Comstock Partners, Inc.February 18, 2010
Economic Momentum May Have Already Peaked
Don't look now, but economic momentum, as sluggish as it was, may have already peaked. Fiscal support for the economy may be more of a restraint as the year goes by, and any attempt at additional stimulus will face major headwinds as public sentiment against further deficit increases is accelerating. The diminution of inventory reductions probably reached a maximum in the fourth quarter when it accounted for nearly two-thirds of the rise in GDP. The accelerated depreciation tax benefit that helped push capital expenditures foreword expired at year-end. Hiring has not picked up while wages remain stagnant and consumers are deleveraging debt.
In addition the Fed is ending its purchases of MBS at the end of March and major increases in home foreclosures are on the horizon. Credit remains tight as consumer credit continues to decline and commercial and industrial loans are also dropping. With both housing and consumer spending not in a position to perform their typical role of sparking an economic revival, there is no major driver for sustaining the economy once the contributions from inventories and fiscal policy wind down.
Adding to the malaise is the unusual weakness of small business in the current cycle, a phenomenon that has not gone unnoticed by the politicians or media. This is particularly important since small business is said to have accounted for at least 50% of all employment growth in the nation over the last few decades. While the latest National Federation of Independent Businesses (NFIB) Index has risen eight points off the bottom to 89, this is still the lowest reading in at least 24 years with the exception of some lower monthly data points in the current cycle. Even after bouncing, the latest index number of 89 is still below the lows reached in the 1990 and 2000-2002 recessions.
Small businesses by and large are still planning to liquidate inventories and reduce employment. For the most part they are not planning to expand. The NFIB stated that "Too many new houses were built, too many strip malls were opened, too many restaurants started, too many new retail outlets were launched in the 2003-2007 period and all those cannot be supported by a consumer that now chooses to save." In addition small businesses are finding it hard to get loans as the community banks that serve them are constrained by the necessity to boost their capital and by regulators urging them to strengthen their balance sheets. That's not to say that small businesses are breaking down doors trying to get loans. When asked about their number one problem, more mentioned a lack of sales than any other factor. For too many, there is just no reason to ask for a loan.
In sum, we believe that economic momentum, such as it was, has already peaked and that a V-shaped recovery is highly unlikely. Adding to the problem is the likelihood of further sovereign debt distress and the strong probability that China will be sharply reducing its commodity purchases. The strong market rally since the March low has discounted a lot more than the world's economies are capable of delivering, and equity prices are facing the prospect of readjusting to reality.