Time To Hunker Down

We are three years away from the next upturn in the economy. So suggests investment strategist Jeremy Grantham in a Barron's interview last week. He expects the current recession to be more severe than in 2000-2002 as we experience an overdue reversion to the mean in several areas:

(1) housing prices: they need to drop 20-25% to become affordable again (or, alternatively, incomes needs five years to catch up to prices). Houses are considered "affordable" at 2.8 times family income, and the current nationwide multiple is 3.9.

(2) profit margins: they will undoubtedly shrink from historically high levels. Private-equity firms trying to manage leveraged buyouts will be unable to service their debt. Next domino.

(3) total debt: needs to be unwound, and there is nothing the Fed can do to save it. From 1952 to 1982, debt amounted to 1.2 times the Gross Domestic Product; now it stands at 3.1 times GDP. And all that debt bought a slower growth rate.

If historical patterns hold up, stock-market investors will have some lean years ahead. The S&P 500 typically retreats during the last year of a lame-duck President's term, as well as during the first two years following a change of party in the White House. Check and check.

What does this mean for Maine? It means that the revenue shortfall forecast for the state between now and June 30 will persist throughout the next biennial budget cycle. To balance the budget, the Legislature will have to either cut government spending or raise taxes. Doing the latter would further dampen economic activity and prolong the recession in Maine.

Grantham's best line: the economy is driven by education, man-hours worked, capital investment and technology. The interview (link below) should be required reading for all our legislators.

This Credit Crisis Has a Long Way to Run - Barron's Online