Only months ago you would have (and probably did) called them crazy, but as economic releases continue to beat consensus, Bear Stearns’ version of the V-shaped recovery thesis is looking a little less absurd. In a report released yesterday titled “Consumer Resilience and Credit Market Improvement Support Recovery Outlook,” Bear fleshes out their argument for a rapid and sustained recovery:
We think the economy is beginning to recover after a sharp two-quarter slowdown. We still don’t expect a recession. We think consumer resilience, as shown in April’s non-auto consumption and sales data, is likely, not the deeper slump assumed in recession forecasts. Economic growth and credit markets should continue to benefit from negative real interest rates and the new Fed liquidity facilities after hitting a deep pothole in the August credit market collapse.
Bear’s argument hinges on two key points. The first is that credit markets are resilient and recovering due to agressive fed intervention and the nature of the losses, which were mostly non-cash and cushioned by big gains during the profits bonanza in the runup to the crisis:
Financial market indicators have also improved markedly. High-yield and high-grade bond yields
have fallen in recent weeks, and narrowed their spreads to Treasury bonds. Signaling stimulus, the
yield curve has steepened to a point reached after the 1990-91 recession and at the end of the 2001
recession. The TED spread, measuring the risk differential between interbank euro-dollar loans and
Treasury bills, has narrowed sharply since April 24… We disagree with the predictions of a long, deep recession from a credit crunch and balance sheet losses at financial institutions – the 1990 credit crunch coincided with an 8% Fed funds rate (today’s rate is 2%) and the balance sheet losses have generally been non-cash, can be replenished by new equity offerings, and are largely being borne by the same large balance sheets which had reaped the gains in recent years.
Bear’s second argument is that consumers are far more resilient than most economists imagine. Furthermore, the perceived weakness is predicated on the misapprehension that home equity plays a large role in consumption. Not so says bear, since consumer spending habits are shaped instead by a long-term perception of earning power. Jobs, not houses, says Bear, are the chief source of perceived wealth for the US consumer. As rebate checks arrive and labour markets remain resilient, the predicted consumption slowdown will never materialise to the degree that the doom-sayers think it will:
In general, consumers spend at a relatively steady pace based on their lifetime earnings expectations, smoothing shortfalls in income with credit and savings as in 2002. Likely auto incentives and the government rebate checks will help… The economic literature shows a relatively low impact on consumption by wealth effects, especially unrealized gains and losses in wealth, but a strong impact from the labour environment… Even if there were a wealth effect on consumption, the biggest asset for most working age Americans is their job, not their house. We think lifetime earnings expectations won’t fall too much from here, allowing consumption growth to recover some in coming months.
Maybe so, but if consumption patterns and housing prices aren’t linked, then why is consumer confidence tanking just as the housing market collapses? Only last month a Reuters/University of Michigan survey showed that consumer confidence has fallen to a 26-year low. This seems like too deep a downturn to be explained by a weak labour market alone. Until Bear (or someone) explains this anamoly, we’ll remain sceptical.