Leaders in the financial sector are shifting their investment strategies based on the increased risk the United States is heading toward a second recession.
In its November “On the Markets” newsletter for investors, Morgan Stanley Smith Barney (MSSB) reports that “the odds of recession in the US and the rest of the developed world are uncomfortably high,” and that the firm is reducing the total risk in its asset portfolios as a result.
How likely is a second recession? The Economic Cycle Research Institute’s “Leading Diffusion Index” is currently at a point so low that only once since 1949 has a recession not followed the economy being in this position.
Other voices in the financial sector say the risk of a second US recession is small.
Given that the economic outlook is sufficiently negative for a major financial leader such as MSSB to make the biggest change in its asset allocation in two years leads us to consider the economic and political implications of a double dip.
Politically, the failure of the Obama Administration’s stimulus bill should be clear for all to see, although its remaining defenders cling to the argument the bill saved the country from an even deeper recession. Such arguments probably hold little sway with the 14 million Americans who are today looking for work. Recall the Administration claimed the stimulus bill would prevent unemployment from surpassing 8% (today it is 9%, while in California it is 11.7% and in Nevada it is 13.4%). It has been above that since mid-2009.
Perhaps one of the reasons we see critics complaining of a lack of leadership from the White House on the economy is that when it comes to its fundamental economic policy, the Administration is out of bullets.
Massive new spending along the lines of the first stimulus bill is out of the question as gross federal debt just passed $15 trillion – a 50% increase since 2008. The growth in federal debt, combined with the failure of Washington to change its trajectory, resulted in the recent downgrading of federal debt and threatens a second such downgrade.
Additionally, businesses remain spooked by the growing federal regulatory burden and future uncertainty associated with the President’s health care bill, Dodd-Frank, EPA actions on climate change, and so on. The new laws aren’t bad news for everyone: the law firm Bingham-McCutchen’s latest advertising campaign seeks to bring in new clients who are particularly concerned about the legal exposure created by new federal legislation and regulations.
In short, the massive growth of federal debt and regulations are leaving President Obama with few options to lead on the economy unless he fundamentally changes his approach..
The economic implications of a second recession are intensely unpleasant to contemplate. Unemployment is already high while consumer confidence, housing values, and overall growth remain stubbornly low. A second recession by definition means negative economic growth, and by extension millions of additional Americans thrown out of work.
For states with high tax and regulatory burdens (California and New York come to mind), a second recession is likely to have a more pronounced negative effect. In times of growth the overall health of the economy is often enough to mask the total tax and regulatory drag which big state governments create. In tougher economic times when employers are faced with “sink or swim” decisions, CEO’s are more likely to consider or re-consider moving to states with lower tax and regulatory burdens, such as Texas.