Are we at risk of a double dip recession? Certainly many investors, economists, and pundits think so.

You may have noted that the Australian Reserve Bank has raised interest rates, and other countries are following suit. Unfortunately for many borrowers in the weaker economies of the Western world, jobs are being cut, and salaries are stagnating as companies and governments fight their own battles with shrinking revenues.

What is a double dip recession?

In short, a double dip recession occurs when the gross domestic product (GDP) growth starts to shrink after a quarter or two of positive growth. This positive growth period itself occurs after a recession.

In other words, the sequence of events is: a recession that precedes a recovery; after a truncated period in the recovery, perhaps only one or two quarters, a recessionary period returns as growth in GDP shrinks again.

Consumers Bite Back

So what do borrowers do facing such double dip uncertainty? They rein in spending, cut expenses and start saving like mad. And we can all clearly see the effects of this, as retail expenditure falls off a cliff, bank balances rise and expensive services get cut, like premium services on cable, mobile phone, etc..

Unemployment in the US is hovering around 10% so job security is a primary concern for many working people. Those with jobs would rather save more money now than spend, spend, borrow and spend, so the employed are increasingly boosting their savings rate to multi-year highs. With unemployment likely to remain high for the foreseeable future, this bodes well for savings rates and workers’ bank accounts and it coincides with a period of lower interest rates.

Banks: Protecting their interests

The banks have acted in their own best guardians in many situations by raising rates on unsecured loan items such as credit cards, personal loans, etc. as they are facing an onslaught of credit defaults and increasingly interventionist laws from governments worldwide that seek to curtail their excessive profiteering.

The latest round of BASEL III talks has threatened to increase capital requirements further, thereby making banks less vulnerable but in short-medium term dampening lending prospects even further.

However, many consumers are experiencing surging credit card rates to as high as 30% pa for their debts, increased levels of minimum payments, and restricted credit lines, or even credit card terminations.

The consequence of this for the economy in the short term is only bad: higher default rates on loans, less leveraged spending on consumer items, less reinvestment by companies, and tightened budgets in both governments and corporations. And banks on the one hand are stashing the extra cash to bolster their banking reserves rather than lend, and on the other cite reduced demand for loan products and services. But governments keep calling for more lending, yet banks only lend to those who don’t need it. Ironic, but true. After all none of this really lessens the risks of a double dip recession by any means.

It’s The Economics That Matter

Why? The inflationary subsidies, tax breaks and bailouts have all served to add stimulus to the economy, preventing the situation getting far worse. Recently, for example, in Taiwan, the economic indicators started flashing green again, after extensive periods of both overheating (until 2007) and recession (2007-2009). So in many markets, there are initial signs of recovery as some exporting economies move out of recession and bond rates are indicating upward pressure, too. But…

Where now, consumers?

Many economists are predicting a double-dip recession in 2010. This may happen, and things may worsen again in the short term as the stimulus measures are withdrawn, run out of funds (new car credits) or expire their terms. Even if that doesn’t happen, I don’t think consumers are going to start spending any time soon. They are scared of the future, and the prospect of a double-dip may only force consumers to redouble their efforts at controlling their spending.

In short, going into the latter part of 2010, there is still a lack of confidence in the recovery; and recent upturns in the stock market are likely to be short-lived. I do not think we will retest bargain basement pricing as in early 2009, but for those with patience, guts, and cash, there will be good opportunities to purchase both stocks and real estate in the coming 12 months.

What’s an investor to do?

With the risk of a double dip recession, typical in a bear market scenario like this, investors are unlikely to be buying for the long haul. They would prefer to ‘trade the markets’ in either direction, buying or shorting stocks when there’s opportunity otherwise staying in cash.

How would you plan to trade these recessionary times? Let me know, via the contact form! Look forward to hearing from you.