Footnote 2011: Being cautiously optimistic was right
In January, I wrote my prognosis for 2011. The title was "Cautiously Optimistic Into 2011". I intend to write another post like this early in 2012 with asset allocation and market calls for the new newsletter. But right now I just want to review the basic outlook I presented.
I had seven major conclusions. Here’s what I said:
- "Double dip recessions are not the norm; they are the exception… So, you really need to see powerful secular forces to overcome this self-reinforcing dynamic. Once a technical recovery begins, we should expect it to continue and blossom into a full-blown cyclical recovery. Obviously, I am talking about the medium-term, not the long-term here. But the point is that we have been in recovery for over one-and-a-half years in the US. Odds are that this will continue for some time to come (through 2011 at least)."
- "I am cautious about this outlook because I still believe the US is in a cyclical upturn within a larger depression. The concept that the structural problems of excessive household indebtedness and an over-reliance on financial services and housing can be solved by money printing and fiscal stimulus leaves me cold. My thesis is that these remedies mask problems only due to the cyclical upturn. If the recovery is not used to whittle the problem away, the next recession will be as bad or worse than the last."
- "Europe: the sovereign debt crisis refuses to go away. The European periphery is hurting but the crisis has infected the core via Belgium and Italy. I expect the crisis to get worse before decisive action is taken because that’s how politicians usually respond. There are three options for the euro zone: monetisation, default, or break-up. The question is whether this – in and of itself – deals a fatal blow to recovery in Europe."
- "US states and municipalities: Meredith Whitney has put this crisis front and center. My take is similar to the one on Europe: The question is whether this – in and of itself – deals a fatal blow to recovery in the US, infecting the global economy. Here, I have always felt that the budget issues would only become dire in a cyclical downturn as declining asset prices created public sector pension losses. In an upturn, tax revenue increases as do accounting gains from asset prices… I do not think this is a 2011 event."
- "Housing: House price declines have resumed in the UK and the US. They never stopped in Ireland and Spain. The housing double dip is in progress… At this point, I see it as the biggest near-term risk for the U.S. in 2011."
- "Currency Wars: a lot of good is done simply by having economic growth. It takes a lot of political heat off politicians. The currency wars are really a political event because they are caused by a lack of aggregate demand. When the pie shrinks, individual countries feel obliged to implement beggar-thy-neighbour policies to maintain their standards of living by taking a larger share of the pie. The developed economies have felt this ‘pie shrinkage’ most acutely. So it is they who are driving the so-called currency wars forward. The emerging markets are merely reacting in kind. I say "First the rate reductions, then money printing, then the currency war, then the tariffs, then…. hopefully economic recovery."
- "Commodity price Inflation: There is a real threat to recovery from commodity price inflation. We have already begun to see signs of food price riots, food price controls and the like in emerging markets. Additionally, Brent crude is at 27-month highs, closing in on $100 a barrel. Just think back to 2008; this type of commodity price inflation was toxic and sowed the seeds of its on demand destruction."
Looking back, the thrust of this prognosis – basically, being guardedly bullish – proved to be on the money. While I was optimistic, I was cautious enough to point out the downside risks, some of which – Europe and commodity price inflation – materialised. But none of the problems proved fatal to the cyclical upturn in the US or globally although Europe has returned to recession. The US equity markets held their own as a result.
Mid-year, I think my outlook looked the worst. The only hurdles that didn’t come to a head were municipal problems and the currency wars. Commodity price inflation did create demand destruction. Europe’s sovereign debt crisis worsened considerably. And Housing double dipped. That’s when bad things could have happened. Europe and the US avoided the most egregious policy errors and recovery has continued.
Will the outlook be as benign in 2012… or better? Stay tuned. I will cover this in one of my first newsletters. Look for more information on launch early next year.
Happy holidays. Be safe.