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Thursday, 14 May 2009

Three Keys to End the Recession

The "green shoots" theory was looking a little brown around the edges Wednesday as stocks fell sharply following weak April retail sales data and another spike in foreclosures.

Noted bear Gary Shilling, president of A. Gary Shilling & Co., says the recent improvement in economic activity was not a sign the worst has passed but a head fake that's typical in most recessions. There have been positive quarters of GDP growth in 8 of 11 recessions since WW2, and the stock market rallied in sync, Shilling notes.

As for the current cycle, he says three trends have to emerge before it'll be safe to declare the end of the downturn, despite the Fed's efforts to flood the system with money:

* Housing bottom: A reduction in the excess inventory of homes, which he estimates are approximately 2 million (down from 2.8 million a few months ago but still very high.)
* A real resolution of the financial crisis: Like John Hussman and others, Shilling isn't convinced the stress tests results proved anything, much less marked the end of the crisis. He's concerned about rising bad loans in sectors outside of residential mortgages, including commercial real estate, auto loans, student loans and credit cards.
* More stimulus: Shilling estimates Obama's $787 billion package only contained about $200 billion will actually stimulate the economy. With Americans in savings mode, including sitting on recent tax rebates, the government is going to need to do more to "break the cycle of a consumer who is cautious, which means less spending, less production more inventory problems, and more layoffs," he says.

If those three trends turn, then Shilling sees the recession ending in early 2010. That's the potential good news. The bad news is, just like Pimco's Mohamed El-Erian, he's forecasting a "slow recovery" and subpar growth after that for many years to come.

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