Our Next Five Years: Recovery, Mediocrity, or Instability?

Trend: We do not know how this financial crisis will end, but the aftermath will determine which investments win.

When I analyze the predictions by intelligent observers about the future of the United States in 2010 through 2015, I can group the forecasts into three distinct camps: Recovery, Mediocrity, and Instability.

I'll describe the best case scenario first.

Recovery

A quick rebound after the financial remedies have the fixed the banking system, with life back to "normal". Jobs are plentiful, consumers are spending, builders are building, real estate prices are up, and the stock market is gaining.

Larry Kudlow at CNBC is a prominent advocate a quick recovery. Here's a sample from his blog at the Kudlow report:

Doom-and-gloom crowd take notice: Today’s retail-sales report showed far more strength than Wall Street economists dreamed possible.

Overall, February was down slightly, but January was revised up to a 1.8 percent gain. Excluding autos, February was up 0.7 percent and January was up 1.6 percent. In terms of core retail sales (ex autos, gas, and building materials), which feed into the GDP reports, February was up 0.5 percent and January was up 1.7 percent.

In fact, consumer spending in first-quarter GDP could turn positive. Overall, GDP will be down because of a massive inventory liquidation, but the sooner that draw-down is complete the faster we’ll get positive GDP growth — maybe even in Q2.

Meanwhile, the retail-sales upturn is hugely important.

In other words, even before one dime of the Obama spending package goes into play, the economy is beginning to show the first signs of recovery.

Stocks, by the way, are up 240 points at this writing — their third-straight daily rise on the shoulders of new banking profit reports and today’s positive retail-sales numbers.

The middle course, Mediocrity, is not that inviting, but much better than the worst case.

Mediocrity

A slow decline in the quality of life in the United States prevails as the middle class slowly slides to a lower standard of living. Consumer spending is undermined by saving and frugality becomes stylish. Real estate prices stay down and jobs are scarce.

John Maudlin, who predicted the financial crisis, writes articulately about the aftermath:

We are in a synchronized global recession. Yes, we will recover, but the causes are not those of the typical business-cycle recession. We are seeing massive debt deflation, deleveraging on a scale never witnessed, a financial industry that has to be rebuilt, and a housing industry that is reeling all over the world. We created a lot of excess in a number of industries. We decimated the savings of a generation that was hoping to retire soon, and now will have to work longer and save more.

This is not a typical recession. And for any analyst, writer, or pundit to trot out past historical data to demonstrate that the stock market is going to rebound at such and such a time and at such and such a pace simply ignores the fact that the future is unlikely to look like the past for at least the next 2-3 years. We are in a brand-new world, macro-economically speaking.

And let me also suggest that when we do get the problems worked out, and we will, the recovery that ensues may be breathtaking in its scope, as the technological changes that will be coming down the pike in the next 5-10 years are simply going to dwarf what we have seen in the past 30. Ray Kurzweil predicts that we will see twice as much change in the next 20 years as we saw all of last century. Think about the implications of that.

Just as we cannot let past performance and wishful thinking blind us to the reality that we confront today, we must not let 3-4 years of a slow Muddle Through world after this recession ends blind us to future opportunity. Projecting the current trends into the long future is nearly always a mistake. And the longer the trend goes, the more complacent (or negative) we get. But trends change. Remember that. (Thoughts from the Frontline)

Instability

A precipitous decline into an era where jobs and necessities are scarce and life is tough. Owners of guns and gold are the smart investors. Gardens and local farms provide most of the food.

Michael Panzner, author of the book Financial Armageddon (published in early 2007, it predicted the financial crisis), describes the plight of the unfortunate many:

To many people, the unfolding crisis feels like a bad dream. Every day they wake up, hoping things will somehow be back to "normal" (whatever that is). But just like the last great unraveling that took place 80 years ago, a good night's rest does not change the reality of the situation. It doesn't eliminate the imbalances that have built up over the course of many decades. It doesn't alter an unhealthy dependence on debt and fast money. It doesn't take the place of a corrective economic cleansing that was way, way overdue. But what it does do is leave those who are ill prepared and scrambling to get by.... (Financial Armageddon blog)

I remember that many of the same arguments were in play about Y2K.

The Big Question

The reason it is important to identify the prevailing trend is that investment winners in 2010 through 2015 will be affected significantly by which scenario prevails. We will be exploring the differences in this blog for investing in each scenario in the future as we scan the environment for clues for how the future will unfold.

Comments

[Gepay]

My opinion is that the return to "normalcy" is not feasible. One of the main questions to be answered is the winner of the war between inflation and deflation. Just last summer it appeared that inflation was winning with 150 dollar a barrel oil and Ice cream being sold in 1.5 qt containers for about the same price (although oil is down, the ice cream is still in the 1.5 qt containers and still costs the same as the 2 qt used to.) Then the bursting housing bubble and the inevitable deleveraging kicked in with deflation actually happening. Then the fiat money moguls in the world' s central banks with Helicopter Ben leading the charge kicked in with trillions. Governments added their stimulus's.
It feels to me that we are in the eye of the storm. The effects of the needed downsizing, the massive unemployment, the needed increase in American household savings (which appears to be happening along with the government keeping the Anerican debt level the same), plus the fact that Europe still has some shoes to drop, say much more is about to come.
At first I thought a kind of 70s stagflation would ensue but there will be no wage hikes to fuel wage-price inflation. Computerizeration of manufacturing > Globalization has effectively stopped the 70s scenario.
I know it sounds zany but I think what the Bilderbergers want to happen to the American dollar will have an effect on what happens. Some of this is a plan but with unintended consequences.
Unless there is some technological breakthrough in energy storage or new energy sources,etc, oil is sure to rise again. There are also bad black swan possibilities like war - between Pakistan and India - between Israel and Iran and then the US. Or others like a real pandemic plague or something like that wheat rust blight that is happening
Every financial crisis is unique. We could have depression and dollar depreciation > inflation of commodities. The financial system could still have a systemic collapse or as John Mauldin says - just a muddle through. Who knows? Prepare for the worst and keep an open mind - “it’s a good thing to have an open mind... just not so open your brains fall out.” Bertrand Russell