Why The V-Shaped Recovery Thesis Is Wrong

empty pockets

Given the trajectory of the stock-market recovery and the likelihood that stocks are already about 20% overvalued, it seems safe to assume that the market is (nearly) discounting a V-shaped recovery.

If we don’t get a V-shaped recovery, therefore, the market is likely to be disappointed.

In a recent presentation, Northern Trust economist Paul Kasriel made a persuasive case as to why the economy will continue to struggle for a while.

Here are Paul’s key points:

  • Consumer spending will not recover strongly because consumers are struggling to rebuild their own wealth
  • The financial system is still not lending aggressively and won’t until it repairs its own balance sheets
  • The unemployment rate will keep rising until the middle of next year, peaking at 10.5%
  • The Fed’s “money printing” is not CURRENTLY inflationary, but it has the potential to be if the Fed doesn’t handle the recovery right

Here are the key slides >

First, the backdrop: We still have debt coming out of our ears

Total debt recently hit 375% of GDP, an all time record.

Some analysts, like Ken Fisher, think the debt-to-GDP ratio can keep right on climbing. Most analysts don't. Most analysts think consumers will continue to cut back their borrowing. This will keep a lid on their spending.

Source: Ned Davis Research

As a result, consumers are borrowing less

Unemployment is still 10%

It's just hard to go hog-wild shopping when you don't have a job.

And 10% of the country is still unemployed.

Source: The Business Insider

And consumers are also a lot less rich than they used to be

Remember the 'wealth effect'? (Consumers spend more when they feel richer.) It's real.

Source: Paul Kasriel, Northern Trust

So consumers are spending less

Instead, consumers are saving

As Paul Kasriel puts it:

'Households are likely to rebuild their wealth through the purchases of stocks and bonds rather than the purchases of McMansions, SUVs, and Plasma TVs'

Source: Paul Kasriel, Northern Trust

Meanwhile, banks are still struggling

Loan delinquencies are soaring.

Hard to get really aggressive about making new loans until you've stopped the bleeding from the last round.

Source: Paul Kasriel, Northern Trust

As a result, private-market lending has plunged

(Yes, the government is mostly making up for it. For now.)

Source: Paul Kasriel, Northern Trust

On a positive note: Double-dip unlikely

Paul Kasriel observes that, in the past 50 years, the Fed has usually 'pushed the economy into recession' by jacking up rates.

Kasriel thinks it is unlikely that Ben Bernanke will suddenly get aggressive about doing this.

(Others think Kasriel is missing the fact that 'this time it's different'--namely, that this is a deleveraging problem and that the economy will go into recession again with no help from the Fed. Time will tell...)

Source: Paul Kasriel, Northern Trust

Another positive: Inflation is likely a ways away

The Fed is pumping vast amounts of reserves into the banking system, but the banks aren't lending them out.

Source: Paul Kasriel, Northern Trust

The money is sitting in 'excess reserves' or currency (a small percentage of the total).

So it hasn't yet found its way into the economy.

Source: Paul Kasriel, Northern Trust

Bottom line: The potential for hyper-inflation has been pumped into the system, but it has not yet become part of the money suppy.

If the Fed pulls back on reserves as the economy recovers, the inflation risk will be reduced. Of course, that's a big 'if.'

Source: Paul Kasriel, Northern Trust

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