Fear, Uncertainty and Doubt Cloud the Economic Picture

Fri, Aug 20, 2010 - 8:37am

Growth and investment thrives when executives have confidence in the future, when prospects for growth are based on expected outcomes. When fear, uncertainty and doubt dominate, companies tighten their purse strings and hold off on any new hiring and investment. The FUD factor (fear, uncertainty and doubt) leads to a weaker economy.

Fear of an Economic Slowdown

Fear that the economic recovery has lost its momentum after companies rebuilt inventories, boosting initial demand. Growing inventories adds to GDP. The consumer remains concern about the future and they are not spending enough to consume the bloated inventories. As a result, companies are cutting back on their stockpiles, reducing their capital spending, limiting hiring and building up their cash as they prepare for the worse.

The widening trade gap indicates the GDP in the third quarter will be lower. Some argue that the government’s stimulus is encouraging consumers to buy low cost goods produced overseas, as they remain worried about the future. While exports are growing, they just are not growing as fast as imports, thus the trade gap widens. Imports act as a drag on the economy, while exports add to GDP. The growing trade gap lowers GDP. Look for a revised GDP to be lower by up to a 0.5%.

The second quarter’s 2.4% GDP rate, down substantially from the first quarter, points to a downtrend for the economy. In July, the economy created 71,000 new jobs. The economy needs to grow at 3% per year to provide jobs for all the new people entering the work force. This still leaves the more than 8 million unemployed and 17 million underemployed competing for jobs with the new entrants. As a result, the employment problem will continue until the economy grows at a much higher rate.

When you consider all the other headwinds the economy is encountering, you see why many people are afraid the United States economy might experience a double dip recession.

Uncertain about the Future

Uncertainty comes in many forms. The new rules from the recently passed healthcare bill will drive up costs for everyone. The prospect that healthcare costs will be higher discourages managers from hiring new people. When you cannot predict how much your costs will be, it is difficult to justify hiring another person.

The large and growing fiscal deficit of the United States adds more uncertainty for companies. As economists and politicians debate the affect of the growing debt, companies become less sure of the future. This uncertainty persuades executives to select more conservative business strategies, investing less as they try to get by with what they already have in place.

Many consumers and business are reluctant to borrow more as they are trying to reduce their debt. They have learned their lesson, as they want to reduce increase their savings and be ready incase the economy slows further.

Those individuals and firms that are seeking credit, find it more difficult to get as banks are returning to more strict lending standards. This is a good move on their part as loans were way too easy to get in years past.

Psychologically, people and managers need to be more certain about the future if they are to make new investments.

Doubt the Government can Turn Things Around

Many executives and consumers believe the government will be unable to find a way to encourage economic growth. The affect of the $800 billion stimulus program is slowing and it has had minimal affect on long-term economic growth. The stimulus has provided some jobs, as well as money for states and local governments to keep teachers, police and firefighters on the payroll. Yet this money is not driving an economic expansion. Faced with the prospect of higher taxes on the wealthy, many small business owners are delaying any new investment and hiring until the future becomes clearer.

The Federal Reserve at their Open Market Committee meeting on August 10 said they would reinvest the proceeds from maturing mortgage securities to buy longer-term government Treasuries. Purchasing Treasuries pushes down interest rates. In this case, longer-term rates fell with the 10-year rate plunging to 2.67% driving up the value of bonds. In April 2010, the 10-year Treasury rate was hovering near 4.00%.

The fact the Federal Reserve is stepping in to drive longer-term rates down indicates they believe the economic recovery is vulnerable and the slow pace of growth will last longer than many believe. While lower interest rates shrink the cost of capital, companies will not borrow if they perceive the future remains clouded. This shift in policy is smaller than some economist want, especially those that worry about deflation. However, a go slow approach gives the Fed additional ammunition to try more aggressive moves if it deems necessary.

The problem is doubt about the current policies remains.

The Bottom Line

Fear, uncertainty and doubt will remain as long as consumers and executives lack confidence in the economic outlook of the United States. The psychological affect of the FUD factor remains a major hurdle to overcome. So far, everyone fears the worst, is uncertain about the future and doubts much can be done to make the situation better. We are in for a slow growth economy for some time. As investors we need to adjust our sails to deal with these difficult conditions.

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hans [dot] wagner [at] tradingonlinemarkets [dot] com ()