Double Dip Potential Increases |

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Thomas J. Feeney's Measure of Value offers periodic commentary on leading financial issues of the day. Additionally, we present occasional articles explaining the philosophical underpinnings of the investment approach that our firms have employed successfully since 1986. Our thinking frequently differs from the common wisdom of the investment industry. The investment approaches we employ always recognize this as a probability business, not a certainty business. In evaluating any investment action, we always weigh the potential damage should the market prove us wrong.

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Double Dip Potential Increases

June 18, 2010

Economists and investment strategists have been nearly unanimous in their belief that the current economic recovery is fated to last at least several more quarters. It is accepted wisdom that economic expansions last longer than the immediately preceding contractions. Double dips, or one recession quickly following another, are extremely rare. While that may yet be the prevailing outcome in the current instance, there is an increasingly amount of data calling the continuation of the recovery into question.

In “The Short View” in today’s Financial Times, James Mackintosh raised the red flag regarding a possible double dip recession. He pointed out that the Economic Cycle Research Institute’s (ECRI) weekly indicator, designed to forecast economic growth, has been plunging since the beginning of May. Last week’s level of minus 3.5% has successfully forecast a recession seven of the ten times it has occurred over the past 42 years. One of the three misses, in 2002, was followed by zero growth, but not a technical recession.

A few hours ago ECRI announced that its reading for the week of June 11 declined again to minus 5.7%. While the index is clearly headed in a negative direction, ECRI Managing Director Lakshman Achuthan indicated that: “…its downturn has not been sustained enough to signal an imminent recession.”

Despite still strong corporate earnings growth, a number of very significant areas of our economy are demonstrating persistent weakness. Housing and unemployment woes are longstanding and barely improving. We have warned about excessive debt levels for both consumers and governments for more than a decade. Those excesses continue to grow. Adding to fears of sovereign defaults in parts of the world is the well-publicized potential inability of many of our 50 states to balance their budgets, even with the inflow of huge amounts of federal stimulus money. Such stimulus will be politically much more difficult to find in the months ahead. Financial problems of our states and other municipalities are likely to become a major story over the next year.

Over the past two months consumers have retreated from their free-spending ways. Banks are continuing their restrictive lending standards, and bank credit statistics are extremely weak. As layoff numbers remain high, it is logical that consumers will retrench and rebuild their personal balance sheets. That paradox of thrift may be wise for the consumer, but could prove destructive for the broader economy. Compounding that deleveraging tendency with a contraction of money supply in many parts of the world increases the potential for a double dip.

Despite a $1 trillion rescue pledge for weak Southern European nations, great fears remain that some of the suspect governments will still default on their debts. Banks around the world hold that debt in their portfolios. Fear of such default is making European banks suspicious of lending to one another.

Hope abounds that China and other emerging nations will stay robust and become the engines that continue to fuel the world recovery. The fact that emerging nations have never before been able to carry that responsibility when first world economies have been weak should make us at least skeptical of their leadership potential. Add to that the recent cautionary comments by Chinese regulators about the growing risks from that country’s credit excesses and the skepticism intensifies.

There is no perfect correlation between economic growth and stock market performance. Current expectations, however, are very high that the economy will remain strong and lead to enduring growth in corporate earnings. Any disappointment in those expectations would likely lead to a significant retreat in stock prices.

Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.