Emerging Asian Economies will spark economic recovery next year

November-
December 2009

by Irby J. Thompson 

I love the story of the New York City sidewalk hotdog vendor. Upon being told by Wall Street types that a recession was coming, he immediately began to cut back on ordering product. To save more money he began using a less expensive hot dog. The “sandwich board” advertising man he employed on weekends also got the axe. And finally, he discontinued the candy bars, because sometimes the last ones got a bit stale. And sure enough, it wasn’t long before the recession arrived. Sales fell and profit along with them. Before it was all over, the vendor wound up being the “sandwich board” man for another hotdog vendor who, upon hearing about the impending recession, had branched out and added gourmet coffee and polish sausages to his cart.

Make no mistake about it – Gloom and Doom is powerful stuff. It sells. And that alone should tell you that there is a good argument to be made that being bullish about 2010 may just be the better perspective. What are the reasons to be optimistic about the economy and the market next year?

First, there is the big global picture.

Bill Gross, head of PIMCO, the world’s largest bond manager, made an observation several years ago about global macroeconomics. He compared the entire world to North America in 1800. Because of Asia and India, the world has a huge population of fairly young, increasingly better educated people, who have never had much, are more free than they ever have been, are learning about the “better life” and are increasingly able to take their place at the table. That is a recipe for economic growth and expansion.

Critics moan that may be true, but it leaves out the good ol’ USA. That’s like saying the research triangle in North Carolina is in trouble because they don’t manufacture or mine very much there anymore. The USA has for the world what the research triangle has for the U.S. – intellectual resources and the economic benefits that flow from them.

The Economist magazine, on the cover of the recent Aug. 15th issue, spoke boldly about “Asia’s Astonishing Rebound.” The article went on to describe  the amazing resiliency of emerging economies

in Asia: China, Taiwan, South Korea, Indonesia and Singapore. These countries are sitting on a 20-year annual growth rate of nearly 8 percent — a phenomenal number. The catalysts for this growth – a more solid banking system, low consumer debt, and stronger government finances – will allow these economies to lead the world out of its current economic decline.

Business Week magazine devoted 24 pages in two late-August issues to

similar themes. The following are some of the reasons cited for being optimistic:

1. Recessions are a natural part of economic life. They shake the assets of human and investment capital loose from older, dying companies and make them available to industries and businesses with better prospects. Innovation is one of the key drivers of these changes and it is an under-valued commodity right now, especially in the eyes of the media. In the Business Week article, Bill Gates reminds readers that both Microsoft and Xerox were launched during economic downturns.

2. Another factor fueling economic growth around the world is the ongoing expansion of education and technology. These things contribute to a growing middle class in the emerging economies and make them a force for economic expansion. The statistics aren’t perfect, but the number of students pursuing post-secondary education has more than quintupled since 1970.

3. A third reason to see promise in 2010 lies in understanding some of the longer effects the current recession will have on the U.S. economy. Business Week quotes experts who compare the current recession to a forest fire, clearing out dead brush and making room for new growth – and also as the needed catalyst to get Americans to rethink unsustainable habits on spending, saving, leverage and risk-taking. Reference is made to signs of stabilization in the U.S. housing market – a key step for the American consumer to regain confidence.

4. The Business Week articles contained a column by the CEO of Thomson Reuters. In it he describes how the free-market principles of transparency, rule of law and market pricing are increasingly being adopted by the developing world. It takes certain types of citizens to make this happen, which is leading to the rise of a global professional class. As an example, historically patents didn’t exist in China – the country didn’t adopt patent laws until 1985. China now issues 30,000 patents annually, encouraging innovation by protecting property rights and providing work for 150,000 lawyers. Today, China  ranks third in patent applications, behind only the U.S. and Japan – and is expected to pull into first place by 2012.

Another instance is the rise of Islamic finance into a $1 trillion business that is growing over 10 percent annually. This was fueled by a skilled community of accountants, lawyers and financial practitioners. As these people continue to have more “skin” in the game of worldwide economic development and stability, they will serve as a counter to the destabilizing influence of radical Islamic militantism.

All of the above notwithstanding, perhaps the best reason to be optimistic about 2010 and beyond is simply the fact that economic history says it’s the reasonable position to take. Does this mean that the likes of Marc Faber, publisher of the Gloom, Doom & Boom Report could not possibly be right? No, it doesn’t, but history suggests that the normal result of freedom, stability and technological advancement is betterment in the lives of people in general, and that has always included economic betterment. It’s never a linear progression, and the downturns can be brutal in specific areas. But to the degree that freedom, stability and technology continue their influence – particularly in the developing world – the ever more connected global economy will be better off.

A difficulty most Americans have today is the same difficulty Englishmen had in the late 1700s, namely an inability to see beyond their own borders. As it turned out, those pesky, backward and troublesome colonies became their savior in later decades. Americans would do well to at least appreciate the possibility that parts of the world we know so little of today may, in our economic future, return the favor.

Irby J. Thompson is president of Wilson Price Wealth Management, LLC.

Consumer spending, commercial lending, unemployment
will hinder growth

November-
December 2009

by Fred Middleton

Do we see a light at the end of the tunnel or is it a train?  I am an optimistic person; however, the current economic situation hardly gives most of us cause for optimism.

The recent market rebound has brought hope that the worst may be behind us. While that is reason for celebration, it is the economy that drives the  markets, and this is where my optimism fails me. From my view, we could be looking at a double-dip recession ... meaning the market could head right back down.

Most people understand that residential real estate and the securities tied to the loans are the root cause of the current crisis.

The simple fact is that a large number of people involved – from the person who bought the home to the person who created the sophisticated securities that were bought and sold on Wall Street – overextended themselves. This overextension caused many banks and Wall Street firms to go to the brink of bankruptcy or to fail completely.

One of the most notable failures last year was Lehman Brothers. Its demise is the result of years – if not decades – of poor spending habits and a refusal to look at the longer-term risk. The failure of Lehman Brothers unleashed a series of rapid events that caused the stock market to plummet. The failure of Lehman Brothers broke the confidence of most investors as the market began pricing for another Great Depression.

Confidence is slowly being restored, but will it be maintained? Or has the public become numb to or blasé about our country’s current economic situation? Have we learned to accept as commonplace what would have normally destroyed
our confidence?

Our strategy at the beginning of this year predicted that 100 banks would fail in 2009, and we were right. By late October, the FDIC reported that 106 banks had gone under.

Let me put the number in perspective. In 2006, there were zero bank failures. In 2007 three banks failed, and 2008 saw the closure of 26 banks. The failure of more than 100 banks by year’s end is enormous, and economically speaking, it simply cannot go unanswered.

You can see for yourself on the FDIC’s Web site. This trend is accelerating, and has been confirmed by the FDIC.

Next year and into 2011 the banks will have to contend with a massive wave of commercial loan resets. Commercial loans were packaged into securities and sold just like residential real estate was. Properties will have to be refinanced and a large portion of them are worth far less than is owed. Adding to that problem is unemployment.

Since companies are hiring fewer workers, or worse, if workers are being laid off, there is less  spending. Earlier we noted how most things revolve around confidence. If you are not confident about your employment, I can assure you that you will not spend as much.

Our economy is about 70 percent consumer driven. Fewer shoppers translates to slower growth and fewer shops opening -- not to mention stores that have to close because of the recession. If you ride through any town, you will see shopping centers that contain businesses and employ people. Now, count the number of vacant shops. Go to bigger cities and you can count the number of vacant shopping centers.

The value of these centers, and any rental property for that matter, is based to a large degree on the occupancy of the building. Buildings with lower occupancy rates are worth less than the same center fully occupied. Values are based on cash flow, and since vacancies lower cash flow, the buildings are worth less. Any building worth less than is owed is not easily refinanced, creating a vicious cycle that feeds upon itself.

Unemployment, it is often pointed out, is a lagging indicator. This is still true. However, in today’s environment, it is also important to consider the “underemployed” and people who have given up looking for work. The official unemployment numbers don’t take this into account. In my view, we are talking about just one thing here – spending.

My guess is just about everyone reading this article knows someone who has been affected by a layoff. Even if you are never without work, knowing people without work makes you more cautious about spending. Losing a job is bad enough, but there are other factors that play into spending as well. Downward pressures on wages, and freezing raises and retirement plan matches are often used by employers to keep from laying off more workers. All of these have an impact on spending and confidence.

Right now, the average duration for unemployment is up to 25.1 weeks. This is the highest since records began in 1948. One in three workers has been out of work for 27 weeks or longer. We have a long way to go before the consumer will be confident enough to spend again. This recession is definitely causing consumers to be more thoughtful about spending.

Unemployment, consumer spending and commercial lending are just a few of the headwinds facing our economy going into the new year. For these reasons, I find myself on the bear side of the equation late next year.

I believe that the stimulus packages signed earlier this year will finally make their way into the economy and, as a result, will cause next year to  start out very positively for the market. However, I don’t think the economy will have recovered enough to sustain the market rise, and therefore I’m bearish at year end in 2010.

Fred Middleton is senior vice president, managing director for W.R. Taylor & Co., LLC.