An Economic Pep Rally

For the past six weeks there has been a consistent drum beat that the economic crisis may be over.  The current administration has been blanketing the media with its hopeful perspective that the worst of the economic crisis is behind us.  The media has been hyping irrelevant and misunderstood economic data and earnings reports as a further sign of hope.  Citigroup’s earnings release last Friday being the latest example.  (Citigroup's Earnings Fantasy)

Beyond the verbal hype, the possibility of an economic recovery appears all the more compelling given the backdrop of a stock market which rallied more than 24% since March 9th.  (DJII 6,547 to 8,131 Friday, April 17th)  This development is a more substantive justification for optimism because money speaks louder than words and represents genuine conviction versus stated hope.

Unfortunately the cheery perspective has proliferated in defiance of reality.

The Crisis is Over…. Again!

The first time the Housing Collapse was declared over was in the Summer of 2006 when traders and investors speculated that the six month long decline in the housing market was over.  I have a clear memory of the event because I shorted Lennar’s stock (a Florida based public homebuilder) just days before the Homebuilder Index rallied by more than 20%.

During the past three years there have been an endless number of predictions stating that the downturn has bottomed or that a recovery is imminent.  Each of these prognostications have been baselessly asserted, born out of a lack of understanding, and proven to be completely wrong.  I have several personal favorites including Henry Fishkind’s disastrous Florida-centric prediction in 2007.  (Fishkind's Florida Folly)

So what makes this time different?  As far as I can tell nothing.  Evaluating the economic fundamentals which, by definition, dictate when a recovery can occur reveals that our policy makers are advancing baseless hope.

The first question to ask is whether the sources of these predictions are credible.  Did the media, entertainers like Jim Cramer, policy makers including President Obama, Larry Summers, Timothy Geithner, Ben Bernanke and Christina Romer, predict the economic events of the past three years?  These institutions and individuals have consistently demonstrated a lack of understanding regarding economic events of the present and future.  Why would we now draw hope from these people who have clearly established their lack of economic credibility? 

It is far more encouraging that the stock market has risen.  This is a real event demonstrating investors’ willingness to risk their capital on the possibility of an improving economy.  Unfortunately, this event is one of several which have occurred in the persistent bear market which began in October 2007.  These rallies were obviously premature, proved to be optimistic and cost investors dearly.  There have been other, industry-specific rallies, reflecting more focused optimism.  To date, none of these events have proven to be persistent as they were more speculative than they were based on improving fundamentals.  

The Last Coordinated Recovery Prediction

The last time pervasive predictions regarding an economic recovery were advanced by a wide array of political and media sources was during November of 2008.  I wrote comments then that apply equally well today.

“The Stock Market

There is unlikely to be a persistent stock market recovery for the next 18 months.  The forces that have yet to significantly impact the economy are powerful and interrelated.  High leverage, contracting credit, falling money supply, increasing unemployment, declining consumer spending and asset deflation will damage the economy and inevitably impact the stock market.  

The Dow is present above 9,100.  Many professional sources are predicting that we have seen the bottom of the stock market slide.  The market may easily rise from its present level but there is no reason to believe that such a rally would be sustainable.  It is difficult to imagine that the stock market won’t set new lows for this bear market in 2009.” 

Despite the soothsayers’ optimism, the Dow declined from 9,100 to 6,626 on March 26th.  After falling 200 points this morning the Dow is presently at 7,920.  The correlation between economic reality and the stock market is not precise.  The Dow may easily rise from current levels.  But the reality is that six months from now the fundamentals of the economy will be material worse than that which exists today.  Unemployment and foreclosures will be higher.  Inventories of houses for sale will be above equilibrium levels and house prices will continue to fall. 

If the future health of the economy is less positive than the present, it stands to reason that the stock market is unlikely to appreciate on a sustainable basis from its current value and is likely to decline.  

Looking Forward

Twelve months from now, in April 2010, it is highly unlikely that the prerequisites for a sustained economic recovery will be present. 

Optimists will point to declining job losses, but net job losses will still continue.  The persistence of rising unemployment will be far more negative than the economic data actually suggests as the job market will increasingly be distorted by the Government’s unsustainable stimulus spending. 

The number of foreclosures will likely stabilize or begin to shrink.  But as long as foreclosures continue to occur in material numbers, they will invariably drive home prices lower.  Falling home prices will continue to detract from consumer spending, trigger more foreclosures, deteriorate the value of mortgage-backed securities, and tighten the availability of credit. 

Inventories of for-sale houses may begin to decline, but as long as they persist above equilibrium levels, the housing market will not stabilize.

The Pre-Cursors of Recovery

Housing prices must stabilize in real terms before a broad economic recovery is possible.  Housing prices will not stabilize, unless they fall to the equivalent value of shelter, while unemployment is rising and foreclosures are plentiful.

The Government continues to pursue policies which are likely to lengthen the time required for housing prices to reach an equilibrium.  Additionally, the current administration’s intended economic policies make it less likely that the job market will stabilize in the near term.  Given the structural impediments, and the Government’s counter-productive reaction to the crisis, the economy is unlikely to experience a meaningful and sustained recovery in 2010.

Hope may spring eternal but the free markets don’t care.