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Recovery on Track; Buy Equities, Sell Bonds
By: Dr. Charles Lieberman
Date: 12/7/2009
The economy continues to remain on a solid upward trajectory, with the latest employment data suggesting that a stronger growth path than observed coming out of the prior two recessions. Job growth is likely to resume within the next few months. Issues remain, with credit availability to small business and the health of the commercial real estate market at the top of the list. Still, conditions continue to improve. Over the course of the next six months, the expansion should gather momentum, become well entrenched and become self-reinforcing. Equities should continue to perform well in this environment, while bonds are likely to perform poorly, as rates normalize.
The recovery continues to be restrained by poor credit availability and very difficult conditions in the commercial real estate market. Banks remain cautious about lending to small business, even though banks can't make any money unless they make loans. As banks regain confidence in the economy, they are likely to resume lending. It is a safe bet the Fed is monitoring this situation very closely and unlikely the Fed would even consider raising rates until the lending tap is reopened. Conditions in the commercial real estate market are improving rapidly, as firms have resumed selling bonds backed by mortgages. Lenders have also figured out it makes more sense to roll over maturing debt rather than force asset sales into a weak real estate market. So while conditions are not back to normal as yet, both borrowers and lenders are buying time for conditions to normalize.
The equities market has rallied dramatically off the low on March 9, but this properly reflects the recovery that has unfolded since then. The market remains very vulnerable, if the recovery were to falter, since the economy has not yet built up momentum to the upside. So the rally is not yet locked into place, even though it is well founded. The risks of a reversal in the market will decline sharply as economic growth becomes better entrenched.
The outlook for the bond market is far less favorable, however. In keeping with our recovery outlook and the cover story article in the latest issue of Barron's, which featured our firm's income with growth strategy, interest rates on investment grade bonds are just too low to compensate investors for the possibility of any kind of economic recovery. 10-year Treasuries are below 3.5%, so investors are likely to earn nothing after taxes and inflation for the entire life of that investment. Investors seeking safety after suffering through the volatility of 2008 will suffer negligible returns in what they have mistakenly and simplistically consider a safe investment.
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