ON THE HIGH PROBABILITY OF MORE ECONOMIC SLUGGISHNESS

From a macro perspective there are still a few major trends dominating future economic direction – primarily the government intervention and household balance sheet recession. Over the last 18 months the clear cut driver of economic growth has been the inventory restocking and government stimulus program as households have remained weak. According to Goldman Sachs the inventories and stimulus trends have helped enormously in bolstering GDP and are now likely to become drags:

(Figure 1)

While most economists and investors have now ruled out a double dip (mainly because of recent ISM reports) the inventory effect (or lack thereof) and the waning stimulus effect are likely to reveal a private sector that is once again very weak. This negative trend is really only just picking up momentum and is going to persist through 2011. I think we are beginning to see signs of this in the ISM New Orders and Inventories data already. The New Orders to Inventories ratio rarely turns negative (as it did last month) and when it does it generally precedes economic sluggishness:

(Figure 2)

The two macro trends above are also perfectly correlated with the strength in the ADS over the last 18 months. The ADS has only just recently turned negative and is forecasting a protracted decline. If the inventory and stimulus effect (see figure 1) are consistent with this data it is likely that the economy will remain sluggish for quite some time.

(Figure 3)

While we’re certainly nowhere near March 2009 levels in terms of household weakness it is still clear that the private sector is not ready to run with the baton. But the environment is vastly improved from the lows and there are signs that the private sector is at least accommodating weak economic growth (assuming no future exogenous threats). So what we have is a situation where a technical double dip might not occur, but economic growth is likely to remain very weak given the government’s lack of aid and the private sector’s continuing healing process. Thus, the economy is likely to feel like its in recession for much of 2011 and possibly longer.