The double-dip threat is growing – what should investors do?

By MoneyWeek Editor John Stepek Aug 24, 2010

John Stepek

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It's shaping up to be another 'risk-off' day.

Asian markets fell back this morning, as did the oil price. Both Japan's Nikkei 225 index, and the Vietnamese VN index are now in bear market territory for the year, having fallen by more than 20% from their second-quarter highs. Japan in particular, has been hobbled by the strong yen, which hurts the country's exporters.

Of course, all of this could change by the end of the day. We might be back to 'risk-on' by the time the US market closes tonight.

But in the longer run, I reckon it'll take at least one more big sell-off to shake the nerves out of this market...

Is the US recovery nearing a standstill?

Despite rampant M&A (merger and acquisition) activity, investors are very jittery right now. It doesn't help that it's August, and so trading is seasonally light. But the malaise goes deeper than a simple summer lull.

The fact is, "we're not seeing sustained signs of recovery in US consumption, housing market, or job market," one Korea-based fund manager told Bloomberg. "Investors will be worried if the US economy appears to be entering a long-lasting slowdown phase, and some also question the sustainability of strong earnings."

They're right to be concerned. Last week's US jobless data was far worse than anyone had expected. The number of Americans filing initial claims for jobless benefits hit 500,000, the highest level in nine months. The figure for the previous week was also revised higher. That's not a great sign for US economic prospects, as my colleague David Stevenson demonstrates on this chart, which compares jobless claims (red line) with US GDP growth (blue line):


 

It's no wonder the property market is slumping

With this sort of grim unemployment picture, it's perhaps no surprise that things are looking gloomy for the housing market too. The trouble is, in a consumer-based economy, the housing market and the broader economy feed off each other.

It's a well-rehearsed formula, and one we're only too familiar with in Britain. When house prices are rising, you get the 'wealth effect'. People feel confident with a big chunk of equity at their backs. When your annual house price increase amounts to more than your annual salary, you don't feel concerned about treating yourself a little. And why not? After all, you deserve it for being such a smart investor.

And of course, a buoyant property market means lots of business for people involved in that market. From delivery drivers to washing machine makers, everyone benefits from all the little transactions and purchases involved in moving home.

Indeed, Moody's Analytics reckons that housing-related spending - on home construction and furniture for example - accounted for 15% of US GDP in the second quarter.

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The trouble now is that since a first-time buyer tax credit expired in April, no one's interested in buying houses. And on top of that, with unemployment still high and rising, Americans are having difficulty clinging to the homes they've got. During the first quarter of the year, one in seven home loans were either behind on payments, or in the process of being repossessed ('in foreclosure', as they put it in the US). That's the worst seen since records began in 1979.

All those repossessions leave a huge amount of supply ready to hit an already over-supplied market. So that means would-be buyers have no real incentive to buy until prices go even lower. Meanwhile, people who are underwater on their home loans don't feel like spending money when their main asset is decreasing in value by the year. It's the 'wealth effect' in reverse.

Housing could kill the recovery

As Bloomberg puts it, "housing led the US out of seven of the last eight recessions. This time, it may kill the recovery."

Markets are meant to price in future events. But they're not perfect at it, by any stretch of the imagination. And if the US does continue this slide towards a double-dip recession, I suspect that will result in quite a nasty sell-off in the stock market.

At the same time, I'm not happy with the idea of betting the house on full-blown deflation and piling into US Treasuries. So how can you invest for such uncertain times? Well, you know what we like - gold and high-quality blue-chip stocks. But for some more specific stock tips, you should read the next issue of MoneyWeek, out on Friday. We got a group of experts into our office for a Roundtable chat and asked them where they'd put their cash now. If you're not already a subscriber, get your first three issues free here.

Our recommended article for today...

Forget grain - buy tractors instead

While global demand for food will only increase, investing in soft commodities is fraught with danger. So it's better to put your money into the tools that increase food production than into the foods themselves, says Merryn Somerset Webb: Forget grain - buy tractors instead.

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Published in How to invest | More articles by John Stepek

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  • 1. Bob Roberts

    (24 August 2010, 11:22AM)  Complain about this comment

    I was chatting with some friends last night and the ocnclusion that we all came to is that, despite the fact that inflation is eroding cash, that cash is the safest place to be currently.

    Property, gold, other commodities, shares were all mentioned and no one felt safe investing in any.

  • 2. Cameron

    (24 August 2010, 05:07PM)  Complain about this comment

    That was quite an interesting piece today John, and I agree that housing is what is going to derail the economy both in the US and in England.

    Where I live (in Canada) we have a housing market that has just begun it's correction. Surprisingly, this correction it is coming almost 4 years after the US housing meltdown began.

    You can follow it live at if you are interested at Greaterfool.ca
    That is a blog dedicated to Canada's housing bubble and the consequences for this country as our correction unfolds.

  • 3. TomJefs

    (24 August 2010, 08:00PM)  Complain about this comment

    @bob, the objective is not being safe. It is about making money which incurs a risk. Cash is guaranteed to lose you money because inflation erodes it. If everyone wanted safety the stockmarket would die.

  • 4. Tom F

    (24 August 2010, 08:12PM)  Complain about this comment

    I don't believe in the double dip theory.

    What empirical evidence is there for a recession 2 years after the last?

    we are coming from such a low basis that a new recession will not occur within the next 1-2 years.

    What will likely happen is a new recession brought on by the debt that Western governments are running. Nonethless this next crises will be 5-10 years away and its effect will be huge.

    If you read the Aftermath of Financial Crises by Reinhart and Rogoff the evidence is that jobless figures, property and stocks all suffer for a long time afterwards. This is typical and not a sign of a new recession.

    http://www.bresserpereira.org.br/terceiros/cursos/Rogoff.Aftermath_of_Financial_Crises.pdf

    the next major crises is a fair few years off and will be Government created (as they all are in one form or another ;-).

  • 5. robert

    (25 August 2010, 02:11AM)  Complain about this comment

    Frankly, I didn't even read that article. I've read so many of them in the last several years that it amounts to nothing. The name simply caught my attention and I decided out of the blue to respond.
    Collapse is inevitable. It is not an "evil" to be avoided. It is necessary in order to make room for a new future that is not so corrupt.
    There are millions like me out there who are more than aware of what is going on, yet feel somewhere between despondent and hopefully waiting for a quick and merciful end, so we can finally get on with something new and interesting for a change.
    As far as those who are seriously following this nonsense, hoping to find a personal path to economic nirvana, good luck with that. This time is far more significant than just another up or down cycle.
    Wake up! good and gentle folks. Change of a kind you can not now imagine, is afoot!

  • 6. Clive

    (25 August 2010, 10:32AM)  Complain about this comment

    @TomJefs

    Surely, the point is to end the investment period (1 yr ?, 3 yr ?) with the maximum amount of money relative to the amount you start with.

    I agree that staying in cash isn't safe. There's inflation to consider and the lost opportunity of gains. However, at least the downside is fairly predictable in scale (basically the rate of inflation).

    Investing in equities, commodoties etc. can clearly rise where cash won't, but has an unpredictable downside (-10% ?, -20% ?).

    In some situations, sitting in cash, taking a small hit, then returning to markets later, may be the right call for some.

  • 7. carol

    (25 August 2010, 10:30PM)  Complain about this comment

    If you invest in good property in a good location you may lose value for a while but like the last property slump, prices eventually came back and surpassed previous values.
    When this big commercial boom started years ago I couldn't help but question where all of these purchasers or renters were going to come from. Whenever a market gets glutted it takes time for the excess to be consumed but in this case I think that some areas are overbuilt and will continue to be overbuilt for the next 20 or so years. We haven't begun to see the mess we have made with our greed and stupidity. The banks have swept these bad debts under the carpet but eventually the piper will have to be paid. Gold, commodities and other real assets are going to be where you need put your money. Property, in the right place, as long as you don't pay too over the odds for it: will still be a good investment because God isn't making any more of it. Patience, and prudence. Amen.

  • 8. Andy

    (26 August 2010, 10:27AM)  Complain about this comment

    Property may go down short term, but as there are so many repossessions (foreclosures) you can buy a house now and rent it out with upwards of 14% yield. The house will repay itself in less than 7 years. The demand is high as all the people who lose their houses need somewhere to live. This is a good time to become a landlord. On the stock market shares are dropping and the dividends paid from the shares are being cut.

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