Economy
Sep 01, 2009

What Will Turn The Economy Around?

by

Joseph A. Monaco, Ph.D.

As my little brother once said at 2 a.m. on Christmas Eve, "Won't it ever be morning?!"

The crisis is over, or so it appears. Most experts seem to agree that the panic which was so pervasive last year is behind us and the likely collapse of the world's financial system is probably now just a distant memory. But, does the end of a crisis necessarily portend the beginning of economic prosperity? Or does it simply mean the beginning of a sustained period of economic malaise?

My sense is that we are much further along in our recovery than most people realize and that the future may indeed be brighter than the current media rhetoric projects. To understand my thinking, it probably would be beneficial to understand what caused previous recessions and what will likely get us out of this one.

First, every recession we've experienced is nothing more than a massive inventory correction. Times are good so we build inventory to meet the ever increasing demand. But, as Billy Shakespeare said, "therein lies the rub." Nothing increases forever. Demand simply increases until it stops increasing. At which point businesses have too much inventory and thus stop ordering more inventory until their current inventory is worked down to manageable levels. Producers of inventory subsequently cancel orders for raw materials and then begin laying off their workforce. Both the laid off workers and those producers of raw materials begin to terminate their purchases of goods, which causes retailers to need even less inventory. And the spiral down continues until businesses one day look up and realize that they don't have enough inventory to operate, at which point they scramble to acquire more inventory and so begins a new economic spiral up.

As most everyone agrees, our current recession was brought on by a surplus inventory of new homes. During the "real estate bubble" of 2000-2006 we built more new homes than the number of new potential home owners, resulting in an oversupply of new home inventory. The quickest way for any industry to deplete excess inventory is to lower price and that's what happened to real estate. Unfortunately for the world, real estate uses more leverage (think debt) than most other industries, so this decline brought on wide-spread calamity for the financial institutions that loaned out the money as well as individuals who borrowed the money.

Today we are in a much different place. I was at the Audi dealership the other day having some minor work done on my car. While they were working on my car I walked around the lot looking at new cars. I was struck by how little inventory existed of new cars. According to industry statistics, we are on pace to sell about 10-million new cars this year, 12-million if you include the "cash for clunkers" purchasing. The last time this nation saw only 10-million new cars sold was way back in 1974. But, according to the same industry reports we are only producing between 7-million to 8-million new cars. This disparity is eating up much of the new car inventory. Therefore, even if 2010 sees only the same level of new car sales as does 2009, we will have to increase production by 25 to 30%. That's a big jump! It's very doubtful that the current inventory level could sustain even a modest jump in sales and there is good reason to believe that the further we are removed from "The Panic Of 2008" the more inclined people will be to spend on new cars.

The same is true for real estate. Believe it or not, new homes are being built and sold in this country every day, just no where near the amount we saw over the past decade. But just as with automobiles, the amount of new homes being built is about 30% lower than the anemic number of new homes being bought. Eventually the inventory of new homes declines to a low enough level that it is not sufficient to accommodate the 3-5% annual increase in our population. When that will happen is open to debate. But when it does the race will be on again. What does appear more clear is that we won't see the same drop off in new home construction from 2009 to 2010 (if we see any drop off at all) that we have seen over the past two years and so we shouldn't see decline of constructions jobs (if we see any) commensurate with what we experienced this year.

And this scenario isn't limited to real estate and automobiles. Go into almost any store you choose and see if the inventory hasn't shrunk markedly. Then ask yourself if the store's inventory appears adequate to service any appreciable increase in traffic.

So, just as an oversupply of inventory brought on the economic decline, an undersupply of inventory should fuel an economic rebound. With inventory levels at or near record low levels and with people calming down from the feelings of impending disaster so prevalent in the recent past, the stage does seem to me to be set for a recovery sooner and more significant than what is generally accepted by most other economists. Hopefully this will result in higher stock prices in the months and years to come, but we will keep you posted on that.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Joseph A. Monaco, Ph.D. and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of August 31, 2009 and are subject to change without notice. Past performance may not be indicative of future results.