Just one week ago, I asked the question, "Will the Recovery Have Legs?"  What I absolutely did not expect was the very real possibility that our "recovery" may be so short-lived in 2010 that we don't even notice it.  This past week was more than a little scary, and I believe we are entering an important moment.

Who would have seriously predicted just two weeks ago that the Democrats would lose their super majority with a Republican winning Ted Kennedy's Senate seat in Massachusetts?  Ironically, along with the surprise, the Democrats can no longer jam through the health care bill which was so emotionally tied to Kennedy's very own crusade.  And now, a young and inexperienced President can celebrate his first year in office with the fact he needs to change direction before he's really even begun. Clearly, this is a major challenge for an inexperienced President, but I wonder if he understands this is a tipping point on so many levels.

Not only was his push on health care and alignment with the Democrats in Congress a huge mistake, it was also a major drain of political capital.  While he has already softened his position, he has not demonstrated the awareness of how he needs to pivot to avoid rattling the markets.  In fact, he seems to believe that changing his focus from health care to punishing the banks is the answer.  Perhaps the timing was just coincidence, but can you believe he would sermonize on "never again will the American taxpayer be held hostage by a bank that is too big to fail".  Are you kidding me? We're trying to build confidence in the recovery not threaten it with saber-rattling.

In the very same week, Warren Buffet comes out and says "the tax on banks just doesn't make sense", and two additional Democrats on the Senate Banking Committee announce they plan to vote no on Bernanke's confirmation.  Really?  Is Congress so oblivious to the fact that a "no confidence vote" on Bernanke is completely irresponsible right now?  So, in spite of very solid earnings announcements from a host of companies, the equity markets sell off and will probably end the week with the Dow off by nearly 5%.  Sure the markets have gotten out ahead of themselves and were bound to experience some correction, but you'd at least expect that to happen based on some economic news.  The data looks good, but our leaders look terrible and that's the problem.

Obama had best figure out that punishing the banks and tongue lashing them in public is even more stupid than trying to push through a massive health care plan when we just went through the Great Recession.  Forget the political consequences for Obama and the Democrats, we can't afford more destabilization.  Somebody in Obama's camp better help him pivot and change direction or we're not going to like what's on the other side of this tipping point.

Let me know what you think.    

As we all know, the recession is technically over and we're expecting a much better year in 2010.  While unemployment is expected to continue to rise for the next few months, most of the experts predict the unemployment rate to peak and for the recovery to begin this year.  We're certainly hoping for a solid recovery, but you have to ask yourself, "Will the recovery have legs?"

Needless to say, the past two years have been a roller coaster with most of the ride plunging downward.  In 2008, we began to see the effects of the real estate bubble bursting, but it was clearly the tale of two stories.  During the first half of the year, the stock market tried to hold on in spite of the write-downs in financial services.  In addition, investors and consumers remained in a state of denial as the presidential election approached and the talk of a soft landing prevented the economy from tanking.  But we all know what happened in the second half of the year as we held on during what felt like financial armageddon.

Similarly in 2009, the first half of the year was devastating as the Great Recession took hold and unemployment raced towards 10%.  Somewhat surprisingly, the financial and stock markets rebounded quickly, and companies began to see the bottom as businesses across the board stabilized, albeit at levels down on average 30%.  The tremendous amount of stimulus and support from the Fed helped as well and companies came up off the carpet to exceed expectations in the second half of the year.  As a result, 2009 was much like 2008 in that the first and second halves of both years produced very different results.

So, here we are in 2010 with talk of a recovery and unemployment peaking and hopefully beginning to come down.  The financial services sector is clearly in much better shape as large bank CEOs are defending plans to pay out large bonuses once again.  The consumer was surprisingly resilient over the holidays, and the year over year comparisons should allow the stock market to hold onto it's gains and continue to rise - at least for awhile.  Companies are also getting back to work and investing again as productivity improvement positions them to perform very well when revenue growth comes back.  As a result, the first half of 2010 is set up for success, but I think the real test will be the second half of the year and the first half of 2011.

My belief is the recovery will run out of steam and the second half could be scary.  As the Fed executes it's exit strategy, companies will be conservative and unemployment is unlikely to change much.  Sure companies will stop laying people off, but jobs will not come back in any noticeable way this year.  As a result, sustainable growth is likely to be difficult to achieve and the emphasis on these risk factors will probably shake the confidence of investors leading to a correction in the stock market.  While my crystal ball may not be 100% accurate, I'd be very surprised if the second half of the year is as strong as the first half in 2010.

After four straight quarters of negative economic growth, the great recession is now over.  While we've certainly made it through one of the most difficult economic periods in our history, it doesn't seem like anyone is celebrating; at least not yet.  So what lies ahead and how should we chart the future?

Growth is good and things will surely get better, but the speed or lack thereof of the recovery makes a big difference.  When the Dow was at 6,600 and Goldman predicted it would reach 10,000 by the end of 2009, few believed it.  For those who sold and stayed on the sidelines for fear of losing even more, they're kicking themselves but justifying they really had no choice as they worried about their jobs and the value of their homes.  We all know the story, but it is important to remember that for the vast majority of people the recession really isn't over. 

To gauge the health of the recovery, it would seem to me that you only need to look at four things; unemployment, housing, US equities, and consumer spending.  Clearly the equity markets have improved and it is expected they will continue to do so in 2010.  Remember, we're still down more that 20% from the highs and the markets are essentially flat over the last ten years.  As a result, the near term downside is minimized.  Having said this, the consumer still has no real value in their homes and the piggybank of home equity loans may not come back for years.  This combined with unemployment that is expected to rise even further in 2010 means that a noticeable recovery in consumer spending may not occur for 2-3 years.  I'm not an economist, but it seems unlikely that we'll return to high rates of spending while the consumer continues to deleverage.

As a result, we're likely to see a rebound over the next few quarters followed by an extended period of flat to no growth.  The markets may spike and fall and uncertainty and risk aversion will likely dominate the corporate psyche for sometime.  As a result, leaders are likely to strategically reposition their companies while simultaneously focusing on improving productivity and profitability of core operations.  Non-core operations will be sold and discontinued, and M&A and CEO turnover will rise.  While all of this activity will be good for dealmakers and senior leaders as they reposition themselves, the positive effects of these structural changes may not be felt for several years.  As a result, the labor market at the middle management level will likely lag behind the most senior levels in the market.

So, what does all this mean?  My belief is that the recovery will stall in late 2010 and early 2011.  While this may cause some turbulence, I also believe that most managers and investors are aware of this risk and unlikely to get out in front of themselves.  As a result, we may experience a flat period in 2011 and into 2012, but I also believe that a sustained period of growth will follow.  If we see solid growth in spending, rising home prices, and much lower rates of unemployment at that time, we could be in for several years of upside.  As a result, it would appear wise to manage your expectations over the next couple of years but get positioned for sustained growth beginning in 2012.

After meeting with a variety of private company owners and private equity investors this summer, I've been surprised by the tentativeness in both camps.  While I'm a firm believer that M&A activity is poised to pick up and is a leading indicator of a recovery, I have to ask, "What are they waiting for?"

We have all heard the same comments from small and medium sized business owners who say they've weathered the storm and feel the worst is behind them.  They reflect on the anxiety they experienced during the crash, and the vast majority of those still standing feel they were fortunate to have saved the business.  While clearly relieved, they also express cautious optimism for the future with a lack of conviction of how quickly things will noticeably improve.  I then ask if they've considered selling the business, and almost to a man I hear, "the private equity guys have disappeared, but that's OK because I sure wouldn't want to sell anything right now if I didn't have to".

As for private equity firms, they've been busy fixing the companies in their portfolio they can save and calming investors.  They've also taken a look at potential deals, but they're extremely skeptical of the future potential of any company that is on the block right now.  As the private company owner says, "Why would anyone want to sell anything right now unless they have to?"  There we have it.  It really isn't about a lack of capital or leverage, it's really about a lack of confidence and unrealistic expectations.  Sellers still haven't adjusted their expectations on valuations to address the risk private investors still see in the market. 

For the buyers, they continue to wait for that magical day when valuations appear more reasonable.  For sellers, they're keeping their fingers crossed that their businesses continue to improve and that private equity buyers will come back.  While it seems like a standoff, I believe the buyers will come rushing in when they feel they may miss the window.  Buying good companies at a bit of premium is going to look a whole lot easier than buying marginal companies at a discount and trying to turn them around.  You get what you pay for.

So, where are the private equity guys?  What are they waiting for? 

Let me know your thoughts.