Seven true & false conceptions about the economy

Misconceptions about the state of the economy abound. So, I set off here to debunk some myths and separate truth from conjecture.

1. It is a truth universally acknowledged that the world is in a synchronised recovery.

True. As evidence I would point to the following conditions:

- US rail loadings are rising

- Chinese production is accelerating

- German exports are surging

- World car registrations are increasing

- Brazilian and Mexican economies are expanding

2. It is a truth universally acknowledged that the US consumer is dead and unable to lead the US economy out of recession.

False. The US consumer has not even left the building. US GDP fell 3.8% from peak to trough during the current recession, the worst economic decline since the 1929 to 1938 period, but consumer spending fell only 1.8%. That is because during the period wages continued to rise and the population kept growing.

3. It is a truth universally acknowledged that the V-shaped recovery is the result of government spending on houses, jobs, and cars and will peter out.

Partially true. The government stimulus efforts have helped to prevent a more devastating collapse; however, the following is also true.

- Only 21% of government money that was allocated to the stimulus has been spent

- Pent-up demand stumps stimuli deals. Since housing prices peaked three years ago, construction of new homes has fallen, while some 5 million new families have been created. That leaves more demand than supply at a time when affordability has risen to near 30-year highs. At the same time the average age of an automobile has reached record highs despite the "Cash for Clunkers" incentive.

4. It is a truth universally acknowledged that bubbles are already being formed.

Not in the stock market. Large-cap stocks do not display historically high valuations on a trend earnings analysis, dividend yield to cash/bonds model, or on a price-to-book model. Stocks have not yet returned to their peaks on many measured levels.

Yes in gold and oil markets. Gold has broken its barrier record price of $1,100 per ounce. However, history tells us that gold prices rise when the federal funds rate is below 2% and fall when rates rise above that. What will happen to gold if the expansion continues and rates rise?

Yes/maybe in commodities markets. There is rising demand for natural resources especially from emerging economies as economic growth improves. However, stockpiles are high, so I think part of the frothy rise has been driven by speculation.

5. It is a truth universally acknowledged that the recent depreciation of the U.S. dollar means that the United States is in decline.

False.

- The US dollar rose during the recession of 2008 to 2009, demonstrating the dollar's role as a safe haven. That appreciation would not have been possible if the United States were in decline.

- Declines are relative. There are only two other world currency blocs big enough to support the piled up reserves of China, Japan, and the Middle East: The yen and the euro.

- A quick analysis of the fiscal affairs of the eurozone and/or Japan would show an equivalent or worse decline, leaving the dollar and mountain of US debt, the best of a bad lot.

6. It is a truth universally acknowledged that the compounding effect of reinvesting dividends and/or income streams is one of the most underrated investment tools.

True. This investment tool should be emphasised more universally to the patient investor.

7. It is a truth universally acknowledged that the technology sector has gone too far.

False. The tech sector has both value and growth elements, and by many valuation metrics has not come close to previous high valuation points.

The views expressed in Chief Investment Strategist Corner are those of James Swanson and are current through November 19, 2009. They do not necessarily reflect the views of individual MFS portfolio managers or other persons in the MFS organisation. These views are subject to change at any time based on market and other conditions, and MFS disclaims any responsibility to update such views. No forecasts can be guaranteed. These views may not be relied upon as investment advice or as an indication of trading intent on behalf of any MFS fund.

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