Last week's news that business inventories and industrial production are rising suggests the recovery is improving along the well-worn lines followed by previous exits from recession. Production and inventories rise, eventually driving improvements in employment. That in turn triggers a "virtuous cycle" of renewed consumer spending that powers further production increases, and so on. But unlike the previous recessions in 2001 and 1991, there are five potentially significant "potholes" in the road ahead, any one of which could thwart the recovery.Lest you reckon me a perma-Bear, note that I have already made the case here for an overdue winter 2010 correction in the stock market, which could be followed by a renewed Bull run up to the elections in November.
Despite the positives being reported, these five issues are so vital to continuing global and U.S. growth that any one of them could impact the recovery story severely enough to wilt the green shoots.
1. Employment continues to decline. As I reported here in December, the actual number of unemployed wage earners is far higher than the headline rate suggests. This is due to several reasons, including under-reporting of self-employed people who are essentially unemployed but cannot draw unemployment benefits, and the statistical results of people withdrawing from the labor pool. This reduction in the total workforce in effect lowers the unemployment number, but that doesn't mean any jobs were actually created.
Even though continuing unemployment claims are declining, there is no way to tell if this is the result of people exhausting their benefits and thus being dropped from the count, or if jobs are in fact being created.
If we look for evidence of actual increases in the number of jobs being created, we find precious little. One place where new job growth would likely show up first is small business. Yet the National Federation of Independent Business (NFIB) report, Small Business Economic Trends, offered little cheer for those looking for rising employment.
According to the report, 10% of the small business owners increased employment, but 22% reduced employment -- hardly a positive trend. Optimism and capital spending were both down as well.
In other words, it's simply not enough that the statistics show fewer people drawing unemployment benefits There has to be a true increase in the number of people drawing paychecks. If that doesn't happen soon, then the "recovery" story would be revealed as more empty promise than solid increases in household incomes.
2. Commercial real estate (CRE) foreclosures continue rising, causing more banks to go belly up. As I reported here in the New Year, commercial real estate has lost 40% of its value and, as a result, CRE has the potential to push the banking sector into a new round of failures. The perception of renewed risk in real estate and banking could lower consumer and business confidence in the recovery and sap construction and other activity that depends on robust a CRE sector.
3. Residential real estate's advance could halt. The Federal Reserve and Federal agencies have provided unprecedented support of the nation's housing market, in effect propping up both the mortgage industry with direct purchases of mortgage-backed securities and credits for new home sales.
Some experts see the winding down of this Federal support as a reason for interest rates to slowly rise -- bad news for a housing market dependent on super-low rates -- and for new home sales to weaken. Others look at 350,000+ option-ARM (adjustable rate) mortgages, which are slated to reset as a factor that could weigh on a stubbornly high foreclosure rate.
Any weakening of the market wouldn't help the foreclosure rate, which hit a new high in 2009. Though foreclosures appear to have topped in July 2009, delinquent loans continue to pile up in many key markets.
Were housing values to turn down again as these experts anticipate, that would negatively affect both household assets and confidence.
4. China's real estate bubble pops. Analysts are increasingly alarmed by skyrocketing real estate prices in China. As values leap higher every month, the chances of the bubble bursting increase accordingly. China's loose monetary policy and massive stimulus spending have driven up real estate and other assets, but central government attempts to "talk down" speculation have had little effect.
A sudden decline in real estate valuations in China would call into question the premise that China's insatiable appetite for commodities will be the driver of global growth; if building slows, so does demand for steel, cement, aluminum and oil/coal.
Though the consequences may be modest in terms of U.S.-China trade, such a collapse in the "China story" could trigger a meltdown in global stock markets, including the U.S. markets. Such a global downturn in equities and commodities would dent the "animal spirits" behind the recovery -- consumer and business confidence that new borrowing and spending will be rewarded with rising valuations and sales.
5. U.S. Sales and income taxes keep declining. For many analysts, the only true measure of economic activity is sales tax, as the other numbers like GDP and unemployment are finagled with dubious adjustments and methodologies. Unfortunately for the "recovery story," sales tax revenues continue downward.
In Pennsylvania, for example, sales and corporate taxes were off 7% in December, and personal income tax declined 1%. Though rising industrial production suggests the recession has ended or is ending, declining sales taxes are not evidence of increasing retail activity.
This decline in sales tax matched the national totals as reported by the Census Bureau at the end of December: a 7% decline in state and local tax revenues.
If the consumer doesn't show up at the recovery party, it's bound to be a drab affair.
Five Potential Potholes on the Road to U.S. Recovery