November 3, 2009: With the improving economic backdrop, equity markets have continued their strong rally. The Dow Jones Industrial Average, which bottomed intra-day at 6,440 on March 9, 2009 has risen above the mystical 10,000 level. The 57% advance in more than seven months is one of the largest on record. The improvement has been largely driven by the extraordinary stimulus efforts of global central banks, but more recently, is accelerating due to the return of economic expansion as consumers and businesses are increasing spending.
What is interesting about the Dow 10,000 level is that while celebrated by the media as a major threshold, the reality is it is just another number. In fact, the Dow has crossed 10,000 (and fallen below it) 28 times since 1999. While the Dow crossing 10,000 is impressive and newsworthy, it does not represent the finish line for this recovery, but rather just another mile marker on the market’s journey to recapture its value lost during the 2008-2009 recession. In fact, if we view the market’s recovery as a relay race, the Dow 10,000 level is closer to the mid-point of the journey as opposed to the finish line.
And similar to any relay race you may have witnessed, this economic recovery will require a “teamwork” of factors to contribute to the healing and ultimately the return to growth. No element of the economy—whether it is the consumer, business or government—can move an economy from recession to recovery alone. It requires a coordinated effort by market forces to “take turns” providing recovery leadership.
With both consumer and business spending at multi-year lows at the start of the year, it was the strength of government stimulus and the powerful demand of China that served as the market’s first runners in the relay race. Global central banks provided quick stimulus to an ailing economy in late 2008 and throughout 2009. Government stimulus served as the jolt that jump-started the economy in contraction to one that now has the backdrop to expand. The effects of easing monetary policy is dramatic, as lower rates can often serve as the most effective catalyst to reverse the recession’s economic contraction. China’s tremendous growth also served as an early runner in the market’s recovery relay race. China has adopted capitalism over the last few decades and its tremendous growth and favorable demographics has it on pace to pass the U.S. as the world’s largest economy in the next 10 years. It has been this growth in China that has taken some of the sting off of the recent recession as Chinese consumption has remained strong.
While government stimulus and robust consumption by China has served as the catalyst for growth, they are not strong enough to move the global economy from contraction to expansion alone. So, the baton needs to be passed off soon to the next runner in the market’s relay race. The next runner appears to be corporations, through increased business spending, creation of jobs (or at least mitigate job losses), and expanded worker compensation. In the end, there is no runner that has a bigger multiplier effect than business spending—as it benefits the economy in two ways. First, it generates demand for new goods and services through increased consumption and a shift from de-stocking to re-stocking inventories. Secondly, as business spending picks up, workers feel more secure, the average work week and overtime hours expand, temporary workers are engaged, and ultimately jobs are created.
The final runner in a relay is called the anchor, which is usually the fastest and most important of the runners. The key is to get the baton in the hands of the anchor runner as quickly as possible and then watch the gold-medal sprint to the finish line. In the market’s recovery relay, the anchor is the consumer. Representing almost 70% of the GDP of the U.S. economy, no recovery can fully take hold until the consumer joins the race. With the employment situation in America beginning to show signs of stabilization, consumers are increasing consumption. While robust consumer spending is likely quarters away, the second half of 2009 has already been ahead of expectations, which bodes well for the upcoming holiday season.
We remain cautious that employment and housing will continue to stabilize and serve to drive economic growth. Sitting in the middle of earnings season now, companies have shown great resiliency as nearly 80% have beaten consensus analyst expectations for earnings. Helped by significant cost controls and a return of top-line growth, companies look poised to benefit from the return of economic growth in the last part of 2009 and into 2010.
While the relay race is far from over, this recovery is well ahead of schedule. Who would have thought at the beginning of the year, that words like “recovery”, “growth”, and even “Dow 10,000” would be the market headlines just a few months later? This just proves that a strong start out of the gates, smooth sprints around the corners, and well executed hand offs can turn a race apparently lost into a gold medal performance at the finish line.