Better, but hardly great
The economy no longer is in a free fall. Everyone has heard that by now, whether or not they feel that it’s true in their own lives.
Wall Street believes it’s true enough: The winter plunge in stocks has given way to a two-month-old rebound that has pushed most major share indexes up 30% or more, and back into positive territory for the year.
The market’s job is to anticipate key inflection points in the economy. Sometimes, it even gets them right.
Yet there’s a specter over this market recovery that looms larger as stocks climb: The short-term outlook for the economy has improved significantly. But there is a glaring lack of faith in the longer term.
Many big investors fear that the huge structural problems facing the economy -- the ongoing need for consumers to shrink their debt loads, for example -- will make it very difficult to foster an expansion robust enough to justify a sustained climb in share prices.
The real challenge for Wall Street, then, isn’t staying optimistic this spring but figuring out how to be hopeful beyond the end of the year, even if the recession has ended.
That’s why faith in a bona fide new bull market is hard to locate among veteran investors. And the two alternatives -- another bear-market swoon, or a long period of share prices bouncing back and forth in a narrow range -- hardly inspire joy.
For the moment, however, the markets are reacting logically to more signs that the economy is bottoming.
After reaching the depths of despair early in March, investors have been cheered by the “green shoots” appearing in the financial system and economy, a term coined by Federal Reserve Chairman Ben S. Bernanke in March.
On Friday, the government reported that the economy lost a net 539,000 jobs in April. That should qualify as a disaster -- except in the context of far larger declines in the last few months, including net losses of 699,000 in March. Compared with the recent trend, April’s employment report looks like a green shoot.
Likewise, in its long-awaited report Thursday on the financial health of 19 major banks, the Fed said it would require 10 of them to bolster their balance sheets by a total of $75 billion to protect against potential loan losses.
After the meltdown of much of the financial system last fall, Wall Street figures that a capital shortfall of $75 billion is a cinch: Bank stocks rocketed Friday, leading another broad advance that pushed the Standard & Poor’s 500 index up 2.4%, bringing its gain since March 9 to 37%.
Skeptics say the Fed’s so-called stress test of the banks is a joke, and doesn’t come close to assessing the likely damage to the banks if commercial real estate loans, credit card loans and other debt follow the path of subprime mortgages.
But there have been enough other green shoots appearing, here and abroad, to push financial system fears off to the side for now.
Indeed, the rebound in U.S. stocks hasn’t happened in a vacuum. Markets have surged around the globe over the last two months. So have prices of many commodities -- another bet on a reviving economy.
Crude oil in New York jumped $1.92 to $58.63 a barrel Friday, the highest price since November, even though U.S. oil inventories are at 19-year highs.
Some investors who correctly called the turn in markets this spring are sticking with the idea that the global economy has seen the worst of the recession.
Veteran money manager Jeremy Grantham, chairman of Grantham, Mayo, Van Otterloo in Boston, urged investors early in March to start putting cash to work. Because he has long been well-known as a market bear, Grantham’s bullish turn got attention.
In a commentary to clients this week, Grantham said government spending aimed at ending the recession “is so extensive globally that surely it will kick up the economies of at least some of the larger countries, including the U.S. and China, by late this year or early next year.”
Yet Grantham sees very little hope of lasting gains for stock investors in coming years. Any steep rally this year, he says, “Will set us up for a long, drawn-out disappointment not only in the economy, but also in the stock markets of the developed world.”
Why? Look to the massive amount of wealth destroyed by the global stock crash and by the housing market’s collapse, Grantham says. In the U.S., the total market value of housing, commercial real estate and stocks plummeted from $50 trillion at the peak to below $30 trillion at the recent low, he says.
That plunge, he says, “is enough to deliver a life-changing shock for hundreds of millions of people.
“Collectively, we will save more, spend less and waste less. It may not even be a less pleasant world when we get used to it, but for several years it will cause a lot of readjustment problems,” Grantham says.
Notably, he warns, this New World Order will keep downward pressure on corporate profit margins. If earnings can’t accelerate meaningfully, stocks’ upside will be limited. And without a powerful earnings recovery, companies will have less incentive to expand and add jobs.
Joseph LaVorgna, chief U.S. economist for Deutsche Bank Securities in New York, says many investors may still be overestimating U.S. consumers’ ability to bounce back from the economic and financial debacles of the last two years.
The severity of job losses in this recession have blown a hole in the nation’s personal income statistics, LaVorgna notes. Add to that the burden of repaying the debt mountain built up over the last 25 years, the inability of many consumers to get new credit and the evaporation of home equity, and “we believe consumer spending will be extraordinarily weak for some time to come, even after the economy stabilizes and begins to improve sometime next year,” he says.
Grantham and LaVorgna are generalizing about the future as they see it, obviously. It’s a big planet with a lot of still-well-off consumers and enterprising companies. If the world isn’t ending, there will be opportunities to make money in stocks even in a slower-growing global economy.
But their central point is that investors overall won’t want to pay up aggressively for stocks if the economy is likely to face a slog, at best.
Of course, when recessions end there always are doubts about the economy’s growth prospects in a recovery, and about how high stocks can go.
The last time doubts were this pervasive was in the expansion and bull market that began in 1982. Many investors were sure that the wild inflation and record-high interest rates of the 1970s would persist, limiting the economy’s potential.
They were wrong. And as inflation and interest rates plunged, that underpinned the recovery and stocks’ gains. So did a renewed borrowing binge by consumers, companies and government in the 1980s.
This time around, key interest rates, such as on mortgages, already are near record lows. The Fed’s benchmark short-term interest rate is at zero. And given the credit catastrophe we’re still living through, we know the next consumer borrowing binge is a long, long way off.
So investors, LaVorgna says, will keep running into the same sobering question about the economy if stocks keep rising: “How good is it going to get, really?”
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