- Who’s Hiring? We expect to see the US unemployment rate peak in 2010 at 11%. While seeing a peak will certainly be an encouraging sign, we don’t believe this will be followed by a rapid economic recovery creating the millions of jobs necessary to lower the unemployment rate down to pre-recession levels (5%).
- I’m fine with fixed returns: The credit crisis of ‘08-‘09 saw many individual and institutional investors badly burned by overexposure to riskier assets like stocks, commodities and real estate. While there has been a strong recovery in many risky assets over the past 10 months, we expect investors will continue to re-allocate towards less volatile investment classes, such as bonds, with a trend towards a classic 50% stock 50% bond allocation.
- Collecting from sovereigns: 2009 ended with warning signs emerging from Dubai and Greece that there is a potential for default or credit deterioration among sovereigns that have over-extended themselves. We expect to see a number of credit downgrades for developed nations as their persistent deficits, long-term pension/health-care liabilities and weak growth come into focus. 2010 may well see a sovereign nation default on foreign-currency debt obligations. We expect the US Dollar and US treasury credit to strengthen in any ensuing flight to safety.
- Reading tea leaves at the Fed: On December 16, 2008, in an effort to encourage banks to lend and provide liquidity for the financial markets, the Federal Reserve lowered interest rates to effectively 0%. This rate held throughout the entirety of 2009. We expect this run to end in 2010 with the Fed raising interest rates in 4th quarter of the year. We expect the Fed to tighten rates to the 1-2% range and then pause for a few quarters. This will likely result in the yield curve flattening since long term yields will not rise as quickly. Unlike many other market commentators, we do not expect high inflation despite large increases in measured money supply. A sharply lower velocity of money and reduced money-creation via private sector credit will dampen inflation.
- Pay me my money down: Continuing the trend from 2009, we believe paying down debt will remain the highest priority for US consumers as they attempt to get their financial houses in order. This will disrupt a strong recovery in corporate profits, particularly retailers (which rely on consumer spending to drive growth), as some businesses will misjudge the new environment. However, this is very good for the long term health of the US economy.
- A cold year for growth: We expect the US economy will see almost negligible growth in 2010. Margins will continue to contract for US businesses and profit growth will remain slim. The expiration of stimulus programs and slim prospects for their renewal in a mid-term election year will reduce aggregate demand. Cost cutting and efficiency measures will continue to be necessary to offset top-line deterioration.
- Arranged Marriages: With margins slimming, interest rates at historic lows, the unemployment rate in double digits and the US consumer cutting spending, we see corporations increasingly turning to mergers and acquisitions in order to grow market share, particularly in the cash rich tech and energy sectors.
- New kids on the block: Emerging markets proved to be more resilient to the global recession than developed economies. We expect growth in emerging markets will continue to out-pace growth in developed economies. But this growth will not be enough to offset the stagnation in developed economies or lead to a robust global recovery.
- Red alert: We believe there is continued risk for a massive correction in China. We remain skeptical of the veracity of the economic data released by the government and don’t see how the white-hot level of growth can be sustained when China’s main trading partners (namely the US, Europe, Japan) continue to suffer from the effects of the global credit crisis.
- Fool’s gold: We believe certain commodities are poised for a sharp sell-off over the next year. Highest on our list for a correction are gold (which only has value if others think it does) and oil (many Iraqi and South American fields coming online and low growth implies low energy use).
Though we remain optimistic about the prospects for US growth over the longer-term, and continue to believe in the diversity and resiliency of the US economy, it is difficult to see much optimism in the short to medium term. Over the past few weeks, we’ve been delving into unemployment statistics at the state and local level to get a better sense of how bad this recession has been for employment.
The national unemployment rate in June was 9.4%. With the exception of the recession of 1982-1983 (when it reached 10.8%), this is the worst unemployment rate in the post-second world war period. At a regional level, in nine states, the current unemployment rate is the highest since 1976 (the earliest year data is available at the BLS), and in another eight states (plus D.C.) it is within one percentage point of the record. Amongst those setting records, are two of the largest state economies CA and FL (also those worst affected by the real-estate boom, and a wide-swath of mid-atlantic states, MD, VA, GA, NC, SC. So in 18 of 50 states, joblessness is higher than most people have ever experienced. In absolute terms, more of the labor force is unemployed now (15.2 million) than at any time since 1948.
It is likely that unemployment will continue to rise until early 2010, and the unemployment rate could well exceed that of 1982-1983 and reach 11%. The primary reason for our pessimism about the speed and strength of a recovery is the shaky ground on which US households find themselves. Years of low and negative savings rates combined with falling asset prices have affected the biggest components of US household wealth, our homes and investments. The reverberations of this wealth effect will be felt for many quarters of US consumption and consumer confidence.
Unemployment affects consumer confidence in a way that GDP figures and corporate profits cannot. Continuing unemployment, seeing friends or neighbors out of work for months on end, makes consumers rethink every purchase.
Since we do not foresee a quick recovery in consumer demand, we believe a quick recovery in unemployment to the 5-6% level is unlikely. In prior recessions of similar severity, unemployment has not returned to the 6% range till 3-4 years have passed. This would suggest a return to full-employment in 2012 or 2013. It may take longer. We believe a structural adjustment is underway, with two sectors of the economy, construction and finance, shrinking to a semi-permanent lower level of activity. Former workers from these industries will need to retool themselves for work in other areas, or may need to relocate to another part of the country. This will take time.
The unwelcome triplet of rising unemployment, falling asset prices, and a financial crisis that has felled many firms that were household names will affect the American consumers’ view of thrift and spending for years to come. We believe the current recession’s affect on US consumer behavior will be long-lasting, as will the US investor’s new-found skepticism towards real-estate, debt and equities. This is similar to how a traumatic episode affects survivors. For an entire generation of Americans, this recession is their first encounter with generally difficult economic conditions and the realities of the business cycle. We believe there is a fundamental shift underway for a generation of Americans, away from a culture of high consumption, towards a new-found frugality.
The grasshoppers are chastened and the ants have been vindicated in particularly dramatic fashion.