It Really is Different this Time . . .

Monday, July 14, 2003 | 12:07 PM

Whenever this phrase is used to describe stocks, it signals that something bad is about to occur. We use the slogan instead to describe this very unusual macro-economic environment. Specifically, the shallow recession, and even shallower economic recovery, is unique in the post-war era.

What makes this cycle so exceptional? This is the first recession and recovery to be characterized by high productivity, continued job loss, and unchanged (read high) consumer spending. There simply are no parallels to this kind of environment since WWII. Every prior cycle since 1940 was during a period of low worker Productivity, with (mostly) decreased spending. Recoveries occur when hiring and spending increase. This is significant for the economy, the markets, and possibly the 2004 Presidential Elections.

The post-bubble, jobless recovery was caused by vast capital over-investment, creating excess capacity for businesses. Simultaneously, it put the tools of increased productivity into the hands of workers. The cure for this overcapacity is simply time: It takes years to grow into, and fully utilize all that excess capacity. What one hopes for from the government is that they simply don't muck things up too much with ill-advised interventions as we wait for normal levels of demand to return.

Contrary to this dour macro-economic news is the massive monetary and fiscal stimulus from the White House and the Fed. For the first time (in my memory at least), these new government policies are specifically targeting the equity markets as opposed to the broader economy.

Consider this: Dividend tax cuts have raised the value of stocks with yield; Capital gains tax cuts encourage greater speculation; Income tax cuts targeted to the highest income brackets encourages investment, rather than spending; The Federal Reserve rate cuts have made “cash trash,” forcing Money to flee Fixed Income Instruments and Money Market Accounts. It has rushed into equity markets simply because it has nowhere else to go.

Government’s expectations are that increased stock prices will raise consumer confidence and low rates generate yet another round of mortgage refis, putting cash into the hands of consumer, leading to additional spending. If spending picks up enough, Business IT and capital spending will also rise. Eventually, businesses start hiring again.

The experiment progresses: Fund managers dance to the music, pouring money into equities in order to stay competitive with their benchmarks. What remains to be seen is who will have a seat when the music finally stops.

Chart of the Week
“Policy has never been more stimulative in the U.S.,” notes The Bank Credit Analyst. “Massive monetary and fiscal ease, together with a lower dollar, should be successful in boosting growth and averting deflation.” The danger is that policymakers are “creating even bigger problems down the road in terms of increased leverage, greater financial excesses and a larger current account deficit,” observes BCA.

Household and Corporate Debt as a % of GDP

Household Debt.gif
Chart Courtesy of BCA Research

“Moreover, policymakers may have limited ammunition to deal with the next economic downturn” BCA notes. The “supercycle of rising debt and illiquidity” can only be avoided through increased inflation, a process that will not be a painless for the markets.

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Quote of the day: "An expert is a man who has made all the mistakes which can be made, in a very narrow field." -Niels Bohr

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