Forecasts for 2011 Continue to Improve, But...
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
2. The Case For Slower Than Expected Growth
3. “Black Swans” & Negative Surprises
4. Conclusions – What Do I Think?
As I have written often since back in early November, most economists and market analysts have been revising their 2011 forecasts upward, and January has been no exception. The Wall Street Journal’s annual survey of leading forecasters was very upbeat about the economy’s prospects in 2011. The same can be said of most of the consensus forecasts in the latest Blue Chip Economic Indicators survey. The consensus in both surveys is that the economy will grow by at least 3% this year. I will get into more details on these two surveys as we go along.
While it is always encouraging to see economists’ forecasts improving, especially after the severe recession and credit crisis we endured, there are still plenty of reasons why US growth could be at least somewhat sluggish for the rest of this year; by sluggish I mean GDP growth below 3%. I will discuss some of these factors below.
Whether you’re in the ‘”ore optimistic” or the “less optimistic” camp, the latest improvements in the various forecasts reflect an assumption that there will be no major negative surprises this year. I’m not at all sure that such an assumption is a safe bet this year. There are still plenty of things that can go wrong in this delicate economy and slowly thawing credit environment.
Think “Black Swans.” Near the end of today’s letter, I have reprinted portions of a recent Fox News article which features an interview with well-known economist Ed Yardini. While Ed is still bullish on the stock market, he speculates on what might be the most likely Black Swan events in 2011.
Economists More Optimistic on 2011 Growth
In this section, I will list some of the latest consensus forecasts from The Wall Street Journal survey (WSJ) and the Blue Chip Economic Indicators survey (BCEI). This year, the WSJ surveyed 56 leading economists and analysts, while BCEI canvases 50 well-known forecasters each month, with some represented in both surveys.
In general, the mood among forecasters has improved somewhat in the last few months as most economic reports have been favorable, with housing the notable exception. Consumer spending increased noticeably in the fall and into the holidays. Manufacturing has seen a slow but steady increase since mid-year. And there have been other favorable actions such as the extension of the Bush tax cuts, generous expensing for capital equipment purchases, and a temporary cut in workers’ payroll taxes.
We don’t yet have the Commerce Department’s estimate of 4Q 2010 GDP growth; the first estimate will be out on January 28. The WSJ consensus has GDP growing by an annual rate of 3.3% in the 4Q of last year, up from 2.6% in the 3Q. The BCEI consensus is 3.2% for the4Q. If accurate, that would mean the economy grew by just over 2.8% last year.
As for 2011, the WSJ consensus has the economy growing by 3.3% this year, and the forecast at BCEI was 3.1%. If GDP growth reaches either of those forecasts, it will be the best since 2005.
These forecasts assume that consumer spending will continue at or above the rate in the 4Q of last year. The BCEI consensus predicted that personal consumption expenditures rose at an annual rate of 3.8% in the 4Q, the strongest pace since early 2006.
As I will discuss below, it is far from certain that consumer spending will remain at these levels throughout 2011. The personal savings rate, which increased significantly during the recession, started to decline again in the last half of 2010, and this may explain why consumer spending increased more than expected late last year.
The outlook for business spending has also improved for 2011. The BCEI consensus predicts that non-residential fixed investment spending will increase by 9.1% this year. That forecast increased significantly in the wake of the more generous expensing rules on equipment purchases that were passed in December.
On the inflation front, the WSJ expects the Consumer Price Index to remain timid with a rate of only 1.9% in 2011. The BCEI consensus is for a rise of only 1.7% this year. These forecasts would seem a bit low, especially with the sharp rise in food and energy prices we’ve seen over the last year.
With regard to interest rates, the WSJ expects the Fed Funds rate to rise to 0.2% by mid-year and 0.4% by year-end. The WSJ consensus predicts that the yield on 10-year Treasury Notes – currently around 3.35% – will rise to 3.6% by mid-year and near 4% by year-end.
As for the employment outlook, the BCEI consensus forecast calls for monthly non-farm payrolls to average monthly gains of 188,000 for all of 2011, as compared to 161,000 in December and only a 92,000 monthly average for all of 2010. They expect the unemployment rate to average 9.4% for all of this year.
The WSJ survey expects a monthly average rise in non-farm payrolls of only 179,000 for all of this year. The WSJ survey expects the official unemployment rate to fall to 9.3% by mid-year and 8.8% by year-end. But that may be too optimistic as I will discuss below.
As noted earlier, the forecasts for the housing market were not nearly so positive. In the WSJ survey, only 17 of 56 respondents believe that home prices nationally will rise in 2011, seven expect no change, and 32 expect home prices to decline more. On a more positive note, the BCEI consensus expects monthly housing starts to average 680,000 units, as compared to only 527,000 in December.
Lastly, the WSJ survey asked the respondents to predict the price of crude oil for this year. The consensus forecast was $88.7 at mid-year and $90.7 by year-end. Crude oil is trading near $86 a barrel as this is written.
The Case For Slower Than Expected Growth
As noted above, the WSJ and BCEI surveys both suggest that the economy will grow by slightly more than 3% this year. But there were plenty of respondents to both surveys that believe the economy will grow by less than 3% this year. What follows is a brief summation of the concerns held by these less optimistic survey respondents, in no particular order.
President Obama’s $800+ billion stimulus spending will largely come to an end in 2011. Many argue that it accomplished little in the way of real growth in the economy. There appears to be little or no talk about further stimulus coming from the Obama Administration, so other than the temporary payroll tax holiday passed in December, fiscal policy will be mostly neutral in 2011. Likewise, the Fed’s $600 billion QE2 will come to an end by mid-year, and as noted above, most economists expect interest rates to rise this year.
State and local governments are drowning in red ink. This will be a drag on the national economy as states cut budgets and lay off workers. In addition, it will also result in higher taxes and fees as states struggle to balance their budgets.
As noted above, many believe that the surge in consumer spending late last year came at the expense of savings. The national personal saving rate more than tripled during the recession, but in the last half of 2010, the rate peaked and fell significantly. While the savings rate is still above the lows in 2005, some forecasters believe consumer spending will not be strong enough to push economic growth above 3% in 2011.
Rising food and energy prices are another serious concern. Several recent studies have shown that the surge in food and energy will cost the average family an extra $1,300 in expenses this year. Since wages are not going up, generally speaking, families will have to cut back somewhere to make up for that added cost.
Next, there is a broad consensus that inventory rebuilding was the main driver of economic growth since the recession ended in mid-2009. Inventories as a percent of GDP fell to the lowest levels in over 50 years during the recession, so they naturally spiked higher in the last half of 2009 and 2010. Forecasters are mixed on the outlook for inventory investment in 2011, but it is fair to conclude that inventory rebuilding will not repeat last year’s levels this year.
As noted above, home prices will remain a drag on the economy this year. Home foreclosures topped a record one million units in 2010 following 918,000 homes seized in 2009, according to RealtyTrac. The firm warned that foreclosure filings could have been substantially higher were it not for the 4Q drop in foreclosure activity amid the controversy over foreclosure documentation and procedures. But foreclosures look to increase again this year.
FYI, Nevada, Arizona and Florida have the highest foreclosure rates in the country. And just five states – California, Florida, Arizona, Illinois and Michigan – accounted for more than half of all foreclosures over the last two years. Home prices are likely to fall again this year in these states and several others.
Next, there are many forecasters that believe the previously red-hot growth rates in countries like China, India, Brazil and others will have to slow down in 2011 to keep inflation concerns in check. This, they believe, will slow down US exports in 2011, another drag on the economy.
Finally, we cannot leave out the sovereign debt crisis in Europe. While the IMF and the European Central Bank have stemmed the crisis with massive loans, it remains to be seen if Spain and/or other Eurozone nations will get into trouble.
This list of concerns is not meant to be comprehensive; in fact, there are plenty of other concerns. I include these issues only to point out that the US economy could underperform in 2011, at least as compared to the survey results discussed above. In the BCEI survey, for example, 16 of the 50 respondents expect GDP to grow by less than 3% in 2011.
“Black Swans” & Negative Surprises
The Black Swan is a 2007 book written by Nicholas Taleb wherein he criticized the financial industry and warned about a coming financial crisis. Taleb describes Black Swans as: high-impact, hard to predict, and rare events that are beyond the realm of normal expectations in history, science, finance and technology. Most consider the financial crisis of 2008/2009 as a Black Swan.
Many also consider the collapse of the stock market on May 6, 2010 to have been a Black Swan event. That day, the so-called “flash crash,” the Dow Jones Industrial Average plunged nearly 1,000 points in a matter of minutes. But less than a half-hour later the market had exploded higher and recouped much of the loss. I’d say that qualified as a Black Swan event!
Reportedly, a large mutual fund firm had dumped a big block sell order – over $4 billion worth, about 75,000 contracts – of E-Mini S&P 500 contracts. The pool of available buyers dried up in minutes, and high-frequency traders who can make trades in a fraction of the time it takes you to blink your eyes started doing attack selling, blowing the effect of the mutual fund's order out of proportion and fueling the dramatic price declines on that terrible day.
The Securities and Exchange Commission, along with the Commodities Futures Trading Commission, spent five months investigating the flash crash. A joint report from the two market regulators was then issued. Bottom line: The events belied "a market so fragmented and fragile, a single large trade could send stocks into a sudden spiral.”
On September 10, the SEC passed new rules backed by the stock exchanges and other market regulators to expand a circuit breaker program that it had earlier installed, this time to include all stocks in the Russell 1000 Index and certain exchange-traded funds. The circuit breakers would stop trading for five minutes on these stocks if they rise or fall more than 10% in a five minute period.
The question is, of course, are there any more Black Swans ahead of us in 2011?
Fox Business News interviewed well-known economist Ed Yardeni in January and published a list of what he thinks are some possible Black Swan events that could happen in 2011. Yardeni remains a cautious bull; he says he has “a 70% subjective probability” to his bullish forecast, and 30% to bearish alternatives. Here is Yardeni’s surprising take on the potential 2011 Black Swan events, as reported by Fox News:
“(1) Inflation heats up, especially in emerging economies, where the majority of consumer budgets are spent on food and fuel. The UN’s Food and Agricultural Organization is warning of a “food price shock” after its benchmark index of farm commodity prices shot up to a new record high last week. Similarly, the International Energy Agency is warning that oil prices “are entering the danger zone for the global economy.” Rising food prices have provoked riots in Algeria. Pakistan’s shaky government reversed a recent fuel price rise despite criticism from the IMF. Indians are crying over soaring onion prices, which have led to an 18% year-to-year increase in food prices. Higher food and fuel prices reduce the purchasing power of the "Have Nots" in emerging economies. This increases the likelihood of social and political unrest. In the emerging economies, central banks must focus on the overall inflation rate. But they can’t strip out food and energy from consumer price indices, as the U.S. Federal Reserve does, since these items account for so much of consumer budgets. This is why most of these central banks have been tightening their monetary policies.
(2) The leader of the Black Swan flock in the food price inflation story this year may be La Niña. “The little girl” is causing havoc in the commodity markets. She is the strongest she has been in three decades and could continue to be disruptive for another three months at least, according to the latest closely watched report from the Australian Bureau of Meteorology released last week. The 1/6 Wall Street Journal reported: “Heat caused by the La Niña weather pattern, for example, is lowering forecasts for South American crops, and Russia banned wheat exports this summer due to a crippling drought. Severe flooding in Australia has crimped its raw sugar output by 20%.”
(3) There are plenty of other Black Swans in La Niña’s flock. Some are stealth swans. They are the Unknown Unknowns, and Yardeni says he won’t pretend that he can see them coming. Plenty to choose from here. Home prices could drop again in the U.S., as foreclosures are estimated to hit 1.2 million, surpassing last year's record high. Europe’s sovereign debt crisis could spin out of control as Spain gets in trouble--Spain's GDP is double the size of the economies of Ireland, Greece and Portugal combined. The Middle East could explode. California could get locked out of the muni bond market if Governor Jerry Brown fails to deliver on promised cuts, causing chaos in the muni bond market, already on the verge of a nervous breakdown. Political gridlock could close down the federal government.
In the interim, having a field day in an ensuing market plunge would be the short sellers, who are like lizards, they eat what's in front of them, as one pundit put it.
But Yardeni is optimistic for the rest of the year. He concludes: “Nevertheless, I expect that 2011 will be more like 2010 than like 2008…”
Conclusions – What Do I Think?
My role as your editor of this weekly E-Letter is first and foremost to bring you a host of forecasts from a diverse group of economic and other analysts. But often my readers want to know what I think is the most likely scenario. My response always is that I don't have a clearer crystal ball than most other analysts, and I am willing to look at both sides of the arguments, unlike the mainstream press and the Perma-Bulls on Wall Street.
With that said, barring any negative Black Swans or other negative surprises, which I would certainly not rule out for 2011, I expect that the US economy will continue a slow recovery, posting GDP growth of 2.5% to 3.5% this year. That should not be surprising given the array of forecasts for 2011 noted above, but I also have several caveats.
For example, I continue to feel that the consensus expectations for inflation in 2011 may be off the mark this year. Commodity prices exploded in 2010, and food and energy prices have increased substantially and could go even higher. Yet most forecasters seem to feel that these price increases will not lead to significantly higher inflation as we are seeing deflationary forces in other areas of the economy.
The question is, will this inflation/deflation balancing act continue through 2011? While most economists cited in the above-mentioned surveys predict that inflation will remain below 2% in 2011, I feel that they could be wrong - by how much I don't know.
As for the stock market outlook, I also have some concerns. The Consensus Bullish Sentiment Index rose to 73% last week, according to Consensus, Inc. This underscores the prevailing view that stock prices will continue higher in 2011. Virtually everything I read, and I read a lot, predicts that stock prices will be higher this year, with most suggesting double-digit gains. The analyses along this line can be very compelling.
Likewise, it is no secret that the Fed's $600 billion QE2 has helped to lift equity prices significantly. Fed Chairman Ben Bernanke admitted as much at a FDIC conference on January 13. Many investors now have the attitude that quantitative easing by the Fed has put a floor under stock prices, even though QE2 is scheduled to end by mid-year.
As a student of the investment markets for almost 35 years, I always consider "contrary opinion," although I must admit that some trends can extend longer than expected. Even so, when things look overwhelmingly bullish, I fear the opposite and vice-versa when things look overwhelmingly bearish.
As noted above, the consensus opinion on stocks is extremely high. Bullish arguments for stock prices in 2011 dominate the financial media. It's almost as if the stock markets have no other way to go but up, perhaps significantly, this year.
That's a big red flag for me, yet I can't put my finger on why these arguments should be wrong this year. After all, we are coming out of the worst recession since the Great Depression, the government has responded with massive stimulus, and the economy seems to be responding at least to some extent, even though unemployment looks to remain high for at least the next two years. Corporate earnings are strong and rising. Interest rates are still relatively low.
Most market analysts assume, correctly in my view, that the government is not going to let any major banks fail. President Obama’s recent selection of William Daley, a long-time Director of JPMorgan Chase, would seem to support that view. Thus, most analysts assume that another credit crisis is not in the offing.
Finally, many investors are still on the sidelines waiting for a chance to get back in. The broad stock indexes have been virtually straight up since mid-summer. Everything sounds so bullish.
Despite all of this, I believe that market risks are still very high, and I believe they will remain high for the rest of this year and possibly longer. A potentially large downward correction could happen at any time in my view, with or without any serious negative surprises and/or Black Swans.
You may agree or disagree, of course, but all this uncertainty argues for having defensive strategies in your investment portfolio that have the ability to move out of the markets and into the safety of cash (money markets) from time to time during bear markets or extended downward corrections – and/or the ability to “hedge” long positions.
To learn more about investment strategies designed to help you manage the risks of being in the market you can:
Wishing you profits in 2011,
Gary D. Halbert
Our So-Called ‘Centrist’ President
Obama’s 2012 Re-Election Campaign Cash Challenge
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.