ECONOMIC RECOVERY NOT ON FAST TRACK

The recession has officially ended but the recovery will be like none other, says Mechanics Bank’s Chief Investment Strategist



Richmond, CA, November 10, 2009 -- The recession as defined in textbooks is over but it does not feel that way for many, according to Mechanics Bank Chief Investment Strategist Brian Pretti.

“Despite GDP (gross domestic product) growing 3.5 percent in the third quarter, year-over-year change in bank lending stands at a four-decade low, and delinquency rates across many consumer credit lines are at historic highs,” said Pretti. “Is this what economic recovery looks like? For now, the answer is, yes.”

Pretti cited two other factors that are altering the appearance of the economy’s recovery:

  • Unemployment. The commonly cited U-3 national unemployment rate stands at a near-three-decade high of 10.2 percent. The U-6 rate, which includes involuntary unemployment, part-time workers, and people whose unemployment benefits have expired or who are too discouraged to seek work, is more than 17 percent.
  • Real estate foreclosures. Home foreclosure rates continue to run at near historical highs, and problems in commercial real estate have begun to soar.

A Slow, Government-Fueled Recovery

“This is not a corporate- or consumer-led recovery to date,” said Pretti. “Government is at the wheel of this bus; it is unlike any macroeconomic recovery cycle in the post-war era.”

Mechanics Bank’s top investment strategist said the federal government’s unprecedented liquidity infusion and other stimulus actions in the financial and other sectors are largely responsible for recent economic growth. He pointed to the Car Allowance Rebate System or “cash for clunkers” program, which sped up demand for new cars, cut inventories to near-record lows and bolstered production.

Other incentives like the $8,000 tax credit for first-time homebuyers, which led to some improvements in the lower-end real estate market, also contributed to GDP growth.

Government-stimulus spending will continue, Pretti believes. Despite historically low interest rates, U.S. consumers and businesses aggressively paid down or defaulted on their debts in the second quarter, resulting in no net borrowing in the private sector.

“I do not see an appreciable uptick in private-sector borrowing any time soon, and that could threaten the return of deflation,” said Pretti. “Expect government spending to continue to be a driving force for U.S. macroeconomic activity. There is no alternative right now.”

The Interest-Rate Tightrope

Pretti warned that the Federal Reserve’s current interest-rate policies—including printing $300 billion in new money this year to repurchase U.S. Treasuries as a means of lowering nominal rates—pose serious, longer-term risks. Among the concerns is increasing pressure from foreign leaders to replace the U.S. dollar as the global reserve currency.

“We cannot ignore that the countries lending us money hold $3.5 trillion of U.S. dollar reserves,” said Pretti. “Since March, they have seen $500 billion of relative value evaporate. Their patience with the U.S. Federal Reserve, which is debasing our currency, will not last forever.

“The Fed is walking a tightrope when it comes to interest-rate and monetary policy. This is the first recovery cycle in modern times when low interest rates have not sparked private-sector borrowing; but standing by indefinitely and watching the U.S. dollar become even more damaged globally is unsustainable.”

The Stock Market: From Armageddon to Nirvana in Seven Short Months

Pretti acknowledged that the stock market has improved this year, noting that the percentage rise in value of the Standard & Poor’s 500 from March through September took three years to accomplish after its steep decline in 2003.

He cautioned, however, that market stability remains uncertain. An indebted private sector unresponsive to low interest rates, historically high unemployment and little or no corporate capital spending indicate that the recovery is far from over.

“Many companies are achieving earnings growth through massive cost reductions,” said Pretti. “This helps present a pretty earnings picture for a while, but ultimately organic revenue growth drives corporate earnings long term, and this is lacking.

“The U.S. economy will improve slowly and, during the healing process, government must continue to stimulate the economy until it is stabilized and strengthened. We need to approach our judgment and analysis of the current economy through eyes willing to see something that has not been experienced for generations.”

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About Mechanics Bank:

For more than a century, Mechanics Bank has been committed to helping people build prosperous communities as a trusted financial partner, forging lasting relationships through teamwork, respect and integrity. The $2.7 billion independent bank, headquartered in Richmond, California, offers personal banking, business banking, trust, brokerage and wealth management services through 33 offices across Northern California. For more information, please visit mechanicsbank.com.