[Crossposted at
bopnews.com]
In the course of a business cycle, there is a point where the economy is deliberately slowed by the Federal Reserve, this point leads either to a new recession if the slowing requires interest rate increases large enough to halt the expansion, or to a boom if such a new source of supply exists, and the Federal Reserve can ease. This is related to whether the economy has created a new source of supply that can expand without inflation. We are at this critical point.
The fall in real wages means that there is macro-economic incentive for people to change areas of work - good. It also means that there is going to be a fall in aggregate demand, or at the least a slowing of the consumer component - bad. (Graphs here on when this effect took hold and what it means.)
The Vix has reached a
secular bottom and is now trying to climb the "wall of worry". The indications from the job front are that the hiring we are seeing is from the macro-economic stimulus of last year's tax bill, which allowed repatriation of profits along with investment. This is producing a round of businss hiring. The upcoming recession in Europe will ease pressures on both oil and on the dollar.
However, this will only ignite a sustained boom phase if the easing of inflationary pressure finds its way into a new source of business supply. The question of whether the US will, over the course of the next 12 months, slip back into recession or will expand is, therefore, a question as to what area of new supply will lead the economy the way jets and electronics did in the late 1960's, retail consolidation and media niche marketing in the late 1980's, and the internet and globalization did in the late 1990's.
At present there are two possible candidates - wireless, and power generation. Since these are being hindered by legal policy and poor fiscal choices, it is very likely that any further growth in the US economy will simply find its way into continued housing inflation. Longer term there is potential in converting the US transportation system to hybrids and a greater diesel presence. None of these candidates are being encouraged by current policy, and therefore it is likely that they will not ignite in time to save the current expansion.
If an investor believes in expansion, now is an excellent time to begin accumulating stocks for long positions - particularly as there will almost certainly be a continued correction in the market. To the "expansion bull" this is a dip to be bought.
If an investor believes that there is no area of expansion, the present signs are bearish, and point to the US slipping into recession soon after Europe does, because it will hurt our exports. There is also a clear signal that the US policy in Iraq is "declared defeat and go home". The loss of this fiscal stimulus - which has been on the order of 100 billion dollars a year, combined with the lack of expansion which will keep forcing the Federal Reserve to tighten or to old interest rates higher, means that the housing market is likely to cool dramatically. With this will come the end of the consumer's ability to borrow against home equity.
The proposition for the investor could not be clearer: the expansion bull should be moving into drug stocks, business equipment manufacturing on the belief that reduced military demand will allow more business expansion, and energy stocks as investment in power generation and transmission begins to pick up in response to higher prices. For the expansion bear, the proposition is a good deal more difficult: the place of flight from the dollar, namely the Euro, is, in the short term, going continue to soften. Long term dollar bears will reinforce their positions, and long term commodity bulls will do the same. However, the fast run up in commodities of the last year will not be repeated this year - the general cooling around the world is because central banks everywhere realize that another large leap in materials prices will set off an inflationary spiral.
My own analysis is that the candidates for expansion are not mature enough, and therefore, while there will be a short boom cycle based on easing commodity pressures, this will be short lived, and will only serve to push the housing bubble through one last phase of expansion. The indications are that after slowing signficantly, the housing market in the bi-coastal zone has picked up again in response to the business hiring (again, macro-driven), and that this means that the result will be another round of commodities pressure. Every barrel of oil that Europe does not import will be imported by someone, because presently there is no non-inflationary growth to be had.
From this it seems clear that we should expect 2005 to be a moderately good economic year, but since current expectations are for a gangbusters year - that is all possible growth is already priced into the market - this will not lead to signficant upside in any of the markets. We've already bought 2005, and the question is 2006.
Absent the fiscal stimulus from Iraq, and absent the borrowing binge that the Bush Socrity Plan would have caused, the preponderance of the evidence indicates that late 2005 will see the disappointment of the consumer, early 2006 will see an increase of the "J Number" in unemployment claims, and the final peaking of the real estate bubble.
The implications for long term policy are also clear: there are bottlenecks to wireless availability caused by legal hurdles over the movement of video as content, these need to be removed by action from Congress. There is also a need for a large investment cycle in power generation and transmission, this will require government involvement and re-regulation of power markets to force growth into baseline, rather than speculative peak, power generation investment.
Wall Street does climb a wall of worry, but it needs equipment to do this, the lack of new business supply indicates that this wall is going to remain unclimbed for the remainder of the Bush term in office, and we are likely to see a second recessionary cycle take hold before his second term in office ends.
The reality is that this business cycle has been incredibly mismanaged by a party in power that sought to use economic crisis to remake society and force a generation their being in power - at each step along the way - from the original revenue reductions of 2001, to the failure to pass a stimulus and conservation bill in 2002, to the invasion of Iraq in 2003, to the failure to implement an effective business stimulus in 2004 - the decision to use the federal government as a giant RNC slush fund has cost the nation trillions of dollars. For the cost of Iraq we could have made significant strides in reducing the problems with power transmission that are costing megawatts of power lost to heat and inefficiency. The mood of national unity could have allowed the beginnings of a more efficient transit grid. The cost of the revenue reductions could have been used to significantly reduce the debt service on the national debt, and thus free up internal investment.
None of these things were done.
However, the problems are relatively clear, and the technical solutions to cutting the fat out of America's energy diet are also clear: by slashing 15% off of America's energy consumption, the US could cut its trade deficit in half. This cut would exact little reduction in real standards of living, and would, instead, act as a spur to research and development.
If the Democratic Party were wise, it would attack, attack and attack at the painful mismanagement of the economy, the wasteful borrow and squander policies, and the failure to address real problems. The only tough decision that Bush makes is which brand of jerky to chew while doing a photo op. But America will only vote for a new party if they look and sound like winners. The Democrats do not.