The New Normal - Slower Growth Ahead

Posted on November 9, 2009 by David Laidlaw

With a year’s perspective after the credit crunch, certain economic and market patterns are now apparent.  From September 2008 until March of this year, the market was signaling that there was the potential for the whole banking system to fail and the economy to be thrown into a 1930's type of depression. The recent rally during which the equity markets increased roughly 50% in value from March to the end of September indicates that this outcome is now very unlikely.

However, the economy is not out of the woods and growth over the near term will most likely be uneven and slow.  Economists segregate the economy into three sectors: the consumer (C), industry (I) and the government (G).*  Consumer spending represents roughly 2/3 of economic activity while government and corporate/industrial spending comprises the remaining 1/3 of the economy.  As discussed below, expanding spending by the government and stable corporate spending will not be sufficient to offset weak consumer expenditures. 

Corporate America has shown itself to be extremely resilient during this recession.  While overall spending by the private sector decreased, most private companies are operating profitably. 

The government has expanded its spending rapidly to prevent the economy from spiraling into a deeper recession.  The most obvious example of this spending was the stimulus bill passed earlier in the year (the other spending policies enacted since the recession began are far too varied to enumerate). In aggregate, government spending expanded at a rate of 6.7% during the second quarter of this year.    

Consumer spending remains depressed and the prospects for the near to mid-term are not good.  The most obvious reason that consumer spending will remain weak is unemployment.  September’s jobs report indicated that the headline unemployment rate is now 9.8%.  This rate rises dramatically to 17% including part-time workers looking for full-time jobs.  The unemployed and those with part-time jobs do not spend since the benefits they receive are not equivalent to full-time salaries and they are rightfully concerned they will not be able to find a full-time job immediately. 

Consumer spending is also restrained by current government spending.  Rational individuals see the Federal and State Governments increased borrowing as future societal liabilities and thus curtail their current spending.  Finally, the housing market, though it has stabilized, will not spur any large spending by the consumer since home values will not increase at the rate they did earlier in the decade for at least another generation.   

Regardless of our somewhat pessimistic view concerning the economy, we still view common stocks as an attractive asset class.  Over the past two years, public companies have slashed expenses to remain profitable.  Corporate balance sheets (excluding financials) are also amazingly strong with record high levels of cash compared to corresponding assets and liabilities.  The recent wave of corporate acquisitions suggests that John Maynard Keynes’s “animal spirits” are alive and that companies are laying the groundwork for future growth.  While the near-term growth in revenues will be slow, the underlying cash flows that companies are producing are attractive. 

The majority of our recent common stock purchases reflect our expectation for a muted rebound.  Companies such as Brown-Forman, Procter & Gamble and Sysco will not produce eye-popping double digit revenue growth.  However, they do provide sustainable cash flows relative to their prices that should hold up well in a struggling economy. 

Corporate America has shown itself to be extremely resilient during this recession.  While overall spending by the private sector decreased, most private companies are operating profitably. 

The government has expanded its spending rapidly to prevent the economy from spiraling into a deeper recession.  The most obvious example of this spending was the stimulus bill passed earlier in the year (the other spending policies enacted since the recession began are far too varied to enumerate). In aggregate, government spending expanded at a rate of 6.7% during the second quarter of this year.    

Consumer spending remains depressed and the prospects for the near to mid-term are not good.  The most obvious reason that consumer spending will remain weak is unemployment.  September’s jobs report indicated that the headline unemployment rate is now 9.8%.  This rate rises dramatically to 17% including part-time workers looking for full-time jobs.  The unemployed and those with part-time jobs do not spend since the benefits they receive are not equivalent to full-time salaries and they are rightfully concerned they will not be able to find a full-time job immediately. 

Consumer spending is also restrained by current government spending.  Rational individuals see the Federal and State Governments increased borrowing as future societal liabilities and thus curtail their current spending.  Finally, the housing market, though it has stabilized, will not spur any large spending by the consumer since home values will not increase at the rate they did earlier in the decade for at least another generation.   

Regardless of our somewhat pessimistic view concerning the economy, we still view common stocks as an attractive asset class.  Over the past two years, public companies have slashed expenses to remain profitable.  Corporate balance sheets (excluding financials) are also amazingly strong with record high levels of cash compared to corresponding assets and liabilities.  The recent wave of corporate acquisitions suggests that John Maynard Keynes’s “animal spirits” are alive and that companies are laying the groundwork for future growth.  While the near-term growth in revenues will be slow, the underlying cash flows that companies are producing are attractive. 

The majority of our recent common stock purchases reflect our expectation for a muted rebound.  Companies such as Brown-Forman, Procter & Gamble and Sysco will not produce eye-popping double digit revenue growth.  However, they do provide sustainable cash flows relative to their prices that should hold up well in a struggling economy.