Is Another Recession Just Around the Corner?
by Joseph A. Monaco, Ph.D.
Registered Principal - RJFS

"63% of Americans believe that the U.S. economy will never recover to the growth rates America has experienced in the past" said a CNBC report on June 13th. Hearing this report perked my ears because I vividly recall when a similar poll in 1999 said that 65% of Americans believe that the U.S. will not experience another recession during their lifetime. The propensity for people to so quickly grab on to the belief that whatever we are experiencing today will forever be the norm never ceases to amaze me.

2011 began with "green shoots" of optimism springing up everywhere. But then the uprisings in the Middle East, the sudden rise in gasoline prices, war beginning in Libya , a tsunami hitting Japan and a slowing of job growth in the U.S. have brought on a return to the fear of "a double-dip" recession. Given this sudden and pronounced return to pessimism it is no wonder that up until about a week ago the stock market was experiencing its worst quarterly performance in a year. The second quarter of 2011 saw the S&P 500 decline 0.38%, bringing its year to date return to 4.97%.

Recessions are serious events and should not be taken lightly. Recessions cause many people to lose their jobs and subsequently their homes. They cause investors to lose money on the declining value of their assets. Worst of all, they tend to arouse fear, inhibiting people from venturing out in an attempt to realize their hopes and dreams.

So while we should always be concerned about the possibility of a recession, we at Monaco Capital Management thought we would take a moment to answer the most frequently asked questions put to us about our economy's future.

Will the growing U.S. government debt and the ongoing debt ceiling debate cause the collapse of the U.S. economy?

According to a July 2010 study published in The Princeton Press by the renowned economists Carmen M. Reinhart & Kenneth S. Rogoff, this is putting the proverbial cart before the horse. According to Reinhart/Rogoff, contrary to common belief, excessively high debt levels when compared to GDP do not cause economic crises, but instead are historically the result of economic crisis. Specifically, according to their report the current high deficit in relation to our GDP stems from the 2008 financial crisis. While their report goes on to show that a when a country's debt level reaches 90% of its GDP it does result in significant structural problems for that nation if not dealt with over long periods of time, those debt levels do not cause the kind of damage in the short run that seems to be the current concern.

Isn't it impossible for the economy to grow without a vibrant housing market?

We all want to see the return of a strong housing and construction market. But it is possible for the economy to grow in its absence. In 2006 new home construction accounted for 6% of our nation's GDP. In 2010 that figure dropped to a paltry 2.7% of our GDP. But, according to the Bureau of Labor Statistics (BLS) over that same time period nominal U.S. GDP increased from $13-trillion to $16-trillion. So our economy can and indeed has grown without a strong construction industry. The good news is that even without a return to a growing housing market, simply a leveling out of real estate would give our nation a real "shot in the arm" by ending the considerable drag that the housing decline has been to our economy.

Job growth has been awful! The lack of jobs will certainly throw us back into a recession, right?

This is a touchy one because the answer is both yes and no. Job growth has been less than one would expect coming out of such a deep recession. And yet, according to the BLS we have added between1.5 and 2 million jobs in the past year. So while job growth has been slow it has not been nonexistent. And there is an interesting anomaly occurring in the current recovery that we haven't seen in previous recoveries. Although new job creation is occurring slowly, the average hours per week worked are increasing at a pretty vigorous pace. Simultaneously with this we have seen a steady increase in the average pay per employee hour. When you multiply the additional work hours per employee by the increase in pay per hour we see an increase in worker income in line with what has been experienced during previous recoveries. I'm not sure what conclusion to read into this statistic but it is nonetheless interesting and portending of something that may be important. Certainly something on which to keep an eye.

Won't the rise in energy costs eat up so much of everyone's income that it will derail the recovery?

Quite frankly, this is my biggest concern. Mainly because all of the previously listed problems are solvable. This one, not so much. The Earth's population grows every day. This causes a constant increase to the world's energy consumption. Unfortunately the world is restricting development of current energy sources (read oil, coal and natural gas) and every alternative energy source (read wind, solar and bio-fuels such as ethanol) are so costly and inefficient (windmills for example do not produce a significant amount of energy when compared to the cost of building and operating them) that they do not appear to be viable short to intermediate term solutions. Tack on to this the change in perception of nuclear power safety in the wake of the disaster in Japan and the problems become ever-more clear. This long-term scenario is what caused Monaco Capital Management to increase our clients' investment exposure to the energy sector two years ago. If in the near term energy prices can stabilize at current levels then the toll on future growth should subside. However, the world's economy does seem to be at risk to a continuation of the swift and significant rise in prices we have seen so far this year. For now the rise in energy costs have slowed the economic recovery and that slowdown has subsequently brought down energy costs. In the short term, the free market seems to be solving its own crisis. Hopefully the free market will be as effective in the long term.

All in all, both the U.S. and the global economy took some significant "body blows" during the first half of the year. So far the world has surprisingly been able to absorb those shocks while maintaining at least some measure of economic growth. Currently, we agree with those economists at the U.S. Federal Reserve who see an economic recovery occurring with a bit more vigor in the second half of 2011. We believe the decline in stock prices experienced in the second quarter have mostly "priced in" the resulting problems of a slowing economy. Should we be correct that a resumption of a more robust world GDP growth occurs in the second half of the year, then a significant rise in share prices would be expected to follow. Of course while we expect to see that recovery, the potential problems stated above are real and do require constant monitoring.

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. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. 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. There is no guarantee that any forecasts made will come to pass. The S&P 500 is an unmanaged index of 500 widely held stocks that's generally considered representative of the U.S. stock market. Specific sector investments, where companies engage in business related to a particular industry, like Energy, are subject to fierce competition, the possibility of their products and services being subject to rapid obsolescence and limited diversification.