Rebel Traders - Stock Market and Economic Analysis

Bearish commentators have been insisting heavily on the lack of resumption in consumer spending to justify doubts on a US recovery, or even the possibility of a double-dip recession by 2010 (other commentators have ascribed a possible double-dip to hyper-inflation, so you can make your choice in the matters of bearish scenarios).

However, an important factor that might be missed is the increase in US savings. In a recent interview,  Jim McCaughan, a representative of Principal Global Investors, pointed out some elements to give a more nuanced image of the US economic situation.

Whereas he believes that a number of smaller banks shall not be able to survive the losses on RE loans, he points out that the larger banks have been adequately immunized by their capital raise. While a lot of reservation can be expressed as to his assessment that US large banks are “transparent”, it remains that the logic of “too big to fail” holds true.

However, McCaughan also points out that the short-term perspectives might be bleak for the economy, considering that the high savings rate also means less consumer spending. But and that’s a point worth noticing, he also points out what I’ve been considering as a “paradigm change”. The high rate of savings is a negative aspect if you take a keynesian perspective; in a monetary perspective, a high rate of savings means more money available for investment.

The danger in considering only the negative side of the hike in savings is of missing the formidable paradigm change and the chance for the US economy if no other issue adds up on to the current predicament.

The reduction in spending means of course a reorganization of the economy and an evolution of the various sectors in order to adapt to more frugal consumers and to use to the best the cash made available by the savings. For one thing, this cash could help to absorb a part of the US debt nationally, and it might be invested into the development of new technologies or sciences. On the whole, once the necessary adjustments done, the economy could emerge stronger, with a strong investment arm (provided that the banking culture is reordered towards longer-term objectives rather than high short-term returns), and provided the necessary steps are taken, with a new industrial sector.

However, precisely because the recession has been accompanied by enormous productivity gains, it should not be expected that personnel is going to be hired in droves any time soon. These same productivity gains and cost-cutting could give some additional surprises in the upcoming earnings season, despite the more or less tepid recovery seen so far.

But the mix of high productivity, the high level of savings and the painful social differences between the “have” and the “have-nots” will make it imperative for the US to develop a social policy at the government level to handle a social rift that might become only more pronounced.

The U.S. economy’s recovery from its worst recession since the 1930s will be helped as savings climb to the highest level in 24 years, according to Jim McCaughan, the chief executive officer of Principal Global Investors.

Americans will keep up to 9 percent of their disposable income in the bank, the most since 1985, said McCaughan, who oversees $201 billion, in an Oct. 2 interview. While less spending will cut U.S. growth and profits at retailers, it will make the expansion last longer by reducing household debt and the nation’s trade deficit, he said.

“You’re going to see a pretty tepid recovery,” McCaughan said in New York. “You’ll have a less leveraged personal sector and financial sector. You’ll get growth. It won’t be 5 percent, it will be 2 percent. That isn’t so bad.”

The outlook echoes predictions from Richard Clarida of Newport Beach, California-based Pacific Investment Management Co. and Gary Shilling, president of A. Gary Shilling & Co. in Springfield, New Jersey. Clarida, whose firm runs the world’s largest bond fund, estimated the savings rate may exceed 8 percent. Shilling said Americans are on a decade-long “savings spree” that will restrain the economy. Both spoke in Bloomberg Radio interviews last month.

Consumers lost $9.67 trillion of wealth last year as the housing bubble burst and the Standard & Poor’s 500 Index fell 38 percent, the most since 1937. The declines spurred them to push savings up to 5.9 percent in May, the highest since 1998. The rate slid to 3 percent in August, above the three-year low of 0.8 percent in April 2008, Commerce Department data show.

Belt Tightening

Only 8 percent of U.S. adults plan to increase household spending, almost one-third will spend less, and 58 percent expect to “stay the course,” according to a Bloomberg News poll from Sept. 17. More than three in four adults said they reduced spending in the past year, the survey showed.

(…)

“You need a more balanced economy,” McCaughan said. “Consumer spending got to 70 percent of the U.S. economy. That’s actually unsustainable.”

The median economist surveyed last month by Bloomberg forecast U.S. growth of 2.4 percent next year and 2.9 percent in 2011. That compares with the gross domestic product expansion that exceeded 3 percent in 2004 and 2005 as consumers used cash extracted from their real-estate holdings to fuel spending.

More Failures

McCaughan predicted more failures at smaller banks as they struggle with mounting losses on real-estate loans. Larger lenders have been strengthened by government cash infusions, he added. Almost 100 U.S. banks have collapsed this year, the most since the savings-and-loans crisis of the early 1990s.

“There will be more land mines” in regional lenders, McCaughan said. “The large U.S. banks have been very good at being transparent. They’ve raised a lot of capital, so I think they’re in fundamentally quite a strong position.” (…)