The Recession is Over. Now What?


In September the National Bureau of Economic Research announced that the longest and deepest recession since the 1930s officially ended in the United States in June 2009. Still, our cautious view of the global economic environment remains largely unchanged. We continue to believe that we are in for a sustained period of subpar economic growth. While the economy continues to recover, the private sector is not yet providing the demand needed to boost economic growth without government stimulus.

Exacerbating the economic uncertainty is the political uncertainty. Regulatory oversight and taxes are likely to rise, but nobody knows by exactly how much. Local and state governments need to reduce spending. Worldwide, governments are debating whether to promote fiscal austerity in order to address the debt problem, or to apply more government stimulus to the global economy.

Political Uncertainty

In the United States, those who advocate fiscal austerity argue that if the creditors who are lending to the government at very low interest rates lose faith in the credit-worthiness of the United States, rates could rise sharply. Those who argue for more stimulus say that a premature move towards fiscal restraint before the economy is on solid ground could result in another recession or worse, as economic historians argue was the cause of the second down-leg of the Great Depression in 1937.

The evidence so far does not strongly support either argument. Unemployment remains high, wage growth is weak, and the housing market is wobbly. But at the same time interest rates remain low and industrial production has rebounded. Households have made progress reducing debt, but they still have a considerable ways to go. Corporations, boosted by cost cutting and exports to emerging markets, are highly profitable and have very high levels of cash, but they are delaying spending on equipment and labor until they have more clarity on the future tax and regulatory environment.

The Federal Reserve

For its part, the Federal Reserve has made it clear that they will do everything they can to prevent another recession. In September, Fed Chairman Ben Bernanke stated the “Fed is prepared to provide additional accommodation if needed.” This statement lowered both the likelihood of another recession and the perceived risk in owning stocks. If the economy continues to recover, stocks should at least maintain their current levels. If the recovery falters, additional stimulus will be applied and all assets, including stocks, should react favorably in the short run.

The Stock Market

The stock market responded with a surprising rally in September. Many market prognosticators were noting that September is on average the worst month of the year for stocks. Instead the S&P 500 Index rose 8.9%, its best September since 1939.

Despite the recent rally in the stock market it seems that investors have lost confidence in stocks as a long-term investment. In September money continued to flow out of U.S. equity mutual funds and into bond funds. This is understandable after investors were burned during the 2008 to 2009 market crash, and with the average age of the population in most developed countries getting older investors’ risk tolerance might stay low for some time. But it probably also reflects some investors’ age-old habit of investing through the rear-view mirror rather than based on a disciplined forward-looking assessment.

While the past 10 years were great for bonds, the next few years look challenging. The U.S. Government’s massive attempts to stimulate the economy may cause the multi-decade tailwind for bonds of declining interest rates to come to an end. But for now, with cash yielding next to nothing and the economy still on uncertain footing, investors are content to invest in bonds, which deliver regular income.

But often it is when investor sentiment toward stocks is low and the economy improves and stocks sometimes begin a long upward trend. We do believe that stocks will drift higher over the next few years, but with plenty of volatility. The primary source of growth for U.S. companies will likely be exports to developing economies, where growth is much stronger than in the developed world. These countries also have relatively little debt, so they should provide strong demand for U.S. goods and services.