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It Is Looking More Like A V-Shaped Recovery
By: Dr. Charles Lieberman
Date: 8/10/2009
The job market remains the laggard, as is typical, in the recovery. Even so, conditions seem to be falling into place for something stronger than the consensus tepid economic recovery. Residential construction and manufacturing should lead the rebound. Once the consumer kicks in, there is a real possibility that the economy could be off to the races. So the possibility of a V-shaped recovery is rising. In this context, the path for monetary policy remains uncertain. Even so, some investment implications are already clear. Equities remain (by far) the best place to be. In addition, high yield bonds are attractive, as investment grade bonds have joined Treasuries as investments that now need to be avoided.
First, construction expenditures, as always, lag behind starts. Second quarter housing investment declined at a 30% rate, reducing GDP, even as Q2 starts rose by 2.5% over Q1. Q3 starts should rise further. So, housing investment could swing from a sizeable rate of decline to a small positive in very short order. In fact, residential construction expenditures rose by 0.5% in June, a modest rise that should get stronger in the coming months.
Similarly, the decline in production jobs over the past year is staggering, 1.398 million or 16.2%. However, inventory liquidation is also massive and clearly unsustainable. So, manufacturing payrolls are likely to flatten very soon and some modest increases seem likely not long thereafter. Manufacturing should be a very solid contributor to GDP in Q3 and Q4.
Third, there ought to be some meaningful benefit from the fiscal package showing by Q3. So far, most of the impact has been on disposable personal income without any discernable impact on spending. That's the consumer still hunkering down after Lehman. Although it is hard, maybe impossible, to figure out what proves to be the trigger, at some point this will turn and it could turn very soon. Fourth, what's happening is clearly global and some other countries are ahead of us, so that should help exports.
The case for a strong economic recovery requires, as well as supports, gains in the credit markets. However, Treasury bond yields still reflect very weak economic conditions, even as high-grade corporate bond spreads have tightened considerably. Investors will experience some depreciation as economic conditions return to normal. While high yield bonds have also rallied, they still have room for additional risk spread tightening. So while high grade bonds are now unattractive, high yield investments remain worthwhile. The high level of unemployment implies that the economy has room for solid expansion for several years. Thus, equity investors can look forward to a lengthy period of growth in profits, yet stock prices are not even back to the pre-Lehman failure valuations, which makes equities the most attractive asset class, by far.
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