During periods of recession, it is right as rain for consumers, banks
and businesses to rebuild cash and cash equivalent liquidity. Since a
serious downturn can add more uncertainty to the outlook, the
rebuilding of liquidity can intensify during such times.
Real personal wages have rapidly turned positive in this quarter
as inflation has subsided quickly and dramatically. Normally, when
the real wage improves, spending quickly follows, and the desire to
build liquidity slowly wanes. So far, that has not happened, as
spending has remained weak and liquidity balances are rising. This
is partly attributable to the shock of a rapid decline in the economy
since late summer, but it may also reflect a desire by householders to
add to savings to offset sinking 401k and home values. If the latter is
so, then we might expect the period of liquidity enhancement to be
stronger and last longer than in prior recession periods, despite low
available rates on savings. The test of liquidity preference is
underway now, since the real wage has recovered quickly, with the
normal expectation of higher spending to follow now in the spotlight.
I would also say if consumers as a group plan to alter budgets to
accomodate more cash on hand to offset losses in asset values, that
stimulative monetary and fiscal programs may not be very
effective for a while until liquidity cushions are fattened further. I
would also point out since 2005, 2 million boomers cross the age 60
threshold annually, when liquidity preference naturally increases.
Banks are not liquid, and the natural process of improvement is to
allow loans to run off and liquid investments to rise. This process
has actually been slow to get underway. Banks are also taking
massive loan writedowns each quarter. This restains capital growth
and it is likely that the bulk of the rest of the TARP program will have
to be released to banks and other credit intermediaries to rebuild
capital. A big test for both consumers and the banks will come this
spring when more nearly affordable homes are prospected by
folks looking to buy (Improved affordabiltiy reflects both lower
prices and mortgage rates).
Business sector liquidity was well repaired after the 2001-02
downturn. However, my profits indicators have fallen dramatically,
and non-financials may want to further shore up liquidity if cash
flows sink as now expected.
As a recession winds down, the capital markets can rally nicely even
as sectors rebuild liquidity, as investors see such a process as normal
and healthy. The hitch comes in if consumers, banks and business
are seen as too zealous in propping liquidity, for that would mean
that recovery may be further afield then expected.
I take the dramatic weakness in the capital markets over the past 15
months as a sign that fundamental changes may be in store and that
one should treat the tried and true assumptions with more reserve.
A first stop for me vis a vis the economy is to watch consumer
spending now that the real wage has recovered sharply.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!