On The Economy & The Odds Of A Recession
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. The Index Of Leading Economic Indicators
2. The Latest Economic Reports
3. Will The Fed Cut Again On Halloween?
4. Why BCA Believes A Recession Is Not Likely
5. Results From Our READER SURVEY
First of all, I want to thank all of you who took the time to complete our Reader Survey last week. We’ve already received over 1,000 responses and many more continue to come in daily. I especially appreciate the many comments and suggestions we have received. Near the end of this E-Letter, I will share with you the results of the Survey. I think you’ll find them quite interesting.
The US economy has been dealt a serious blow, what with the housing downturn and, in particular, the subprime mortgage meltdown. While we don’t know the exact magnitude of the housing downturn, we do know it is large and likely to get larger. Numerous forecasters believe this alone could send the US economy into a recession next year.
Also, as I have discussed in previous weeks, most of the latest economic data have not been positive, and I have noted that the odds of a recession have increased. In the pages that follow, we will look at the latest economic reports and their likely implications. More and more forecasters are revising their outlooks downward, with many now suggesting a recession is just ahead.
And of course, how could I not speculate on whether the Fed will cut rates again on October 31? Everyone else is. Many analysts are against any further rate cuts, as they fear inflation is coming back, especially with gold soaring to near $750. On the other hand, many analysts believe the Fed must cut rates again on Halloween, because of the credit crunch and fear that we are headed for a recession.
Yet the editors at The Bank Credit Analyst continue to argue that a recession is not the most likely scenario just ahead. BCA believes that the housing slump and related problems ensure that the US will see at least 2-3 more quarters of below-trend growth (GDP under 3%), but they continue to believe that a full-blown recession in the US is not likely over the next year. I will explain their reasoning later on in this E-Letter.
The Index of Leading Economic Indicators
Before jumping into the latest reports on the economy, I want to make some important observations about one of my favorite economic reports, the Index of Leading Economic Indicators, or “LEI.” There are some in the economics world who do not believe the Index of Leading Economic Indicators is a very reliable forecaster of the US economy. I don’t know why. I think the LEI is one of the best indicators of the major trend in the economy.
The Conference Board publishes the LEI monthly report, as shown below. The gray-shaded vertical areas in the chart denote periods of recession. If you look closely, you will see that the LEI turned decidedly lower in advance of each recession.
As you can clearly see from the chart, the LEI has been a very good indicator of recessions and well in advance. While there’s no guarantee that it will always be so accurate, it is not currently signaling that we are headed for a recession in the near future. Interestingly, the LEI has been in a broad trading range, essentially sideways since 2005.
If you would like to read the entire Conference Board report on the latest LEI, click on the following link.
The Latest Economic Reports
While not all of the economic news has been bad over the last month or so, most of it has not been encouraging. In September, the government released its final estimate of 2Q economic growth at 3.8% (annual rate), down from its previous estimate of 4.0%. 3.8% growth is very impressive, but quite a lot of bad news has appeared since the end of June, and few forecasters expect anything near 3% growth for the 3Q. We don’t get the government’s first estimate of 3Q GDP until October 31.
The Index of Leading Economic Indicators fell 0.6% in August (latest data available). The LEI report for September will be released this Thursday, and advance estimates suggest a modest improvement last month. We’ll see.
On the manufacturing front, the ISM Index fell to 52.0 in September, the third monthly decline in a row. Factory orders fell 3.3% in August. Durable goods orders fell 4.9% in August. The good news is that industrial production and construction spending rose very modestly in August (also latest data available).
The unemployment rate rose to 4.7% in September. According to the Labor Dept., the largest job losses were once again in manufacturing and construction.
The Consumer Confidence Index plunged for the second month in a row in September, falling 5.8 points last month to 99.8, the lowest reading in almost two years. Likewise, the latest University of Michigan Consumer Sentiment Index remains very low at 83.4.
Surprisingly, consumers continue to spend, although the trends point to a slowdown. Retail sales rose 0.6% in September, above expectations, following a rise of 0.3% in August, and the latest we have on personal spending was a 0.6% increase in August. While the latest spending figures are positive, the sharp drop in confidence suggests that consumer spending is likely to slow in the months ahead on a seasonally adjusted basis. It will be interesting to see how consumer spending holds up during the upcoming holidays.
Since consumer spending makes up apprx. 70% of GDP, this is the key number to watch, since the level of spending will likely determine whether or not we have a recession next year. As long as consumer spending remains at least marginally positive, we should avoid a recession.
Much of that depends on the housing market which continues to slide. New and existing home sales fell again in August. Pending home sales fell another 6.5% in August, following a 10.7% decline in July. Pending home sales plunged 21.5% for the 12 months ended August, the largest one-year decline on record. The inventory of unsold homes rose another .4% in August, pushing the number of unsold homes to 4.58 million, a 10-month supply at the latest rate of sales according to the National Association of Realtors.
Will The Fed Cut Again On Halloween?
The next Fed Open Market Committee meeting is on October 30-31, and there is much heated debate as to whether Bernanke & Company will move to cut rates again at that time. Economists and market forecasters now are split in two camps. On one side are those who maintain the Fed’s rate cut last month was too aggressive and who see no reason for further moves. On the other side are those who say the housing slump has us headed for a recession and believe the FOMC will have to cut again, given this and other signs of US economic weakness.
I happen to be in the camp of those who believe the Fed should cut rates again at the end of this month. The Fed’s September 18 policy statement suggests, in my view, that more cuts are certainly a possibility:
Clearly, the Fed is aware of the housing related credit crunch and how serious it is. Likewise, they are well aware that the economy is slowing down. As discussed above, most of the economic reports that have come out since September 18 have been negative. The “advance” GDP report for the 3Q will be released on October 31 at 8:00 a.m. EST, and as noted above, this report is expected to be considerably weaker than the 2Q number. If so, I would think that pushes the Fed to cut rates again on October 31.
BCA believes it is possible the FOMC could cut the Fed funds rate, currently at 4.75%, to 4% before yearend. One big reason the editors at BCA believe this is their outlook for US inflation, which they expect to surprise on the downside in the months ahead. It has been concerns about inflation that have made the Fed hesitant to cut rates.
Why BCA Believes A Recession Is Not Likely
Long-time clients and readers know how much I respect The Bank Credit Analyst (www.bcaresearch.com). As I have written often over the last several months, BCA continues to believe that a recession in the US is not the most likely scenario in this cycle. Martin Barnes and his fellow editors at BCA are well aware of the seriousness of the housing slump and the credit crunch. As a result, they certainly don’t rule out a mild recession, but they expect the US economy to surprise on the upside once again, as it has for the last 25 years. Here are some of the reasons why.
BCA points out that over the last 50 years, it has been restrictive Fed monetary policy that has led to recessions. In other words, the Fed kept monetary policy too tight, too long and raised rates too high, usually due to inflation fears, and that resulted in recessions. In the current cycle, however, inflation is falling and the Fed is not raising rates. As discussed above, BCA believes the Fed has plenty of room to lower rates several more times if need be.
Many analysts and forecasters place a great deal of emphasis on the “inverted yield curve,” which we have been in since June of last year. An inverted yield curve occurs when short-term rates rise above long-term rates, generally speaking. An inverted yield curve has occurred prior to each US recession in the last 45 years. Thus, it is no surprise that many forecasters believe a recession in the next few months is all but inevitable. However, it is important to point out that an inverted yield curve, by itself, is not a guarantee of a recession.
BCA also points out that bond yields, and interest rates in general, are so much lower in the current cycle than they were in most previous cycles that led to recessions. Thus, the inverted yield curve may not be a major factor this time around. BCA believes that bond yields have fallen significantly in recent years largely due to the enormous global demand for US Treasuries and the decline in inflation. Both of those phenomena are good things, they argue.
In addition, in past cycles the yield curve inverted when rates were rising, not falling as is the case now. For all these reasons, BCA does not feel that the current inverted yield curve is a harbinger of recession.
BCA considers the impressive strength in the US equities markets to be another sign a recession is not the most likely scenario. They point out that in every recession since WWII, the equity markets experienced a major decline. Yet this year, we’ve seen the major equity indexes punch out new record high after new record high, and the BCA editors believe this is another sign that we are not headed into a recession at this point in the cycle.
BCA refers to several other indicators that support their belief that a recession is not the most likely scenario just ahead. However, the editors do make it very clear that if a recession occurs just ahead, it will be caused by the continued slump in the housing markets. They do not believe the housing slump is over and suggest it will persist for at least another year. But they continue to believe that a recession is not likely.
The bottom line, as I see it, is we simply don’t know if the housing slump will worsen to the point that it chokes off consumer spending and we go into a recession. I am not convinced that we have heard all the bad news that is to come from the housing slump, the subprime meltdown and the credit crunch. And let me emphasize that while BCA maintains that a recession is “not the most likely scenario,” they do not rule it out.
In light of the current uncertainty regarding the economy and the credit markets, I would argue even stronger for “actively managed strategies” in your portfolio, especially with the major equity indexes screaming to all-time highs. It is precisely in times like these when I want professional managers that have the flexibility to go to cash or hedge positions on my team. Call us at 800-348-3601 for more information on the money managers I recommend.
Results From Our READER SURVEY
First, let me say that I am once again overwhelmed by the level of response we received to the Reader Survey and how quickly so many of you responded. I am also surprised by how resoundingly positive your responses were. Even most of our hard-core liberal readers who responded were courteous and respectful, even though they disagree with my political views. Many even said that while they disagree with me politically more often than not, they appreciate the fact that I will criticize President Bush and the Republicans when I think they are wrong.
I cannot thank those of you who responded enough! Your responses and suggestions will make me a better writer and analyst.
One last thing before I give you the results. As with our 2005 Reader Survey, we engaged a private, independent company to administer the survey so that it could be truly confidential and anonymous. This year, we used an online survey administrator, SurveyMonkey.com, and we have been very pleased and the cost was surprisingly affordable. The level of reporting and analysis that they provide is excellent. I am very impressed.
Okay, now for the results.
Level of Response – In our 2005 Reader Survey, experts told us generally what level of response we should expect from such a large audience of readers, most of whom I don’t even know. The response was 3-4 times what they projected. The 2007 Survey was no different, with completed survey responses continuing to roll in, even as I provide this summary. I don’t know what to say but THANK YOU again.
Level of Comments & Suggestions – In surveys like this, it is very hard to get respondents to take the time to write in comments and suggestions. People will check boxes they can just click on, but they are reluctant to take the time to actually type in comments and suggestions. Yet we literally got hundreds of comments and suggestions! We’re still trying to go through all of them, and we value each and every one – even those who had reasoned opposite opinions or negative comments.
Here is a summary of your overall responses to the 14 questions in the Survey:
1. How would you rate Gary’s Forecasts & Trends E-Letter overall, as it relates to you? Over 60% of you indicated that the E-Letter was “very helpful” to you. Over 75% also indicated that the information that I cover each week is “very interesting,” and over 80% considered it to be “very informative.” While it makes me feel good personally that you hold my writing in such high regard, it’s even more important to me that I’m providing information that you feel is valuable.
2. How often do you read this E-Letter? As in our previous survey in 2005, a high percentage of you (over 65%) indicated that you read the E-Letter every week. This is quite impressive, considering the amount of information on the Internet competing for your attention. This is unheard of, based on my 30+ years of writing newsletters, doing marketing and what we are told by other Internet sources.
3. In general, how would you describe your political orientation? This is a new question that was not on the 2005 Survey. Not surprisingly, almost three-quarters (73%) of you consider yourselves to be “conservative,” with another 19% opting for “moderate.” Only 4% of you consider yourselves to be “liberal,” based on the survey results. We did get some responses saying that we should have included “Libertarian” in the mix, but I wanted to stay away from specific political party designations.
4. Topics you like best. Your overall responses on this question were not a big surprise. The topic choices were (in order): economics and investments; geopolitics and world events; domestic politics and media bias; with military, specific investments and retirement issues close behind. There was a high level of interest in all the topics, but as you might expect, economics and investments were the most popular.
5. What should I write about in the Future? As in our previous Survey, a huge majority of you (over 87%) told me to continue to write about what interests me the most, and to continue to mix up the topics/content as I see fit. A number of you also asked for more domestic political analysis, as well as additional retirement-related articles.
6. Other topics you’d like to see covered. This question asked you to write in your suggestions for other topics you’d like to see addressed in future E-Letters, and many of you provided suggestions. We are now going through them and I will consider these in the future, at least those I am knowledgeable about.
7. How long have you been reading the E-Letter? This was another new question that we included in this latest Survey. As I somewhat expected, the vast majority of you (97%) have been reading the E-Letter for more than one year, with almost half having been regular readers for more than three years. Again, thanks for sticking with me!
8. Length of the E-Letters. Here again, over 81% of you said the length is “just about right” (7-8 pages per week). More than you know, this helps me a lot. I do not want to bore you, or take too much of your time each week.
9. Do you read the SPECIAL ARTICLES links at the end of each E-Letter? While over 18% of you said that you read most of the Special Articles, the majority (57%) indicated that you read “some of them” but not all. This is exactly the response I expected based on our previous Survey.
Just keep in mind that I rank the articles in order of importance, to me at least, so read the top one or two even if you don’t read them all. Many of the Special Articles pertain to topics discussed in the E-Letter, while others are political commentaries I think you would enjoy.
10. Third-party advertising. This is also a new question not covered in our previous Survey. 77.5% of respondents said they realize that I have no control over the advertising inserted by the Internet publisher in my E-Letter. Sometimes, I get responses from readers that indicate they think either my company sponsors the products offered in these ads, or that I endorse the products and services discussed. This is definitely not the case.
In fact, I never know what third-party advertising will be in my E-Letter until I get my own copy from InvestorsInsight. For those of you who may have assumed that I sponsor or endorse the products and services offered in these ads, I hope this explanation clarifies the issue.
11. Do you also read John Mauldin and other authors? The response to this question was also consistent with our previous Survey results. To provide a little background, John Mauldin and I both write for InvestorsInsight.com each week. John was the initial Contributing Editor for InvestorsInsight.com for a year before I started my weekly column.
John Mauldin and I are old friends and former business partners. John has learned a lot about investing from me, and on his own, and I have learned a lot about marketing from him over the years. In our 2005 Survey, I was somewhat surprised to find that apprx. two-thirds of you read both of our E-Letters. In the 2007 Survey, this is still the case.
12. Why You Haven’t Invested With Us? This response was very interesting to us, and the answers varied widely. The top three responses were:
This pattern of response is also in line with the results of our 2005 Survey. I will address these and other responses, as well as some of your written comments and suggestions in future issues of this E-Letter, but space does not permit this week.
13. What other types of products or services would be of interest to you? This is also a new question, and is based on an item that I have included in my periodic client surveys over the years. While question #12 above shows that many of you prefer to manage your own money, many other readers of this E-Letter have invested in the programs I recommend over the last several years. Therefore, it is important to me that I offer the kinds of investment programs that you feel are valuable.
The product lines that got significant most indications of interest were actively managed international equity programs, aggressive investments and ETF-based investment programs. However, the most interest was directed to “retirement income” programs. This is not surprising, considering that the Baby Boomers are now reaching early retirement age. I appreciate all of you who provided your opinions, as this will help us develop the types of investment products you deem most valuable.
14. Feedback & Commentary. The 2007 Reader Survey ended with a space for you to provide suggestions, comments, criticisms or whatever you wanted. We literally received hundreds of such comments - so many, in fact, we’re still in the process of reading and digesting them. As always, almost all of the comments and suggestions were very thoughtful and are very much appreciated.
Overall, the survey results were very interesting and very helpful. I’m overwhelmed by the large response. Thank you so much!
I also want to include a SPECIAL THANKS to our good friends Dr. George and Meredith Friedman at Stratfor.com for graciously allowing us to offer a 24-hour unrestricted free pass into their website for all who completed the survey.
Finally, if you did not participate in the Reader Survey, it’s not too late. Just click on the link below.
Very best regards,
Gary D. Halbert
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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.