This commentary is a guest contribution from Byron Wien, Vice-chairman, Blackstone Group.
Blackstone is pleased to offer the following Market Commentary by Byron Wien which shares his thinking on global economic developments, market insights and other factors that may influence investment opportunities and strategies. Learn more about Byron.
Denying the Double-Dip
August 2010
The poor performance of the stock market since April has convinced many that the economy is going to slide back into recession. Some argue that over the years we have learned that the market often sees trouble coming before the weak data appears. While market valuations seem reasonable based on projected earnings, a resumption of the downturn would throw earnings estimates into question. Aside from the normal economic indicators, there is concern that health care costs will be increasing under new legislation, financial service regulation will be severe, taxes will be raised and the current administration in Washington is anti-business. The handling of the British Petroleum oil spill, the firing of General Stanley McChrystal and the uncertain progress in Afghanistan and Iraq have eroded confidence in the administration, and this has shown up in the decline in the President’s approval ratings.
The hostility and partisanship on the part of both Republicans and Democrats and the preoccupation with the outcome of the November elections rather than what seems to be in the best interest of the American people makes many feel that our government is dysfunctional. As for business itself, the oil spill in the Gulf raised the issue of whether companies care more about profits and executive bonuses than their employees and the community. Goldman Sachs, arguably the leading investment banking firm, agreed to pay the largest Securities and Exchange Commission settlement ever, $550 million, to put fraud charges behind it. Finally the “Flash crash” in May and high-frequency trading have made investors think that technology has gone too far and long-term fundamental portfolio managers don’t have a chance against quantitatively based strategies with a short-term horizon.
Against this background it is a wonder that the stock market ever has an up day. While there is some basis for all of these concerns, I believe that our democratic system is sound, business and financial firms are trying to do the right thing, the economy will grow at around 3% in 2010 and long-term investors can still make money in equities. The double-dip view is based on the present condition of several factors: inventories, housing and employment. There was enormous inventory liquidation in 2008–09 as a result of the recession and the recovery that began in the spring of last year was fueled largely by bringing inventories back to normal. That largely accounts for the 5% rate of real growth in the fourth quarter of 2009. By the middle of this year inventories had been rebuilt, no longer providing a boost to the economy.
The second problem is housing. Starts are running at a record low level of 500,000 units monthly with residential vacancies at 2.6 million, again a record. Who would want to build a house with so many empty homes out there? During the housing boom many construction workers found it easy to find work, but now these people are unemployed and their prospects for finding a job are slim. House prices have stabilized in spite of the overhang, but if they head down again, there will be a further negative impact on consumer spending.
Ordinarily in a recession unemployment increases about two percentage points, but when the recession is accompanied by a financial crisis as is the case with this one, the unemployment rate can increase more than three points. Moreover, a financial crisis makes employers reluctant to rehire and it can take years for the unemployment rate to drop to its pre-recession levels. Washington is focusing hard on this problem because they know it is imperative to bring the jobless rate down below nine percent before the November election or the Democrats will be in danger of losing control of the House of Representatives. But it is difficult to do much about the problem without heavy government expenditures, and it will be hard to get these passed in the present political environment.
With all the uncertainties in the outlook, corporations are reluctant to start major capital spending programs. With operating rates running at 73% they don’t need to do more than replace obsolete or worn out equipment. In fact, with low inflation and low utilization rates in both the manufacturing and service sectors, there is a risk of deflation. Perhaps the bond market is right in pricing the 10-year Treasury below a 3% yield.
My view is that the economy is going through a temporary lull and business conditions will improve later this year and in 2011. Europe may be an example. When the financial crisis hit and the markets were worried that “contagion” from a possible Greek default would not only put Europe into recession, but spread to other parts of the world, austerity programs were announced by many countries and they were expected to reduce demand seriously. Now the European recovery seems to be continuing, exports are strong and the surprises are occurring on the favorable side. The Bank of England monetary policy committee recently warned that economic conditions “deteriorated a little,” but Britain impressed economists there with a 4.5% increase in second quarter gross domestic product. Business confidence in Germany rose to the highest level since reunification. Both services and manufacturing were up in Britain. Exports led the way in Germany. While there is some criticism of the stringency of the methodology, the fact that most banks in Europe came through their “stress tests” well has bolstered confidence on the continent. Could that happen in the United States as well? Or is it only a temporary favorable phase in Europe?
