January 2009

“Are we there yet?”

These days, anxious investors must feel like carloads of fidgety kids on their way to some far-flung locale. They wonder, where are we on this trip through the worst recession since the 1930s? And when will we finally round the corner toward economic recovery?

We’ve been on this road for some time. The current recession began in December 2007, according to the National Bureau of Economic Research, the private organization that keeps tabs on the business cycle.

But the trip ahead could be just as long.

The next expansion is unlikely to start before the fourth quarter of this year, says Paul Kasriel, Northern Trust’s director of Economic Research. He projects that real gross domestic product (GDP) — the gauge of the economy’s health based on what and how much people and companies produce in the United States — will contract by 2.5% on an annual average basis in 2009. That would make the current recession the longest, in terms of a one-year decline in real GDP, since World War II.

Road to recovery
What will it take to spur the economy and financial markets toward that recovery?

Two things are essential, says Northern Trust’s economic experts: 1) Credit needs to flow; and 2) U.S. and foreign households, businesses and governments need to increase spending.

For that to occur, lending and credit markets must function again so that people and businesses can get loans. And incomes, profits and tax revenues must grow, all helping restore economic confidence.

But we’re not there yet.

Consumer spending, which accounts for more than two-thirds of total U.S. economic activity, remains weak as income growth slows and household wealth falls. Businesses faced with leaner times are cutting inventories, spending and payrolls. And export demand is dropping, reflecting the overseas slowdown.

That leaves central banks and governments as the spenders of last resort.

The Federal Reserve has been exploring “creative” use of its balance sheet, including spending aggressively by purchasing mortgage-related and other asset-backed securities, ensuring funds flow for car loans, credit cards and student loans, and slashing interest rates to virtually zero. It also is working with the Treasury department on other inventive ways to lower home loan rates further and make new jobs.

Mapping a plan
One way the government can help jump-start consumer spending and shore up the economy is by creating jobs. That’s central to President Barack Obama’s proposed stimulus package, which is expected to make the largest new investment in infrastructure, such as roads, bridges, water supply and telecommunications, since the 1950s.

A large portion of this package is expected to flow to infrastructure projects that can improve the nation’s ability to produce goods and services in the future. Tax cuts, on the other hand, are expected to support consumer spending.

Ultimately, the government expects these efforts to rebuild confidence among businesses and workers, who will spend again and drive the economy toward its destination: recovery.

It’s still too early to call an end to the bear market, Northern Trust’s economists say. While some necessary ingredients for a market bottom and eventual recovery may be coming together, we’re not quite there yet.