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New York City isn't alone. According to a recent survey by the National League of Cities, 64% of 319 cities queried say they're less able to make budgetary ends meet than in 2007. That's a huge turnaround from last year's survey, in which 70% of cities said they were in better shape than in 2006. State governments -- pretty much everybody but the government in Washington, D.C., which can print money -- are in the same boat.
The vicious economic cycle this sets off works like this: A slowing economy reduces tax revenue, which leads to budget cuts, which reduces economic activity even more. Which cuts tax revenues. Which leads to even deeper budget cuts.
The same thing is going on in the private sector. For example, General Electric, which held its dividend steady instead of raising it to conserve cash, is also reducing lending at its huge GE Capital business in order to shrink that businesses balance sheet and preserve the company's AAA credit rating. On Sept. 26, fast-food chain Sonic (SONC, news, msgs) announced that GE Capital would stop making new loans to the company's franchisees. During the past year, GE Capital was the source of about 10% of the loans taken out by the company's franchises.
None of this guarantees a recession, but most economists think the odds are rising. For example, the economic advisory committee of the American Bankers Association said Sept. 17 that it's likely that the United States will slip into a mild recession. Other economists think the economy has already slipped from a slowdown into a recession. "The odds that we are in a recession are pretty high," Jeffrey Frankel, a Harvard University economist who sits on the business-cycle-data committee of the National Bureau of Economic Research, told Canada's Globe and Mail newspaper Sept. 25.
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Not that economists were feeling especially enthusiastic about the economy even before the most recent stage of the crisis. The early September forecast from the Blue Chip Economics survey of economists showed the consensus calling for growth at an annual rate of 1% in the third quarter and 0.2% in the fourth quarter, with a "rebound" to 1.1% growth in the first quarter of 2009 and to a 2.7% annual rate by the fourth quarter.
Reason for hope
Now, I can't claim that any of this makes me feel good, but I see some hope in all this bad news. Or, more precisely, a reason not to lose all hope.Take a look at the timing of the bear market of 1973-74 and the recession of 1974-75. This 21-month bear market was a killer. The Standard & Poor's 500 Index ($INX) fell 50% from January 1973 through October 1974.
The economy didn't actually go into a recession until the third quarter of 1974, although when it did hit, the recession was a doozy. Economic growth fell 4.4% in the third quarter of 1974, 2.2% in the fourth quarter of 1974 and 5.1% in the first quarter of 1975.
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If you compare the timing of the recession and the end of the bear market, you'll notice that the stock market bottomed in October 1974. That's at the beginning of the fourth quarter. At that point, the recession had just begun and had another quarter and two thirds to run. From the end of October 1974 through the end of March 1975, while the recession was running in full roar, the S&P 500 actually climbed 13%.
Because stocks don't reflect the economy but anticipate it, the stock market rallies before a recession actually ends. And it was the visible onset of a recession that, in the case of the 1974-75 recession, helped the stock market find a bottom.
History doesn't repeat itself, but as the saying goes, it does rhyme. So I think we will see something like a 1970s replay in early 2009. By that time, the economy is likely to have visibly slipped into a recession. Wall Street analysts, having finally gotten around to writing down overly generous estimates for 2008 earnings growth, will have overreacted with cuts and pessimism in their estimates for 2009 earnings.
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Having heard threats of financial Armageddon, we'll be relieved to discover that, bad as the economy may be, the world hasn't come to an end. Investors, in relief that they now know the worst, could well make a recession the bottom in the stock market.
Before you get too giddy at that prospect (and the thought that if you still have a job, you can safely invest in stocks again), remember what happened after the stock market bottomed at the end of 1974. The recovery off that bottom was excruciatingly slow. The S&P 500 didn't break above its January 1973 high and stay there until 1982. The cyclical bear market did indeed end in October 1974, but the years that followed were a terrible period of stagnation for investors, with the economy burdened by high energy prices, high inflation and slow growth.
Sound familiar?
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