Vanguard Mutual Fund Co's Chief Economist - Nice Fair and Honest Assessment of Economy - No Booyah

[Median Democrat]

I admit that I like Vanguard mutual fund, and am a boring index fund investor. My bias is to distrust the CNBC Mad Money types who I think obscure far more than they educate, similar to Fox News. So, I was looking at their site, and they had this nice, very basic discussion of the state of the economy in very fundamental terms. It is pretty even keel in that it says that things are pretty bad, but also honestly assesses the President's fiscal policies as helpful. The thing that is interesting is that Vanguard is an actual investment company communicating to its investors, so they aren't going to cheerlead for the President, but they also don't decry everything as socialism either. Instead, it discusses some of the pros and cons of the President's policy choices, and it appears pretty supportive of the stimulus bill, while pointing out the costs down the road.

I think its one of the more educational statements on the state of the economy, and I thought I would pass it on. It is also available on Vanguard's website. It is nice to see a real fair discussion of economic issues, and how they affect invidual investors:

/snip

Video transcript: How will the economy respond to rescue efforts?
How deep a recession are we facing?

Well, to use the medical analogy, the patient's in serious condition and, as we talked about in previous webcasts, this recession is shaping up to be not only the longest but the deepest in over 70 years. So gross domestic product (GDP) at the end of 2008 contracted the most since the early 1980s, over 6% annualized rate.

And, unfortunately, the data for the first half of 2009 are tracking to be a similar rate of descent. In large part, the reason for that is the number of vicious cycles that are reinforcing each other. So job losses continuing to increase, home values continuing to deteriorate, that's leading to credit availability continuing to contract, and then, finally, financial market instability.

And to put it in perspective, consumers and businesses in particular are pulling back hard. Consumers, all households, have lost what I would estimate as $15 trillion in the value of their assets over the past 18 months. That's more than the entire size of the U.S. economy in one year.

How much will the stimulus bill help the economy?

In my mind, there are two critical factors that will ultimately determine the length of this recession. One is confidence and second is policy. So in terms of the fiscal stimulus package, it's sizeable by almost any measure. It's roughly 6% of GDP. So this $787 billion package is divided into both tax cuts as well as an array of spending initiatives that will kick in at various points in time later this year and into 2010.

Now, is this sufficient in and of itself to propel the economy to a full-fledged recovery? Unfortunately, no. And the reason why I say that is even though $787 billion is an incredible amount of money, we're currently about $1.4 trillion below where our economy would be if we had full employment. So the gap is still sizeable.

That said, in my mind, this fiscal stimulus package, along with an array of other initiatives, will help prevent a more dire outcome, but there is a price to this initiative. And that is the intergenerational trade-off the policymakers are making with higher budget deficits and potentially even higher tax rates decades into the future.

Is the government making progress in resolving the banking crisis?

If policymakers are fighting a war, then it needs to be won actually on three fronts. The first front is housing. The housing market continues to deteriorate, as we've talked about in previous webcasts. Home prices in particular continue to fall as foreclosures continue to rise. Now there have been some important developments that I think in the margin will help slow the rate of descent in home prices, which, again, is really key to the situation.

One is homebuilders have really cut back on construction activity, which should help at the margin to improve the excess inventories on the market. Second are the initiatives addressed around housing demand. So affordability has increased with some proposals through Congress, and the Obama administration really addressed that, increasing refinancing activity for certain households as well as preventing at the margin certain foreclosures.

Now we cannot save everyone, and I think policymakers are beginning to realize that. And I think, ultimately, what we also need to see is lower mortgage rates. We are seeing improvement on that front, but it will still take some time as we go through this year to see some stabilization around housing.

The second front is restoring liquidity in the credit markets, and what I mean by that is just normal functioning of trading and other activity in the fixed income markets and money markets. I think in that front we've seen the most progress. The Federal Reserve in particular has been instrumental in fostering increased liquidity. We've seen that through various aspects of the credit markets, and we're going to see further progress as some other initiatives—such as TALF, or the Term Asset-Backed Securities Loan Facility—get up and running very shortly.

The third front is also the most critical, and that is restoring solvency to certain financial institutions. This is also by far the hardest problem to solve. And so this is where the U.S. Treasury comes into play and how they're going to address the situation of certain so-called toxic assets on the balance sheets of institutions, which—whether we like it or not—are preventing greater creation of capital and credit, which are the life blood of any functioning economy. Without stabilization in the financial markets, in particular without addressing the solvency issue, we will not have a broader economic recovery. So it's going to be instrumental how the Treasury addresses that front in the next several months.

When might the economy start to turn around?

If the consensus forecast is correct, then we should start seeing some modest improvement in the various economic statistics actually by this summer. And I don't mean that all the economic statistics start to increase in terms of rates of growth, but that the rate of decline starts to slow. And we should start to see that across a number of fronts: housing, consumption, as well as industrial and other business activity measures.

I think the most important question is what will the recovery look like once it begins? And let me be clear. The economy will recover as it always has, in part because businesses will need to replenish depleted inventories, and eventually these government policies, which are humongous by any measure, gain traction.

The recovery, unfortunately, will be more tepid than I think the previous recoveries we've seen over the past 50 years. Biggest reason for that is in the past, when the economy recovered, it tended to be generated or propelled by consumer spending, by "dissaving" of households (using their savings for current expenses), and by increasing housing and other highly cyclical industries. I think this time it's going to be much more government-led. It's going to be accompanied, actually, by a rise in the savings rate in this country rather than a fall.

In the long run, that is very good for this economy given how much we have dissaved over the past 20 to 30 years, but, nevertheless, it does mean a more gradual recovery period over the next two or three years.

What is the outlook for the stock market?

So much of the business commentary is focused on the immediate here and now: So has the stock market bottomed, or what is the stock market going to do over, say, the next three or six months? Quite frankly, no one has a crystal ball. I think more importantly for investors to keep in mind is: What is a reasonable, forward-looking, long-term expected return for the various assets that they have in their portfolio?

We at Vanguard spend a great deal of time on research on this very topic. And I can tell you that our long-term expected return—for the global equity market, for that matter—centered in the 8% to 10% range, also acknowledging a wide distribution around that range as we've witnessed, unfortunately, over the past 10 years.

Now where do these estimates come from? They come by looking throughout history at the profound changes we've seen. Despite dozens of bear markets and even more recessions and depressions in our economic history and the changed world they're in, the fundamentals of long-term expected returns, economic productivity growth, corporate earnings growth, and valuations are supportive of those estimates. And I think that's an important reminder in the time where the returns over the past 12 months have been quite painful.

/snip

[tanyev]

1. I never watch CNBC, so Jon Stewart's clip package a couple nights ago

was the most I've ever seen of the channel. It looked like nothing but a 24 hour informercial for Wall Street.

[Phx_Dem]

2. Great read. Add him to the list of economists who think the recession

will turn around by summer. The list is growing. :-)

[Median Democrat]

3. It Is Nice To Have An Economic Analysis That Is Designed To Inform Rather Than Entertain Or Mislead

Look at CNN for example. They often feature commentaries by this economist who is listed as a Senior Lecturer at Harvard. However, when you look him up, it turns out he is total media whore who writes Op-Eds on virtually everything from a "libertarian" perspective. So, rather than providing an objective analysis, he is trying to push a viewpoint.

CNBC, of course, is just trash, as is Fox News. What we really need is a nice sober discussion of the economy without the booyah. This is why I loved this somewhat plain analysis of the economy.

[high density]

4. The question is if the fundamentals have changed this time

Since WW2 we have been an economy that tilts further and further each year to consumer spending. At the same time our corporations have done everything possible to minimize wages of the middle class and the number of bodies that they need to employ. The "investor class" gets the vast sums of money and then sits and counts it instead of creating new businesses and jobs.

I love Vanguard and I have most of my savings in their funds, but I think their long term outlook horizon is getting so far out there that it's not of much use to anybody but institutions like themselves.

[avaistheone1]

5. I believe you are right. How can it be expected that the middle class is going to go out and shop

their hearts out when so many of their jobs have been eliminated and off-shored.

I don't believe any of these forecasts that see a resumption of strong consumer spending, unless something dramatic happens with the creation of new jobs in this country. If that doesn't happen this will become such a long depression it will become a way of life. We will soon know no different. The classes in this country will continue to polarize, and the middle class will continue to evaporate at a more dramatic pace. Actually I think everything is going according to plan. This is the plan the elites want. This I believe is the new world order.

[Median Democrat]

6. So, You Agree With This Economic Report's Prediction Of A "Tepid" Recovery

I actually do. I think the report is a pretty frank discussion that does not cheerlead or diss on the President's proposals. Yes, there will be a recovery, but it will be tepid. Yes, the President's stimulus is needed to stop the slide in unemployment, but it is too small to reverse that slide entirely, and it will need to be paid later on with more taxes. In other words, no panaceas, and the report appears to generally support Obama's policy rationales.

I know that a lot of upper income types don't give a shit about what happens to the other 98% of the country, thus they are going to fight tooth and nail against modest increases in their marginal tax rate to the levels that were in place during the Clinton era.

The problem I see is that the corporate media CNBC/WSJ types are going to amazing lengths to distort the modest nature of Obama's proposals as socialism despite the fact that the top marginal tax rates under Obama are less than they were during the first six years under Reagan when top marginal tax rates were 50 percent.

What is missing are reports like the one I included that honestly discuss the costs and benefits of Obama's economic policies, as well as honestly identify the really hard issues like addressing the insolvency our Nation's banks.

Both liberal and conservative extremists distort the discussion by characterizing the decision as easy with some liberals pushing nationalization as a panacea and some right wingers pushing a let everyone go bankrupt because they deserve it as a populist talking point.

I know some folks like to demonize government officials, and during the Bush administration, there was a good reason to do so. However, my take on Tim Geithner is that the reason he hasn't solved the banking crisis in less than 60 days is because it is FUBAR.

Obama does not benefit from having uncertainty regarding the solvency of the nation's banks. The reason why he has not acted is because there is a lack of resources and the problems are extremely big, and maybe there really is not an easy answer.

Let me give you this example. Lets say you were a Madoff investor. The ponzi scheme is discovered. You now want your money back. What's the answer? The answer is that you are generally screwed, and depending on efforts to recover the assets, you may be a little less screwed, but you are still screwed at the end of the day.

I think the situation with our nation's banks is that we're screwed thanks to the Bush administration. The only question is how bad. There will be no magical policy that fixes things overnight, yet this will not stop liberals and conservatives from complaining that Obama has not magically erased the problems of the Bush administration.

[northernlights]

7. I don't see how there can be any recovery this summer

With unemployment rising at this rate. The 2000-20001 recovery was a "jobless" recovery -- new jobs created in the past 8 years did not keep pace with new entries into the job market. And the jobs that were created by and large were low pay, service jobs and part times.

How many jobs have been lost in the last year? Frankly, I've forgotten. But 3-4 million jobs created or saved from the stimulus package still leaves an awful lot of people out of work or underemployed. And I'm also sick and tired of hearing partime workers referred to as people who "want" to work full time, as if it were an option and a luxury. Sheesh -- who the eff can live on full time work these days, never mind part time?!?

People aren't "saving" so much as paying down debt. And they can't pay down their debt as fast as their net worth is dropping if they are unfortunate enough as to have a mortgage.

So exactly what is going to turn this recession around by this summer? Or as investors do they see the recession in terms of, "the stock market will have bottomed out, just ignore the bodies you're tripping over on your way to your investor's office?"

[Median Democrat]

8. I Wish The Report Was That Positive - Only Refers To "Modest Improvement"

The article unfortunately does not predict recovery in the summer. Instead, it only predicts a modest improvement in the economic indicators, which I interpret as the slide will begin taper off, but still be negative. In other words, we lose 400,000 jobs a month instead of 600,000. The articles describes a subsequent "tepid" recovery, and makes clear that the recovery will take longer than prior recessions.

[GeorgeGist]

9. Capitalism deserves to die ...

and dancing around the sacred cow makes one a fool.