What Do Economic Recoveries Feel Like?

Pundits, journalists and, often, the man in the street follow the herd instinct. The implication being that just like the stock market, the conventional wisdom often swing from one extreme to another. From over-optimism to over-pessimism. From over-buying a never-ending boom to over-selling the doom and gloom. The reason why a perfect market do not really exist even with perfect information is that the cognitive powers of human beings are wired to be self-affirming. In other words, we see whatever that proof us right and clever, and discount everything else that are to the contrary.

As an investor, I am forever tuning my senses so that I remember what it felt like when the world was coming to an end (Asia circa 2H 1997, Sep 2008), or when things are getting worse and will never recover (1998), Oh-my-god! we didn't see this one coming (SARS 2003, 9-11 2001, Lehmans 2008), "Wow! I can't believe every part of the world is booming" (Dot-com 1999, 2007), or "this time it is different" (every boom and every recession). Having all these gut-memory means knowing how to react the next time it happen. That is what makes a better investor.

I could even remember the early 1980s when Ronald Reagan was the worse and dumbest President ever...that the recession and unemployment would never end...deficits doubled...that Japan is kicking America's butt and this time its different. I was - what, 10 or 12 at the time? Then I remember reading about rising productivity and economic growth, the 1984 Los Angeles Olympics and suddenly it was sunrise in America. Same thing later around 1993, how US recovery snucked up while everyone was besotted with Asian Dragons. Back in 2000 in Malaysia, I remember people investing, spending and buying property while the world media were still doing capital controls and Anwar etc. Same with Indonesia and Thailand which was booming by 2003 even when the debris of the 1997 Asian Financial Crisis were still attracting all the attention. Moral of the story is that media is always reactive and and on hindsight.

The point I am getting to is that the US economy is in the middle of a significant and sustainable recovery - and this point will become obvious according to conventional wisdom around April or June 2011.

As of this month, the financial markets have recovered to pre-Lehman level (it has been close since March 2010). The stock market is usually the leading indicator. In the past quarter, the nominal size of the US economy has also begun to exceed that on the eve of Lehman Brother's implosion. In fact, by the end of September, it is 1.7% larger than in September 2008.

For the past few quarters, (Main Street) US corporate earnings have repeatedly been beating expectations. In fact, large numbers of corporations have record earnings for 2010. US corporations are reporting explosive growth in export earnings - accelerated no doubt by the weaker dollar and by demand from large parts of the world where economies are booming. Unlike in the past, to see the full picture one has to look beyond US, Europe and Japan. Corporate forecasts and earning guidance are being revised upwards - and guidances are usually conservative to ensure surprise when they report their results - so reality could be even stronger.

US corporations are now sitting on record cash reserves. When the recession began, corporates were overly aggressive in slashing their stock levels. As a result, there was massive restocking in 2009 that pulled Chinese economic recovery into record territory. China is the leading indicator in the global supply chain: the fact that China grew mightily throughout 2010 is a good indicator of what US retailers really expect on consumer demand at the end of this year. Apart from stock levels, I believe corporates also over-slashed their head count: one sign, US economic productivity continued to grow throughout the recession, which means employment was cut even deeper than production i.e. demand. Productivity, hours worked and total wages continued to grow as economy recover but employers try to squeeze more work out of existing workers. Part time workers are going up, seasonal workers for the holiday season is going up. I noticed that for the past few months, while the pundits have been focused on the current month's payroll and unemployment numbers the numbers for the preceding months were always being revised upwards. Last Friday when the news was all about the net increase of 151,000 jobs for October, less noticed was that August and September numbers were revised upwards 80,000+. That under-counting shows that the initial estimates have been too cautious. That is a good sign for recovery overall. I see the end of this year could see the tipping point when new hirings and new corporate investments return with a vengeance. Such is recovery when it happens.

Plenty can still go wrong of course. I am cautious about ill-timed cut-backs by state and local governments. The housing market is still anaemic (but not as sick as middle of the year) and de-leveraging takes time. Some European economies can still fall back. But one thing I learnt is that lately most of the bad things people worry about did NOT happen: remember Greece dragging Europe into a recession? Remember the fears of a double-dip? Remember the fears of China losing steam in early 2009? And, I believe, eventually so will the fears about deflation (and inflation) and many more fears and nerves along the way.

In fact, there will be new fears for pundits and journalists to warn about even as the papers report 4% growth, millions of new jobs in the US next year amidst continuing momentum for growth.