The Double Dip Threat
Without doubt the two biggest issues before the US economy are the threat of a double dip recession and what happens when the massive liquidity pump is i) stopped and ii) put in reverse. And of the key macro economic indicators, deflation is by far the biggest bogeyman (and wildcard). Even in the context of so-called better than expected economic data, i.e., the growth in GDP, a more exhaustive dig through the deflator for gross domestic purchases reveals that deflation has still firmly gripped the economy. Yet price perceptions, which have an impact on the consumer saving and spending rate, while critical are merely one of the numerous indicators that one has to keep an eye on. The group of the four horsemen portending the shift from a recession to a depression also includes overall systemic leverage, the availability of credit, and unemployment.
A useful chart to visualize these trends is presented below.
So while the administration has released unprecedented fiscal stimuli, which are already waning, with Obama's stimulus package expected to have no marked beneficial impact on GDP past the third quarter (and in fact to extract from growth in future periods), the question is how monetary intervention will be adjusted correspondingly to fit in with what the talking heads have already pronounced has been the end of the recession. In this vein, the overall market reaction provides a useful test of how the bulk of Obama's and the Fed's intervention has impacted the economy.
Yet the real challenge for investors is digging through all the data and determining what is one-time in nature (ISM spike) and thus subject to a prompt reversal once either fiscal or monetary mechanism exhaust their impact, and what has s long-term systemic benefit. If one listens to Bernanke (and Bill Gross), the economy could easily be overheating yet Fed Fund rates will likely hug the flatline well into 2011 (and certainly will not be increased before the current and any future quantitative easing episodes are used up). Will Bernanke's policies lead to a much worse credit bubble than Greenspan? The answer is probably yes, as even the Fed chairman has trouble discerning at this point the non-recurring versus the traditional economic trends, ergo the double dip threat. It is a virtual impossibility at this point that the same Federal Reserve that was blatantly ignorant of so many indications in the 2002-2007 period which were screaming for a rate hike, will have the foresight to know not only when to reverse the liquidity stream, but which key milestones to use as an indicator of frothy liquidity.
And with regards to equities, the conundrum that has speculators scratching their heads is whether the nearly inevitable double dip will in turn result in a hyperinflationary episode, which will likely push equities into the stratosphere for a brief parabolic flash before everything comes crashing, ala the Weimar Republic, or if the market will by then be rid of day-trading speculators who see beyond the hype and decide to be the first to get out of the game of Ponzi musical chairs.
One thing is certain - Chairman Ben's life over the next year, and for the duration of his second term, will be filled with numerous exciting (and by all counts, wrong) decisions. And as the market now is priced to perfection, one wrong choice and it will all come crashing down, compliments of the market now being a house of cards built upon complete economic disconnect. Alas, based on the Chairman's track record of being pathologically behind the curve, the future looks bleak indeed.
Charts from Morgan Stanley