Productivity Growth vs. Demand Growth
After a tremendous rally from lows hit in March, stock investors want to know if the rally will continue into 2010. Leading economic indicators produced by the private firm, Economic Cycle Research Institute (ECRI), suggest the economic expansion that started in the 2nd quarter of 2009 will continue well into 2010. Their most recent comments suggest an improved job market may only be a few months away. We won't have to wait long for clues, several employment reports will be released in the first full week of January.
An improved job market could be a near-term catalyst to help stocks move to higher ground. But don't expect unemployment back in the 5-7% range anytime soon. If economic growth brings unemployment down by half a percentage point per year, a figure used by Lakshman Achuthan of ECRI as historically relevant going back many decades, strong employment numbers will not be reached until 2020. With the U.S. economy growing more slowly in recent decades, a lower unemployment number may be elusive for an even longer period of time.
Structural changes in the job market have seen some manufacturing jobs permanently eliminated, jobs that will not come back in a recovery, largely due to productivity increases. If productivity growth is higher than demand growth, the imbalance results in job losses unless structural changes are made to the employment market. Ironically, all the political talk about health care cost being too much of our GDP is exactly wrong under this scenario. Yes, we want our health care dollars to go as far as possible but for long-term replacement of manufacturing jobs industries like healthcare, education, and finance are logical areas for private market job expansion.
Lakshman expects more frequent recessions in the coming decade than we saw in the last two or three. Part of the reason has to do with the difficulty in smoothly withdrawing stimulus funds. If they are pulled back to quickly we could fall into another recession; to slowly and surging inflation may develop.
The business cycle expansion that started in Q2 2009 appears firmly rooted to carry us into at least the first half of 2010. This should bode well for stocks, but after an amazing run from 2009 lows it is difficult to gage how much more upside they may produce. Most of the rally took place before October. From March 9th through September 30th the S&P 500 gained 56%. From September 30th through December 21st it has gained only 5.4%. It looks like the S&P 500 will be up around 25% for 2009. The market consolidation over the last few months may ultimately turn out to be just what the market needs before moving higher in 2010.
As we close out 2009 another shift appears underway. After declining most of the year the U.S. dollar staged a sharp rally in December, up over 4%. Surprisingly the S&P 500 delivered gains (they have been inversely correlation since March) for the month but international stocks struggled. Both developed country and emerging market stocks show small declines. A strong dollar is often bearish for U.S. stocks. There are many inputs at work in the markets and as Wilbur Ross said recently on CNBC, "Now that the value of information has gotten to be about zero, there's an overload, and I think what's gonna be the end result is the value of expertise is gonna go to infinity. Because it is harder and harder for people to digest all these inputs, let alone make sense out of them, let alone translate them into investment decisions."
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I remain cautiously optimistic about stock returns in the first half of 2010. The action of leading stocks has improved somewhat in December which improves the likelihood stocks will break out of the current trading range. I believe deflation has moved off the table for the time being and inflation is generally contained. At present stock investors appear willing to discount ongoing credit market issues and place more emphasis on somewhat improved economic measurements.
All of this is subject to change depending on fiscal and monetary policy action, not to mention potential credit market surprises. For now we can be grateful for the gains the market presented us with in 2009; Dightman Capital in on track to produce a very strong year for all three of our growth strategies.
Have a Wonderful New Year!