1. The U.S. will retain its reserve currency status.
This theme is paramount because it answers the question of our age: If the U.S. is backing its financial system, who is backing the U.S.? The question is critically important because the U.S. continues to need massive amounts of money to finance its efforts to restore stability to its economy and its financial system. Thus far, support has been superfluous, as evidenced by the low level of Treasury yields, and the success of this year’s Treasury auctions, which have been very strong.
A chief reason the U.S. is able to retain its reserve currency status is because it remains the world’s preeminent power economically, politically and militarily. Moreover, the currencies of rising powers such as China are not yet ready to absorb the $7.5 trillion in reserve assets the world holds, particularly because their bond markets are immature and can’t house reserves as U.S. markets can. Any loss of reserve status is more likely to be a lengthy process, not an event.
2. Home inventories will continue to decline and prices will continue stabilizing.
The Case-Shiller home price index increased on a month-over-month basis five straight months through October, the first such string in three years. The increases suggest home prices have fallen enough for the time being. Why are prices stabilizing? Perhaps it is the record level of housing affordability, or the much lowered price-to-rent ratio.
One factor impacting home prices is almost certainly the supply dynamic, which is shifting before our very eyes. A case in point is the 38-year low reached in October in the number of unsold new homes. The supply of existing homes is falling, too, although the tally remains high. Inventories are falling because home builders have substantially curtailed the construction of homes whiles the population continues to grow.
This concept is more important to the supply dynamic than the falling home ownership rate and the difficulties that people are having in obtaining a mortgage. Here’s the story: The U.S. population is growing by close to 3 million per year, which results in 1.2 million new households (household formation slows during recessions, and is likely running at a pace that is hundreds of thousands lower than that, but it is a delay in the inevitable).
If builders are constructing just 500,000 or so new homes, the net increase in the housing stock is only about 400,000 or so, because some of the tally represents the reconstruction of homes from storm damage and such, and as a result of teardowns. That’s far fewer homes than what is needed to accommodate the growth in household formation.
Some will counter this idea and say that foreclosure activity will stem any decline in inventories. This misses the simple notion that people need shelter—they have to go somewhere. People are born short a roof over their head and they are forced to cover, whether through the purchase of a roof or the renting of one. Don’t believe in this concept? I refer you back to the 38-year low in the number of unsold new homes, which was reached amid massive foreclosure activity and extremely low sales activity.
3. Secular issues will restrain the recovery.
Many of the problems that are affecting the U.S. economy are structural, not cyclical.
For example, many of the jobs lost during the recession have been in industries impaired by low levels of activity relative to what these industries are geared toward. This means that the jobs lost won’t be recouped for years (it took four years before all jobs lost in the 2001 recession were recouped).
One of the structurally challenged industries is the automobile sector. For years, automobile sales ran at a pace of around 16 million. Sales ran at a pace of a little over 10 million in 2009 and are now expected to run between 11 and 13 million over the next couple of years.
Similarly, housing starts for years ran at a pace of around 1.5 million before peaking at 2.27 million in January 2006. Recently the pace has run around 500,000 or so. Here again, then, is an industry geared toward levels of activity that are much higher than will likely be seen for some time, meaning that job losses in the sector are structural, not cyclical.
Other structurally challenged industries include finance, retail, and commercial construction.
There are many other secular issues aside from the levels of economic activity, including de-leveraging and re-regulation. These issues will impede economic activity and stymie investment returns. So, while a cyclical rebound could produce further gains in risk appetites in the early part of 2010, any gains will ultimately be restrained by these powerful secular influences.
Tony Crescenzi is Senior VP, Strategist, Portfolio Manager, Pimco. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."