Saturday, December 20, 2008

Steep Drop, Slow Ascent

Steep Drop, Slow Ascent

Investing for the long haul is even more important in today's volatile markets, but as John Maynard Keynes once quipped: "In the long run, we're all dead." Right now most people just want to know what's in store for the coming year. To get some ideas, BusinessWeek surveyed 45 economists around the nation about their expectations for everything from growth and profits to inflation and unemployment.

It's not a pretty picture. On average, the forecasters expect the economy to contract 0.2% in 2009, the same as in 2008. The worst of the declines in real gross domestic product will come early, with some stabilization in growth by midyear, followed by a tepid start toward recovery. That scenario will lift the jobless rate to a peak of 8.1% by yearend.

The recession, plus plunging oil prices, will push inflation sharply lower. By yearend these prognosticators believe consumer price inflation will have fallen to 1.2%, having already slid to an expected 2.1% by the end of 2008. Not surprisingly, profits will get hammered. Even before the Federal Reserve's latest radical move, the forecasters looked for the Fed to cut its target federal funds rate to nearly zero and hold it there, perhaps all year. The Fed accommodated that expectation much earlier than expected by slashing its target rate on Dec. 16 to a range of zero to 0.25% and committing to hold it there for as long as it deems necessary.

The tumble in homebuilding is expected to bottom out by midyear, but house prices will fall an additional 9.8% by yearend 2009, the economists project, after a nearly 20% decline in 2008. On balance, they believe that enormous policy efforts by the Fed and Congress will prevent a serious recession from becoming worse. Here's a more detailed view of how they see the coming year:


The recession already is a year old. If the forecasters are right, it will easily exceed the severe 1973-75 and 1981-82 downturns in length and about match them in depth. Those two slumps each lasted 16 months, with peak-to-trough declines in real GDP of 3.1% and 2.6%, respectively.

Almost all economists, however, think the risks of an even worse outcome are high. "There are no precedents in modern-day experience for the breakdowns in financial markets dominating this recession," says Robert DiClemente at Citigroup. (C) In the classic pattern of past slumps, the Fed eased, financial conditions improved, and recovery took root. This time, faced with dysfunctional markets, conventional Fed policy is powerless to kick-start growth. "The downturn in the economy and problems in the financial markets are self-reinforcing, and the current dynamic will not self-correct any time soon," says Robert Mellman at JPMorgan Chase (JPM).

Much damage has already been done, and the economy faces a bleak winter. "Consumer spending is the No. 1 factor taking the economy down right now," says Nariman Behravesh at research firm IHS Global Insight. Job losses, tight credit, and crumbling confidence are overwhelming the benefits of lower energy prices, and declines in real estate and stock market wealth are devastating nest eggs. "Individuals will need to begin accumulating wealth the old-fashioned way—by higher savings, which will limit growth in spending," says Michael Moran at Daiwa Securities America.

With demand slumping badly, businesses are throwing in the towel. The Business Roundtable says CEO confidence tumbled at yearend, and sharp cutbacks in hiring and capital spending are sure to follow. "Costs cannot be cut fast enough," says Kevin Logan at the investment bank Dresdner Kleinwort, as businesses scramble to protect their bottom lines. Donald Straszheim, who heads his own consulting firm, thinks earnings estimates are still too optimistic. "Few sell-side stock analysts have any adult memory of past serious business cycles," he says. "They weren't even in the business yet."

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