The Great Global Recession: Instability and Uncertainty Among Worldwide Economies
With the current economic downturn now extending beyond domestic shores, how much worse and for how much longer will we experience the Great Recession? Find out what you can expect during this risky and vulnerable period.
December 18, 2008
Sponsored by Rochdale Investment Management
by Garrett R. D'Alessandro, CFA, AIF®, Chief Executive Officer & President, Rochdale Investment Management
Today, we find ourselves in the midst of the worst economic decline in the post-war period. The deterioration in economic activity that occurred this past October and November has rarely been experienced in U.S. economic history and the next three quarters, at least, look to be just as negative. In fact, news flow in the coming months will likely be jarring to the senses. Combining the financial-system stresses, housing-value declines, rising delinquencies, consumer deleveraging and job losses with worldwide recessionary trends will make this the Great Global Recession.
The question then is how much worse and for how much longer, will we experience the Great Recession? Unfortunately, with every aspect of the U.S. economy including the services, manufacturing, construction and exports sectors all headed lower, it seems very likely that there will not be any real recovery until the later part of 2009, at the earliest. Of course, much will be determined by how and when expected monetary and fiscal policies are implemented. Likewise, much depends on whether and when the plans implemented by the government to stop foreclosures and stabilize house values will have a great effect. For now though, too much uncertainty exists as the negative trends underway are not so easily corrected given their simultaneity.
Presently, while this is still a significant recession, there are many reasons not to place a high probability on this leading to a depression or period of deflation. Authorities today have a clear understanding of the monetary and fiscal policy prescriptions that led to the Great Depression and Japan's "Lost Decade," and the belief that the Fed, the Treasury and the Obama administration will work relentlessly to avert those mistakes. In addition, the current economy is supported by a series of automatic stabilizers such as deposit insurance, Social Security, unemployment benefits and other government aid that helps to soften the blow of economic downturns. These social assistance structures did not exist in the 1930's and it was the severity of the Depression that highlighted the need for such programs.
One of the more important determinates of where this Great Recession will lead in the months ahead depends on U.S. fiscal policy, monetary policy and other interventions in the housing and credit markets. Without debating the ideology of the U.S. government making investments in companies to prevent them from failing, the essential point is the timing of the investments and it is of the utmost importance. If the fiscal and monetary actions are to have the intended effect of reducing the length and depth of the Great Recession, then empirical evidence shows they need to be targeted, timely and sufficient.
The core problem in this crisis remains the recession in housing and the inability of millions of homeowners to pay their inflated mortgage obligations. In turn, this has triggered a reverberation of illiquidity and insolvency throughout the banking system. We are of the view that there can be no stability in the economy unless you have stabilized the banking industry and there can be no stability in the banking industry until you achieve stability in housing prices. Unfortunately, there remains a huge inventory overhang, at nearly double the normal level, from speculative overbuilding that we must work our way through. In addition, housing prices will become ever more challenged as job losses mount, delinquencies rise and foreclosures increase. To address this, the government will need to develop a comprehensive plan to rescue financially distressed homeowners.
The feedback process of our economy is now in full recession mode. When the process begins, it requires a force to stop what is in motion. Presently, we see nothing that will stop the force of economic downturn. What is particularly troubling is the state of the labor market and unemployment. Consumers are losing their sources of income and currently have no sources of credit to fall back on. There is a straightforward economic linkage: fewer jobs cause less spending. When combined with declining home and stock values, it is easy to see why consumer spending in the third quarter suffered the first quarterly drop (-3.1%) in over 17 years. Further declines are expected in the fourth quarter and even in the first quarter of 2009. At 71% of GDP, consumer spending has long been a driver of growth but the credit crunch and deteriorating labor markets have taken a major toll.
The combination of lower income growth, decreasing job security, declining net worth and high borrowing costs is creating a deleveraging cycle in the consumer sector which has no comparison in the last 40 years. Household balance sheets are in their worst condition since the early 1980's. The debt-to-asset ratio for the U.S. household sector has surged over the past decade due to aggressive credit "re-flation" and the boom in real estate values. That said, it is not difficult to see that with falling real estate and stock prices, the debt burden for the household sector is climbing quickly. What is worse is that as the job market is weakening significantly and unemployment is rising, the chaos in the financial system has hiked up borrowing costs for the consumer sector, making the debt more difficult to service. In other words, credit availability is drying up. After a decade-long increase in our household debt levels, the consumer is being forced into a painful period of deleveraging that is likely to remain in trend through next year and beyond.
We are now facing the worst global recession in a generation. The additional negative feedback to our domestic economy from a synchronized trade-induced global slowdown represents a high concern. For some time, the received wisdom was that while the U.S. would go into a recession, the rest of the world would de-couple and remain relatively unscathed. While we have noted there was some truth to this notion of de-coupling, it was clear to us that, ultimately, the global economy could not completely escape the repercussions from an economic slowdown in the U.S. The material risk is that an increased negative global feedback loop is likely to develop, leading to further declines in U.S. retail sales as well as business demand for imports. If falling U.S. demand for imported goods and services further weakens foreign economies (as we saw in the 2001 recession), this negative feedback loop is likely to reverberate to the vital U.S. export growth segment. This is going to be one of the worst U.S. and Global recessions in our lifetime. The end of the recession is not yet in sight and we remain in a risky and vulnerable period. Nevertheless, even our current fear is finite and will burn itself out at some point. All bears ebb and flow and this one will be no exception.
Garrett R. D'Alessandro, CFA, AIF®, is Chief Executive Officer & President of Rochdale Investment Management, a private client money manager specializing in personalized portfolio management for high net worth individuals and families. For more information or for a confidential tax impact analysis of a client’s portfolio, please call Patrick J. Vignone, CPA, at 800-245-9888 or email firstname.lastname@example.org.
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