By John W. Schoen Senior producer
updated 3/1/2009 6:37:30 PM ET 2009-03-01T23:37:30

The latest news on job losses, house prices and the stock market has a lot of readers asking some very hard questions. Like when is the economy going to recover? And when will the stock market start going back up? We have no idea. But here are some things to keep an eye on as we keep slogging through the roughest economy in at least a generation.

While we are in the midst of a very slow economy, what do past recessions tell us about the recovery? When it does rebound, does it take off quickly? Come back slowly? Does the stock market react first? Or real estate? Do companies start to hire again soon? Do banks start to lend money again fairly quickly? What will be signs to economy is turning around?
Dave, Youngstown, Ohio

If you want to pick one set of economic statistics to watch, keep an eye on the job numbers — both the monthly employment report and the weekly numbers showing how many people sign up for unemployment insurance for the first time. At the moment, these are the most worrisome because they seem to be accelerating downward. The next monthly reading comes this Friday. Some economists are talking about job losses of as many as 750,000 in February,  up from 598,000 in January. Last week, 667,000 signed up for unemployment benefits, the most in one week in a quarter century, bringing the total to about 6.5 million.

The problem now is that as GDP contracts, the workforce doesn’t shrink accordingly. Once the contraction is over, there will be millions more people out of work than when it began. When the economy begins growing again, it will take time for those unemployed people to be absorbed back into the workforce. It’s impossible to know how long that will take, but even during “boom times,” the economy was barely creating jobs fast enough to keep up with the growth of the workforce. Until everyone has a job who wants one, the consumer spending power that makes up 70 percent of the economy (or did before the downturn began) will remain weak.

Recent historical comparisons offer limited guidance. Since World War II, we’ve become accustomed to economic downturns that last, at worst, 16-months or so. The 1980-82 recession (really two back-to-back recessions) ended with a sharp upward recovery. But that was largely because the recession was induced by the government, which jacked up interest rates as high as 20 percent to stamp out inflation. Once the Fed eased off on rates, the economy came back to life, and pent-up demand sent the stock market soaring.

This contraction is different. Wall Street borrowed real money from private investors, with a promise to pay it back, and then lent it to people who can now never pay it back. Some of those lenders thought they’d get their money back. Many more knew the housing boom was a house of cards but kept lending anyway because they thought they could shift the risk to investors. Some borrowers were foolish. Some were prudent but are being hurt by the sharp, ongoing drop in the value of their house, which makes up a big chunk of most Americans’ wealth.

When the contraction stops — maybe sometime next year — we may begin growing again. (Most economists seem to have quietly abandoned last year’s widely-held “second half 09 recovery” forecasts.) But when growth does kick in, it will be slow and from a much lower base. It’s entirely possible we won’t see the Dow hit 14,000 — or our houses recover their 2007 value — in my lifetime (I’m 56).

Housing is probably the second most important indicator to keep your eye on. The goal of the government’s $75 billion housing relief package is to stop as many of the 10 million foreclosures expected by 2010 as possible. The Obama administration concedes many homeowners won’t be helped. If even half of those 10 million foreclosures take place, that would more than double what we’ve seen since the crisis began. As we’ve reported, without aggressive efforts to stop them, these foreclosures may drag on through 2011, which will preclude any recovery in the housing market before then. Without a housing recovery, you can’t have a consumer spending recovery.

My investment company, Vanguard, has repeatedly suggested that my investments should contain more long-term stock options. Given that my retirement from work is 22 years away, and the how low the cost of stocks are, is this a good time for me to reinvest for the long run?
— Monica M.,Fairfield, Iowa

Just to be clear, we don’t think anyone has yet figured out how to forecast where stocks are headed in the long run. In the very long run, they go up. But in times like these, it’s worth noting that following the stock market crash of 1929 and the ensuing decade of the Great Depression, the Dow did not recover its pre-crash peak until 1954.

Some stock salespeople — sorry, "investment advisors" — are still offering dire warnings that “you can’t time the market,” so “you have to be/stay in the market to participate in the rally when it comes.” It sounds plausible. But it seems highly unlikely we’re on the verge of a sharp updraft in stock prices so sudden it will leave long-term investors like you out in the cold without a chance to get in on a sustained, long-term rally.

One way to think of the of the current economic contraction is that we’re all “giving back” trillions of dollars of imaginary money that were counted as real economic output and wealth during the housing and stock market booms. It turns out that growth and wealth was based on alchemy; the result was fool’s gold. It’s gone to Money Heaven, never to return.

As a result of that giveback, the stock market, housing market and economy are now "resetting” to lower levels. Stocks usually lead the other two because they’re the most liquid. Housing is less so. Though the economy is now contracting rapidly, we’re still feeling the waning momentum from the lending boom. Many older, unemployed workers, for example, are spending down their remaining retirement savings. When that’s gone, and they have no more surplus spending power, that will further weaken their contribution to economic output.

What the government is trying to do now is fill the multi-trillion money hole created by the departure of those trillions of imaginary dollars on Wall Street. The $800 billion stimulus package is an attempt to get dollars flowing back through the system. But that system, globally, is badly broken. All those tax dollars we’re going to spend on new bridges won’t flow very far if the pipes remain clogged with bad credit. To fix the plumbing, the government is also committing $700 billion to try to fill the hole on the banking industry’s books.

At the moment, we’re still adding up the tab. That $700 billion, for example, may be just down payment. The International Monetary Fund recently estimated losses of $1.5 trillion — just for European and U.S. banks. Based on the broadest measure of the stock market, the DJ Wilshire 5000, something like $10 trillion has been wiped out there. One in five homeowners owes more on their mortgage than their house is worth. That loss — many more trillions — doesn’t get tallied until those people sell their house, convince their lender to take or share the loss, or walk away and mail in the key.

Until the damage to the banking system is repaired and the depth of the “wealth crater” is fully measured, it’s hard to see how the stock market is going to resume the reliable, upward path we’ve all come to expect.

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