A recession in confidence, not economy
WASHINGTON – Sept. 7, 2011 – Feeling glum? Unsure of the future? Putting plans on hold? Hoarding cash and buying gold?
Chances are your negative state of mind has a lot to do with the double-dip crowd’s Weather Channel-like warnings of another catastrophic economic storm bearing down on the USA. The drumbeat of recession talk, which gathered steam Friday after the government reported that the economy created no jobs in August, has all but cemented a recession in the minds of investors – but not necessarily the type that is measured in negative GDP, ever longer lines at the unemployment office or shrinking output at factories. At least not yet.
Instead, the gloomy predictions about the economy, which is now operating at stall speed, are causing a different type of contraction: shrinking confidence.
“We are definitely in recession, but it is a confidence recession. Not an economic one,” says Jeffrey Kleintop, chief market strategist at LPL Financial.
Still, renewed turbulence Tuesday in Europe and fresh fears that the eurozone’s debt woes will worsen and hamper growth in the U.S. sent the Dow Jones industrial average tumbling 101 points, or 0.9 percent, to 11,139.
In theory, the economy is not in recession, which is defined as two consecutive quarters of negative GDP. The economy crawled along at a growth rate of 1 percent in the second quarter of 2011 and 0.4 percent in the first three months of the year. But Wall Street has increased the chance of a recession to about 40 percent. And the market’s nearly 20 percent drop from its April high suggests investors are already pricing in a “mild recession,” Deutsche Bank says.
This debilitating drop in optimism – if it persists – could act as a mental roadblock and rile markets. A confidence recession poses dangers to the economy, because when the masses think the future is bleak, not bright, the negative thinking manifests itself in all sorts of hunker-down behaviors that act as a drag on growth.
The fear: All the negativity puts a chilling effect on risk-taking and prompts investors, consumers and businesses to play defense.
The potential fallout: Austerity replaces spending. Hoarding cash trumps longer-term investing. Businesses spend less on future initiatives and hire fewer workers.
The risk: A negative feedback loop takes root that could cause worries about recession to turn into a self-fulfilling prophecy.
The historic market volatility the past five weeks is due to the growing perception that the economy is suffering from more than just a soft patch and is just one shock away from tipping into recession.
Still-visible scars from the 2008 financial crisis are adding to the uncertainty.
“We are in the middle of a mania of pessimism,” says James Paulsen, chief investment strategist at Wells Capital Management. “We have a crisis-phobic investment culture. The nation is suffering from ‘Armageddon hypochondria.’”
Daniel Robb, 41, of Washington, D.C., a self-described “natural optimist” who has always sought buying opportunities on market dips, now fits the profile of a pessimist. He blames a lack of leadership from President Obama and his economic team, as well as Congress, for ratcheting up his anxiety level.
“I know the situation is bad, because I find myself keeping money in bank accounts,” Robb says. “I have stopped looking to buy a home, and I am just far more concerned than I have ever been in my life about committing to any large purchase.”
Negative media coverage is adding to the angst. In July and August, there were nearly 1,900 references to “double-dip recession” in U.S. publications, nearly triple the amount cited in the first three months of the year, according to LexisNexis. And mentions of the term “crisis of confidence” nearly doubled in the same period.
That angst is showing up in the stock market, where selling has intensified the past three sessions, with the Dow suffering triple-digit declines each day and tumbling 4.1 percent.
The source of the despondency stems from the political dysfunction in Washington that led to the nation’s first-ever credit downgrade, worries that debt problems in Europe will lead to a global slowdown and a perception that government leaders don’t have the right tools or ideas to get the slow-growing economy moving again.
Many on Main Street are pointing fingers at Congress. William Simmons, an administrative pastor at Christ Memorial Lutheran Church in St. Louis, describes his attitude as not a “crisis of confidence” but rather a “loss of confidence in Washington.” His retirement savings are in “conservative” funds. He is paying off his credit cards each month. And he won’t make big purchases unless he has the cash. “That has delayed the replacement of our older car by a year,” he says.
The big debate on Wall Street is whether the downturn fears are accurate or whether the country is simply talking itself into recession.
Muddled messages
It may feel like a recession. But there’s a catch: The incoming economic data, while soft, are mixed and have yet to definitively signal that a double dip is 100 percent certain. The outcome might not be clear for months.
Fanning the flames of the debate is a disconnect between the different messages being sent by the economic data and surveys that measure the sentiment of consumers and executives.
For example, the August reading of consumer sentiment measured by the University of Michigan fell sharply, extending a three-month decline that is the second largest on record. The “expectations” component of the phone survey fell to its lowest since 1980. Similarly, a survey measuring the sentiment of manufacturing executives in the Philadelphia area in mid-August plunged to levels ordinarily associated with recession.
But the bulk of recent data tell a different, more-balanced story. On Tuesday, the ISM’s non-manufacturing index, which measures the health of the large services component of the economy, came in better than expected.
Consumer spending rose 0.8 percent in July, topping expectations. Factory orders grew 2.4 percent in July, beating estimates. Retail sales rose a solid 4.4 percent on average in August. And auto sales last month also came in surprisingly strong, rising 7.5 percent vs. the same period a year ago. U.S. automakers fared particularly well, with Chrysler posting a sales jump of more than 30 percent. The July reading on durable goods orders rose 4 percent, doubling analysts’ expectations.
Says Paulsen, “When I started out in the business almost 30 years ago, most of the economic reports counted widgets and reported those counts. Today, most of the economic reports are not counting widgets. They are asking, ‘How do you feel about the widgets?’“
The result? Mixed messages.
These mental snapshots gleaned from sentiment surveys are influenced by negative news headlines.
“When people answer questions, a lot of emotions are involved,” says David Bianco, head of U.S. equity strategy for Bank of America Merrill Lynch. “Even if people have jobs, they are less secure than they were.”
Despite consumers’ rising angst, the hit to corporate earnings, the lifeblood of stock prices, will be far less severe than believed, as just 15 percent of Standard & Poor’s 500 profits come from companies in the consumer discretionary sector, Bianco says.
But investment strategist Rich Bernstein of Richard Bernstein Advisors offers a counterpoint as to why sentiment is weaker than the actual economic data. “The sentiment data (are) more timely and reflect August surveys, whereas (many of) the economic reports are still focusing on July,” he says.
Signs of trouble
There is no shortage of signs that people have less confidence in the future. Some eye-opening statistics that scream “caution” include:
• Rising bearishness on Main Street. More than four out of 10 investors polled last week by the American Association of Individual Investors said they were “bearish,” much higher than the long-term average of 30 percent.
• Shrinking P-Es. Despite the fact that Corporate America has posted 10 quarters in a row of better-than-expected profits, investors are shelling out less for each $1 of earnings posted by companies in the S&P 500. In fact, the price-earnings ratio, or P-E, for the 12-month period ended in June was 13.3, half of what it was in March 2009 near the bottom of the bear market, S&P data show.
• Rising cash balances. The “world is awash with cash,” Bianco noted in a recent research report. Non-financial companies in the S&P 500 had nearly $1 trillion in cash, the 11th-consecutive quarter of record cash holdings, says S&P’s Howard Silverblatt. That is nearly triple the amount of cash on corporate balance sheets compared with 10 years ago.
And it’s not just businesses hoarding cash. Federal Reserve data show that there is $7.3 trillion parked in savings accounts, certificates of deposit and money market funds, up roughly $1 trillion from July 2008, just months before the financial crisis intensified with the fall of Lehman Bros.
“There is nothing like cash. Investors know that during times of turmoil cash is the only thing you can depend on tomorrow,” says Peter Crane, president of Crane Data, which tracks money market funds.
Plunging mortgage applications. Despite historically low interest rates for home loans (the average 30-year, fixed-rate mortgage is 4.32 percent), purchase applications for mortgages are at their lowest level since 1996, the Mortgage Bankers Association says.
Mike Fratantoni, the MBA’s vice president of research, blamed the plunge in applications on skittishness caused by the debt-ceiling debate in Washington, the downgrade of U.S. debt from triple-A to AA+ and the wild swings in the stock market.
“Most buyers just stepped back,” he says. “No one is willing to commit given the high amount of uncertainty and volatility.”
In another sign of caution, an index of “defensive” stocks tracked by Russell Investments has outperformed more aggressive stock indexes for the latest monthly, quarterly and year-to-date periods.
“The defensive index has a heavy weighting in stocks of health care, consumer staples and utilities companies that pay above-average dividends,” says Abigail Huffman, director of research at Russell. “These sectors are all perceived as safe havens.”
The importance of confidence was summed up by Alcoa CEO Klaus Kleinfeld: “Confidence is like air that the economy needs to breathe,” he told CNBC in July. “If you suck the air out, you are killing the economy.”
Reasons to be cheerful
So what will it take to breathe fresh life into an economy running on fumes?
For starters, a good job-creation plan from Obama, says Huffman. Obama will unveil his plan to boost job growth in a speech to the nation Thursday. “He needs to present an amazing jobs program,” she says.
Another potential boost: any signs that members of the special congressional committee set up to find ways to slash the nation’s huge deficit can work together and forge a plan that is well-received by investors, she adds.
Friday’s weak jobs report has increased optimism that the Federal Reserve will take further steps to stimulate the economy. Other market-moving news would include better news out of Europe and signs the recent soft patch was transitory.
If there is good news it is that extreme pessimism means there’s nowhere to go but up, unlike the go-go 1990s when extreme optimism involving the Internet meant there was nowhere to go but down.
Stocks have fared well historically in periods following low readings on consumer confidence, says Sam Stovall, chief investment strategist at S&P. His data show that stocks have been up a median 20.7 percent in the 12 months following the 10 previous times the University of Michigan’s consumer sentiment survey dropped below 60, as it did in August.
For now, the future is anything but bright, says Frederick Ampel, president of Technology Visions Analytics in Overland Park, Kan.
“Future? What future?” he says. He’s postponing vacation plans, stockpiling cash and “jumping into hard metals.”
Not exactly the portrait of a confident American.
© Copyright 2011 USA TODAY, a division of Gannett Co. Inc., Adam Shell
Copyright © 2011 The Associated Press, Derek Kravitz, AP economics writer. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.