Musing on the Markets : US Consumer

Beyond the Sound Bite: An Interview with Michael J. Mauboussin

Vinny Catalano, CFA — Tue, 03 Nov 2009 20:51:00 GMT

In my latest interview with the Chief Investment Strategist for Legg Mason Capital Management, we discussed a bottom-up view of the markets, the sustainability of the US economic recovery, and key segments of his new book: "Think Twice: Harnessing the Power of Counterintuition", including concepts such as decision making danger zones.

The length of the interview is 14 minutes 10 seconds.

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Vinny Catalano, CFA, Global Investment Strategist with Blue Marble Research publishes the "Sectors and Styles Strategy Report" newsletter, which contains the market beating Model Growth Portfolio. To learn about subscribing as well as other benefits, click here.

Beyond the Sound Bite: An Interview with Susanne Trimbath, Ph. D.

Vinny Catalano, CFA — Wed, 09 Sep 2009 15:26:00 GMT

My interview with the CEO and Chief Economist of STP Advisory Services includes her libertarian perspectives on the virtuous circle, the risks in the Fed's exit strategy, key consequences of financial innovation, and the next global financial crisis: public debt. Dr. Trimbath is also the author of "Beyond Junk Bonds: Expanding High Yield Markets".

The length of the interview is 18 minutes 28 seconds.

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The End User Dilemma

Vinny Catalano, CFA — Wed, 19 Aug 2009 03:02:00 GMT

Back on August 3rd subscribers to my weekly newsletter - Sectors and Styles Strategy Report - read the following:

"China may become the bigger fly in the bullish ointment. Unlike the US, China has spent all of its stimulus package money not on consumer demand related areas (where it is most needed) but on more infrastructure projects. Since the US consumer is and will remain in balance sheet repair mode for a while and developed economy consumers (Europe and Japan) reluctant and/or unable to pick up the slack, end user (consumer) demand must materialize from emerging economies. With savings rates very high in China and other developing economies, expectations of V-shaped global economy recovery of a sustainable nature (meaning balanced and asset bubble free) seem fairly unlikely.

Therefore, a close eye should be kept on China and the very real prospect that a bubble burst may occur in that country. Should such an event occur, the global growth story becomes highly suspect, and equity values based on a global V-shaped recovery and expansion very problematic."

At the end of the day, somebody has got to buy something from someone else. The government may be the lender of last resort but it is not the buyer of last resort. That title belongs you and me - the consumer. And, despite its best Keynesian wishes, the prospect of demand being a guaranteed result of fiscal stimuli remains an unresolved mystery. Therefore, as helpful as next year's conveniently politically-timed US stimulus package will be, it cannot be, nor should be, counted on as lifting the world economy out of its end user dilemma. Moreover, government schemes like "cash for clunkers" get you only so far. They're like a life preserver keeping one's economic head just above the water, and nothing more.

Investment Strategy Implications

When stocks moved away from the abyss a certain sense of relief was taken to a modestly enthusiastic extreme. The more optimistic drank the valuation kool-aid of born again bullish investment strategists. "The more things change, the more they remain the same" became the mantra as business as usual replaced the panic-driven mindset - business most unusual.

With the past few days of market decline, perhaps reality will begin to sink into the valuation equation. Hopefully (but not likely), the vital focus on what is necessary for a sustainable global economic recovery will take center stage. And with it a concentrated effort to appreciate the end user dilemma.

Beyond the Sound Bite: An Interview with Donald Rissmiller

Vinny Catalano, CFA — Wed, 11 Feb 2009 15:40:00 GMT

In my second interview with the Chief Economist at Strategas Research Partners we explore the probabilities of multiple economic Ws, the importance of monitoring interest rate sensitive industries, capex for signs of economic stability, and the multiplier effect of the monetary and fiscal stimulus, and the need for global coordination of economic stimuli.

The length of the interview is 12 minutes 48 seconds.

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A Most Dangerous Inflection Point

Vinny Catalano, CFA — Tue, 06 Jan 2009 15:51:00 GMT

“If we don’t act swiftly and boldly, we could see a much deeper economic downturn that could lead to double-digit unemployment.”
President-elect Barack Obama
January 3, 2009

There is a major economic battle underway pitting the resurgent Keynesian forces of President-elect Franklin Delano Obama against the monetarists and the remnants of the laissez faire/supply side crowd. To exemplify this policy struggle, consider the following two recent quotes from Paul Krugman:

“The biggest problem facing the Obama plan, however, is likely to be the demand of many politicians for proof that the benefits of the proposed public spending justify its costs — a burden of proof never imposed on proposals for tax cuts.”

“(Milton) Friedman’s claim that monetary policy could have prevented the Great Depression was an attempt to refute the analysis of John Maynard Keynes, who argued that monetary policy is ineffective under depression conditions and that fiscal policy — large-scale deficit spending by the government — is needed to fight mass unemployment. The failure of monetary policy in the current crisis shows that Keynes had it right the first time.”

To help complete the picture of this economic/political battle royal we have the factions of the newly empowered Democratic Party and its liberal wing seeking to spend the political capital they think they have earned courtesy the recent election results. Then, on top of all this is the stickiness of Washington business as usual and the reality that entrenched power is rarely ceded without a fight.

Needless to say, the task before Mr. Obama is daunting. And we will all learn if his campaigning skills can be translated into effective policy decisions.

Investment Strategy Implications

The central question is not whether all the money being thrown at the global economy (both fiscal and monetary) will produce positive results. It will. Rather, the key question is whether the policy actions under vigorous (and potentially divisive) debate involving trillions of dollars ends up stabilizing and then turning things around or merely mutes the decline to an era of lessened living standards and a lower quality of life. If the former, a new era of growth ensues. If the latter, get ready for the Great Depression II and a highly dangerous future.

Krugman and El-Erian in the Valley of FUD

Vinny Catalano, CFA — Wed, 19 Nov 2008 12:43:00 GMT

In his excellent book, “When Markets Collide”, PIMCO chief Mohammed El-Erian writes about the journey and the destination that the global economy and markets are undergoing and puts in context and helps clarifies much of the current economic and financial chaos. In it, Mr. El-Erian describes a world that will be but is clear to note that the process of getting there may be “bumpy”.

Nobel laureate Paul Krugman points to the same concept in his blog posting yesterday (“After the Stimulus”) in which he lists the components of the US economy for 2007 and their averages from 1979 to 2007. As the accompanying table from his blog shows, the economic mix of the US economy got to be quite imbalanced primarily due to credit inspired high consumption levels by the US consumer. In the process, net exports became the counterbalancing force*.

As El-Erian declares in his book, a transformational world (economic and financial) is inevitable and has been underway for some time (long before the current credit and now economic crisis). And Krugman states, “Consumption probably isn’t going back to a 2007 share of GDP — savings are back. So what will fill the gap, once the stimulus is gone? Housing? Not for a long time. Business investment? Hard to see why. The natural thing would be to trade lower consumption for a smaller trade deficit.”

It is logical to assume that the US economy will experience two mega trends in the coming years:

• US consumer spending will fall while US consumer savings rise (aided by the baby boomers’ need to provide for their retirement years now that the wealth effect has gone kaput) • Net exports will improve as global growth, particularly in emerging markets, continues to expand (certainly relative to developed economies)

It is also likely that non-residential investments (capex) will move closer to their average as corporations retool to meet the global export opportunities while government spending will increase as the US government seeks to stabilize the US economy (large fiscal deficits and other government programs like TARP).

Investment Strategy Implications

The bottom line for those investors willing to look beyond the valley of FUD (fear, uncertainty, and doubt) that we are currently wallowing in is to position their portfolios (what’s left of them) to exploit these mega trends. To follow this direction, however, requires context, perspective, and perseverance – something sorely lacking in a panic stricken financial climate. *table contents

C = Consumer N = Non residential investment (capex) R = Residential investment (housing) G = Government expenditures NX = Net exports (exports minus imports)

There They Go Again

Vinny Catalano, CFA — Tue, 26 Aug 2008 10:45:00 GMT

commentary from this week's "Sector and Styles Strategy Report*: Back on February 11th I wrote a report titled “What are the Sell Side Analysts Smoking?” The commentary and report focused on the excessively optimistic outlook earnings forecasts for 2008 by bottom up analysts. Excessively optimistic in that top down forecasts were substantially below the bottom up numbers.

At the time, the operating earnings projected for the S&P 500 for 2008 was an astounding +24% over 2007’s numbers. Whereas, the top down forecasts had operating earnings for 2008 in mid $80s on down to the mid $70s.

Since then, particularly over the past two months, the bottom up forecasts have gradually ground down to reality so much so that now they have now reached the slightly negative territory of -2.4% (see Earnings Outlook on page 3 of report*).

One might conclude that for 2009 the bottom up boys and girls would factor in more of the data and analysis from the top down crowd but that is just not the case. For 2009, the numbers are equally, if not more, astounding.

According to the recent consensus forecasts, bottom up earnings growth expectations for 2009 is a whopping +26%! Even after you exclude Financials you still end up with a +13.3% number. Excluding Financials and Energy gets you to 13.8%.

And, lest you think that this dream state is restricted to the US, think again. The global numbers are a cool +18.7%, up from 2.8% currently projected for 2008. Where does this thinking come from? How do you get such optimistic numbers when most top down forecasts (from economists and investment strategists, often in the very same firms!) are much like this year – closer to 0%.

I believe a major part of the problem lies in the process by which bottom up analysts go about making their forecasts. Specifically, when it comes to making earnings forecasts, many if not most bottom up analysts have a “silo” mentality, often acting as though there were no interconnections between their defined industries and companies and the broader macro climate. To be more specific on this point, I am not talking about your basic, tradition GDP starting point but rather the thematic and trend issues that are often hard to quantify such as the credit crisis and the risk of contagion therefrom.

Investment Strategy Implications There is no news in stating that there are many risks facing investors as the last leg of 2008 unfolds and 2009 comes closer into view. Yet, what seems to be news to many bottom up analysts is the interconnectedness and impacts from thematic and global macro trend issues.

Therefore, for the benefit of those who insist on using bottom up forecasts exclusively, let me offer that the great risk for 2009 is the one I have written about time and again – credit related losses that move UP and OUT: UP the quality spectrum (within an asset group) and OUT to other asset groups, such as credit cards, student loans, auto loans, and corporate debt.

This danger is tied to the economic pain that results from deleveraging, with deleveraging not restricted to the banking industry but to the US consumer as he/she comes to terms with the consequences of a negative wealth effect and the need to repair their seriously overleveraged balance sheet. The result would be more savings, less spending, an extended period of subpar growth, and a transformation of the US and world economy away from its high dependency on US consumption.

Reliance on the traditional and the standard methodologies during times of economic transformation and change can and almost certainly will lead to faulty projections that can be very expensive.

*Published Aug. 25, 2008. Subscription required. To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

Wildfires

Vinny Catalano, CFA — Thu, 17 Jul 2008 10:45:00 GMT

It hardly instills deep confidence in our government officials when, after nearly a year, its prime modus operandi is to react to the latest financial crisis with yet another 11th hour solution. This is one of the longer term implications of the bailout plan for Fannie and Freddie.

For all the near term good that could be construed from the latest financial wildfire containment, it is hard to understand why after nearly a year Messrs. Paulson and Bernanke are still in a reactive mode. Given all the resources at their disposal and all the warnings that are plain for everyone to see, it is most disturbing to hear the hurried pitch for unlimited back stop funds for the two GSEs.

Investment Strategy Implications The Nouriel Roubini scenario where the write-down contagion spreads both up (the quality spectrum, which in the case of mortgages involves Alt-A’s, near prime, and prime) and out (to other categories, such as credit cards, auto loans, and corporate debt) is the nightmare scenario that is threatened by the reactionary mode of government. The economic dangers that $1 trillion (on up) in banking losses would produce cannot be fully measured. But what can be assumed with a fair degree of certainty is that the deleveraging process that such a credit creation contraction would generate will exacerbate an already fragile global economic and financial situation, if not tip the global economy into a depression.

Getting ahead of the curve, being proactive with a well thought out plan would go a long way toward instilling far more overall confidence in financial institutions and, thereby, likely result in stable if not higher asset values (not to mention a better level of consumer confidence).

Putting out wildfires is necessary and helpful but hardly sensible forest management.

Smokey the Bear would not be proud.

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Where's John Maynard Keynes When You Need Him?

Vinny Catalano, CFA — Thu, 10 Jul 2008 08:19:00 GMT

This morning’s testimony before Congress affords US Treasury Secretary Paulson and Fed Chairman Bernanke yet another opportunity to allay the fears of all parties interested in the health and wellbeing of the world’s economies and markets. Unfortunately, however, what is likely to be heard is more dogmatic drivel regarding the magic of the markets as the elixir that cures all ills.

Words such as “market discipline” will almost certainly be uttered by Messrs. Paulson and Bernanke today, as they cling to an ideology, “market fundamentalism” (laissez-faire or neo liberalism, if you prefer), whose time has passed. For with their adherence to “market discipline” comes the front line, the first wave of economic chaos in the form of a rolling destruction of major chunks of the financial services industry (not wholly undeserved) and the multi-dimensional feedback loop that the resulting deleveraging and radical shrinkage of the credit creation process will produce on the US (and ultimately world) economy.

Perhaps one might wonder if those on the other side of today's testimony table might provide some philosophical leadership in this highly charged political year. Guess again.

The Republicans find themselves locked in a defensive mode attempting to preserve their market fundamentalism ideology. (Supply side voodoo economics still rules this roost.) And where they are proactive is in areas that are tied to the ole timey magic of the “invisible hand” such as oil crisis = more land for drilling. No real solutions. No real comprehensive energy policy. More of the same animal spirits, magic-of-the-markets thinking.

As for the Democrats, their agenda is fairly obvious – look busy! As they appear to “fight” for the US consumer against the dark forces of cowboy capitalism and market fundamentalism their real end game is more power via a landslide victory this fall. Until then, why take more than band-aid economic action that will result in any form of a rebounding US economy when the more advantageous political objective is to pin the McCain tail on the Bush donkey?

Investment Strategy Implications

Cowboy capitalism expressed in the financial markets is market fundamentalism. They are rooted in the same philosophical thinking that has wrecked havoc on the world’s economies and markets via fat tail economic and financial crises that mega trends such as globalization, technological innovation, and financial innovation have only exacerbated.

What is needed, and getting more desperately so with each passing month, is new thinking and a new intellectual philosophy regarding government, the economy, and the markets. A good start would be a clear recognition that the philosophical underpinnings of the past two decades, the market ideology known as market fundamentalism and its economic counterpart, cowboy capitalism (replete with trickle down economics and ever resetting stock options for corporate executives), has produced radicalized results for the interconnected world economy and markets. What is needed is fresh thinking and a willingness to transform a broken system rooted in a defunct ideology. But that is not what you and I will hear today. What you will hear is regulation and half measures. But neither is a real, sustainable solution. Therefore, the only remaining question is what will it take for transformative action that will produce less radical economic and financial results? The answer might lie in a global recession to rival the one some 70 years ago. Then we may see who emerges as this century’s John Maynard Keynes.

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Beyond the Sound Bite: An Interview with Dr. Peter Hooper

Vinny Catalano, CFA — Wed, 09 Jul 2008 11:07:00 GMT

My interview with the Managing Director and Chief Economist for Deutsche Bank Securities includes the state of the global economy, prospects for stagflation in the US, the expanded role of the Fed, and the US consumer.

The length of the interview is 13 minutes 21 seconds.

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What's Wrong With This Picture?

Vinny Catalano, CFA — Thu, 05 Jun 2008 11:28:00 GMT

Someone help me out with this one.

If, as the true believers in the purity of market forces say, the price of oil is a function of supply and demand AND considering the fact the US economy consumes more oil than any other country in the world, then how does one explain the accompanying chart from today’s Wall Street Journal?

Recently, before Saudi Arabia relented to political pressure, country leaders said that there is no need to increase their output as supply is meeting demand. Moreover, according to various sources, the cost of extracting oil from the ground ranges approximately from the mid teens to $60 per barrel, depending on various cost factors including the ease of access to the crude. Therefore, as I noted in my last appearance on the Business News Network, the fair value for oil seems to be somewhere in the $80 range, if one assumes an average exploration cost of $50 plus an extra $30 (60%) for all associated additional costs and reasonable profit margins.*

That said, perhaps the following excerpt from George Soros’ testimony before Congress yesterday might help shed light on the debate re a commodity bubble and help explain $120 oil:

"Madame Chairperson, distinguished members, I am honored to be invited to testify before your committee. As I understand it, you are seeking an explanation for the recent sharp rise in the oil futures market and in gasoline prices. In particular, you want to know whether this rise constitutes a bubble and, if it is a bubble, whether better regulation could mitigate the harmful consequences.

In trying to answer these questions, I must stress that I am not an expert in oil markets. I have, however, made a life-long study of bubbles. So I will briefly outline my theory of bubbles, which is at odds with the conventional wisdom and then discuss the current situation in the oil market. I shall focus on financial institutions investing in commodity indexes as an asset class because this is a relatively recent phenomenon and it has become the 'elephant in the room' in the futures market.

 According to my theory, every bubble has two components: a trend based on reality and a misconception or misinterpretation of that trend. Financial markets are usually very good at correcting misconceptions. But occasionally misconceptions can lead to bubbles because they can reinforce the prevailing trend and by doing so they also reinforce the misconception until the gap between reality and the market's interpretation of reality becomes unsustainable. The misconception is recognized as a misconception, disillusionment sets in, and the trend is reversed. A decline in the value of collaterals provokes margin calls and distress selling causes an overshoot in the opposite direction. The bust tends to be shorter and sharper than the boom that preceded it.

This sequence contradicts the prevailing theory of financial markets, which is based on the belief that markets are always right and deviations from equilibrium occur in a random manner. The various synthetic financial instruments like CDOs and CLOs, which have played such an important role in turning the subprime crisis into a much larger financial crisis have been built on that belief. But the prevailing theory is wrong. Deviations can be self-reinforcing. We are currently experiencing the bursting of a housing bubble and, at the same time, a rise in oil and other commodities, which has some of the earmarks of a bubble. I believe the two phenomena are connected in what I call a super-bubble that has evolved over the last quarter of a century. The misconception in that super-bubble is that markets tend toward equilibrium and deviations are random.

So much for bubbles in general. With respect to the oil market in particular, I believe there are four major factors at play, which mutually reinforce each other. First, the increasing cost of discovering and developing new reserves and the accelerating depletion of existing oil fields as they age. This goes under the rather misleading name of 'peak oil'.

Second, there is what may be described as a backward-sloping supply curve. As the price of oil rises, oil-producing countries have less incentive to convert their oil reserves underground, which are expected to appreciate in value, into dollar reserves above ground, which are losing their value. In addition, the high price of oil has allowed political regimes, which are inefficient and hostile to the West, to maintain themselves in power, notably Iran, Venezuela and Russia. Oil production in these countries is declining.

Third, the countries with the fastest growing demand, notably the major oil producers, and China and other Asian exporters, keep domestic energy prices artificially low by providing subsidies. Therefore rising prices do not reduce demand as they would under normal conditions.

Fourth, both trend-following speculation and institutional commodity index buying reinforce the upward pressure on prices. Commodities have become an asset class for institutional investors and they are increasing allocations to that asset class by following an index buying strategy. Recently, spot prices have risen far above the marginal cost of production and far-out, forward contracts have risen much faster than spot prices. Price charts have taken on a parabolic shape which is characteristic of bubbles in the making."

*I realize this is a rather simplistic analysis and that factors such as global growth has been strong. Nevertheless, the primary focus is on the "fair value" of oil, which is a function of overall supply and demand. And that of course includes the global growth story. The bottom line is simply this: if one can determine the fair value of any asset, then why can't one determine the fair value of a commodity? Unless, of course, one buys the bogus argument that the current market value is the fair value.

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Tapped Out

Vinny Catalano, CFA — Tue, 03 Jun 2008 13:25:00 GMT

Commentary from this week’s Sectors and Styles Strategy Report:

I found today’s Wall Street Journal story (“Pinched Consumers Scramble for Cash”) to warrant its most viewed story of the day. To quote: “As consumers max out their credit lines and banks clamp down on lending, many older and middle-class Americans are resorting to pricey, often-risky alternatives to stay afloat. Some are depleting their retirement accounts, tapping 401(k)s for both loans and hardship withdrawals.”

Without the aid of rising real wages and the positive wealth effects of increasing home values (thereby enabling home equity withdrawals – HEWs), the US consumer, still addicted to maintaining an unsustainable lifestyle have turned not only to the aforementioned retirement accounts but to higher cost debt, such as revolving credit (most notably credit cards).

One would assume that this consumer behavior has only so far to go before sanity overwhelms the power of denial. This will almost certainly occur the longer weak real wage growth (along with a higher cost living) puts increasing pressure on the household pocket book.

And the longer this process takes, the closer it brings baby boomers to the painful reality that assets that have been counted on to supplement Social Security payments will need to be supplemented themselves. In other words, more savings less spending.

Investment Strategy Implications

The longer-term investment implications of a transformation of the US economy away from domestic consumption and more toward exports (where domestic consumption will be on the rise) is a secular play that benefits those sectors and industries best positioned to compete in that space. At present, the infrastructure build in emerging markets accrues to Industrials, Tech, Basic Materials, and Energy. However, as emerging economies realize an emerging middle class, the competition for those domestic consumer markets will be hotly contested by all developed market players (US, Europe, Japan) as well as the domestic players within the emerging economies.

For now, the focus remains on the very near term economic and investment climate. In that regard, a summer rally (albeit modest) appears in the cards. However, investors would be wise to not follow the lead of the US consumer and wait until conditions are forced upon them and change occurs. Anticipation of a new global consumer market is best considered sooner rather than later.

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W (not the movie)

Vinny Catalano, CFA — Tue, 20 May 2008 00:24:00 GMT

The economic debate seems to have settled into which letter best fits the future trend of the US economy: V, U, L, or W?

The most bullish group, which includes many in the Goldilocks-redux crew, believe in the down (maybe strong) then up US economic scenario. V for victory, perhaps. Then there is the down then flat group, differing only in whether an upturn occurs sometime in the foreseeable future. U shows eventually, L says “who knows when?”. Some days things look up versus down and dirty for longer than you think.

The last group is the double dip club, my group. The US economy rebounds this year emboldening the Goldilocks dreamers to spout out their dreams of an economic “morning in America”. Unfortunately for them, the false dawn will result in a “mourning in America” when 2009 rolls around and the tailwinds of the stimulus package give way to personal economic reality for many US consumers.

Driven by a negative wealth effect, US consumers spend less and save more for that retirement rainy day as concerns over Social Security and a diminished asset base begin to change habits. Such a change will take time, however, as the spending addiction of US consumers still has some strength to it – a strength that will likely exhaust itself in the morphine known as the stimulus package, fiscal and monetary.

Investment Strategy Implications

Oliver Stone may be working on a movie about George W. Bush titled “W”. But investors will likely spend more time next year focused on another W – the double dip in the US economy.

Short term, equities will likely continue to benefit from the dreams and hopes of the Goldilocks crew. And investors should continue to exploit that fantasy. However, a changed business model for most financial institutions will contribute to a diminished level of credit creation stimulus for the US economy, which when combined with a less profligate, more frugal US consumer will coincide with a new domestic political dynamic leaving only emerging markets to save the global economic day. And that may turn out to be more difficult than it appears.

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Beyond the Sound Bite: An Interview with Don Rissmiller

Vinny Catalano, CFA — Wed, 14 May 2008 12:12:00 GMT

In my comprehensive interview, the Chief Economist with Strategas shares his thoughts and insights on a long and shallow US economic downturn, the US consumer - credit, spending, and savings, and residential and non residential construction and lending.

The length of the interview is 17 minutes 52 seconds.

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The Economic Guessing Game Has Begun

Vinny Catalano, CFA — Tue, 22 Apr 2008 15:45:00 GMT

In the past weeks, several clear signs have emerged signaling that investors are shifting their focus away from the credit crisis and toward the real economy and traditional investment analysis. The first and most obvious sign is the earnings reports. The next two are less obvious, but are no less important – the rise in the 10 year US Treasury rate and the increasing number of comments in the media and from economists re the direction of the US economy.

The 40 basis point rise in the 10 year US Treasury rate (from 3.31% on March 17 to 3.71% yesterday*) suggests a degree of relaxation in the flight to quality panic due to the credit crisis. This modest return to normalcy apparently implies that more than a few investors buy the credit crisis end is in sight story.

The other sign that investor focus has shifted is the increasing number of real economy related stories in the media. For example, the April 12th cover story in the Economist magazine, “The Great American Slowdown”, and yesterday’s FT commentary, “Road to ruin? America ponders the depth of its downturn”, explore the depth and duration of the US slowdown/recession. All this brings us to the emerging debate of the shape of US economy slowdown/recession – V, U, L, or W?

The more bullish sentiment is a V shaped decline and subsequent sharp economic recovery. Painful, yet short. The U shape crowd, on the other hand, believes the current difficulties will linger into next year when the end of 2009 comparisons show a sharp enough recovery and return to prosperity.

The L shaped advocates foresee an extended period of economic weakness a la Japan. Then there are the W shape believers, which is the camp I occupy. Things get better for a while (thanks to the stimulus package and the sustained strength of the global growth story – yes, Virginia, decoupling has worked to a meaningful degree) only to be followed by an economic decline into 2009 for a whole host of reasons, including a withdrawal from the US stimulus and a decline in US consumer spending and concurrent rise in US consumer savings (more on this in the near future).

Investment Strategy Implications

The US economy is undergoing a transformation on multiple levels that will produce major disruptions in the financial and valuation models for equities. These more thematic issues – credit crisis and its consequences, for example – will likely alter the economic landscape for years to come thereby producing substantial opportunities and risks. One outcome will almost certainly be a redistribution of economic growth in the US away from a US consumer dominated economy and toward a more export driven model.

That said, it is advisable to cover the traditional bases. Therefore, whatever shape your US economic doughnut might be (despite the fact that the credit crisis is likely to be far from over), the time has arrived for investors to form their view on the future direction of the US economy.

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