The Post-Meltdown Economy: Will Historical Averages Return?
Reversion to the mean is a popular theme in finance. Whenever we see a sudden deviation from a long-term trend, we can usually expect that it is merely an anomaly and that things will return to normal given time. But how can we tell when we are entering a different situation that forms a new average? (To learn more, check out The Linear Regression Of Time And Price.)

Let's take a look at three key economic indicators and analyze what average we can expect in the future.

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Unemployment
Recently, there has been some worry that high unemployment rates might persist over the long term, or that they might even be a permanent change in our economy. By looking at historical unemployment data, we can get an idea of whether there is a trend that suggests we should fear that this is the new average.

When trying to get an idea of what the true average is for an economic indicator, I like to start by looking at the longest time period available. In the case of unemployment rates, the U.S. Bureau of Labor Statistics has relatively consistent data on yearly unemployment rates back to 1940.

Looking at this data, we notice that the unemployment rate fluctuates pretty significantly. It has varied from 2% to over 10% during this time period. But for the most part, it seems to stay within a range of about 4% to 8%. In 2009 it suddenly jumped up to 9.3%, and remains at 9.8% as of the most recent data in November 2010.

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High Unemployment - We've Been Here Before
While these unemployment rates are alarming, the United States has seen these levels before, most recently in the early 1980s. Both jumps were caused by significant financial crises, so we can understand that these exceptionally high rates are the result of exceptionally hard times. These high unemployment rates have been around for about two years, but that does not constitute a long-term trend.

It may take some time, but I expect we will see a reversion to long term the average unemployment of 5.6%. History shows that such large disruptions cause a lot of structural unemployment. That is, the jobs created as the economy improves may not be in the same industries or geographic locations. People may need to retrain or relocate in order to take these new jobs. So even as the economy improves, there can be considerable delay as the labor force adjusts to find where the new jobs are. (For more, check out A Review Of Past Recessions.)

Real Estate Prices
The data provided by Princeton Economist Robert Shiller from his book, "Irrational Exuberance," tells the tale of home prices in U.S. from 1890 to the present. For whatever reason, we continue to hear news stories from people who expect house prices to recover, or resume their upward climb. The long term average data tells a very different story.

In the 1990s and early 2000s housing was all the rage. Due to a combination of factors, home prices rose at never-before-seen rates all over the country. As Mr. Shiller's data indicates, real U.S. home prices nearly doubled from 1990 to 2006. If you read personal finance books from this period, there is almost invariably some indication that real estate will make you rich. I usually skip through that section. (To learn more, see Why Housing Market Bubbles Pop.)

That period was a very unusual time for real estate prices based on this data. I think that we are in a new average period now, where we will see home prices return to their pre-bubble trend of roughly keeping pace with inflation.

Naturally, this is a conclusion about U.S. real estate in general. Local market dynamics can differ significantly from the overall trend, just as individual stocks differ from the market indices. Buying your own home may still be a good investment, but probably not from a price appreciation standpoint unless you have favorable trends in your local market.

Inflation
Recently we have seen incredibly low inflation rates, including a negative inflation rate in 2009. In fact, there is even some worry from the Federal Reserve that we may encounter deflation in the economy longer term.

While deflation may be a worry due to the rarity of such low inflation rates, it seems less likely when you consider that United States has not experienced a period of significant deflation in more than 70 years. In the BLS data series from 1948 to 2010, the inflation rate has turned negative only 3 times.

Save for the oil shocks in the 70s and 80s, for the better part of the last 60 years, inflation has been very consistent at around 2% to 4% per year. This meshes well with the standard estimate of inflation at about 3% per year. Currently, inflation looks like it will come in slightly positive for 2010, which could be a sign that inflation may be gradually returning to more normal levels. (To learn more, see our Inflation Tutorial.)

The Bottom Line
As the saying goes, the more things change, the more they stay the same. Often, economic indicators will revert to their long-term averages. Just make sure you are looking at an average derived over a representative time period. (For a relating reading see Jobless Recovery: The New Normal Since 1990.)

Find out what happened in financial news this week. Read Water Cooler Finance: Steady Stocks, Big G's And Madoff News.




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