A Historically Weak Economic Recovery

| July 30, 2011

The Bureau of Economic Analysis (BEA) released its advanced estimate of second quarter growth, forecasting a real annualized growth rate of 1.3%, well below consensus expectations for growth of 1.9%. More significantly, major downside revisions to data for the past few years indicate that the last recession was much worse than originally reported. The following graph from Shadow Government Statistics displays real GDP data for the past five years.

The three data sets represent the 2009, 2010 and 2011 benchmarks. As expected, the earlier data were much more optimistic than the latest figures. The 2009 trough was more than 2% lower than originally forecast and a rebound that was predicted to have moved up to new highs has yet to return to pre-recession levels. In terms of growth rates, the recent high of 3.5% in the third quarter of 2010 was the lowest peak recorded since the Great Depression as shown on the following graph from John Mauldin’s latest weekly commentary.

Additionally, a decline of year-over-year (YOY) GDP growth below the 2.0% level has been followed by a recession every time during the last 60 years. The YOY growth rate now stands at 1.6%, indicating that a return to outright economic contraction during the next two quarters has become more likely.

Since the economic rebound began in early 2009, our analysis has suggested that the cyclical recovery would be weak by historical standards and the GDP data are trending exactly as anticipated. As we have noted many times during the past several years, the primary reason for the tepid recovery is excessive debt. The following graph displays total US debt as a percentage of GDP.

The surge in debt that occurred from 1980 until 2010 was a prototypical unsustainable trend and we have now entered the necessary, albeit painful, deleveraging phase. The last time a comparable unsustainable advance developed, a sharp decline followed, engendering two decades of subpar economic growth and an accompanying secular bear market in stocks that lasted from 1929 until 1949. It is no coincidence that the stock market has been mired in a secular bear market of similar character for the past 11 years.

Research has clearly demonstrated that an excessive debt problem cannot be solved with more debt. Once a structural deleveraging process of this magnitude begins, it must proceed to completion before the foundation for the next structural growth cycle can be formed. Given the early stage of the current deleveraging cycle, it will likely not complete before the second half of this decade. Until then, the economy will continue to struggle and the secular bear market in stocks will continue to limit the long-term investment potential of equities.

With respect to the cyclical bull market from early 2009, the deteriorating GDP trend suggests that the development of a long-term top is becoming more likely. Cyclical uptrends have an average duration of 33 months when they occur during a secular downtrend. Therefore, at a duration of 29 months, the current bull market will likely terminate sometime during the next nine months. Additionally, the extreme nature of the reaction off of the 2009 low suggests that the next cyclical downtrend will be equally violent in character.

There have not been any meaningful long-term breakdowns with respect to technical or cycle analysis, but an important signal will likely be generated sometime during the next three months, so it is time to monitor market behavior closely.

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Category: Commentary, Market Update


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