3-01-2010

There Will Be Not Be a Double Dip

Two and one half years ago, most economic pundits thought that housing would be a drag on the economy. They searched for positive reasons why we would only have a slow-down that would lead us to a soft landing, in which we would all be protected. We weren’t. 

One year ago, the vast majority of market watchers thought that the economy would continue to spiral down and that the stock market would continue to fall. It didn’t. 

Today, the same vast majority of observers are worried about a double dip in the economy. They point to many weaknesses in the current economic recovery and conclude that the nascent recovery will abruptly stop and we will again be headed down. We won’t. 

There are few things that are as sturdy to hang your hat on in the wardrobe of forecasters as the contrarian notion that the vast majority is often wrong. 

It’s not because the vast majority of forecasters are stupid. They are actually almost all smart. It’s not because they have a desire to be wrong; we all know they want to be right. The problem is that they anchor on recent data points and extrapolate them forward. This prevents them from calling turning points, and when a trend starts with  bumps in the road, the bumpy data points throw them right off the road!

Most observers who get things right more than they get things wrong usually subscribe to the supertanker metaphor for economic cycles. It’s hard to get the ship turned, and it happens slowly, but once it’s turned and headed in a direction it stays that course.

The world economy went into recession. The world economy came out of recession and has started to recover. It’s exceedingly likely this recovery will continue. What recent data points are taking the majority off of the road to a successful forecast?

Recent jobs numbers have been weaker than expected. This is really funny. A few months ago, the vast majority expected jobs to turn positive near the end of 2010 or at the start of 2011. November and December came in better than expected and suddenly the vast majority expected jobs to turn positive in February. Bad weather has had a significant negative effect on January and February job numbers. However, the consensus is locked on recent data points as reason to worry about a double dip.

Housing has not come back quickly. It probably won’t for a number of years. On the other hand, house prices have stopped going down. The states with the biggest housing problems- namely Nevada, Arizona, Michigan, Florida and California- will probably have housing acting as drag on their economies for quite some time. Texas suffered after oil prices collapsed in the 1980’s. They eventually worked through the problems and so will these states. The housing part of the economy will not lead the economic recovery. It was the leading edge of the last business cycle expansion.  Many people believe this is a reason for a double dip. It doesn’t have to lead,   it just needs to stop being a drag on psychology and spending. That is starting to happen now, and will happen more as the year goes on. If the government, working with the banks, actually figured out how to take an honest and purposeful approach to resetting individual’s mortgage terms it would happen faster. 

Tax increases are likely to be extreme. Federal spending is leading to uncontrolled budget deficits. Many believe this will necessitate outsized increases in taxes by the current administration and states and local governments.  They believe that adding bigger taxes to a slow recovery will cause a double dip. Our take on this, which we have voiced before, is that representative democracies move slowly but surely. The population is massively moving toward wanting smaller government spending, not bigger taxes.  Every part of the U.S. economy has been re-engineered and cost cut except for the public sector. People are genuinely sick and tired of hearing about multiple pensions, bigger government solutions, and entitlement sprawl. The current administration can propose expansions of government that would require more government revenue from taxes. However, it will be difficult- if not impossible- to get them through a Congress that is starting to get a clear recurring message from the public.

China is beginning to slow its growth. Many observers believe China is a bubble. They believe that when the bubble pops we will have a double dip here. They believe that China’s recent moves to slow down expansion of credit prove their point. We believe China is midstream in its amazing expansion. They avoided the devastation of the global recession by expanding bank credit year over year by over 30%. Do you think it may be prudent to slow down this rate of credit expansion? If they didn’t act to slow down their growth rate, observers would have said that they are on a scary inflationary expansion path. It is probable that they will have to increase the value of their currency voluntarily this year to contain inflation pressures. This would also be a positive. 

In a world dealing with terrorism and Muslim extremism, there certainly are scenarios filled with externalities that could cause a double dip. These are neither forecast-able nor are they anything we would prognosticate.    

We continue to observe that bull markets climb a wall of worry. The double dip crowd has certainly punctuated this market correction with their worries. We will soon be on the other side of this correction. The U.S economy supertanker is turning, slowly, toward a move visible expansion with job creation and all.  

Fred S. Fraenkel
Vice Chairman and
Chairman of Investment Policy
Beacon Trust Company

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