A tale of two economic recoveries

November 3, 2009

Which one do you believe? John Hussman sketches them out:

1) One possibility, which is clearly the one that Wall Street has subscribed to, is that the recent downturn was a standard, if somewhat more severe than normal, post-war recession; that the market’s recent strength is an indication that it is looking forward to a full “V-shaped” recovery, and that the positive print for third-quarter GDP is a signal that the recession is officially over. Applying the post-war norms for stock market performance following the end of a recession, the implications are for further market strength and the elongation of the recent advance into a multi-year bull market.

2) The alternate possibility, which is the one that I personally subscribe to, is that the recent downturn was the initial phase of a more prolonged deleveraging cycle; that the advance we’ve observed in recent months most likely represents mean-reversion – qualitatively and quantitatively similar to the large and often abruptly terminated “clearing rallies” of past post-crash markets; that major credit losses are continuing quietly but are going unreported thanks to changes in accounting rules by the FASB this past spring, which allowed for “substantial discretion” in accounting for loan losses and deterioration in the value of securitized mortgages; that a huge second-wave of mortgage losses can be expected from a reset schedule on Alt-A and Option-ARMs that has just started (following a lull in the reset schedule since March) and will continue into 2010 and 2011; that intrinsiceconomic activity remains abysmal; that recent GDP growth is an artifact of massive fiscal stimulus that is unlikely to have sustained follow-through; and that recent market valuations are not representative of those observed at the end of most post-war recessions, but are instead similar to those observed at major market peaks prior to the mid-1990′s.

One comment

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How about a middle ground? My take is the 3.5% GDP number took the v-shaped recovery off the table. As you pointed out in a previous blog entry, that number is quite low compared to the first quarter of recovery after previous downturns and therefore should have been interpreted as a disappointment.

Having said that, I’m not sure I can buy off on an overly gloomy picture going forward. I’ll take Hoffman at his word regarding the credit problems he listed, but does all of that translate into an economy that has only one place to go — down? I’d say it translates into an economy that still faces some headwinds. But headwinds or not, it’s usually been foolish to bet against the American economy. And oh yeah, don’t fight the Fed.

So my vote is for a modest recovery going forward, but recovery nonetheless.

Posted by Bill, Fairfax, VA | Report as abusive