My partner Taylor McGowan responded:
I don’t think our behavior changes until we are forced to change it. This only occurs through a really bad, long lasting recession/depression that scars an entire generation and completely changes the American psyche. The government is not only unwilling to allow this to happen, but it actually continues to do everything in its power to keep Americans spending.
Letting the housing market find its natural bottom and pulling back fiscal and monetary stimulus is all well and good in theory. The reality is that without the government’s help, we would probably be in awful shape because the banks would have failed and the stock market would have gone down a lot more. The average person gets hurt much worse under this scenario and poor people no longer have access to food under this scenario. In other words, we need to sort of be careful about what we wish for…
And our partner Keith Davis followed up with:
I liked Taylor’s comments about not doing things until forced. I also was thinking about the three key variables to watch to determine the consumers' ability and willingness to spend discretionary income (and therefore the strength of the recovery). I believe these variables are the level of stock prices, gas prices and interest rates. I believe that the "recovery" we have seen so far has been driven by higher stock prices, which has led to higher spending by well-to-do Americans. This type of unbalanced recovery is not a healthy one. In the process of driving stock prices higher (through QE2), the Fed also caused oil and other commodity prices to spike. This hurt moderate income Americans and is likely one of the major causes of the "soft patch" we are now enduring.
Low interest rates are imperative to support housing prices. As rates rose over the past few months, we saw housing prices begin to fall again. I personally don’t think low mortgage rates are enough to stop further prices declines. There is simply too much supply in the pipeline. However, low mortgage rates can certainly limit the magnitude of price declines.
So the recovery looks like it may wax and wane based on stock prices, oil prices and interest rates. Now that interest rates have declined dramatically and oil prices are off their highs, we may begin to see better economic data over the next few months. However, the overhang of falling housing prices (as huge inventories are worked off) will likely limit the voracity of the recovery in even a best-case scenario. In addition, I think there is a ceiling on how strong the recovery can get because improved economic indicators will likely be met with higher interest rates and higher commodity prices.
Another point that I haven’t heard anywhere else is that the end of QE2 may turn out to be a good thing. Rates have declined dramatically in the face of the imminent ending of QE2. At the same time, commodity prices have declined. So as long as rates stay low and stocks don't plummet, the economy may benefit by a decrease in gas prices (which I believe is a major factor in predicting consumer spending).
Tough to tell when a rally will come, but we’re due for a short-term bump. I think indexes may languish over the summer and into the fall. As much as I hate saying “it’s different this time”, we have to recognize that the financial crisis that brought us here was different, that the government’s response was different, and therefore; the recovery is different. Housing markets have not been allowed to clear, and while that may have been necessary, they have yet to reach a bottom unassisted by government funds and policies. Investors are worried about jobs and endless government spending.
Individual consumers who are dealing with years of accumulated debts are loath to see government spend them and their children into perpetual indebtedness. I don’t think we can look for a fundamental upturn until we are done with the fundamental downturn. We need to bottom (economically, not share prices), capacity needs to shrink to meet demand, and then demand needs to outpace capacity. A lasting, sustainable recovery will come only when driven by higher demand.
While inflation will be a problem whenever the US Debt comes front and center, we expect interest rates to remain low for quite a while. Though the Fed has provided lots of liquidity, it has not led to meaningful job creation or the sort of resilience that may be expected from any type of multiplier effect. With such meager results, Americans are questioning the efficacy of government dollars. Capitalism is ultimately the answer. Business and innovation will create growth and jobs, but at a point the government has to step aside and let free market capitalism do what it has always done. Good old American capitalism, determination, and hard work will lift us from this mire and return us to the path of prosperity. How long are we willing to wait to take the hard necessary steps?
Michael K. Farr is President and majority owner of investment management firm Farr, Miller & Washington, LLC in Washington, D.C. Mr. Farr is a Contributor for CNBC television, and he is quoted regularly in the Wall Street Journal, Businessweek, USA Today, and many other publications. He has been in the investment business for over twenty years.