Expectations are critical, and if most people expect little from the economy, they may well get what they ask for.
The next recession may be years away or right around the corner. But global growth remains anemic and fragile. At the same time, uncertainty, ranging from a potential Brexit or European banking crisis to the U.S. election, is undermining business confidence, sparking renewed concerns that one unexpected event could cause a new downturn.
The probability of enough soft economies in both developed and emerging markets collectively turning negative still appears unlikely, but many key economic indicators, including U.S. employment statistics in April and May, are raising real questions about the next recession. “Everything looks like it sucks because it does,” said Geopolitical Futures’ George Friedman in late May at John Mauldin’s Strategic Investment Conference.
Such melancholy sentiments are pervasive seven years into the weakest recovery and least-loved bull market in modern memory. Yet at Mauldin’s conference, a group of leading economists—including Gary Shilling, Lacy Hunt, David Rosenberg and David Zervos—discussed the slow-growth predicament and none were predicting an outright recession on the horizon anytime soon.
Rosenberg, contacted after May’s miserable unemployment report, maintained that a U.S. recession was probably years away. “You don’t get recessions until the output gap is eliminated and we move to an excess demand environment that triggers a monetary shock,” the chief market strategist of Gluskin Sheff in Toronto contends. “History says it will take five or six years for this condition to surface.”
Calling Rosenberg an optimist, as some at Mauldin’s conference did, borders on the preposterous. “Nothing is more pathetic than that the stock market still looks to Janet Yellen to ride to the rescue,” he told attendees.
In America, capacity utilization stands at 75% and the Fed has never raised interest rates when it stood below 78%. If a recession remains far away, Rosenberg considers the bull market in equities over and mired in some sort of purgatory, where it could continue to drift sideways like it has for almost two years.
In a world where safe yields are scarce, dividends should keep a floor under equity prices. It’s a sign of the “topsy-turvy” times that people are buying stocks for income and bonds for capital gains, he noted.
Gary Shilling, like Rosenberg a former Merrill Lynch chief economist, and a man who can boast that he may be the only person fired twice by former Merrill CEO and Treasury Secretary Donald Regan, described his outlook as equally subdued. “It’s realistic, not bearish,” he said.
Shilling, who has run his own eponymous economics consulting firm for decades and predicted the housing crash, said that for the economy to snap back and return to rapid growth it will require some kind of spark driven by new technologies. That’s unlikely to happen until deleveraging advances.
On this front, Shilling actually offered a positive note. Household debt today stands at 105% of GDP, above its norm of 65% but significantly below its 2007 high of 130%.
Shilling and Rosenberg both pinpointed weak income growth as the chief culprit causing our current malaise. “Slower economic growth is affecting incomes, as has cost-cutting, and there is little unit growth or pricing power [for businesses],” he explained. That is now showing up in declining profit margins.
Throw in the demographic problem of baby boomers being forced to save with negligible income increases and it’s obvious to see why growth remains so slow. The labor force participation rate declined from 66.4% in January 2007 to 62.6% last month. Shilling attributed 60% of that decline to aging boomers retiring; the other 40%, he said, were discouraged workers throwing in the towel.
But Shilling is no orthodox Malthusian gloom and doomer. He urged advisors to short commodities and oil and buy long-term Treasurys and the U.S. dollar. “Commodities are not a long-term investment,” he said. “Human ingenuity beats shortages any day.”
Another advocate of long-term Treasurys was Lacy Hunt, executive vice president at Hoisington Investment Management Company and a former top economist at the Dallas Fed. At the start of this century, Hunt argued the U.S. faced several problems. Chief among them were too much of the wrong kind of debt and too little economic activity to sustain our standard of living.
“Now we have another problem; the rest of the world has too much debt and the quality of debt is deteriorating,” Hunt said. “Debt can provide transitory gains,” but that is all in his view.