Scott Grannis is an investment advisor and writes for 13D Research. This is his response to an email discussion among friends on the state of the economy — an optimistic view and I think we could use a little of that.
Reasons for Optimism – note from Scott Grannis
No, and this isn’t even close to a depression. Or recession, for that matter. There is no reason to even try to compare today’s economy to the Depression economy. Our debt problems are most definitely not extreme, and the Fed today is easy whereas in the Depression money was tight and taxes rose signficantly; neither of those problems plague us today. Comparing debt to income, nothing stands out as excessive. The subprime problem will almost certainly result in losses that are significantly less, relative to the size of the economy, than what happened in the S&L crisis of the 1980s. Here’s something I wrote to a friend recently:
The economy is certainly struggling, but there is as yet no reason for a recession call. It’s still not insane to be more optimistic than the market. I expect GDP growth will be modest, 1-2% for the next several quarters, but that is pretty optimistic relative to where the consensus appears to be.
This has the feel of a final market blowout. Bank stocks are at a major new low. Spreads are climbing. Broad equity indices are now in bear market territory. Confidence is super low. Newspapers are full of bad news. Gasoline is at $5, everyone’s upset. The bears are predicting an economic collapse. Oil is reaching previously unimaginable levels. The dollar is near an all-time low. Worst of all: The Fed seems to be in a box: the inflation problem is getting worse every day but they can’t take action because the economy is weak. And Obama is considered a shoe-in, and the first thing he’s going to do is push through a massive tax increase which will crush the economy.
Obviously I think the pessimists are overreacting. Things aren’t that bad. Exports are incredibly strong. Residential construction looks to be very close to a bottom; the drag on GDP is going to go way down in the future. Commodity prices are still rising (the global economy is still booming). The Baltic freight index is still extremely high. The employment situation is far from dire; it’s not even nasty. $140 oil is seen by most to be a sign of impending collapse, but what it really means is incredibly strong demand, and surging investment in all sorts of energy sources. A recent Gallup poll showed that only 13% of the population thinks that income redistribution is a good way to solve our current problems. There is not anything even remotely resembling broad-based support for higher taxes. People are increasingly getting pissed at the Democrats for refusing to allow drilling. I just don’t think that a massive tax increase is very likely. If there’s anything good you can say about Obama, it’s that he has no problem abandoning his principles if it is politically expedient. Check out today’s WSJ Op-Ed which echoes this view.
For now, the Fed holds the key. All they need to do is start tightening.
Everyone thinks that the economy is very fragile, and so any tightening would be catastrophic and thus impossible. But why is the US or the Euro economy going to wilt if interest rates rise 25, 50, or even 100 bps? Offsetting any potential problem that higher rates might bring would be a huge increase in confidence and a reversal of bearish expectations, not to mention a stronger dollar.
This feels like late Feb or early March of this year in a way: back then the financial sector was collapsing and there was no way anybody could do anything to stop it. We were staring into the abyss. And then the Fed surprised everyone and things really improved.
So the solution is simple: the Fed just needs to worry more about inflation and less about the economy. How hard is that?
Meanwhile, encouraging signs:
- The NAPM index is being described as only slightly above the boom/bust level. But it has moved higher in recent months, and strongly suggests continued positive growth.
- Export activity is extremely strong. No sign here of anything like a recession.
- The weakness in residential construction has been so massive, for so long, that it can’t get a whole lot worse. Rates of decline are slowing. We’ve probably passed through the inflection point, meaning the bottom in activity isn’t too far off in the future. The drag on GDP is going to go way down no matter what.
- Rising prices are becoming a widespread phenomenon. This is not a sign of weakness, it’s a sign of very strong demand. And also a sign of loose monetary policy.
- Debt burdens have risen a bit, but only marginally. Most of the increase in debt burdens happened in the 1990s, way before the housing crisis hit.
- The employment situation would have to deteriorate significantly before we could call this a nasty recession.
I guess it’s my contrarian genes, but I just can’t help myself when I see overwhelming doom and gloom out there, at the same time as I see very attractive valuations on a lot of things (mainly stocks but also the dollar). There is definitely no shortage of bad news, I’ll be the first to admit. But when that happens, and when everyone knows it’s bad, then prices have probably reflected most of the damage to come. So that’s when you have to be an optimist. I’m not saying the economy is going to boom, I just think that it can continue to do a little better than everyone thinks. I think we can avoid a big disaster. When you look at the bond market, with interest rates of 2-4% alongside inflation of 2-5%, then you know that people are expecting such a big economic collapse that it will crush the inflation that is spreading like wildfire. I just don’t think that’s going to happen.
I would worry much more about inflation than I would about a recession or a depression.
