The Stumble Along Economy

by Hans Wagner, TradingOnlineMarkets.com | August 20, 2008

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As an investor who wants to beat the market, do you have a valid idea, which way the US economy will go? Investing in the stock market requires each of us to understand the impact of economics on the markets. I believe the US business cycle is at a critical tipping point the real question is which way it will go. Answering this question requires us to address two important questions: 1. Has the economy reached bottom and 2. Where are we headed in the latter half of 2008 and 2009?

There are several scenarios that investors might take to answer these questions. The first and one many consider most likely is the Stumble Along or the Long Slow Transition to a new economy. The other one is popular with some investors and it calls for the total melt down of much of the US economy. The final article will be one with a more positive focus on the economy. At the end I will ask you to vote on which one is more likely from your perspective. I will then tally the scores and let you know our collective thinking. For this article, let’s focus on Stumble Along scenario.

Hit Bottom

In the fourth quarter of 2008, the US economy begins to find a bottom as housing starts level off, loans losses decline and foreclosures plateau. The approximately $161 billion in stimulus checks have been spent, but retail spending is still in the doldrums even with the Christmas buying season upon us.

Energy prices have stabilized as demand has fallen in the US and slowed its torrential growth in much of the emerging economy. Make no mistake, demand for energy is still growing, but just at a slower pace. The price of oil has stabilized in the $100 to $120 range, but there is an underlying feeling that demand will pick up as the world’s economies return to growth mode at some time in the future (the next year or so). There will be upward pressure on the price of oil as demand outstrips supply.

Renewable energy is still the rage even as some point out there is still a need for other sources of energy to meet the world’s growing appetite for energy. For example, wind and solar cannot be depended upon to provide a consistent level of power, since the wind does not blow and the sun does not shine all the time.

Inflation stays stubbornly higher than many hoped causing the Federal Reserve to be stuck between keeping rates low to help stimulate the economy and higher rates to help control inflation. Finally, the Fed gives in and raises rates.

Unemployment has risen to above 6.0% as layoffs continue and consumer spending stays flat. Consumers remain worried about the future, especially their jobs, and their ability to pay bills.
The stock market rebounded briefly before falling further with the DJIA getting close to the 10,000 level. All the pundits and talking heads are calling for drastic action to shore up the economy.

The new administration faces an economy in the doldrums. Great hope is place don the economic policies of the government to help correct the economic difficulties. Primary on the list is a stimulus program to help rebuild the infrastructure of the US including bridges, roads, and mass transit. Numbers in the $100 billion to $200 billion are under consideration. This will cause the deficit to rise to the highest level ever, getting very close to the $1 trillion level.

Financial Liquidity Returns

As 2008 ends and with out a lot of notice, the financial sector begins to find its footing. Loan losses are leveling off and money for mortgages and business loans becomes more available. Credit becomes more available, especially for those with excellent financial history. Credit standards are higher and questionable borrowers find it almost impossible to borrow. Banks are able to take advantage of the positive yield curve generating good credit spreads.

Unfortunately, rates remain higher than expected as the government takes up more and more of the demand for money with its increased borrowing. The banks are only too happy that the rates stay up.

The Federal Reserve struggles with balancing the need to stimulate the economy, fighting inflation and helping to fund the growing government deficit.

Growth Returns Slowly

Pockets of the economy find they are able to grow, especially those providing services that help to reduce costs of operation, access to new sources of information as Web 2.0 (video, etc.) takes off, improve healthcare, ways to lower energy costs.

In some locals, home construction starts to pick up as inventories of unsold houses fall. This helps to encourage new construction. Builders are only building with firm orders, not wanting to hold inventory.

Unemployment remains high, though skilled workers find work; especially those with engineering, information technology, healthcare and sales experience are able to find work. New government programs to help retrain workers have little effect as the people out of work do not have the financial resources to support their families and go to school.

The promise of new government infrastructure stimulus generates growth for the engineering and construction industry, especially the larger firms, though there are some stipulations that small companies get some of the money.

The higher US debt pushes the US dollar down further, which causes the price of oil to rise. As a result, many companies are still facing higher costs for energy as they try to grow their businesses. Economic growth stumbles along slowly. The stock market recovers slightly from the lows reached at the end of 2008, but each move up is followed by another back down, as investors remain unsure of the strength of the economy.

Next week I will include another scenario, focusing on a melt down. The following week will be one with more promise. I then will ask you to let me know which you think is more likely. Once the votes are counted, I will let everyone know our joint view.

If you wish to read more on evaluating the economy, I suggest reading Economic Growth by David Weil. An easy to read book that presents the key factors to understand global economies. It is expensive and is used as a textbook for college students, but it is worth the money.

 

Copyright © 2008 Hans Wagner
Editorial Archive

If you wish to learn more on evaluating the market cycles, I suggest you read:

Ahead of the Curve: A Commonsense Guide to Forecasting Business and Market Cycles by Joe Ellis is an excellent book on how to predict macro moves of the market.

Unexpected Returns: Understanding Secular Stock Market Cycles by Ed Easterling.  One of the best, easy-to-read, study of stock market cycles of which I know.

The Disciplined Trader: Developing Winning Attitudes by Mark Douglas.  Controlling ones attitudes and emotions are crucial if you are to be a successful trader.

Bio As a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market. Feel free to visit the site at http://www.tradingonlinemarkets.com/ 

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Hans Wagner | Colorado, USA | Email | Website

The opinions of FSU contributors do not necessarily reflect those of Financial Sense.