SERIOUS MONEY:Investors failed to see warning signs in 2007 – should we now believe the recession is over? asks CHARLIE FELL
WILLIAM SEWARD Burroughs of St Louis, Missouri, invented the first workable adding machine and was granted a patent for his device on this day in 1888.
His business took off and thrived long after his death in 1898 as the Burroughs Adding Machine Company became the industry leader. It became ubiquitous office equipment and was not displaced until the arrival of the personal computer in the 1980s.
However, in spite of the greater sophistication of the information age, Burroughs would be surprised to learn that elementary counting has been lost on the knowledge economy. After all, we celebrated the new millennium 12 months too soon, with many failing to appreciate that a new decade, century or millennium begins on the digit one.
It should therefore be no surprise that the overpaid underachievers in the investment community seem unable to perform more complicated numerical tasks.
It is said that the proof of the pudding is in the eating and digesting recent investment commentary provides supporting evidence. One investment manager declared at the second quarter’s end that equities were trading at or below fair value on any long-term measure. The statement may well be true, but it is also an inadvertent admission that stocks were ridiculously expensive at the peak in 2007 and during most of 2008.
The investment manager maintained indefensibly high equity allocations as the market topped out, argued forcefully that stocks were cheap following the demise of Bear Stearns 15 months ago, and warned at that time, that it was imprudent to avoid equities.
Needless to say, equity allocations were high last year and now, with prices almost 25 per cent lower than in spring 2008, beleaguered pension fund clients are advised that stocks are trading at close to fair value. Is it any wonder such wisdom has proved so damaging to pension fund solvency if not the manager’s own employment status, and that such experts’ performance has been outpaced by a basket of consumer goods over the past decade?
Now, the industry’s experts reveal to clients that they believe the US recession is at an end. This is the same expertise that failed to spot the warning signs in 2007 that included a downward-sloping yield curve and rising credit spreads. Once the evidence became irrefutable, they argued that the recession would be mild and brief.
In fairness, there have been encouraging economic reports over the last several weeks, including the less-than-expected decline in second-quarter GDP and a mere 247,000 drop in payroll employment in July. However, it is also fair to say that these positive surprises go a long way to explain at least part of the 50 per cent jump in stock prices from their intraday low in March.
It is important to note that the National Bureau of Economic Research (NBER), a private non- profit group, is the semi-official arbiter in dating business cycles.
It defines a recession not as two consecutive quarters of negative growth but as “a significant decline in economic activity spread across the economy, lasting more than a few months”.
Indeed, the economy never suffered two consecutive quarters of negative growth during the mild recession of 2001 while this downturn, which began in December 2007, only registered back-to-back falls in quarterly GDP in the latter half of last year.
Instead of quarterly data, the NBER emphasises monthly data and non-farm payroll employment, real personal income excluding transfer payments, real manufacturing and trade sales and industrial production.
The evidence from these indicators suggest it is far from certain if the recession is at an end irrespective of whether the economy records an inventory-led bounce in the third quarter.
Real manufacturing and trade sales nudged into positive territory in June while industrial production turned the corner in July following several consecutive months of decline. However, the remaining data is far from encouraging. Non-farm payroll employment continues to decline and though the pace of job losses in July was an improvement on previous months, the monthly loss at 350,000 is still higher than the average losses of 150-260,000 during previous recessions.
Furthermore, the number of part-time workers has soared over the past 18 months, suggesting that a recovery in the labour market is far from imminent.
Real personal income excluding transfer payments continues to decline and has dropped by over $10 billion in the past two months.
Labour market trends are not encouraging as cost containment efforts has seen private sector labour compensation slow to 1.5 per cent in the 12 months ending June 2009, the smallest increase on record and a significant reversal is unlikely with the unemployment rate at roughly 4½ percentage points.
Should the NBER decide that the downturn concluded in June, the implications for asset allocation are not obvious.
Typically, a turn in all four indicators aligns well with the NBER’s recession ending dates, but this was not the case in 2001. Payroll employment and real personal income lagged the semi-official recession trough by 16 and 21 months respectively.
The bottom line is that pension fund clients would do well to ignore expert opinion.
