U.S. and Europe in recent days adds to the
headwinds by increasing the cost of capital for new borrowings,
reducing mortgage refinancings, etc. Such high real-bond yields
at this point in the recession spell trouble for the sustainability
of a recovery. They are also likely to pressure equity-valuation
models, which thrived on the lower bond yields of October and early
November.
As with the
oil price spike in 2000, some will misinterpret the higher bond
yield as a sign of economic growth and inflation risk. Instead,
the higher bond yields should be interpreted in a
straightforward way as a strong new drag on the recovery.
In 2000-2001,
I argued that oil prices would fall one way or another - either
through an early correction based on a market reassessment or later
on through a global recession. The same logic holds for bond yields
- either the market will lower the yields soon based on a proper
reassessment of the inflation and Greenspan rate risk, or the yields
will fall later on based on a renewed economic downturn.
Several factors
argue for near-term strength of the economy (a sharp rebound), softening
the decline in fourth quarter GDP. Positive indicators include auto
incentives; government purchases related to September 11 and the
war on terrorism; and pent-up demand for inventory and investments
after the November 12 progress in Afghanistan. This last factor
began to reverse the intense global capitulation into liquid dollars
in October and early November. That hoarding of liquidity came at
the expense of inventory and deferrable investments, so when the
spiral broke on November 12, there was a rush back into necessary
business investments and inventory (pushing up the price of DRAMs
and copper and down the price of a two-year Treasury note).
Yet, the reasons
for the sharp rebound identified above are not, by themselves, sustainable
engines for a recovery. The restocking will run its course. The
auto incentives are too costly to sustain. And government purchases
will probably stabilize once they've been ramped up.
To create a
sustained recovery, we'd need to see sequential, multi-quarter growth
in consumption,
housing, investment, exports, or inventory levels. Given the strong
headwinds — high bond yields,
consumption and housing already relatively strong, heavy tax burdens,
foreign recessions weighing on
exports, leftover deflation pressures from the dollar's 1996-2000
strength, and plentiful capacity - it's hard to see sustained growth.
One key driver
for a normal recovery is consumption. It doesn't have much upside
now, since it has stayed relatively strong during the recession.
There was good reason to disagree with the negative wealth-effect
arguments in early 2001, and don't expect a positive wealth-effect
from the equity rebound for the following reasons. Consumption faces
headwinds in the form of 1) weaker growth in personal income; 2)
precautionary increases in savings in response to rising unemployment;
and 3) fewer people working due to higher unemployment, a decline
in the percentage of the population in the labor force (from the
very high participation rates in the late 1990s), and fewer immigrant
workers. While personal spending in the U.S. rose 2.9% in October,
the growth in personal income has slowed to zero month-over-month
in September and October.
We're in a
bowl, America. Yes, we'll see (and are seeing) a nice spike in the
economy, but we're gonna have to ride through a longer stretch before
we reach a sustained recovery.
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