Why There is No Bottom: Economic Forecasts
Since the stock market seems to have no bottom, investors want to know why. We shall consider this in a series of articles. This is Part One, dealing with economic forecasts.
What People Read
We know that individual investors are frightened, a perception fueled by stock market results. For most, the stock market is the barometer for economic forecasting.
Fueling this is the popular perception of the economic prospects. The New York Times pulled together a number of op-ed pieces, asking When Will the Recession be Over?
This is powerful material, drawing together the opinions of many experts. Readers should review all of the pieces. We know from reader feedback, emails, and calls that it was an important article.
Jim Grant, erudite, polished, and persuasive, tells us, "don't ask when."
Stephen Roach, of Morgan Stanley, predicts late 2010 or 2011.
A. Michael Spence, the Nobel-Prize winning management Prof from Stanford says "unusually long and deep global recession through 2010." That is if governments get their acts together.
William Poole of the Cato Institute rails against unwise government bailouts, which he believes are making things worse.
Eric Schmidt, Chairman and CEO of Google, expects signs of life later this year, and a resumption of normal lending in 2010, with the Internet playing a key role.
Financial writer George Cooper sees a financial drag extending into the next decade.
Harvard historian Niall Ferguson sees two years of contraction and two lean years after that.
Princeton Econ Prof and former Fed Governor Alan Blinder sees growth resuming in the fourth quarter of 2009, but with many caveats.
University of California-Riverside economists Marcelle Chauvet and Kevin A. Hassett take a probabilistic approach based upon past recessions, and see the probability of the current downturn lasting through 2009 at 50-50.
University of Maryland economist Carmen Reinhart focuses on a return to normal growth, setting out four years or more as the time frame.
NYU Econ Prof Nouriel Roubini sees a three-year recession, with chances for much worse.
A Different Approach
A different approach to the problem is to use a continuing panel, not selected for star quality. The Wall Street Journal forecasting survey provides such a comparison.
The Journal article on the latest survey carries a gloomy headline, Economists' U.S. Outlook Dims. The Journal surveys 52 economists, and reports on 2009 as follows:
The average forecast now sees growth in the third quarter at 0.7%, less
than half the rate expected last fall. The fourth-quarter picture has
also darkened, but just slightly, to growth of 1.9% from the 2.1% seen
in November. Five economists see growth declining through the fourth
quarter of 2009; they say the current consensus outlook, which says the
recession will end in August as GDP growth returns positive, is far too
optimistic.
Briefly put, the economic panel has reduced estimates for growth, but is dramatically more positive (less negative?) than the New York Times group. They see the monthly job loss for the year as 183,000 per month, much better than current rates, and unemployment peaking at 8.8%
A key difference is attention to the stimulus package, which they see as saving about 90K jobs/month. Interestingly some say it was too large, and others, too small!
Our Take
The entire media approach is very negative. The New York Times has an all-star cast of experts, but it leaves us wondering a
bit. When an article like this appears it creates an illusion of
scientific sampling. We are also bothered by the lack of
attention to the dramatic government intervention begun many months ago, policies with known lags. The peak of the crisis came right after the Lehman fall and credit freeze.
None of the economic models have any experience with the myriad of Fed programs, not to mention the stimulus package.
Models can be quantitative or qualitative, but are always based upon
experience. None of us have the relevant experience for this
particular crisis, so our models are suspect. It is also natural to highlight experts who have
been right — those who "got it" in the popular Street parlance. The
question is whether the skills involved in predicting the problem are
also the right skills for identifying the possible solutions.
We find the WSJ panel to be an interesting counterpoint. The investment prize will go to those who can identify economic indicators showing any bottoming signs. With equity prices at depression levels, even a moderation in the depth of the recession could be good news.
Meanwhile, most investors are focused on the headlines.
“With equity prices at depression levels, even a moderation in the depth of the recession could be good news.”
Just curious what metrics you are looking at in that determination? It does seem to vary across sector. Some of the cyclical sectors like energy and materials do seem priced for a lengthy depression, while some seem to be basically fairly valued such as many staples. I can find energy stocks with P/E ratios under 5 and 1-2x operating cash flow, but many staple names are still trading at mid double-digit P/E ratios. The market seems to be saying we will all still buy our brand name toothpaste, soda, razors, etc. but that energy prices will stay permanently depressed and/or fall much further.
It would be interesting to see what the WSJ panel said in March 2008…
But your point is correct on both counts. They were right, but any panel with Jim Grant AND Roubini is skewed towards pessimism. lol And you are correct that out of the thousands of professional opinions, someone will be right. They will then be the new guru and they will stop getting quotes from Roubini (until the next bear market which he will be continuously predicting from now until then). Maybe Elaine Gazarelli will have the winning prediction? 😉 She is due.
This is why we have scholars: to record and analyze our history, and determine the relationships, or patterns within it. And economists are the first to try to put bands around how relevant that experience is to our present circumstance.
Carmen Reinhart, whom you mention, has done a great survey together with another economist (Rogoff), of the great financial crises of the twentieth century, only one of which directly hit the US. That ought to serve as a guide to those of us who are trying to transcend our personal experience and capture what history tells us about the present. Those of us who care about relevance should know it, and guide others to it. That, plus a bit of focus on the Great Depression, Japan, and how the Crisis is affecting other nations, makes it obvious that this is NOT a “subprime crisis.”
Rather, we have Yet Another Financial Crisis, in which debtor nations (the US, UK, Australia, Spain, …) and creditor nations (China, Germany, Japan, …) did a dance that looked individually smart but got us into a world-embracing mess. We took their cheap loans to build McMansions; that worked out badly by putting ourselves deeply in hock while we exported our jobs. They over-invested in export goods production, and are now in the middle of a production/export crisis.
Funny, the CRA, elevated greed and “irresponsible borrowers” are a tiny part of that broader story. Not quite as ridiculous as claiming that 1930’s Germany would’ve been OK had Hitler only brushed his teeth a bit more often, but similarly missing the point.
Patrick – The mainstream economists, as you suggest, were way off in March of 2008, as they would be any time we have a huge economic change.
We are all well aware that some forecasters saw this all as inevitable. If one looks at data, the real collapse came after the Lehman failure and a complete six-week credit market freeze. Apparently everyone needed to see that before policy action could occur.
Thanks for your helpful comment, bringing us all a chuckle as well.
Jeff
Attempts to explain why the stock market keeps falling, and why unemployment keeps going up, and why almost all the news flow is skewing negative can list a lot of contributing factors and agree on the directional effect of each factor, but there simply isn’t enough data to have any confidence about factor weights. For example, possible reasons why the stock market keeps falling:
1) Belief that many financial institutions are technically insolvent leads to an expectation of more bad news flow to come.
2) Long term investors are giving up after negative returns for the last decade.
3) Active market participants these days all primarily momentum and growth investors (with negative expectations, who often short on the anticipation of more good news or sell their longs after each negative news item regardless of underlying valuation). This is because long value investors either got in too early and were largely wiped out ove the last year or their funds are seeing large redemptions.
4) People are selling because they need the cash now to make up for shortfalls in income.
5) The market is disappointed with Obama’s financial team or his tax proposals.
6) Long buyers are on strike because they’ve been burned so often.
7) Macro views that the economy will go through a process of adjusting to lower demand levels worldwide and elimination of excess production capacity.
8) Belief that much higher taxes are going to be needed in the future, regardless of which U.S. govt. is in power, to keep up payments on the U.S. debt and to provide social programs to keep retirees out of poverty.
The point is that any of these things could be factors, but there isn’t any kind of data available to assess their relative importance.
“The question is whether the skills involved in predicting the problem are also the right skills for identifying the possible solutions.”
Excellent point. Roubini comes to mind, though the claims he is just being bearish for the sake of bearishness above by Patrick is unfair. He analyzed this very well, it wasn’t luck.
The problem isn’t that Roubini is a congenital bear (I, and nobody else, has any evidence of that) it is that analyzing the housing bubble, the debt bubble, the incredible overvaluation across asset classes, etc., in no way implies that in knowing what to do going forward he has any necessary leg up on people who did miss that. One might be able to spot all kinds of problems at GE for example as an analyst, but it in no way qualifies you to run it.
“Those of us who care about relevance should know it, and guide others to it. That, plus a bit of focus on the Great Depression, Japan, and how the Crisis is affecting other nations, makes it obvious that this is NOT a “subprime crisis.”
I couldn’t possibly agree more with every word of this statement.