10% Unemployment not enough to derail recovery

When I wrote my article entitled “SLUGGISH RECOVERY, GOOD FOR INVESTORS” in July before I went on my summer vacation, many “gloom and doomers” thought I was crazy.  In fact I was bold enough to predict an 11,300 Dow for the end of September.  That was on July 21 when the DJIA closed at 10,120. We are not quite at 11,300 yet but the DOW closed up at 10,860 last Friday, September 24, 2010.

The direction of the market is really not hard to predict.  Now that the NBER has ruled out a double dip recession, stock prices will keep going up unless there is a new recession.  Yes there will be days when stocks will go up, down and sideways but investors will continue to be bullish if the economy is still expanding.  1% to 2% GDP growth is good enough to continue an upward trend in stock prices.  This statement is easily proven.  In the beginning of the year, many economists predicted the economy to grow 4% to 5% this year.  The projection had been revised downward several times and stocks tumbled each time the lower projection was announced.   The knee jerk reaction of investors is to dump equities in favor of bonds and tangible assets upon hearing a lower growth rate.  Then investors become accustomed to the sluggish growth, after which they start buying stocks again.  The bullish trend will not stop unless there is another recession.  Even if there is negative growth in one month, 2 months or even in an entire quarter if the economy recovers again in subsequent months to show growth in GDP, the market will come back.  There will be fluctuations and corrections in the market but the sophisticated investor will remain invested in equities unless signs point to another recession.  At the risk of repeating myself, commodity prices are up, corporate profits are up, many publicly held corporations including numerous financial institutions have resumed paying dividends because of their huge profits, many publicly traded stocks of companies in a wide assortment of industries have hit a 52-week high.  These are not signs that there is another recession just around the corner.  Another proof is that inflation is back.  It means that the deflationary period is gone and the economy is starting to heat up again.  Foreclosures are up and housing starts are down, but this is a normal cycle after homeowners enjoyed double digit increases in home prices for many years.

The not so rosy sector of the economy is the high unemployment rate.  1% to 2% GDP growth will only make a small dent in the unemployment.  We need 8% GDP growth like in the Reagan expansion years to reduce unemployment to 5%.  Many economists are of the opinion that the reason for the high unemployment rate is the reluctance of small businesses to invest and expand because of the uncertainty in taxes and new regulations.  I disagree with their opinion.  In a free market economy like ours, the desire to make money is so intense and the chance of success is so high compared to a government controlled economy that most smart entrepreneurs will not postpone their plan for growth and expansion just because of regulations and a few percentage increase in taxes.  However, I agree with Rep. Paul Ryan (R-Wisc) that keeping the Bush Tax Cuts and reducing spending will accelerate business investments.  Paul Ryan who is a ranking member of the Congressional Budget Committee and Ways and Means Committee is a Reagan conservative who is touted as a rising star in the Republican Party and possible nominee for the 2012 presidential election.

Now that the “great recession” is over, it is wise to review what caused it.   The NBER, a historical recorder of past events declares the recession started in December 2007 and ended in June 2009.  The “great recession” was caused by the consumer who stopped spending, caused by worries of the stability of the banking and financial system, caused by massive default of derivatives issued by the financial institutions, caused by the housing bubble burst, caused by massive default of homeowners in payment of their mortgages, caused by increase in mortgage rates and high fuel prices. What could be so simple?

I went to a party last Saturday night.  The state of the economy became the dominant subject of conversation because many of the guests were sophisticated entrepreneurs and economists.  I found that the adage “ask 10 economists a question and you will get 10 different answers” is really true.  Most of them disagreed on the state of the economy and how to “fix” the nation’s economic problems.  However, the wife of the CEO of a popular restaurant chain offered her solution in the form of a question in between sips of mimosa.  She asked “why doesn’t Obama give every American citizen, man, woman, child $100,000 each?  If the population of America is now 350 million, wouldn’t one hundred thousand dollars for each person cost much less than the new stimulus of 50 billion dollars the Obama administration had been dangling about? “It suddenly became quite, although some of the party goers dismissed “her solution” with some condescending remarks.  I quickly excused myself, went to the men’s room, locked myself inside a stall and pulled my new iPhone which has a calculator. Lo and behold, $100,000 x 350 million is indeed $35 billion…less than the $50 billion Obama stimulus package. When I came out of the men’s room I was surprised that most of the guests continued to discuss and debate her solution.  A CFO of an oil refining company said her idea is great because those who deserve the money will find a way to legally take the money away from those who do not deserve it. To me, the idea of this lady, a trophy wife who is relegated to ribbon cutting ceremonies and home decorating made as much sense as ideas from her husband and the other guests.

This article is not intended to provide financial advice.  Please consult your financial advisor before acting on any advice provided herein. Any opinions and views expressed herein are the sole responsibility of the writer

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