If we were to modernize the myth of Sisyphus, we might give him the task of forecasting what lies ahead for investors, considering the uncertain state of the U.S. economy.
Since Sept. 11, economists have been busy revising their outlooks for U.S. and global growth, and each revision is rich in caveats. So many of the data points forecasters examine to gauge where the economy is headed -- from financial institutions' willingness to take on risk to consumer sentiment to the price of oil -- are in flux.
Yet economists have begun to form a sort of broad-brush consensus on where we are now, and where we are headed. Arguments about whether a recession is imminent have fallen by the wayside; everybody agrees that the decade-plus expansion has come to a close. Most economists also agree that the economy will probably begin to grow again by the middle of next year. Once investors feel confident in the prospect of recovery and the subsequent return of profits growth, they should feel comfortable adding stocks to their portfolios again.
But how soon people start liking stocks again will depend a lot on what shape the economic recovery takes. And here, economists begin to disagree.
V for Victory
The predominant view is that once the economy finds its nadir, it will bounce back strongly. The recession will make U.S. companies leaner. Both businesses and consumers will curtail spending, creating a mass of pent-up demand. Meanwhile, deteriorating global demand for core commodities will put a lid on inflation. That sets the stage for a powerful move once the forces of monetary and fiscal stimulus come into effect.
"Policymakers are aggressively pushing a strong bounceback," says Banc of America Securities chief economist Mickey Levy. "You're going to get that V-shaped recovery."
At 3%, the fed funds target rate is already as low as it's been in more than eight years. Levy believes it could fall as low as 2.25%, which would put it in territory not seen since the 1960s. Meanwhile, Congress is almost certain to pass another fiscal stimulus package, along with footing some of the rebuilding costs and upping defense spending. All will give a big liquidity boost to the economy.
GDP Growth in the Quarter Following Recession
Source: Commerce Department
Moreover, most recessions end with a powerful jump in growth. In the last half-century, gross domestic product has grown at an annualized 7.1%, on average, in the quarter following a slump. Anything like that, and stocks -- particularly those of companies whose earnings are closely tied to economic growth, like retailers and capital equipment makers -- could be much higher a year from now.
A Cell Is L
Yet some economists believe that even though the downturn will be deeper and longer now, recovery when it comes will be halting. "We don't think the lift is going to be as powerful as people expect," says Goldman Sachs director of U.S. economic research Bill Dudley. "You'll probably see a stronger recovery than before, but I'm not sure it's going to be all that marvelous."
For Dudley, hangover effects from the long boom seem too significant to make for a strong bounceback. With increasing confidence that the economy would continue to prosper, the household savings rate fell to 1% in 2000. Despite the slowing economy, that number has hovered in that area for much of this year. The world is a scarier place nowadays, which is reason enough for Americans to sock away more of their hard-earned cash. Compounding fears for the future, stock investments have fallen hard (again), casting many people's retirement plans in doubt and, it is likely, compelling them to save more. Rather than feeding the economy, much of the stimulus that Congress eventually crafts could end up feeding people's piggy banks.
Similarly, the business world may put a higher premium on safety than on growth, and as a result remain less disposed to taking investment risks. Even as recovery takes hold, banks could resist extending credit to fledgling businesses; companies could continue to put off breaking ground for new plants and investing in new technologies.
But perhaps the biggest worry is not so much what the economy will do for the next year or so, but what it will look like after recovery. The so-called peace dividend that came from the end of the Cold War has had a very real effect on the U.S. Morgan Stanley chief U.S. economist Richard Berner notes that over the past 15 years, defense spending went from more than 7% to less than 4% of GDP, helping end the era of budget deficits.
A Wall Falls and Productivity Gains
Source: Bureau of Labor Statistics
That prompted the government to scale back debt issuance, which in turn brought Treasury yields down. Corporate bond yields fell as well, allowing companies to more easily raise money for new plants and equipment. The resulting boost in productivity meant that the economy could grow at a faster pace, and could employ more people, without courting inflation. The result was a virtuous cycle and an era of unprecedented prosperity.
Now, says Berner, we may be in for an extended period of "less investing, less capital deepening and less productivity growth." The threat is that when things get back to normal, normal turns out to be an economy that grows at a slower rate and a country less prosperous than it once was. And that stocks turn out not to be very good investments for a long time.