Is This Recession Really Different ?

The current financial crisis has affected investors worldwide. The common belief is that the US housing meltdown has rippled globally to cause financial institutions to default and a cause the credit crunch.

In response, governments in North America, Europe and Asia have offered rescue bailouts in the billions to these institutions and far-reaching guarantees to consumers. In addition, drastic interest rate cuts have been implemented in an effort to soften the slowing economy. At last, there are encouraging signs that these initiatives in their totality have finally started to show signs of effectiveness.

Although the recession cloud is upon us, there are several signs of a silver lining. Here are the good indicators showing that this recession isn’t likely to be a severe one, let alone a depression.

Indications that credit is starting re-flow:

An active economy is heavily reliant on credit lending, by both large institutions and individuals.  When credit markets froze earlier this year, most businesses started running out of money. That is why it was crucial to reinvigorate the credit system to become as seamless as it was in the past.

  • The lending rate that banks use to lend to one another, known as the London Interbank Offer Rate (LIBOR), has decreased from a peak of 6.88% earlier this month to less than 1.3%. The lower rate signifies a higher propensity for lending.
  •  The spread between 3-month LIBOR and U.S. Treasuries (the risk-free rate) decreased from a record high 4.65% earlier this month to 2.7%. A narrower spread indicates that banks are more willing to lend to each other.

Better Indications for US Housing:

The housing market represents one of the fundamentals of the economy and house prices correlate directly with good and bad economic times. Clearly the housing market is still volatile but some encouraging news have emerged.

  • U.S. fixed-mortgage rates has been decreasing, which helps qualify more borrowers
  • Fed rate cuts are causing variable rates to continue decreasing
  • Continued Oil and gas price declines result in more affordable heating costs for homeowners as we head into the winter months
  • Data from August and September shows a reduction of US home inventory. The 10.6 months supply of homes in August moved down to 9.9 months supply in September. The lower the inventory, the higher the home value
  • The FDIC and the U.S. Treasury are working on a proposed plan to prevent additional foreclosures by offering guarantees to lenders and mortgage providers. There is also talk of a rescue plan for the mortgage owners in a form of a stimulus, court intervention in mortgage agreements and other solutions.

There is good reasons to still believe this recession will last beyond 2008, but it’s also important to remember that the equity markets are often leading indicators of the economy. Therefore, good news as provided above, can be seen as a positive start to a credit market recovery and the housing crisis reaching a bottom.

Historically, markets have retracted prior to and in the early stages of recessions. After such a period, the markets tended to rise quickly and subsequently economic recovery ensued. On average, most recessions last between 12 to 16 months, so even if only a third of the recession is behind us it is likely that more signs of recovery will appear in the coming months.

Combine these statistics with a likely fiscal environment that supports deficit spending and additional government investments on a massive scale to grow the economy once again. While the risk-adverse investor might not wish be fully invested in the stock market during a recession that is priced in, it is wise to have at least some of your equity there to benefit from the inevitable climb back to prosperity.