Friday, 5 August 2011

Double Dip Looms: The Case For A Return To Recession

 

Capital Markets have a tendency to lead or follow, but very rarely to simply reflect, economic reality. The situation in the U.S. is no different. Following a market bottom in the spring of 2009 both equity and debt markets staged a tremendous recovery (now slipping on well-justified fears). Sadly, in the case of the U.S., the recovery has far outstripped underlying facts on the ground.

There is a growing case to be made that the U.S. will experience a double-dip recession in the near to mid-term.

1. Revenue Challenges

  • A recent study of over 3,000 U.S. companies with market capitalizations over $50 million by Georgia Tech professor Charles Mulford found average YoY revenue growth of less than 1%. The dirty secret of the U.S. economy, which any middle market lender or investment banker will tell you, is that once you scrub away the revenue pop that many companies saw coming off a truly atrocious ’09 (in some part simply survival bias, as many companies found themselves with a few less competitors due to the severity of the last recession), sales growth has been an enormous challenge.

2. Government Fiscal Strain

  • Spending cuts at the federal level, combined with severe fiscal stress at the state and municipal levels will continue to present economic headwinds for the U.S. Regardless of political affiliation, the fact is that reducing government spending in an environment of low corporate growth will further depress economic activity.

3. Disheartening Economic News

  • The polite summation of the latest Beige book from the Federal Reserve is that indicators are negative and worsening. It is hard to find much to be bullish about when the situation continues to deteriorate.

4. Credit Market Risks

  • Many have pointed to the health of the bond and syndicated loan markets as signs of overall economic health. My read is different. These markets recovered quickly because one of the first steps the government took was to recapitalize the banking system. While community banks continue to struggle regional and multi-national lenders are now competing vigorously for lending opportunities, and the supply of lenders (and money to be lent) currently exceeds demand, which is forcing lenders to accept increasingly aggressive pricing and terms or lose out on deals.
  • This artificial situation is inherently unstable. Shocks from an eventual downgrade of the U.S., the emerging sovereign debt crisis in the euro zone or the continued fiscal stress of U.S. states and municipalities would likely reverberate throughout the credit markets, leading to a severe curtailment of risk appetite.

The natural pro-cyclical bias in business reporting often manifests itself in a continual search for signs of recovery following periods of economic downturn. Generally optimists, even those who are somewhat premature, will be rewarded for their efforts. But the severity and nature of the 2008-9 recession argues for a more cautious approach. The current economic situation is far too tenuous, and there are far too many risk factors, to permit a sanguine assumption that our troubles are behind us.

About the author:

David Johnson is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services to companies and municipalities. He can be reached at 312-505-7238 or at david@acm-partners.com.

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