No one question haunts investors, economists and policy makers more than the five words above. It’s easy to see why: if the economy trails off in the second half of 2010, the stock market will surely head south since it is not now pricing in such a dark scenario. Indeed, Tuesday’s strong rally got the cnbc anchors announcing that the correction was officially over. Good news for investors, provided there is sufficient economic momentum to deliver on investors’ rising hopes (that is, news better than Wednesday’s report of a 10% drop in Housing Starts in May.)
For economists, it is a gut wrenching time where they must consider the crazy and conflicting stats from an economy on steroids, a world unwinding from debt-driven excesses and wild moves in the currency markets. One can only presume that at some point they hold their finger to the breeze to come up with a big call on the months ahead. In the end it comes down to those who believe—and those who don’t. And both sides makes a good case…
Those from the No-Double-Dip camp (NDD) are taking heart in Europe’s surprisingly good industrial production number for April, super low interest rates here and abroad, a slowly improving labor market in the U.S., as well as anecdotal stuff like more customers at the local eaterie. Here’s a succint account of the ‘plus’ column from Morgan Stanley’s chief U.S. economist, Richard Berner:
First, we think that monetary policy remains ultra-accommodative, and central banks are eager to immunize economic growth from contagion by delaying or tempering their exit strategies. Second, aggressive fiscal tightening is not on the agenda for most large economies, and in those nations where officials are implementing public austerity, it may even ‘crowd in’ private spending. Third, lower energy quotes and lower mortgage rates that have resulted from double-dip fears will give consumers an extra boost. Finally, we think that those daunting secular headwinds are more likely to depress the future trend rate of growth rather than to abort the cyclical expansion.
That all makes sense but it does not quiet the other camp, the Double Dippers (DD), who see much of today’s positive news as artificial (thanks to the stimulus) and thus short lived. Gluskin Scheff’s economist, David Rosenberg, one of my favorite economists on the dark side, has a knack for spotting the soft underbelly of bullish statistics. He is even unimpressed with the low interest rates prevailing today, seeing it not as fuel for growth but rather as an eerie reminder that there’s something unreal about our progress since the recession lows.
Anyone with a pro-cyclical bent has to answer for why it is that the yield at mid-point on the coupon curve is barely above 2%, a year after a whippy rally in equities and commodities and what appeared to be a sizeable policy-induced GDP jump off the bottom. The answer is that the U.S. economy is susceptible to a growth relapse, with all deference to the various purchasing managers’ reports, which for portfolio managers, should be treated as coincident indicators (equities historically have done far better the year after ISM comes off the 30 level than the years after the 60 milestone is reached, just as an example). A variety of recent consumer-related reports, including the May employment and retail sales releases, have been sub-par and are posing appropriate questions as to whether the recovery will be V-shaped. That mortgage applications for new home purchases have plunged 40% in the past five weeks to a 13-year low despite a 25bps decline in mortgage rates is, to be polite, disconcerting.
Needless to say, Federal Reserve officials are not above the fray. As the Wall Street Journal reported on Tuesday, there is an active debate among the nation’s top bankers over whether this economy can travel under its own steam or not. For me, the NDDs vs. the DDs is the nerd equivalent to the Lakers and Celtics (without the jerseys, the beer and the good cheer) and this series is far from over.