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Beware the Second Leg of the Next Great Recession

http://www.fool.com/investing/value/2009/11/23/beware-the-second-leg-of-the-next-great-recession.aspx

Richard Gibbons
November 23, 2009

There's no doubt that there are green shoots in the economy. The housing market, which brought on the crash, may finally be starting to recover. Housing stats bottomed in January, and it looks like the rate of decline of housing prices is slowing. Citigroup (NYSE: C  ) and JPMorgan Chase (NYSE: JPM  ) reported declining credit card write-offs in October. And corporate earnings aren't as big a disaster as everyone thought they'd be.

But now is not the time to be complacent.

Delusions of grandeur
Unfortunately, there's been very little evidence of a solid recovery. Sure, the financial crisis seems to be past, and the economy didn't collapse. After the turmoil that followed Lehman's failure, the government's quick actions to shore up the financial sector have convinced people that the government won't let another big bank fail. Consequently, the sheer terror we experienced last fall has faded to mere paranoia.

But beyond that, it's unclear when the real economy will recover. America's Gross Domestic Product (GDP) was plummeting, and it now seems to be flattening out, but that isn't a great indicator of a recovery. It's almost inevitable that without a complete financial collapse, GDP won't keep shrinking for long. A big part of the decline in GDP has owed to inventories, which have been plummeting since October last year. But manufacturers eventually have to increase output, or they'll run out of widgets to sell, and that boosts GDP figures.

What's more, the government has been throwing money at the economy to try to reverse the vicious cycle of layoffs resulting in lower corporate sales, which in turn lead to more layoffs. This, too, props up GDP, so it's not really surprising that GDP seems to have bottomed.

The key to recovery
But funding a recovery with huge government spending and massive debt is like using a defibrillator to treat a heart attack. It can work well in short doses, but it's completely unsustainable over the long term. Maybe General Motors, Ford, Toyota, and Honda (NYSE: HMC  ) aren't complaining about the 30% boost to car sales in August as a result of the Cash for Clunkers program. But does anyone really believe that demand will be sustained through the end of the year?

The government isn't the key to recovery. Neither are corporations. Consumer spending is what really matters, accounting for 70% of the GDP. But right now, consumers are acting as cheap as a Congressman who has to spend his own money.

Americans seem to have finally realized that taking on a third mortgage to buy a second 74-inch TV for the bathroom is not a sensible decision. Household debt, which has been steadily rising since the 1950s, has actually started to decline. And consumer confidence, while improving, only looks good when you compare it to the all-time lows it hit in February.

But why should consumers be confident? The unemployment rate is 9.5%, just off a 26-year high. As if that weren't bad enough, 1.3 million Americans could exhaust their unemployment benefits before the end of the year.

And you expect consumers to help the economy rebound? Good luck with that.

Mixed messages
Insiders are nervous. According to TrimTabs, the ratio of insider selling to buying in August exceeded 30, the highest level since TrimTabs started measuring the statistic in 2004. Companies as diverse as GameStop (NYSE: GME  ) , Celgene (Nasdaq: CELG