There is comfort in the realization that the economy is in recession. It helps us to orient the map to the ground: Market highs don't occur in recession; that's where market lows are found. We may not be able to ascertain our current location on the map with high precision, but just as we can tell which side of the equator we're on by the way water circles the drain, knowing we're in recession provides a gross sort of guidance to help find our way in the markets.
Any doubts about the downturn were blown up on Friday when the October employment report was released. It was unrelievedly bleak: 415,000 jobs lost, workweeks and overtime cut back, weekly earnings down, unemployment up to 5.4%. The service sector, formerly immune, caught the job-cutback infection that has plagued the goods-producing sector for the past year. Job losses in travel, retail and restaurant industries were directly the result of terror's impact on behavior.
The market has taken a drumbeat of bad economic news with a high degree of resilience. Many see this as complacency, an unwillingness to recognize just how grim are today's circumstances. The perspective I prefer is one that sees the market as getting grounded in this recession, recognizing it for what it is: a transitory state. Recessions don't last: never have before, not likely to do so this time.
Part of the reason that recessions run their course is inherent in the cyclical process. The negative progression from sales to production to employment to income and confidence and back to sales, etc., is self-limiting. Not everyone is in a cyclical occupation and many people have sources of income not related to current employment. There are "automatic stabilizers" in the progressive nature of the tax code and in such programs as unemployment compensation. Such features have meant that the U.S. economy is, structurally, not an explosive process.
Still, it would be a lot more volatile than we would like if it were not for discretionary monetary and fiscal policy acting to "lean against the wind." President Bush has demanded that Congress get a bill to his desk by the end of the month that will provide still more of a boost to private sector incomes and public sector spending.
The outlines now circulating on the Hill still must pass through the whirring blades of partisanship, but the scale of ideas for rebates, tax cuts, and emergency spending suggests that 2% of GDP is the ballpark they're playing in. You have to go back to the first Reagan budget to see something similar.
Reagan's stimulus was partially offset by the Volcker Fed's drive to kill inflationary expectations that had persisted from the 1970s. The Bush boost will be accommodated unstintingly by the Greenspan full-throttle
. Liquidity is sloshing around now, awaiting commitment: M2 money-supply growth has boomed to a double-digit pace. The fed funds rate target is nominally at 2.5% today and likely to go lower.
Everything from two years in on the Treasury yield curve is at or below the Fed funds target. With trailing 12-month CPI and PCE deflator inflation rates at 2.6% and 1.5%, respectively, the so-called "real" rate of short-term interest is zero, or nearly so.
Free money is effective, apparently, if the October Big Three auto sales are relevant. Zero percent financing resulted in cars being driven off the lot as quickly as if the keys had been left in them. Sure, these sales borrow from the future -- but that's at least part of the idea behind stimulus, to get people to act now when they might otherwise have waited.
Cheap and abundant credit is a money-burns-holes-in-pockets temptation that is likely to be resisted only temporarily -- and then watch out. The rolling boom in mortgage refinancing is part of this process, as the household sector does a bit of home improvement on its balance sheet by lowering, permanently, its monthly debt-service burden.
The household sector won't have to compete with the Treasury for 30-year money any longer. In retiring the long bond, Undersecretary Peter Fisher stated that it was no longer necessary as an element in the management of the public debt. Some see conspiracy here -- a desperate Fed prevailed upon Treasury to help it bring long rates down -- but I see no compelling argument for disbelieving the official version. It is unlikely that the public purse will return to the chronic deficits of decades past and the interest-rate sensitivity of the public debt can be adequately managed with issues having original maturities of 10 years or less.
Current market yields on Treasury notes and bonds have now fallen through the trough levels reached during the 1998 Russia/Long-Term Capital Management flight to quality. Those who argue that stocks are not cheap are overlooking an important factor if they don't take this into consideration. There is a gusher of liquidity sloshing around in money markets these days, earning roughly a zero real return. That is an unstable situation -- it won't last. That money is going to go somewhere.
It is unlikely soon to be committed to greenfield additions to new productive capacity. The broadband buildout from the backbone to the last mile is unlikely to accelerate anytime soon. New McMansions are not at the front of people's minds these days. That liquidity is likely to be committed to financial assets, stocks and bonds, before it goes anywhere else. And
are not cheap, Treasury bonds anyway.
"Safe" Treasury investments offering historically low yields have virtually no upside and the longer-duration instruments have more than a little downside. With equities, given that low-risk Treasury yields are where they are, you've got at least a shot at positive real returns.
Another part of the strategy for economic stimulus and recovery is to get people to move out of the risk spectrum, to drive them out, really. They're hunkered down now, averse to risk. They're paying a price for that safety in the form of a zero real yield on their money market investments. In the long run, that's not sensible stewardship. It's been an article of faith with me, in a long and only occasionally painful forecasting career, not to bet against sensibleness for very long. Once the post-Sept. 11 uncertainties are better understood, people will get it figured out -- as the market seems to be doing now.
Jim Griffin is the chief strategist at Hartford, Conn.-based Aeltus Investment Management, which manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. While Griffin cannot provide investment advice or recommendations, he invites you to send comments on his column to