Sunday 11 September 2011
US Economy Recession
The global economy is in a similar state. The fear of contagion is so immense that even a Greek default is a chilling prospect although history shows that it is a frequent occurrence for small countries to default on their debt, and often the best solution for a beleaguered economy. The apprehension is that any such event could lead to a global pandemic that takes down the eurozone, and subsequently the global economy.
Investors in this environment are consistently de-rating risk assets including stocks even though the sell-side keeps crying hoarse how 'cheap' such assets are compared to recent history. For instance, dividend yields on US stocks are above government bond yields - a rare occurrence in 50 years. Other valuation metrics for stocks too look discounted when viewed against the experience of the 1980s and 1990s, but none of this seems to matter for investors putting money to work.
This just shows that we are in the midst of a major regime shift where many of the rules that worked in recent times are breaking down. Just a few weeks ago, economists were confident that the US would not head back into recession anytime soon as none of the indicators that called a recession in the 1980s and 1990s was flashing red. The yield curve - or the gap between long- and short-term interest rates - was very steep whereas it was inverted before the 1990 and 2001 downturns.
Corporate America too appeared to be in great shape with profits rising strongly whereas they typically fall in any downturn. As recently as this May, the consensus was calling for a strong second-half performance for the US economy with supply disruptions from the Japanese earthquake set to wane and the manufacturing sector expected to grow again led by the auto sector.
Instead, the US economy is now stalling and the odds are that a recession will follow. When US economic growth has fallen below 2% on a year-on-year basis in a quarter, the economy has entered a recession in seven out of the previous 10 instances. The economy grew below that threshold level in the second quarter of this year. Similarly, a rise in the unemployment rate and a fall in domestic final sales are also sending out disturbing signals although they have not fully tipped over yet.
Investors in this environment are consistently de-rating risk assets including stocks even though the sell-side keeps crying hoarse how 'cheap' such assets are compared to recent history. For instance, dividend yields on US stocks are above government bond yields - a rare occurrence in 50 years. Other valuation metrics for stocks too look discounted when viewed against the experience of the 1980s and 1990s, but none of this seems to matter for investors putting money to work.
This just shows that we are in the midst of a major regime shift where many of the rules that worked in recent times are breaking down. Just a few weeks ago, economists were confident that the US would not head back into recession anytime soon as none of the indicators that called a recession in the 1980s and 1990s was flashing red. The yield curve - or the gap between long- and short-term interest rates - was very steep whereas it was inverted before the 1990 and 2001 downturns.
Corporate America too appeared to be in great shape with profits rising strongly whereas they typically fall in any downturn. As recently as this May, the consensus was calling for a strong second-half performance for the US economy with supply disruptions from the Japanese earthquake set to wane and the manufacturing sector expected to grow again led by the auto sector.
Instead, the US economy is now stalling and the odds are that a recession will follow. When US economic growth has fallen below 2% on a year-on-year basis in a quarter, the economy has entered a recession in seven out of the previous 10 instances. The economy grew below that threshold level in the second quarter of this year. Similarly, a rise in the unemployment rate and a fall in domestic final sales are also sending out disturbing signals although they have not fully tipped over yet.
