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It was July of 2008 and oil prices soared to a $147 per barrel. At that time grain prices were going through the roof, the Chinese economy was overheating, the general population of the undeveloped emerging economies were on the verge of revolt, US consumers were angry about having to pay $4.50 per gallon of gasoline, stocks were heading lower every time oil prices were making new highs, and to top it off inflation was the main concern for just about every economic policy maker.

My my my, how quickly things have changed. Who’d a thunk it? Oil would drop down to as low as $32 a barrel, the DOW down to the 6000’s, copper at less than $1.50 a pound; it appeared that the entire capital market structure was on the verge of collapsing.

What a scary time it was not just for investors, but for anyone who had a bank account. I remember having conversations with my friends and family, wondering if their nest eggs would be safe in their 401 K’s, IRA’s, equity holdings and even in their savings accounts. Panic and fear ruled the world there for a few months.

Then with a few actions from the Federal Reserve, US treasury, revisions in the mark to market accounting rules, and a massive $850 Billion stimulus bill, VIOLA, Confidence was “restored”. Banks balance sheets improved, toxic assets held by the banks suddenly disappeared (through accounting magic of mark to market), and artificial stimulus was provided through the America Recovery and Investment Act. Unprecedented global government spending was running rampant, 0% interest rates were provided for the banks, and furthermore $1.4 Trillion worth of Quantitative Easing through the purchase of mortgage bonds and US treasuries from the Federal Reserve was enacted. The Dow climbed from the 6443 to as high as 11,205. The CNBC stock cheerleaders were proclaiming a firm “recovery” was in place and that we could expect a V shaped recovery.

It never made sense to me. I told my clients that there wouldn’t be a V shaped recovery and that I strongly advised them to not get fooled by the hype. Take everything that was said with a grain of salt and just remember who they are and what their functions are in their professional lives.

I told my clients that the reason there wouldn’t be anything resembling a V shaped recovery in any shape or form was that we had way too many structural headwinds for this to occur.

1. In the housing market the amount of foreclosures are continuing to climb while the Federal foreclosure plan enacted by the president so far has been a huge failure, according to Special inspector general for the financial bailouts, Neil Barofsky, who said the program has not “put an appreciable dent in foreclosure filings”. Meanwhile Elizabeth Warren, who chairs a separate Congressional Oversight Panel on the bailouts, has said that Treasury’s failure to act more quickly could certainly be hurting the recovery. A problem that once was just for subprime mortgages has recently morphed into the ALT A and prime mortgages, causing an even deeper predicament. Now that the $8000. tax credit program has expired in April, we have had the worst home sales numbers in the last two back to back home reports. Without a recovery in the housing market, people don’t feel confident as they see in many cases the highest value asset they own deteriorating, therefore curtailing their normal spending habits. Former U.S. Federal Reserve chairman, Alan Greenspan, recently warned that a fall in house prices could derail the U.S. recovery and trigger a double-dip recession.
2. Credit, which is the life line for many businesses, is nowhere to be found. I’ve argued that it isn’t so much a problem of lack of liquidity as much as it is a problem of lack of credit worthy borrowers and aggregate demand for domestic goods and services, and if you couple that with all the toxic debt that banks are still holding on their balance sheets coming to a standstill, this is what you get; a severe lack of issuance of credit. Until the labor market markedly improves and commercial and residential properties are on safer ground, banks simply won’t lend, period.
3. A structurally damaged labor market. Many of the jobs that were lost during this downturn were in the construction and manufacturing base and many of those jobs won’t be coming back for a very long time. The overhang in residential and commercial properties is enormous; the demand for goods was crushed, which in turn devastated manufacturing jobs. Even now, with prospects of the manufacturers slightly improving (mainly due to growth from emerging economies), jobs still aren’t being offered, and a big reason for that has to do with technology and spending on equipment and software. As John Ryding, the chief economist at RDQ Economics stated, “You can understand that businesses don’t have to pay health care on equipment and software, and these get better tax treatment than you get for hiring people. If you can get away with upgrading capital spending and deferring hiring for a while, that makes economic sense, especially in this uncertain policy environment.” The growth from our economy simply isn’t growing fast enough to meaningfully improve the unemployment rate, as even the chairwoman of the president’s Council of Economic Advisers, Christina Romer said, “We need 2.5 percent growth just to keep the unemployment rate where it is. If you want to get it down quickly, you need substantially stronger growth than that. That’s what I’ve been saying for the last several quarters, and that’s why I’ve been hoping that we’ll please pass the jobs measures just sitting on the floor of Congress.”
4. State and local budgets are looking horrendous, without federal aid over 500,000 jobs are going to be eliminated through 2011. In this political climate, the will to continue to spend and bail out state and local governments, much less anyone else just isn’t there. It looks as if they will be going through their own very painful deleveraging process.
5. Uncertainty for corporations and small businesses due to tax hikes and burdensome regulations from the health care law and Wall Street Reform. There is a reason why corporations are sitting on $1.8 Trillion and why small businesses aren’t hiring and if it wasn’t already difficult enough for these entities to hire people as it is, government policies and their incessant need to demonize corporations and their profits are making it that much tougher for them to do so. The crew from PIMCO, who are the largest bonds dealers in the world, and home of the brightest economic minds, nailed it when they coined the term THE NEW NORMAL in 2009, which is defined as slower growth worldwide (more so in the G-3 than in emerging markets), higher unemployment, more de-leveraging, more regulation, and a weaker U.S. dollar over the next 3-5 years. I remember it was just last year when the president’s top economic advisor Larry Summers disagreed with PIMCO’s assessment of our economy entering into the “New Normal” period. It looks now as if Mr. Summers was dead wrong! El Erian, the man who coined the New Normal, compared Summers’ view of the U.S. economy to a three-stage rocket ship attempting to escape the pull of Earth’s gravity. The first stage is government spending, followed by inventory reductions and consumer demand. Summers “has this concept of escape velocity,” El-Erian said Oct. 9 2009 at a meeting of financial-market professionals in Toronto. “We don’t have enough to achieve escape velocity.”
6. The 800 pound gorilla in the room is our National Debt risk. Look what happened when little old Greece had their problems; then it looked as if the entire European Union was going to come crashing down. People were talking about the Euro currency not surviving, and may I remind everyone that even though it appears that things are back in control again, that situation is far from over. It will re emerge again as all they did was buy some time and all these countries are now just beginning a very painful deleveraging process through austerity measures by cutting budgets, pensions, jobs and benefits that will certainly weigh on the entire Euro zone’s growth prospects which means their ability to pay back their own debt will diminish. Considering that…

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Ihab Salloum