‘Uncomfortably Close' To a Recession
By LIZ PEEK
August 14, 2007
Does the recent market turmoil throw us into a recession? It's an important question. If the answer is yes, then the slide in stock market valuations and widening of credit spreads will have been prescient, and could continue. If not, bargain hunters will be rewarded handsomely. (See what I mean about the important question?)
Ed Hyman, Wall Street's favorite economist and head of International Strategy and Investment Group, has been grappling with this question. Despite some negative readings from the firm's recent surveys, Mr. Hyman does not think that we are not headed for a recession, but admits, "We will get uncomfortably close."
He rates his confidence in this projection as "pretty high," but at the same time forecasts that the economy is likely to get worse before it gets better. As we've already seen a sizable slowing of growth, he points out, his forecast suggests that the next few quarters could be dicey.
Mr. Hyman does not understand the Federal Reserve's expectation that growth will start to climb again in the second half of this year. Its reliance on currently strong employment data, a lagging indicator, is puzzling. In Mr. Hyman's view, the weakness in housing activity and employment in housing-related industries will surely be an ongoing drag for at least the next six months. ISI's study of temporary employment trends, a good predictor of overall employment, suggests weaker job formation ahead.
Mr. Hyman expressed surprise at the severity of market reactions to recent events, but he is not at all shocked that we are experiencing a financial crisis. His firm has been projecting a mid-cycle slowdown for some time, and he has warned repeatedly that every Fed tightening cycle has without fail brought on a financial crisis.
As he described it in a recent memo: "Financial crises ... indicate that the economy is under pressure, that central bank tightenings are working. The weakest link breaks." We should have been paying better attention.
He calmly ticks off preceding "events" going back to 1970: the failure of Penn Central in that year; Continental Illinois in 1984; Black Monday in 1987; the Mexican debt crisis in 1994; the Pac Rim/Russian/Long-Term Capital Management crisis in 1997; Nasdaq in 2000. It's a gruesome catalog that actually includes several others that I've omitted for brevity's sake. About half the time, these events were accompanied by recessions, with fairly disastrous results for the stock market. The rest of the time, the economy recovers and the stock market tends to bounce back nicely.
This is why stock investors will be hoping that we can avoid a recession. Specifically, ISI is estimating third-quarter real gross domestic product growth at 1.5%. If it is correct, the economy will have expanded for five quarters at a rate averaging below 2%. "We've never grown that slowly and not gone into a recession," Mr. Hyman says.
On the other hand (this is an economist speaking, after all), there are a number of reasons for optimism. The agricultural sector is booming, and the weakness in the dollar has boosted American exports. Also, we are only five years into the current expansion, which by historical standards is roughly middle-aged, and no wage-price spiral is discernable.
In comparing the current situation to the one caused by the Russian default in 1998, which took a far greater toll on stock prices than anything we've seen in recent weeks, Mr. Hyman's firm finds several comparatively positive elements: Cyclical stocks are outperforming, which would not likely be the case if the economy was about to tank. Global growth prospects are good, as indicated by the OECD GÂ-7 leading indicator. Meanwhile, the developing world, which today accounts for some 30% of global GDP, is still expanding nicely. Cash balances are high, especially in the hands of oil producing nations and central banks, while at the same time corporate balance sheets are still displaying near-record strength. Finally, valuations are not excessive.
Overall, Mr. Hyman is forecasting that weakening jobs data will prompt the Fed to cut rates later this year and that we will wiggle through without a downturn in output. The Fed chairman, Ben Bernanke, has demonstrated a "reasonably high threshold" of pain, but real growth in the vicinity of 1.5% should get his attention, according to the ISI team.
At the same time, relatively benign inflation numbers may be sufficient to calm the Fed. As the ISI folks point out, the enormous number of LBOs in recent years and continued rise in outsourcing have helped contain wage growth.
Doubtless the market would be cheered by a cut in rates. The timing is uncertain, but the ISI team points out that "hikes are planned -- cuts are surprises." Based on last week's performance, when the Fed was considerably less generous than foreign banks in supplying liquidity to the markets, Mr. Bernanke will require some push to cut rates. Real people losing jobs and being unable to meet mortgage payments are no doubt more compelling to the Fed than overleveraged hedge fund managers disappointing investors.
The risk today, according to Mr. Hyman, is of greater "contagion." That is, what started as a fairly narrow problem in the subprime mortgage market has already broadened to numerous other sectors, and to other countries. "Add to that the regulators are cracking down," Mr. Hyman says. "It's almost comical if it weren't so serious." He is concerned that forcing lenders to tighten standards in the midst of a credit crunch is like throwing gasoline on a roaring fire.
One indicator worth noting: The most recent retail sales reports cited "teenage chains" such as Abercrombie & Fitch reporting disappointing results. Of all the economic data streaming past, that is perhaps the most worrisome. In my experience, almost nothing can slow teenage spending.
peek10021@aol.com
August 14, 2007
Does the recent market turmoil throw us into a recession? It's an important question. If the answer is yes, then the slide in stock market valuations and widening of credit spreads will have been prescient, and could continue. If not, bargain hunters will be rewarded handsomely. (See what I mean about the important question?)
Ed Hyman, Wall Street's favorite economist and head of International Strategy and Investment Group, has been grappling with this question. Despite some negative readings from the firm's recent surveys, Mr. Hyman does not think that we are not headed for a recession, but admits, "We will get uncomfortably close."
He rates his confidence in this projection as "pretty high," but at the same time forecasts that the economy is likely to get worse before it gets better. As we've already seen a sizable slowing of growth, he points out, his forecast suggests that the next few quarters could be dicey.
Mr. Hyman does not understand the Federal Reserve's expectation that growth will start to climb again in the second half of this year. Its reliance on currently strong employment data, a lagging indicator, is puzzling. In Mr. Hyman's view, the weakness in housing activity and employment in housing-related industries will surely be an ongoing drag for at least the next six months. ISI's study of temporary employment trends, a good predictor of overall employment, suggests weaker job formation ahead.
Mr. Hyman expressed surprise at the severity of market reactions to recent events, but he is not at all shocked that we are experiencing a financial crisis. His firm has been projecting a mid-cycle slowdown for some time, and he has warned repeatedly that every Fed tightening cycle has without fail brought on a financial crisis.
As he described it in a recent memo: "Financial crises ... indicate that the economy is under pressure, that central bank tightenings are working. The weakest link breaks." We should have been paying better attention.
He calmly ticks off preceding "events" going back to 1970: the failure of Penn Central in that year; Continental Illinois in 1984; Black Monday in 1987; the Mexican debt crisis in 1994; the Pac Rim/Russian/Long-Term Capital Management crisis in 1997; Nasdaq in 2000. It's a gruesome catalog that actually includes several others that I've omitted for brevity's sake. About half the time, these events were accompanied by recessions, with fairly disastrous results for the stock market. The rest of the time, the economy recovers and the stock market tends to bounce back nicely.
This is why stock investors will be hoping that we can avoid a recession. Specifically, ISI is estimating third-quarter real gross domestic product growth at 1.5%. If it is correct, the economy will have expanded for five quarters at a rate averaging below 2%. "We've never grown that slowly and not gone into a recession," Mr. Hyman says.
On the other hand (this is an economist speaking, after all), there are a number of reasons for optimism. The agricultural sector is booming, and the weakness in the dollar has boosted American exports. Also, we are only five years into the current expansion, which by historical standards is roughly middle-aged, and no wage-price spiral is discernable.
In comparing the current situation to the one caused by the Russian default in 1998, which took a far greater toll on stock prices than anything we've seen in recent weeks, Mr. Hyman's firm finds several comparatively positive elements: Cyclical stocks are outperforming, which would not likely be the case if the economy was about to tank. Global growth prospects are good, as indicated by the OECD GÂ-7 leading indicator. Meanwhile, the developing world, which today accounts for some 30% of global GDP, is still expanding nicely. Cash balances are high, especially in the hands of oil producing nations and central banks, while at the same time corporate balance sheets are still displaying near-record strength. Finally, valuations are not excessive.
Overall, Mr. Hyman is forecasting that weakening jobs data will prompt the Fed to cut rates later this year and that we will wiggle through without a downturn in output. The Fed chairman, Ben Bernanke, has demonstrated a "reasonably high threshold" of pain, but real growth in the vicinity of 1.5% should get his attention, according to the ISI team.
At the same time, relatively benign inflation numbers may be sufficient to calm the Fed. As the ISI folks point out, the enormous number of LBOs in recent years and continued rise in outsourcing have helped contain wage growth.
Doubtless the market would be cheered by a cut in rates. The timing is uncertain, but the ISI team points out that "hikes are planned -- cuts are surprises." Based on last week's performance, when the Fed was considerably less generous than foreign banks in supplying liquidity to the markets, Mr. Bernanke will require some push to cut rates. Real people losing jobs and being unable to meet mortgage payments are no doubt more compelling to the Fed than overleveraged hedge fund managers disappointing investors.
The risk today, according to Mr. Hyman, is of greater "contagion." That is, what started as a fairly narrow problem in the subprime mortgage market has already broadened to numerous other sectors, and to other countries. "Add to that the regulators are cracking down," Mr. Hyman says. "It's almost comical if it weren't so serious." He is concerned that forcing lenders to tighten standards in the midst of a credit crunch is like throwing gasoline on a roaring fire.
One indicator worth noting: The most recent retail sales reports cited "teenage chains" such as Abercrombie & Fitch reporting disappointing results. Of all the economic data streaming past, that is perhaps the most worrisome. In my experience, almost nothing can slow teenage spending.
peek10021@aol.com
Labels: recession, The Job Market
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