Photo: Bloomberg TV
Last week, Gary Shilling wrote a four-part series for Bloomberg View on why the U.S. economy is on the fast track to a brand new recession this year.(Read Part 1, Part 2, Part 3, Part 4, and a follow-up column on Bloomberg.)
While he pointed to various data points and recounted a number of anecdotes to prove his point, Shilling’s argument was simple: the consumer strength we saw earlier this year was fleeting and highly accommodative policy from the Federal Reserve and the possibility of more quantitative easing are the only things propping up markets right now.
In fact, the fundamentals of the economy lead him to believe “the U.S. economy is overdue for a recession.”
Most importantly, Shilling writes that “consumer spending is the only major source of strength in the U.S. economy this year,” but now all signs point to retrenchment:
- While consumers should be “reduc[ing] debt and rebuild[ing] net worth, they have been doing the opposite lately.”
- However, continuing sluggishness in hiring lead Shilling to believe that this trend is unsustainable. “The U.S. has a lot of job openings, but having endured huge layoffs in recent years, employers are being very picky in new hiring,” he writes.
- Further, the workforce isn’t properly trained to fill many of the jobs available.
- And the job market is sticky: “homeowners whose mortgages exceed the value of their houses can’t easily sell their property if they take jobs in distant locations.”
Despite a string of positive earnings reports this season and high corporate profit margins, Shilling argues that much of this is hot air. In fact, a closer look at industrial production and inventory paint a grim picture:
- Since the financial crisis, profits have been generated by cost-cutting measures and increasing labour productivity, meaning that corporate gains have been shallow.
- Shilling points out that increasing inventory means that companies are likely to cut back on production because demand is not keeping up with supply, and industrial production was already sliding to begin with.
- Inventory has also exaggerated GDP growth, particularly in the last quarter of 2011. During that period, “inventory growth accounted for 60 per cent of the increase in GDP.”
- He adds ominously, “The liquidation of excess inventories is responsible for a major share of the decline in economic activity in recessions.”
Last but not least, Shilling says the clamor for a new age of “Nifty 50” stocks demonstrates that investors are actually quite sceptical of the recovery, preferring instead to place safe bets on companies with such “wonderful long-term growth prospects that investors could simply buy them and never worry about selling.”
The zeal for Apple, whose share price is up more than 50 per cent this year alone and is almost double its year-ago level, reminds me of the early 1970s and the era of the Nifty 50 “one decision” stocks…I remember becoming concerned when the interest focused on only four companies — McDonald’s Corp. (MCD), Polaroid Corp. (PRDCQ), Walt Disney Co. (DIS) and Winnebago Industries Inc. (WGO)…If investors were avoiding just about everything else, they were implying that the economy was in trouble. This, along with a huge, but generally unrecognised, inventory buildup, led me to successfully forecast the 1973-1975 recession, until then the worst since the 1930s.
This sentiment is also reflected in the crush of investor enthusiasm at any whisper of a new round of quantitative easing from the Fed. “If Bernanke hints that the liquidity tap is closed for now, stocks tank, Shilling explains. “This narrow focus suggests that investors aren’t happy with the fundamental state of the economy.”
Not to mention that the possibility of renewed crisis in Europe and a hard landing in China—compounded by a decline in demand for Chinese products from Europe—continue to hang heavy on prospects for the global economy.
Thus, he concludes, a new recession is inevitable:
The U.S. economy is overdue for a recession. I believe that it entered the down phase of the long cycle in 2000, and the five to seven years that remain in the age of deleveraging are part of this period of weak economic growth and more frequent recessions. History reveals an average business cycle length of 3.7 years in the down phase. The economy peaked in the fourth quarter of 2007, meaning the present cycle is long in the tooth.
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