The Economy & What To Expect In 2010

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
December 29, 2009

IN THIS ISSUE:

1. 3Q GDP Revised Lower Than Expected

2. Debt Ceiling Raised For Only Six Weeks

3. Disappointing Holiday Spending in 2009

4. A Little Good News on the Housing Slump

5. The Outlook For 2010 – Who Knows?

Introduction

We will touch on a lot of bases in this holiday issue of my weekly E-Letter. We start by looking at the latest economic data, and how hard it is to get a new job if you become unemployed. We also examine President Obama’s new “jobs program” that would spend what’s left of last year’s TARP money that was supposed to be repaid to taxpayers.

Next, we look at the Democrats’ move to raise the national debt ceiling, and what they really have in mind for the debt limit in January. Following that, we will look at the disappointing holiday spending levels – as if anyone is surprised. On the plus side, there was at least a little encouraging news on the housing front over the last couple of weeks.

Normally, I devote this year-end issue of my E-Letter to respected predictions for the economy and the markets for the New Year. But this year, on the heels of the worst recession since the Great Depression and the credit crisis, predictions for 2010 are all over the board. Even my most trusted sources are in disarray as to what they see for next year.

Near the end, I will make some observations on this subject, but frankly I don’t think anyone knows for sure what lies ahead, especially in the last half of 2010.

Finally, I sincerely appreciate all of you who have read my weekly E-Letter regularly over these last seven years. I especially appreciate your comments and suggestions (for the most part) more than you can know, so please keep them up.

3Q GDP Revised Lower Than Expected

Last Tuesday, the Commerce Department released its third and final estimate of 3Q Gross Domestic Product, and it was lower as I have suggested in recent weeks. The latest 3Q GDP report came in at +2.2% (annual rate), down from 2.8% in the second estimate and down from 3.5% in the initial report. The pre-report consensus suggested the final number would be unchanged, so the reduction came as a surprise to many (but not my readers).

It is important to note that the Bureau of Economic Analysis (BEA) stated in its most recent release that motor vehicle output added 1.45 percentage points to the 3Q change in real GDP. In other words, 70% of the 2.2% increase in real 3Q GDP was due to increased auto production brought about by the one-time “Cash for Clunkers” program. When you consider that at least part of the increase in personal consumption expenditures was also due to purchases of autos under the Clunkers program, we come to the conclusion that the rise in 3Q GDP was largely a federal government-induced phenomenon.

The latest GDP report is causing some forecasters to lower their estimates for 4Q GDP and the first half of 2010 as well. Still, there are estimates all over the board for the next 2-3 quarters. Some still expect GDP to be in the +4-5% range for the 4Q and the first half of 2010. While the GDP reports for 4Q 2009 (to be released on January 29) and 1Q 2010 will likely be positive, keep in mind that they will be compared to the two worst quarters of the recession: 4Q 2008 GDP was -5.4%, and the 1Q 2009 GDP was -6.4%. Thus, it is almost certain we will see positive GDP reports for the 4Q and the first half of 2010.

The Index of Leading Economic Indicators (LEI) rose a solid 0.9% in November, marking the eighth consecutive monthly advance. The Conference Board which produces the Index noted: “The Conference Board LEI has been on an uptrend for more than half a year and it is now slightly higher than its latest peak in July 2007. Improving financial conditions, labor market indicators, and housing permits have helped the LEI continue its gains in November.”

This is another indication that the economic recovery will continue to unfold in the first half of 2010, as inventory rebuilding will be the main driver. It remains to be seen if the economy will deliver the 4-5% GDP growth in the first half of next year as some forecasters predict. As I discussed at length in my December 15 E-Letter, we are not likely to see robust economic growth until consumer lending recovers and the unemployment rate improves significantly, and that could be a year or two away.

Speaking of the unemployment rate, it remains to be seen whether the December number will fall below November’s 10% rate which was down from 10.2% in October. Initial claims for unemployment benefits have continued above 450,000 per week in December. While initial claims are down from 600,000 per week early this year, these numbers need to get down to 350,000 per week or lower for the unemployment rate to come down in a meaningful way.

I ran across an interesting chart that depicts how difficult it is for an unemployed person to find a new job. According to the US Bureau of Labor Statistics (BLS), the probability of a newly unemployed worker finding a job in a given month has plunged to less than 20%. During the worst of the 2001 recession, the probability was close to one-third. During the downturns of the 1950s, it was nearer to one-half. So this is indeed the worst recession since the Great Depression.

Lost in Unemployment Probability of exiting unemployment

Obama’s New Job Creation Program

The unemployment situation is so dire that President Obama announced earlier this month that he wanted Congress to approve a new job creation program that some are calling “Stimulus II.” Apparently, there is still some $200 billion left over in the original $700 billion TARP fund from 2008, and several big banks are paying back billions that they were lent during the credit crisis. Now Obama wants to spend a lot of that money on a jobs package.

Everyone knows how the TARP money was to be used. It was not intended for spending. It was supposed to be a loan. It was supposed to rescue the banking system during the credit crisis, and most of it would be paid back at some point (as is now happening). Most importantly, it was not going to add to the deficit. In fact, the government was supposed to make a profit on these loans.

Frankly, as soon as I heard that the big banks were repaying their billions in TARP loans, I wondered if the Democrats would be able to resist finding a way to spend that money. Apparently, given how the TARP language was written, it is technically illegal for the government to spend that money. Yet President Obama wants Congress to concoct a way to spend it on his new jobs program.

Details on the proposed jobs program are still sketchy, but we all know how the $787 billion Stimulus I that was loaded with pork barrel projects worked. Very little of the stimulus money went to “shovel-ready” projects that would create new jobs.

On the subject of spending the leftover TARP money, syndicated columnist Charles Krauthammer noted: “It is a perfect political ploy. The Democrats will not resist it. And even though it is against the law as written in the TARP law and supposed to be returned [to the Treasury], today the Democrats are the law and they will change it if necessary.”

Nancy Pelosi and the House Democrats wasted no time either. On December 16, they passed a new $154 billion “jobs” program. Once again, no Republicans voted for the measure.

Debt Ceiling Raised For Only Six Weeks

In its last action of the year, the Senate voted 60-39 on Christmas Eve to raise the US debt ceiling by $290 billion to $12.4 trillion. The current debt ceiling is $12.1 trillion and is set to be reached by December 31. Unfortunately, that extra $290 billion will only fund government expenditures until mid-February when it will have to be raised again. The government piled up a record $1.4 trillion deficit in 2009.

The Senate Democrats could muster only 59 of the required 60 votes to pass the increase since Evan Bayh (D- IN) refused to vote for the measure and in fact, voted against it. Only when George Voinovich (R-OH) crossed the line and voted for it did it pass. Jim Bunning (R-KY) did not vote.

The Senate is expected to take up the debt ceiling again after they return in January. The Democrats want to further increase the debt limit by a whopping $1.8 trillion, which will be the largest increase in history. That would be enough to get through the mid-term elections in November. They don’t want to have to remind Americans that we are running massive record budget deficits as we approach next year’s elections. It remains to be seen if they will be successful.

Disappointing Holiday Spending in 2009

According to the International Council of Shopping Centers, holiday spending remained below yearago levels in 2009. On December 22, the ICSC noted: “The holiday [gift buying] completion rate was especially low through Sunday, December 20, in the Northeast at 65.7% as the rest of the nation had an average 72.1%. The average holiday-gift buying completion rate at the same time of 2008 was 80.1%.”

Making matters worse, the severe snow storms that hit the Midwest and Northeast over the last few weeks also had a negative effect on holiday shopping. Despite the snow storms, retailers were hoping for stronger holiday spending this year given that personal income increased in both October and November, but that didn’t happen.

With the economy only just beginning to recover from a serious recession, and with house prices still falling in many areas, it should not have been a surprise that consumers were reluctant to spend more this holiday season. Add to that the fact that surveys continue to show that some 70% or more of Americans feel the country is headed in the wrong direction, and it is no wonder that holiday spending was disappointing.

As this is written, some reports suggest that holiday spending rebounded in the last week before Christmas and may have slightly exceeded 2008 levels. We will get more data in the weeks ahead, but it is clear that the 2009 shopping season was less than retailers had hoped for.

A Little Good News on the Housing Slump

On December 22, the National Association of Realtors reported that sales of existing homes rose 7.4% in November from October to a seasonally adjusted annual rate of 6.54 million units, the highest rate since February 2007. Buoyed by a tax credit for buyers and low interest rates, sales were 44% above November 2008, when fears over bank failures were near their peak. The median sales price last month was $172,600, up from $172,200 in October, the first monthly increase since June, the Realtors group said.

But the very next day, the Commerce Department announced that new home sales fell 11.3% in November to a seven month low. While new home sales typically lag the trends in existing home sales, the drop in November was considerably larger than expected.

RealtyTrac reported that US home foreclosures rose by 306,627 units in November, a decrease of 8% from October but still up 18% from November 2008. RealtyTrac noted: “November was the fourth straight month that U.S. foreclosure activity has declined after hitting an all-time high for our report in July, and November foreclosure activity was at the lowest level we’ve seen since February. Loan modifications and other foreclosure prevention efforts, along with the recently extended and expanded homebuyer tax credit, are keeping a lid on the most visible symptoms of the nation’s ailing housing market — foreclosures and home value depreciation.”

Housing starts and building permits both rose modestly in November. While things are still quite bad in the housing market, overall conditions over the past few months appear to be improving modestly in most, but not all, areas of the country.

The Outlook For 2010 – Who Knows?

2008 and 2009 have been two of the most unusual years in recent history. We’ve seen the worst recession since the Great Depression and an unprecedented credit crisis. We’ve seen the worst housing slump in over a half century. We’ve seen a huge ramp-up in government spending on a scale never seen before, with a record budget deficit of $1.4 trillion for fiscal 2009.

Making matters worse, President Obama plans to run another $1.4 trillion budget deficit in fiscal 2010 and almost another $1 trillion in fiscal 2011. The Congressional Budget Office estimates that Obama’s projected deficits over the period from 2009 to 2019 will almost double the national debt. Clearly, we are in uncharted waters.

In the short-term, that is the next 2-3 quarters, it would seem reasonable to assume that the economic recovery will continue, absent any major surprises. As noted in the Introduction, forecasts for economic growth in 2010 are all over the board. Some analysts believe that GDP will expand by 5-6% in the first half of the year as businesses rebuild inventories. There are others who believe that economic growth will be slow in the 1-2% range, especially in light of the weaker than expected revision in the 3Q 2009 GDP number.

My guess is that the first half of 2010 will see growth somewhere in between the two, most likely in the 2-3% range. Unfortunately, the unemployment rate is likely to remain high through the first half of next year. Most analysts I follow expect the unemployment rate to peak sometime around mid-2010 and fall only to around 8% by the end of next year, at best.

Beyond the middle of next year is anyone’s guess, in my opinion. US consumers will still be in a deleveraging mode – increasing savings and reducing debt – and will not be in a position to fuel the economy into overdrive. Assuming inventories are rebuilt in the first half of the new year, that leaves open the question of what will boost the economy in the second half of the year and beyond. Frankly, I don’t see much

There are too many uncertainties to predict a return to recession in the last half of 2010 and on into 2011, but I would not rule it out. With the US running deficits of $1.4 trillion in 2009 and 2010, we also cannot rule out a renewed run on the US dollar. While the dollar has seen a nice bounce over the last month, the long-term trend is still down.

The outlook for the stock markets in 2010 is equally blurry. I know of no one who predicted that the S&P 500 would soar 65% off the March lows, without even a 10% correction along the way. But with the government spending unprecedented amounts of money, the Fed spending unprecedented sums buying up troubled assets, and interest rates near zero, this excess liquidity had to go somewhere and much of it went into equities, creating what some now call the next asset “bubble.”

It would be very easy to turn bearish on stocks following such a run. The problem is, there are still several trillion dollars of investor money on the sidelines waiting for an opportunity to get back in. This is one reason why the equity markets have soared beyond expectations. Markets rarely do what John Q. Investor expects them to do.

What I can say is that I do not expect a repeat in equities in 2010. Most of my sources believe that US equity prices will be sideways to modestly higher by the end of 2010, and a serious downward correction could easily happen along the way.

Finally, I believe that 2010 will be another challenging year for all investors, especially those who are still out of the equity markets and looking for a place to get back in. The last two years have been a particularly tough time for “buy-and-hold” investors, many of whom were scared out of stocks and mutual funds during the severe bear market in 2008/early 2009.

Government bonds are likely to be another very risky area for buy-and-hold investors in 2010. With enormous, unprecedented federal budget deficits on the horizon for at least the next several years, bond yields are almost certain to head higher sometime in 2010 and beyond. If so, that would mean losses for bond investors next year and probably 2011 as well.

Given all of these risks, and given that federal spending is clearly out of control, risks in the investment markets are higher than ever, at a time when Baby Boomer investors and those already in retirement desperately need to boost their investment returns and avoid big losses.

As always, I continue to recommend alternative investment strategies that have the flexibility to exit the stock and/or bond markets or “hedge” long positions during market downturns.

Thanks to You, My Loyal Readers

As we close out 2009 and celebrate the New Year, I would like to express my sincere thanks to all of you who read this weekly E-Letter on a regular basis. When I agreed to write this weekly column seven years ago, I had no idea what a time commitment it would be.

Finding something interesting and useful to write 7-8 pages about 52 weeks per year to an audience of more than 1 million potential readers every week is a daunting challenge that takes a lot of time (and I readily admit that some weeks the letter is more interesting and useful than others).

What keeps me going are the positive responses many of you send me, and I can’t tell you how much that means to me. And I must admit that even the occasional negative responses are also helpful (for the most part), as they make me think of ways to make the weekly letter better.

So, THANK YOU for all your feedback! Please keep it coming.

I also want to thank Mike Posey, our Senior Vice-President at Halbert Wealth Management, who helps me every week to make this E-Letter possible. He does a lot of research for me, suggests topics to write about, and even helps write some of the letters for me, along with helping run our business. Many thanks, Mike, and everyone here that help make this E-Letter happen!

In closing, let me thank you for your continued readership, and wish each of you a Happy New Year, even as we face an increasingly challenging investment environment.

Wishing you a Happy & Profitable New Year,

Gary D. Halbert

P.S. I strongly encourage you to read all three of this week’s stories below.

SPECIAL ARTICLES

Why the Democrats are defying public opinion (must read)
http://online.wsj.com/article/SB10001424052748703478704574612630389421904.html

Healthcare Reform: A Less Than Honest Policy
http://www.nytimes.com/2009/12/29/opinion/29herbert.html?_r=2

Has President Obama's shift to a law enforcement strategy
for fighting terror left the nation less safe?
http://detnews.com/article/20091229/OPINION01/912290309/1008/opinion01/Editorial--It-s-time-to-revisit-U.S.-terror-policy