Inevitable US double dip recession to drive equities lower

How nice it would be to think that last week represented something of a bottom for US financial markets and that a recovery is about to lift stocks much higher.

Yet on any realistic assessment that just cannot be the case. The fragile US recovery thus far is from a huge burst of government spending and profits boosted by job cuts. That stimulus package is now a fading force and unemployment is up from 9.7 to 9.9 per cent.

Austerity unavoidable

Both are self-defeating anyhow and merely postpone an austerity adjustment to put spending and deficits back into balance. Raising government debt to pay off private sector debt still increases the size of the debt problem, and does not reduce it at all, on the contrary it makes it worse and we all know that the public sector is not the best allocator of capital.

Cutting jobs boosts profits but it undermines the size of the consumer base and creates a smaller total market. You cannot carry on raising profits by cutting costs in a static or falling market, eventually profits will also start to decline.

Take the insolvency and nationalization of General Motors. Keeping this giant producer of second rate cars alive preserves some jobs but at what cost to other businesses that could do with the money?

On any sensible assessment then the US recovery is a postponement of a day of reckoning and not the start of a solid economic recovery. This is a W-shaped or double dip recession. Who can really believe it is anything else? Where is the catalyst for a real recovery?

Lower interest rates? Already there and cannot go lower. Indeed, the pressure is now for interest rates to go up. The housing market? About to take another fall with a surge in repossessions. Wall Street? Having risen too far, too fast, stocks have now broken all the key indicators pointing to a further downturn. Besides the fundamentals still howl overvaluation.

The wake-up call is coming from Europe. The euro zone sovereign debt crisis means an end to the cheap dollar as a support to US recovery. That is another prop gone for US export profits. Then again exports to Europe are bound to fall anyway as austerity packages cut spending. The pressure on US interest rates from the fall out in Europe is already clear.

Banking sector

Higher interest rates and falling asset prices impose a new burden on the banks and their customers. Insolvencies will surge in such circumstances, and the seemingly well-capitalized US banking sector will once again be severely tested.

Asia to the rescue? Not so fast, Beijing house sales plummeted 80 per cent last month. As Jim Chanos says this is ‘Dubai times one thousand’ with the Chinese economy heavily reliant on construction spending for growth. China is also steadying for a slowdown in exports to its largest export market, not the US, the eurozone; its dollar-pegged currency is now a handicap.

If only this were a passing headache and a bad morning. The fantasy was the sudden V-shaped US recovery and the reality is going to be something very different.

We are heading into a world of bigger government and static or declining economic growth, and asset price deflation followed by yet another panicky bailout that will only bring more of the same. This is the modern version of a deleveraging deflationary debt spiral.