Economy

Getting Better      September, 2010


The global economy was in full meltdown mode in the fall of 2008.  Somehow we managed to survive, and growth returned in July of 2009.  Now it looks like we've switched again, this time to a slower growth track.  The question on everyone's mind these days is, will we have a 'double dip' recession?  Our answer is an unequivocal and resounding NO.  Widespread fear about another recession is based on a few faulty assumptions.  First, the conventional view is that unemployment is getting worse.  But the numbers don't bear this out.  Unemployment is getting better, but not by much.  And there is enough weakness in the job market to keep everyone on edge and worried.  Our view is that employment will continue to improve, and the pace of improvement will start to pick up in the months ahead.

Another widely held but false belief is that the housing market is getting worse.  It is not.  Foreclosures are down almost 10% on a year-over-year basis, home prices are slowly moving up, and pending home sales are increasing.  Overall, we're not out of the woods yet with housing, but things are not as bad as the media portrays.



Consensus Forecast

Bearing in mind that the consensus forecast is usually wrong, here is what the so-called experts are predicting for the rest of 2010.  GDP will grow at 2.8% which is less than the typical 6% growth we see after a recession.  But if the economy only grows at 2.8%, it would be a problem, because it would not be enough growth to generate new jobs fast enough to absorb the 8 million souls who are currently out of work in the U.S.

The S & P 500 will finish the year at 1,215, which would be roughly 10% higher than where we are today.  This target is based on earnings of $83 for 2010 and a P/E of 15 times.  Fed Funds will end the year at 0.5% and the 10 Yr Treasury Bond will be 3%. 

The consensus forecasts come from twelve Wall Street strategists and investment managers who were interviewed by Barron's in June 2010.  According to this group, the economy will continue to limp along for the next 6 months, aided by the Fed who will keep rates low and money easy to get.  At mid-year 2011 the Fed is expected to start raising rates, and this will put the brakes on the pace of the recovery. 

Our Methodology

Our economic models are based on four key elements:  output, employment, income, and sales.  There are thousands of indicators that are published and available for anyone who cares to look them up, and our work over the years has taught us that these four elements are the most informative about the direction of the economy.  This affords us the luxury of being able to tune out most of the economic data that is widely disseminated and often misinterpreted by the media.  We can focus our attention and effort on those forces that have the most impact on growth.  Let's consider these four elements one at a time.

Output

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- grew at an annualized rate of 2.8% during the 1st quarter of 2010.  The increase in real GDP was largely driven by the twin engines of massive government stimulus and inventory restocking.  In order for output to show sustainable growth, banks will have to start lending and employment will have to start growing.  We expect these things to happen in the 3rd quarter of 2010.  Our forecast for 2010 GDP growth is 3.2%.

Employment

The employment picture continues to show signs of improvement.  The numbers turned positive in March for the first time since the recession began.  With the unemployment rate at 9.7% we don't expect it to get worse.  Employers have learned to do a much better job of getting ahead of economic downturns, and as a result they cut positions more quickly this time around.  Our forecast for 2010 unemployment is 8.7% by year end.

Income

In another sign of an improving economy, personal income rose by 1.3% in the 1st quarter of 2010.  We see this uptick as not much more than a technical bounce, and the only way it can be sustained is for employment to improve.  

Sales

One of the most surprising aspects of the current economic situation is the resilience of consumers.  By almost all measures, the consumer should have pulled back on spending to a much larger degree than what we have seen in the numbers.  Consumer spending rose at an annualized rate of 5.6% in the 1st quarter.  While this is an encouraging sign, bear in mind that spending is still significantly below where it was in late 2007 before the recession hit.

Conclusion

It appears that the massive stimulus is working.  Bear in mind that only about 2/3 of the stimulus money has been spent so far.  We expect the economy to continue showing gradual improvement throughout 2010 as the rest of the stimulus is released.  

Once the stimulus programs end, it will be difficult to predict whether, or  how well the economy will do on its own.  At this stage we are hopeful, but there are so many risks that we could turn more negative on the outlook at any time.  Stay tuned for further developments.