Outlook and Market Review - Fourth Quarter 2009


The advanced announcement of 5.7% real GDP growth was surprisingly strong and exceeded the consensus estimate by over a full percentage point. Part of the robust growth occurred when third quarter growth was revised downward, moving about 1.5% from the third to the fourth quarter. While the second consecutive quarter of positive growth suggests that a recovery is underway, there are reasons to be cautious about the strength and duration of the rebound. Over half of the 5.7% growth was due to inventory adjustment. Tax credits for homebuyers along with fiscal stimulus provided higher growth. But, these one-time boosts are not representative of more normal robust growth from pent-up demand following a recession. Consumers continue to increase savings rates and repair personal wealth that was shattered by declining home prices and portfolio values. For example, the 5% decline in the S&P 500 since the start of the year has reduced household wealth by an estimated $500 billion.

The labor market shows signs of improvement but there is a long way to go before the economy climbs back to pre-recession levels of employment. The unemployment rate declined to 9.7% in January but it is unclear whether this is a real reduction in unemployment or a statistical artifact of revisions to employment data. The economy must grow at about 2.5% just to keep up with the growth in the labor force and rising productivity. Significant reduction in the unemployment rate will require growth in excess of what most analysts believe to be a sustainable level.

As long as inflation remains low the Fed will maintain a policy of low interest rates and high bank liquidity. While the Fed must eventually deal with the massive expansion of bank reserves, there is no near term pressure as long as the economy remains weak. The most likely scenario is for the Fed Funds target to remain unchanged until much later in 2010 or early 2011. Interest rates are likely to continue a trend of ticking up at the long term end of the yield curve as long run expectations call for higher interest rates and potential inflation from massive increases in bank liquidity.

The best case scenario is for a more typical recovery in 2011 if the labor market stabilizes, federal stimulus runs its course, credit flows improve, consumer confidence climbs to more normal levels, pent-up consumer demand is released, and a stronger housing market develops. This combination of events is not guaranteed and a “second” dip in growth is also possible. The bottom line is that continued and significant improvements need to be seen in the labor and housing markets before the economy can be considered out of the woods.