Hear ye! Hear ye! The recession is over! Well, that was the headline news on September 20th anyway. It seems that the National Bureau of Economic Research (NBER), a leading private, non-profit, non-partisan research organization released their findings on the economy. What was more surprising than the announcement the recession was over was just exactly when it was over. According to the NBER, the recession officially ended as of June 2009!

According to the Bureau of Labor Statistics, the national unemployment rate stood at 9.6% as of the end of August 2010. This is little changed from the 9.7% rate as of the end of June 2009 when the recession officially ended, but down from the peak of 10.6% in January 2010. Meanwhile, gross domestic production – the output of goods and services in our economy – grew at an annual rate of just 1.7% for the second quarter of this year. Real disposable income grew an average of 0.3% per month through the end of August. Meanwhile, prominent NYU economics professor Nouriel Roubini predicted in early September that the chances of a ‘double dip’ recession were greater than 40%.

In the face of all of this negativity, it’s very easy to become sullen and depressed. After all, in spite of what the NBER stated, it would seem the opposite is true and we are still mired in a recession. However, there are a few nuances that you must understand before the scoffing begins. The first thing you need to understand is the official definition of a recession. Officially (according to economists) it is “a period of falling economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” [http://www.nber.org/cycles/sept2010.html#navDiv=6] What the NBER release actually stated was that June marked the end of the trough or the lowest point according to all of the measures combined. Some started to improve in July while others, such as employment, have lagged a bit and did not seem to peak until a little later in the cycle.

In the face of all of this negativity and the media’s attempts to keep it going, I would like to offer up some positive words for this quarter-end. After all, things may not be as bad as they are portrayed. This is not to say that we are seeing more of the infamous “green shoots” of last year or that all is back to normal. We can all agree that we are not back to normal. Well, not the normal we came to know and love before 2008. We may be in what PIMCO CEO Mohamed el-Erian has stated, we may be in for a “new normal” for some time to come.

What does this “new normal” look like and what can we expect? Prior to this meltdown, our economy was largely built on credit. Borrowing against homes, against credit cards, against stocks and anything else of value was normal. For example, margin debt – people who borrowed against their stock portfolios – grew from a low of $130 billion in October 2002 to $314 billion by June 2008 before the market crashed in September 2008. The level of this debt fell to around $173 billion by February 2009 and while it has bounced back with the market recovery to around $235 billion, the borrowing is still 25% below the peak levels of 2008. Mortgage debt peaked at $14.6 trillion in 2008 and had fallen to $14 trillion by the June of this year. While that may not seem like a big drop (it’s only about 5%) understand that in absolute terms, that is $600 billion of debt that is now gone.

While getting rid of this debt is great for the borrower, it is not so great for the recovery. All of that debt was going somewhere and that somewhere was into purchasing “stuff”. Now that people are reducing their debt, the money formerly earmarked for goods and services now goes to pay down debt. The bottom line to all of these numbers is that any recovery we see will take longer than normal. In the past, we were able to “spend” our way out of recessions. That is clearly not going to be the case in this recession. Spending promises to be slow, housing prices are likely to remain depressed and unemployment is likely to remain high for some time to come. With messages of much slower economic growth, lower spending by consumers and higher unemployment for more extended periods, it is easy to be pessimistic. What doesn’t help are the depressing headlines about depressed housing prices, rising foreclosures, and political discord in Washington DC.

Actually, in spite of all the negativity, there is positive news. The good news is that, in spite of the sluggish pace, we are in a recovery period. Things are getting better. Granted they are getting better at a glacier’s pace, but our economy is in a recovery. Further bolstering this assertion, consulting company McKinsey & Company surveyed leading executives around the world. Fully 51% say the world economy is in recovery and 58% say their country’s economy is getting stronger. Nearly 40% expect to hire more before year-end*. The better news for us is that corporate profits are recovering. So far, companies that are in the S&P 500 Index that have reported earnings are showing nice gains versus last year’s earnings. In fact, we are seeing net income up just over 25% versus last year’s earnings. What is more time-consuming to measure is whether these gains are the result of top line (sales) growth, cost cutting (think lower head count due to unemployment), or share buybacks (the companies needed to deploy excess cash somewhere, and one way to do that is to buy back shares of their own stock). This is something that we will look into over the next week or so and blog about on our web site.

During the late spring and early summer, there were rampant fears of a double dip to this recession. Those fears are largely gone. Certainly the recovery is going to take a lot longer than anyone would like, but we are undeniably in a recovery. The stock market, in spite of this negative sentiment, is booming. In fact, the stock market is up over 10% for the quarter. This strength has allowed us to trim some positions to take some profits to be redeployed elsewhere. For example, in several client accounts we trimmed positions in stocks such as GE and Innophos Holdings (IPHS). During August, which was actually a down month for most stocks, we took advantage of this weakness to add to positions in CRH plc and Span-America Medical Systems. Both are still very good companies but have some short-term weakness that seems to be more market-driven than fundamental. In addition, after seeing quite a number of bargains in the agri-business sector, rather than trying to pick and choose from among five or six different companies, we managed to buy all of them (and more) via an exchange-trade fund.

We continue to remain cautious about stock prices. As far as the broad stock market is concerned, we think stock prices are getting a little ahead of themselves. We will continue to trim positions when appropriate and have started “hedging” client accounts by buying put options – options that will profit if stock prices fall. These are short-term solutions, though, to a long-term issue. Over the long-term, we continue to look at good companies that are trading at great prices. As stocks continue to climb, we are more cautious about buying and prefer to await better entry prices on many positions we are watching.

As always, it remains a privilege to serve you by managing a portion of your assets. If you have any needs or questions regarding any of the decisions in your portfolio, please feel free to give us a call.

Sincerely,

Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(336) 306-5496
(866) 857-4095
www.aeriecapitalmgmt.com

*http://www.mckinseyquarterly.com/Economic_Conditions_Snapshot_September_2010_McKinsey_Global_Survey_results_2672