Green Shoots and Weeds: Both Are Now Growing In the Economic Garden

By Ken Mahoney

www.thesmartinvestors.com

In the past several months, a number of economists have been writing about “green shoots” (signs of any growth) in our economy. There have been indicators that the economy, while still contracting, is contracting at a slower rate.

Since World War II, recessions in this country have generally been mild and referred to as “garden variety”. The current recession does not appear to be of the garden variety type – it may be deeper and longer than anything we have seen in the last 70 years.

There has been a market rebound of sorts, or “green shoots”, but we are still faced with the unwanted “weeds” that have infiltrated the housing, commercial real estate and rising unemployment sectors. Many economists believe that unemployment will rise above 10% and when we do recover that it may be a jobless recovery.

Also among the “weeds” of concern is rising inflation. While inflation is always a threat, the current environment is one of deflation or falling prices. It is difficult to see inflation with the decline of earnings and the rise of unemployment. The risk of inflation should always be monitored but presently it does not appear to be a threat.

On the other hand and despite the economic uncertainty we are experiencing there is, as with every investment environment, always opportunity. One should consider researching the municipal bond market. Municipal bonds are issued by states, cities, and counties, to raise capital for public work projects and are generally exempt from federal and state taxes. As tax rates continue to climb to pay for government-sponsored projects, municipal bonds may be more in demand.

Also, during past market cycles, “smaller” companies (small cap) tend to outperform “larger” companies (large cap). Smaller companies tend to have more flexibility, can change quicker, tend to have lower debt ratios and are more adept at taking advantage of market opportunities than their larger counterparts.

We will have to continue to watch the relationship between government and business. The administration has been aggressive with policy, from TARP to TARF. It appears, at times, to be friendly but also over-reaching. Some of the uncertainty in May was a result of several of the banks’ efforts to return TARP money only to have been rebuffed.

A number of the government’s efforts will take awhile to filter through the economy. The Fed's decisions tend to move though the economy quicker than fiscal stimulus, so perhaps in the second half of 2009 we will continue to see more “green sprouts” take hold and fewer weeds.