What Indicators Will Herald the Recovery?

Patience will be needed while investors and consumers wait for the government’s efforts to have impact.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

March 16, 2009

Here's how you'll know a bottom is near, in a recession turned far uglier than anticipated: first-time claims for unemployment benefits will drop, consumer spending will have more oomph, boosting retail sales for a few months in a row, and stock market rallies will last for weeks.

Typically, stock markets foreshadow recoveries. This time, though, investors may wait and watch for signs that the government's efforts are working. The seeds of growth are only being sown. It will be summer before they sprout, nurtured by Washington's massive efforts to help.

The impact of the $787-billion stimulus package will be uneven. It'll take months to get stimulus cash spent: $50 billion in infrastructure funds for all 50 states. In contrast, paychecks are already getting bigger, with $116 billion headed to workers over two years, thanks to an adjustment in federal tax withholding that is part of the stimulus.

"Passage of the stimulus will be seen as the beginning of the end of the worst recession in postwar history," Christina Romer, chairman of the President's Council of Economic Advisers, told a recent meeting of the National Association for Business Economists: Schools will get $44 billion next month with $56 billion more to arrive later this year and in 2010.

Up to $75 billion in mortgage aid is ready, to be used as early as April both for refinancing as well as to modify loans on homes at risk of foreclosure. Thirty-year fixed rate mortgages are already low at 5%, and under President Obama's plan, those who qualify for modification of their mortgage could see rates as low as 2%.

To remove toxic assets from banks' books, private equity groups will team with Treasury in April. It's a key step toward thawing credit and encouraging borrowing. The Federal Reserve is also pledging up to $5.5 trillion in loans and loan guarantees to companies and consumers, one more step to end the credit crisis.

As stimulus money starts to flow, already there are faint glimmers of a brighter tomorrow. Energy prices remain low, and so average weekly pay gains are continuing to outpace the rate of inflation. Retail sales, excluding autos, increased in January, and again in February. Consumer spending looks to be flat to slightly higher this year after plunging 4% on an annual basis during the last two quarters of 2008.

Investors are beginning to test the waters and wade back into equities. With trillions of dollars sitting on the sidelines in cash, the rally that began on March 10 in major indexes hints at the impatience of some investors eager to put cash to work.

The dollar remains relatively strong, which is a negative for exporters, but it allows Uncle Sam to continue selling billions of dollars of Treasuries in a currency favored by investors. Plunging home prices are luring buyers and providing an underpinning to home sales. That will persist through 2009 as more of the overhang in the inventory of unsold homes is reduced.

Still, there will be plenty of bad news between now and when a recovery starts: failure of a big bank or the collapse or takeover of a major automaker, for example. Indeed, the 8.1% jobless rate will keep climbing, for quite a few months after recovery begins to take shape. Any jolt to confidence will trigger a setback, and when recovery comes, growth will be uneven and sluggish. Diane Swonk, chief economist with Mesirow Financial in Chicago, says, "All we can do is mitigate the pain, not eliminate it."

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