Michael Hanson

Cheerless Recoveries

By, 07/23/2009
As an editor at MarketMinder, a lot of material comes across my desk. Our staff looks at over a hundred global publications daily, and as a result we see just about every finance-related headline, editorial, and opinion piece of substance out there.

In the last few weeks, we've noticed a subtle, but real shift in headlines. Where it was "The recovery is far away or may never happen," now it's "Yes, the recovery is coming or maybe is here, but it won't be good."

Cheerless recoveries are nothing new. But it's usually a sentiment issue, not a reality issue. Truth is, I've never seen nor studied an economic recovery most people didn't ultimately "like." Recoveries are good! Yet, in every bear market into a bull market I've seen or studied, we're told "Why You Won't Like the Recovery."

Recall, many deemed the rebound from the 2001 recession a "jobless" one. That mantra—beaten into our brains over and again through much of this decade—turned out to be absurd. The US jobless rate approached historic lows through 2007. Yet, today the same grim thrum emerges.

What's going on here? Be a fly on the wall for any marketing or editorial meeting for a major financial publication, and you'll realize the idea "fear sells" is redundant (and something of a tautology). That's basic behaviorism and editors know it—fear gets our attention and sells newspapers. Analogously, then, you'll never see an "all clear" or a "looks like the recovery's on its way and it's gonna be great!" headline. Also, folks are naturally once bitten and twice shy—at least for awhile. After a big bear market and recession, it's natural to be skeptical.

But this goes a lot deeper and gets to a fundamental misunderstanding about how economic recoveries work. Most investors tend to look to economic data (like GDP, unemployment, industrial production, etc.) as an indication of broad recovery. But that's almost exactly backwards because economic data is backward-looking—sometimes by many months. I challenge you, as an investor, to train yourself to study the chain of events in any recovery. Here are a few tips:

First, new money hits capital markets first. This is a basic, structural feature of how money flows and a likely reason stock markets—and in some sense asset prices generally—tend to move ahead of economic data. Well, at this moment we're getting an unprecedented amount of fresh capital in the form of monetary and fiscal stimulus globally, and that will continue for awhile.

Second, ultimately earnings drive stock prices. This is the real key. Initially, earnings suffer as revenues slump but firms can't adjust expenses quickly. Then, firms get leaner—they dump inventory, reduce headcount, and shutter plants. This, in turn, lowers production and capacity utilization and raises unemployment. Notice the chain of events—companies act first, economic data follows.

Precisely the same happens as recoveries begin. Revenues stabilize but continued cost cutting and higher productivity improve earnings. This allows earnings to rebound before any improvement of the general data, which in turn means stock prices, which reflect expectations for future earnings, can recover before the general data too.

Just as importantly, chain-of-events thinking helps you see why improving earnings begets jobs and consumer spending, not the other way around. As firms tighten up and stabilize profits, they'll eventually hire more and order more goods, and then things like consumer spending and industrial production rebound. Again: Stocks and earnings first; economic data second.

So far, stocks are leading the way back up and earnings this quarter are exceeding extremely dour expectations. Along the way, expect many "it's not as good as a recovery as you think" headlines. That's okay—savvy stock investors know cheerless recoveries are fine things.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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