What is important to remember is that a recession isn’t a statistical event but rather a cycle that occurs within the economy. However, this isn’t a normal business cycle recession but a balance sheet recession. Unfortunately for the Keynesian economists running our government they haven’t understood this fact. Recessions, furthermore, are not just about GDP. Recessions are about declines in industrial production, employment and real incomes.
In every normal business cycle recession these indicators have always achieved new highs before the next recession has occurred. As of this writing none of these have attained the highs of 2007.
The drop in real incomes has led to a drop in sales. This drop in sales has led to lower production needs which has resulted in declining employment and income, which in turn weakens sales further. This has spread from industry to industry which is what recessionary cycles are all about.
The problem with a recession occurring now is that it will magnify the problems that Washington is currently embattled with. Spending will increase, debt will rise and deficits will increase. Jobs will become even harder to find and the recession will feel more like a depression.
David Rosenberg summed this up extremely well last week: “Depressions often are marked by balance sheet compression and deleveraging: debt elimination, asset liquidation and rising savings rates. When the credit expansion reaches bubble proportions, the distance to the mean is longer and deeper.
Unfortunately, as the legendary Bob Farrell’s Rule #2 points out, excesses in one direction lead to excesses in the opposite direction.”
Clearly this is what we have seen over the last thirty years as personal savings have been drained and credit piled onto the balance sheet in order to support economic growth far in excess of its real capacity. Currently, the bond markets is far beyond pricing in a normal recession with rates on short maturity treasuries below 1% which was only seen during the last balance sheet recession, depression, in the 30’s. Without the benefit of the credit boom cycle behind it the economy has been unable to achieve anything close to an “escape velocity” which is why after more than two years the economic output gap is close to 7% – a feat not witnessed at any time since WWII.
David goes on to bring out an excellent point in this regard: “Even after nearly four years of unprecedented interest rate relief, multiple liquidity backstops, banking sector capital injections, loan modifications, massive tax relief, there is still no end in sight for the contraction in credit, bear market in financial stocks, softness in real economic activity, stagnant employment, or any signs of normalcy to the markets (the Dow has swung by triple digits, on an intra-day basis, nearly 70% of the time in September).
The most inclusive measure of joblessness suggests that the real unemployment rate has risen to over 16%, an unheard-of level at this stage of the cycle. Such massive excess capacity in the labor market is in turn reflected in an ever-lower share of companies signaling their intent to raise wages over the near and intermediate term.
Similarly, there is now 25% idle capacity in the manufacturing sector, something that is generally saved for recessions, not recoveries. We shudder at how far operating rates could fall in the next downturn. It promises to be a highly deflationary development.
It is against this massive level of unutilized resources in the industrial space that business intentions to raise prices have recently plunged. The return of inflation remains a consensus forecast, but certainly not a realistic prospect for coming months, quarters, or perhaps even years, as long as aggregate demand is playing catch-up to aggregate supply. The math is daunting but uncomplicated.
After all, to eliminate the output gap (the gap between where GDP actually is and where it would be if the economy was operating at full capacity) we would need to see real growth of 4% for each of the next six years or 5% over the next three years. We doubt even the most optimistic forecaster believes that demand conditions will be that robust, even after we come out the other side of this credit collapse.”
The point here is that it is highly likely that the next recession is already upon us. Therefore, the answer to the question is that the next “bear” market is likely just beginning rather than ending. The question now is just how much damage will likely be done.
A Repeat Of The Past
The only other time where we saw so many things in common with today was the recessionary periods in the 30’s as the economy struggled with debt deleveraging, low interest rates, government bailout programs and high unemployment.
Much like the last decade of the 21st century the economy has been plagued by rolling recessionary bouts. Very similar to what was witnessed during the “Great Depression”.
It is very important to note that the “Great Depression” was not just one LONG recession. It was a series of three recessions that continued to plague the economy along with high unemployment, a debt deleveraging cycles and lots of government intervention.
The markets were highly volatile then just as they are today. Therefore, to draw comparisons between these two periods it is likely that the recent decline of just a little more than 17% from peak to trough on a closing basis is going to spell the end of the current bear market decline. After the second recession ended in 1938, the market rallied to a lower high, before declining in ADVANCE of the recession that began in 1945. The markets fell more than 45% before a longer term bottom was found prior to the U.S. joining the war effort. This is the only time in history that a decline was complete BEFORE the recession took hold.
Without a war to boost additional government spending, spending cuts being put on the table, government hiring retracting, private employment stagnant or falling, real incomes declining, housing prices falling, so forth and so on, it is highly likely that the next decline will be to levels that are close to the lows of the last bear market, however, that is hardly the point.
What is important for you as an investor to understand that the recoveries needed post declines are FAR greater than the declines themselves. The most critical point to remember is that while you MAY make up lost principal after a severe market decline you can NEVER regain the time you have lost towards reaching your retirement goal. Time is the most precious commodity we have and chasing market returns, like a gambler in casino, can lead to irreparable damage to your financial health.