Last week, Dr Shane Oliver, the AMP’s chief economist, went through all the reasons why the cyclical bull market in shares has further to run: the economic and profit recovery has further to go, inflation and interest rates remain low, and there is still plenty of cash sitting on the sidelines.
Of course the outlook is not without risk, so this week he looks at the risk of the much talked about “double dip” recession for the US next year.
The first thing to note is that talk of a double dip is common towards the end of most recessions.
For example, such talk arose after the early 1990s recession and was similarly rife in 2003 as the world emerged from the tech wreck.
Usually it doesn’t happen, but of course there are notable exceptions to this:
- The early 1980s traced out a W-shaped pattern in the US, with recession in 1980 followed by a brief recovery in 1981, only to return to recession into 1982;
- The 1990s saw back-to-back recessions in Japan; and the US went back into recession in the late 1930s after recovering from depression in 1934, 35 and 36.
All of these situations had one thing in common – premature tightening.
In 1981 the US Federal Reserve led by Paul Volker raised interest rates aggressively to squeeze out inflation.
In the 1990s Japan tightened fiscal and monetary policy before recovery became sustainable.
And in the mid 1930s US authorities moved to raise tax rates and tighten monetary policy (via tighter bank reserve requirements) before a sustainable recovery took hold.
But normally, fears of a double dip prove unfounded.
A range of factors are cited this time around as potential drivers of a double dip in the key US economy next year including: monetary and fiscal policy will be tightened too early; a US dollar crisis; rising unemployment will cut into consumer spending; the banking system is too weak to lend and will be hit by more shocks; households are too weak to borrow; there will be another oil price driven energy crisis; and we are seeing the “mother of all carry trades” that will soon come crashing down.
I will now address the main double dip drivers in turn.
“Monetary and fiscal policy will be tightened too early”
This one is easy. The IMF and key governments have been stressing the danger in premature tightening having studied the 1930s depression and Japan in the 1990s.
With underlying inflation continuing to fall and unemployment very high, there is neither the inclination nor necessity to embark on premature tightening.
This was most recently restated by the G20 Finance Ministers meeting where they “agreed to maintain support for the recovery until it is assured.”
So premature tightening seems unlikely.
There is no doubt there could be some gyrations in markets when the authorities do move to seriously unwind the extreme fiscal and monetary stimulus, but that could be several years away.
Similarly new bank capital requirements being agreed globally will amount to monetary tightening, but the G20 has only agreed to implement them by the end of 2012, i.e. 3 years away.
There is a related concern that the recovery is solely due to monetary and fiscal stimulus and it will quickly fade once stimulus is removed.
This concern arises in most recoveries, but it’s invariably the case that once stimulus has primed the pump, stronger confidence helps take over in making the recovery self sustaining.
A turn in the inventory cycle is also playing a role in driving this recovery, which can also help fuel better confidence.
“A $US crisis will force premature Fed tightening”
Talk of a US dollar crisis is common, but it’s hard to see a collapse.
The two most traded alternatives (the Yen and Euro) are no more attractive than the US dollar.
Both have similar or worse public debt problems and arguably worse economic prospects.
And the Chinese won’t allow a sharp rise in the Renminbi.
In any case, it’s doubtful that the Fed is overly concerned about a weak US dollar given the absence of inflation in the US. (While some fret about the Fed “printing money” the reality is that until banks start lending more and economic activity and capacity utilisation returns to more normal levels, inflation will remain a nonissue.)
“Unemployment will drag the US back into recession”
Unemployment is undoubtedly a serious problem in the US and Europe.
But it’s worth noting that unemployment invariably lags the economic cycle.
In the US the unemployment rate peaked two months after the ending of the 1982 recession, 15 months after the 1990-91 recession ended and 21 months after the 2001 recession ended.
The reason it lags is that just as companies are slow to fire into downturns they are slow to hire in upturns as it takes a while for them to regain their confidence.
The key point is that rising unemployment doesn’t keep economies mired in recession or trigger double dips – it is just normally one of the last indicators to turn.
Moreover a range of indicators suggest that the US labour market may be on the mend.
Leading labour market indicators such as falling unemployment claims, falling announced layoffs, rising temporary employment and rising employment intentions in business surveys, suggest that US employment will be growing again early next year.
This in turn suggests we may be close to the peak in unemployment (albeit it could still go a bit higher).
It’s also notable that US companies may have overreacted in laying off worke
