All Bets Off on U.S. Recovery If Equities Plunge

January 21, 2010

A very wide dispersion persists among U.S. growth projections.  Some analysts expect real GDP to expand more than 4.0% in the year between 3Q09 and 3Q10, and others have penciled in a return to recession.  The pessimists tend to stress the temporary nature of factors behind the impressive rebound of activity, namely a favorable turn in the inventory cycle and significant support from monetary policy, fiscal policy and measures directed specifically at the befuddled financial markets.  I submit that an even more powerful catalyst for the recession’s end, derived from the others, was the rapid and extensive revival of the stock market, which then fortified business and consumer confidence.

Stock market swings have coincided with changes in real economic activity.  Drops between August 28, 2008 and March 9, 2009 of 48.0% in the S&P, 47.4% in the Nasdaq, and 44.1% in the DJIA were associated with the virulent part of the Great Recession.  From the lows of last March 9 to closings this past Tuesday, the Nasdaq, S&P and DJIA shot up 82.8%, 69.9%, and 63.8%, and those improvements dovetailed with a faster recovery of the U.S. economy than pessimistic forecasters had assumed.  If stock markets instead had continued rebounded 10%, remained steady at their cyclical lows, or continued to fall, the U.S. recession would still not have ended.

The two-day 2.9% drop of the DJIA from the close on Tuesday to the quote today at 11:20 EST (16:20 GMT) was the greatest such loss since a 3.3% two-day slump in the middle of last June and the largest point decline since the end of last March.  Did somebody say, here we go again?

If stock prices now proceed on a new bear leg, dropping 20% or more, a return to recession will be difficult to avoid.  Japan’s experience does not bode well.  The Nikkei-225 did not decline 72.1% from 38,916 at end-1989 to its present level of 10,868 in a linear fashion.  This mother of all bear markets has been interrupted by several substantial rebounds.  Many were not only sharp but long-lived in duration, yet each failed to be sustained.  The initial drop of 48.0% to 20,222 on October 1, 1990 was followed, for example, by a 34.2% advance to 27,147 on March 18, 1992, only to see a subsequent slide to a new cyclical low of 14,309 over the ensuing five months.  Japanese real GDP increased just 1.2% per annum in the decade of the nineties and probably less than 0.7% per annum in the noughties.  In periods of chronic sub-trend growth, the weakness of equity prices and real GDP act as cause and effect to one another.

The beleaguered U.S. labor market is one of the economy’s Achilles’ heels.  New jobless insurance claims were their highest in the week of January 16 since the week of November 14 posted their biggest week-to-week deteriorations in eight months.  It’s going to be very difficult to absorb young workers entering the labor force and to retrain and reabsorb laid-off employees at the other end of the working age spectrum.  It may take a decade for the labor market to return to a previous notion of full employment.  So long as rapid growth in China and other emerging markets remains principally export-led, such will have a comparative muted influence on the U.S. and other advanced economies.  When yuan appreciation starts up again later this year, it most likely will proceed no more rapidly than the climb from July 2005 to July 2008, and that pace was not significant enough to be an engine of U.S. growth.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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