Why Recession Fears Are Overblown

Economy's lousy, but if there's another recession, it'll be much quicker and shallower than the last.

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The economy stinks. Are you surprised?

If you've been expecting the magical return of easy prosperity, then you have reason to be alarmed right now. Economic growth has been so weak this year that many economists fear we've hit "stall speed," at which the economy can't grow on its own and stagnation settles in. Hiring is dismal. Debt problems in big European countries like Italy and Spain are starting to seem like a real crisis, not just a theoretical one. Consumers aren't spending and businesses are starting to follow their lead. Investing firms are slashing their forecasts for the rest of the year and for 2012, which is causing a gut-wrenching pullback in the stock markets. Washington's response? Congress spent most of the summer arguing about the national debt, then left for a month-long vacation without doing anything about the jobs shortage or the sinking economy.

[See 6 unwanted outcomes of the debt deal.]

All these woes have raised the specter of another recession, which would fulfill the much-feared "double-dip" scenario. "After a series of sucker punches earlier this year," Bank of America Merrill Lynch said in a recent note to clients, "the economy is only one shock away from falling into recession." There's even a 10 percent chance we're in a recession right now, B of A believes. But anybody having terrifying flashbacks to 2008 or 2009 can probably relax a bit. While the economy is undeniably weak, there are several reasons a recession remains unlikely. And if there is a double dip, the second dip will probably be a lot shallower than the first. Here are five reasons why fears of a fresh recession are overblown:

Big companies are in great shape. They don't reflect the whole U.S. economy, but big companies like those in the Dow Jones and S&P 500 stock indexes weathered the last recession quite well, and most of them are a lot stronger than they were a few years ago. They've become far more efficient, thanks to lots of layoffs and timely investments in technology. They've been borrowing money at record-low interest rates and stockpiling cash. Globalization hasn't helped American workers, but it has allowed big companies to diversify around the world, so they're less dependent on the fortunes of any single economy. The firms in the S&P 500 index now get nearly half of their earnings from overseas, which allows them to cash in on the booming economies of India, China, Brazil, and other developing nations.

[See 10 ways to create jobs.]

That won't necessarily help solve the jobless problem, but a strong corporate sectors helps the whole nation in fairly direct ways. Strong corporate profits will continue to lift the stock markets above where they would otherwise be, which adds value to pension and retirement funds and family investments. Big firms still account for much of the employment in the United States, and companies with strong balance sheets will be less inclined to lay off workers if there is another recession. And many big companies are ready to hire; they're just waiting for business to pick up.

Stocks have had a remarkable bull run. The recent downturn in stocks amounts to a "correction," or a 10 percent drop from the market's peak in late April. But it's worth recalling that stocks have had a remarkable bull run since the recessionary low point in March of 2009. They're still up more than 80 percent from that low. If stocks fell another 10 percent—which would be the equivalent of a "bear" market—they'd still be up 65 percent from the 2009 lows. Many stock pickers think stocks remain underpriced, with a consistent run-up due once it's clear that the global economy is recovering for good. If they're right, gutsy investors willing to buy now could make a ton of money.

[See 11 countries with worse problems than America.]

Most bubbles have already popped. In the fall of 2008, the financial markets collapsed because a lot of things went wrong all at once. The housing bubble burst—especially the doomed subprime sector—which caused huge losses at banks holding mortages and complex securities tied to them. Consumers who had taken on record levels of debt began to default in record numbers, compounding the financial crisis. A lot of companies had taken on too much debt too, and many declared bankruptcy or went out of business. Healthier companies still pared their payrolls and got rid of bloat.

The "deleveraging" process required to pay down excessive amounts of debt at every level of the economy is already well underway, with more pain behind than ahead. The one exception is government debt, which has been a concern for a long time. This summer's debt deal in Washington is the start of a pay-down period for the U.S. government that could last for a decade or more. Across the Atlantic, Greece, Ireland, and Portugal have already begun to pay the steep price for years of excessive debt, with Italy and Spain coming next. Dealing with that huge overhang of sovereign debt will be painful, and will take a while. But the iceberg is smaller than it was in 2008.

In fact, some economists think the bigger problem right now isn't the economy but gridlocked politicians in Washington and Europe who seem paralyzed and unable to enact aggressive policies to tackle fiscal woes. If debt problems truly become a crisis, that could be the very thing that triggers needed political action.

[See how a debt downgrade would harm America.]

The Fed could stimulate, again. As the economy gets weaker, the odds rise that the Federal Reserve will enact a third round of "quantitative easing" by buying yet another big batch of securities to boost asset prices. There are many critics of this form of monetary stimulus, and the Fed itself is reluctant to do it again. But it can be an effective economic and psychological stimulant. While it's hard to isolate an exact cause-and-effect relationship, it's worth noting that the stock markets surged by 85 percent between March of 2009 and the end of June 2011, the run during which those two QE programs were in effect. Since the end of June, when QE2 ended, stocks have fallen about 8 percent. Since the Fed hasn't announced QE3 and the markets aren't expecting it, there would probably be a market pop if the Fed changed its mind and gave a green light to QE3.

Volatility is the new normal. Economists have been warning for several years now that the economic recovery, which officially began in mid-2009, would be bumpy and unpredictable, and wouldn't even feel like a recovery at times. That's partly because debt-triggered financial crises, like the one we just endured, take a lot longer to heal than more conventional recessions caused by business-cycle ups and downs. It's also clear that the whole U.S. economy is undergoing a major adjustment that we don't completely understand yet. The twin phenomena of globalization and digitization are upending the economic order that's prevailed since World War II, and many workers are finding that skills they thought they could count on for an entire career are rapidly becoming obsolete. Workers and investors will adjust. Just not as smoothly or quickly as most of us would like.

Twitter: @rickjnewman

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