Why It's Not a "V"

12/10/2009 9:40 am EST

Focus: MARKETS

Gary Shilling

Columnist, Forbes

Gary Shilling, editor of INSIGHT, says optimists who look for a “V”-shaped recovery are betting that US consumers will return to their free-spending ways.

Most economic forecasters and investors think, or at least hope, that the Great Recession is over. They point to initial claims for unemployment insurance, which often bottom with the economy. Payroll employment is still falling, but at a lessening rate.

Existing home sales have risen in recent months, as they usually do before the end of recessions. Industrial production, a coincident indicator, has risen recently. Also, real personal consumption expenditures rose in the third quarter. The Institute for Supply Management’s manufacturing index is above the 50 mark that separates expansion from contraction.

Most of all, the optimists pin their beliefs on the robust stock recovery since March and note the usual lead of equities over the economy. And they point to the global nature of recovery with many, but not all, countries enjoying economic growth in the third quarter.

We find this an excellent example of a reality we’ve long observed—theory follows fact. In this case, the fact is the rapid rise in stock prices. That absolutely demands an ironclad theory that will produce the rapid corporate earnings growth in 2010 needed to justify current and even higher stock prices. Hence, the “V” recovery forecast.

But it’s unlikely that those factors that pushed third-quarter growth to a 2.8% real annual GDP advance will persist. And housing, capital spending, and net exports are unlikely to provide much stimulus in future quarters and years.

So, implicitly or explicitly, the optimists assume consumers will return to their profligate ways of earlier years—that the retail buyers’ strike that drove the recession in past quarters was just a bad dream from which the country has awoken.

So far, that return to the free-spending salad days hasn’t occurred despite massive government stimulus. Real personal income has collapsed under the weight of the worst recession since the 1930s.

We believe the US consumer has crossed a watershed and is replacing the quarter-century spending binge that drove the household saving rate from 12% to 1% with a saving spree that will push it back into double digits over the next decade.

All that earlier borrowing expansion and saving reduction financed the leap in consumer spending from 62% of GDP to 70%, but we expect it to return to 62% in the next decade.

The key difference between the consensus and our economic outlook is simply this: The vast majority sees no lasting change in US consumer saving, borrowing, and spending habits. We, however, believe the patterns of the last quarter-century have been chronically reversed.

We foresee a self-reinforcing cycle of depressed consumer spending, production, and purchasing power. The recession will finally end [in mid-2010] when additional fiscal stimulus breaks the self-feeding cycle of consumer retrenchment and business cost-cutting.

The recovery we see commencing in late 2010 will probably be so tepid it may be far from clear that the recession is over. It could resemble the slow-growth, jobless recoveries that followed the 1990-1991 and 2001 recessions—only even more subdued.

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