W (not the movie)

The economic debate seems to have settled into which letter best fits the future trend of the US economy: V, U, L, or W?

The most bullish group, which includes many in the Goldilocks-redux camp, believe in the down (maybe strong) then up US economic scenario. V for victory, perhaps. Then there is the down then flat group, differing only in whether an upturn occurs sometime in the foreseeable future. U shows eventually, L says “who knows when?”. Some days things look up versus down and dirty for longer than you think.

The last group is the double dip club, my group. The US economy rebounds this year emboldening the Goldilocks dreamers to spout their dreams of an economic “morning in America”. Unfortunately for them, the false dawn will result in a “mourning in America” when 2009 rolls around and the tailwinds of the stimulus package give way to personal economic reality for many US consumers.

Driven by a negative wealth effect, US consumers spend less and save more for that retirement rainy day as concerns over Social Security and a diminished asset base begin to change habits. Such a change will take time, however, as the spending addiction of US consumers still has some strength to it – a strength that will likely exhaust itself thanks to the morphine known as the current stimulus package, fiscal and monetary.

Investment Strategy Implications

Oliver Stone may be working on a movie about George W. Bush titled “W”. But investors will likely spend more time next year focused on another W – the double dip in the US economy.

Short term, equities will likely continue to benefit from the dreams and hopes of the Goldilocks crew. And investors should continue to exploit that fantasy. However, a changed business model for most financial institutions will contribute to a diminished level of credit creation stimulus for the US economy, which when combined with a less profligate, more frugal US consumer will coincide with a new domestic political dynamic leaving only emerging markets to save the global economic day. And that may turn out to be more difficult than it appears.