Debt Crisis 2011
As I write to you today, August 3, 2011, I am one of millions of people trying to digest the aftermath of the debt ceiling vote and understand what is happening to the economy and why equity markets throughout the world have corrected so quickly over the past week.
In order to help provide insight, I decided to go back to the last period following a recession, October 2002 through February 2005. I chose that period because that 29 month period was equal to the time that has passed since our markets bottomed in March 2009. What I found was an interesting similarity.
October 2002 - February 1 2005 Dow Jones Industrial Average -Source BigCharts.com
March 2009-August 3, 2011 Dow Jones Industrial Average-Source Bigcharts.com
Now that I established that the two recoveries were similar from a market standpoint,
I then looked at how the Dow Jones performed after 2005 and the economic circumstances that we were experiencing at the time.
Here’s what I figured out:
Both post recession periods show a fast recovery in equity prices in the 18 months following the bottom, but after February 2005 there was another 18 month period where stocks traded sideways before a resumption of the rally that ended with the sub-prime crisis in late 2007.
The economy in February 2005 was stronger than today as the Fed was actually raising interest rates in order to slow down a housing bubble that was in full ready to pop mode. In 2005, consumer confidence was higher as was the trajectory of government spending and private sector technology and equipment spending. More importantly, the financial sector was much larger and more willing to lend during the time prior to the collapse of Lehman Brothers and the government reforms created after the financial crisis in 2008.
Today the economy vacillates between slow and getting better and one mistake from another recession. The recent GDP, employment and manufacturing data have confirmed this reality. This information added to the confusion and lack of leadership coming out of Washington leads to lower corporate and consumer confidence which accounts for nearly 80% of overall economic activity in the US.
I will not bore you to the point where you believe I can predict the future of the world’s economy with any accuracy. Instead, I will state what I feel are the important conclusions that I can draw from the past few days.
The equity markets are correcting because data was released that indicates that the economy may be slowing to the point that often leads to recessions. The data caught most people by surprise, especially those who were fixated on the debt ceiling deal. Whether recession actually occurs, we will not know that until it’s over, but investors hate uncertainty. Bad news can be measured, a fog of political and financial uncertainty can not be measured. Some investors feel the best way to handle uncertainty is to sell. Investors need clarity. That clarity will happen as the details of what the government will cut become public, and then think tanks will begin to crunch the effects of these cuts on individual issues and whether the cuts will be detrimental or beneficial to our fragile economy.
Let’s look at the bright side; both parties ate crow but got a budget deal done that addresses the issue of reducing debt over the next ten years. That’s the first step. US corporations who are financially strong, are waiting for clarity as well. Clarity on healthcare and regulation will allow them to employ cash reserves to hire more employees necessary to capture additional sales currently coming form overseas. More sales should lead to higher profits and higher stock prices. More employees and additional sales will lead to a stronger economy. The average American needs leadership, leadership that leads to job creation and small business lending. More jobs means more income, more confidence, more spending on housing that leads to more construction that leads to more economic growth that leads to more taxes being paid. At that point, stock prices will have already risen along with consumer confidence and the argument will begin as to when the next recession will start. That’s how it should work.
Lastly, let’s not forget it’s August. The good news is that it’s not uncommon for stock prices to drop this time of year. So don’t be surprised. The bad news is that according to data from the past 100 years, August is one the three worst investing months of the calendar year. The other two are September and October. Let’s pray for snow!