Like the Harvard and Yale endowments, the endowment at Dartmouth is feeling the pain of the slowing economy and falling market, losing 18 percent, or to $3 billion over the last year (see Bloomberg article). The losses are resulting in spending cuts of 8.6 percent. Of interest is that like its bigger Ivy League members, Dartmouth had only about 12 percent of its assets in US stocks. Like Harvard and Yale, it also had a number of illiquid assets (such as private equity) whose values have not been updated. To its credit, trustees at the college projected early last year that the US economy was entering a recession and subsequently lowered its exposure to corporate bonds and MBS, and began purchasing additional TIPS. Eighteen percent is painful, but foresight and diversification seem to have helped to ease the pain at Dartmouth.
There is an interesting article in the WSJ regarding recessions and productivity numbers. As seen in the figure below, the last six recessions have occurred at a time when productivity numbers were decreasing (although the numbers were still positive for the last two recessions, and productivity was relatively strong during the most recent recession in 2001).
While productivity has averaged 0.8% over the last six recessions, it is currently growing at an annual average rate of 2.5%. This is important since high productivity numbers allow the Federal Reserve to keep interest rates lower than normal since higher prices are being matched with higher productivity, at least to some extent. As an example, if workers are making x% more of a product in the same amount of time, then wages can increase by the same x% and the per unit labor cost will stay the same. Simplistic, but you get the idea. Productivity gains were the key to the 1990s, and one of the reasons Alan Greenspan was often espousing the benefits of high productivity, providing yet another reason to keep interest rates low, sub-prime notwithstanding.
Of course, higher productivity can allow you to keep from hiring new workers, or even allow you to reduce headcount, since now you can do more with less. Furthermore, the current high productivity numbers may just be an artifact of the recent environment. Housing, which is a less productive industry, is currently being shifted out of while higher productivity industries, like those exporting, are increasing in emphasis. The weak dollar is also having an effect in amplifying the export-based productivity numbers. Given that the U.S. is trading overseas more now than in the past, the higher export productivity numbers make sense.
So, if productivity is not cooperating for those talking recession, what about other numbers in comparison to previous economic conditions, such as the stagflation days of the 1970s that many analysts are comparing the current conditions to? Given higher energy costs, producer price increases for finished goods are worse now than during the 1970s, causing lower consumer confidence and higher levels of consumer credit as a percentage of GDP. The savings rate is down, as it has been for a while, and the number of vacant homes is increasing.
Yet, all is not bad, or falling off a cliff. The ISM index is hovering about the benchmark contraction / expansion levels, and disposal income has still not collapsed, even with increasing job losses. Industrial production, while flat, is also not severely contracting. Furthermore, core CPI (without food and energy) is not excessive, nor is core PPI. The unemployment rate, while rising, is also not yet close to approaching high single and low double digit levels. High productivity is keeping unit labor cost down (as discussed before), and wages have stayed in check for corporations. After-tax corporate profits as a percentage of GDP are also still good, and long-term Treasury yields are not excessive in comparison to the stagflation years.
So in short, is the picture rosy? No. But are we heading for another decade of stagflation with sustained lower growth and high inflation? Right now the data does not point to this conclusion, regardless of the continued comparisons. Housing and crude oil still seem to be ruling the day, the fallout of which is affecting nearly everything in the economy. When the former finally turns around, and the later sells off with conviction, we may be able to finally get rid of both the "stag" and "flation".
There is an interesting post at the Trader's Narrative blog (click on the post title for the link). It is worth a read. In a nutshell, we currently have a steep yield curve, and what this usually signals is that the economy is about to speed up its growth, that the end of any recession/slowdown is near, and that a major economic expansion is close.
Nice article and supporting graphs/charts at Mark Perry's Carpe Diem site showing how high unemployment is not only rare, but usually occurs for a short amount of time. Given that unemployment is at 5.1%, below the 50-year long-run average of 5.9%, it is still not time to panic. Next Friday's job numbers may tell a different story, but for now unemployment appears relatively contained. Furthermore, the median duration of unemployment is currently at 8.1 weeks, or about 2 months, with over 2/3rd of unemployed workers out less than 14 weeks. Of course, if you are unemployed, this may be encouraging, but of little consolation, especially when we continue to hear daily about how bad the situation is.
The length of a recession (assuming we are in one), is critical for subsequent gains in the market. This week's Barron's states: "In post-war recessions lasting less than 12 months, the S&P 500 has gained an average 9.85% a year after the recession started, according to PNC's Stone. But if the slump dragged on more than 12 months, the average stock-market return a year after the recession started is -22.64%." Past bear markets have also historically been followed by an average compression in P/E multiples of 22%. Bespoke Investment Group also finds that the cumulative return of the S&P 500 since late 2002 (when the bull market began) has been -8.1% during earnings season (starting next week and ending in mid-May). On the other hand, market returns between earnings announcements (once they end and before they begin again) has netted +61.6%. Not necessarily unexpected during a bull market, but interesting nonetheless. No doubt some of the negative returns during earnings season may involve buying on the rumor and selling on the news, especially when companies beat previously lower expectations.
