Are we heading for a double dip recession?

July 26, 2010

BRITAIN/-Kully Samra, UK Branch Director, Charles Schwab. The views expressed are his own.-

Over the last couple of weeks we have heard some commentators talking about the possibility of a double dip recession sparking fear for many investors.   Whilst I understand the reasoning for such fears, at Charles Schwab we do remain relatively optimistic on the United States economy and the market.

We don’t argue with the concerns regarding the U.S.  economy as recent economic data from the States has been consistent with a soft patch.  Jobs data has been disappointing and other reports have been moderate. The economic data has been murky at best, leaving investors uncertain about what to do going forward.

But are we headed into the dreaded double dip recession that’s received more and more media attention? Or are we settling into an economic growth rate that, after the initial V-shaped rebound off the economic trough, is more consistent with low but stable growth?

We lean toward the latter, rather than a double dip we believe that the likely shape of the recovery will be a “square root”.  Most historically reliable indicators still show little chance of a near-term return to recession.

The likelihood of a rare back-to-back recession got a lot more attention recently as some economic indicators have pulled back from the highs they reached during the recovery. We believe that the possibility of such an event is still relatively remote.

A main factor for our “square root” recovery belief is based on the yield curve.  This has been a very accurate, and often overlooked, indicator of future economic conditions and, as such, it remains quite steep — longer interest rates much higher than shorter rates.  It’s when the curve inverts (short rates higher than long rates) that the probability of a recession greatly increases.

Other economic data supports our view as it has confirmed that growth is slowing, but not contracting. The Institute for Supply Management Manufacturing Index for June pulled back to 56.2 from 59.7, while the ISM Non-Manufacturing Index — which tracks the more dominant service sector — declined to 53.8 from 55.4. Readings greater than 50 point to an expanding economy, albeit levelling off.

Admittedly, there’s been some downright weak data recently. Pending U.S. home sales fell 30 percent in May, beginning what we believe is likely to be a string of weak housing data as we give back some of the gains seen prior to the expiration of the homebuyers’ tax credit.

We don’t believe this foretells a renewed deep drop in housing, given that mortgage rates are historically low, housing affordability is historically high and inventory levels are slowly ebbing. Data should start to smooth out and indicate continued stabilization in housing as we head into autumn.

As a result of the economic uncertainly, the only investing strategy that we believe has staying power is that of having a well-diversified portfolio with your long-term goals in mind. As a reminder, we don’t recommend investing any money in equities that you may need in the next three to five years. As we’ve seen, things can be very volatile over time spans shorter than that, which could affect your ability to meet your financial goals.

None of the information constitutes a recommendation by Schwab or a solicitation of an offer to buy or sell any securities. The information is not intended to provide tax, legal or investment advice. Schwab does not guarantee the suitability or potential value of any particular investment or information source.

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