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Related Resources See how StockScouter rates a stock View the all 50 top-rated stocks What were the best-performing industries? SuperModels Recent articles: • Mail call: Lottery picks (and pans) and a Belkin backlash, 5/19/2004 • Cant figure out the global economy? Go local, 5/12/2004 • Prepare for worst, market seer warns, 5/5/2004 More... | SuperModels Growth signals turn yellow One of the better economic forecasters around says the economy will slow dramatically over the next three to six months. But dont run for the exits just yet. By Jon D. Markman Economic forecasts are like bellybuttons. Everyones got one. But a few are worth more than others, and the J-Lo of U.S. economic forecasting in the past few years is Lakshman Achuthan at the Economic Cycle Research Institute in New York -- one of the few who accurately forecast the last recession and recovery. In recent weeks, Achuthans navel-gazing has produced a picture almost as disturbing as the movie Gigli. He says the U.S. economy is on track to slow dramatically over the next three to six months -- an unexpected turn of events that could threaten the presidents re-election bid, frustrate job-seekers and potentially jeopardize corporate expansion plans. The forecast is based on an abrupt downshift in his organizations venerable Weekly Leading Index. The index forecast the 2001 U.S. recession in mid-2000 at a time when most economists and corporations saw only sunny skies ahead, and in turn forecast a recovery in 2002 at a time of much bear-market despair. A downturn ahead? The WLI is composed of eight signals that independently take the pulse of the economy at key pressure points. Some of those pressure points are still positive, but the majority have turned negative in recent weeks despite the upbeat outlook articulated by federal monetary and political officials, not to mention Wall Street brokerages. The growth rate of the index, in fact, has hit its lowest level since late June 2003 -- a time when the models expectations for economic strength were, with good reason, ramping up. Now the expectations are ramping down. Its a pervasive decline, Achuthan said in an interview from his office in New York. And theres not a lot countering it. Its not just oil, which is a relatively minor factor in the economic forecast, weighing on the index. A host of reasons is driving ECRIs model into negative territory, among them: the flattening money supply, diminishing mortgage applications, sinking industrial prices, falling stock prices and rising corporate bond yields. Rising employment and narrowing bond risk spreads are the only two positives it sees on the horizon.
Achuthan, who has just published an excellent book, Beating the Business Cycle, about the methods ECRI uses to forecast the economy, says the growth slowdown is by no means a three-alarm fire. He just wants to warn businesses and individuals that the above-trend 4.5%-5% growth the country is now enjoying is likely to start gliding back down toward the long-term trend of 3% to 3.5% growth. Economy on the cusp The indicators are not plunging, so there is no immediate threat of a shift to below-trend growth, or recession. But they do show that the economy is on the cusp of a transition from an acceleration to a deceleration phase, and its that differential in pace that puts equity investors on edge. It would be good for bond holders, because if it occurs the Federal Reserve may not have to raise its interest-rate target as fast as the consensus now believes. But its not so good if youre an entrepreneur whos considering doubling the size of your factory on the belief that consumers will keep spending over the next six months like they spent over the last 12 months. Why are those negative indicators important? Lets take them one at a time.
The wild card None of these factors is as alarming as they were in 2000 or 2001. But the wild card now is the consumer, who accounts for two-thirds of the economy. In the past two years, individuals cashed in on low interest rates to withdraw money from their homes and rack up credit card bills. If higher rates and pricier energy finally lead consumers to back off on their spending spree, the economy will depend on businesses to take up the slack. Businesses are doing some of that already -- adding employees and capital expenditures in sync with improved profits. But a smooth handoff is never assured. Achuthan compares this point in the business cycle to a relay race. Were watching for the passing of the baton between the consumer and corporations, he said. Its tense, and you expect it to happen, but theres always the potential for a costly mistake. Mistakes of over- and underconfidence are inherent in the business cycle. Up-cycles occur, and are reinforced, as a positive feedback loop develops: Improved economic activity engenders more employment, and happy workers buy more things, generating more economic activity. On the downswing, the virtuous cycle morphs into its evil twin, the vicious cycle, as a cutback in demand leads to cutbacks in employment, which in turn lowers demand further. The inflection points between up-cycles and down-cycles come about as a result of individuals emotional reactions to the swings. Right now, most people and businesses believe that the economy is strengthening. At some point, they become so optimistic that they begin to seed the potential downturn by overbuilding factory capacity, taking on too much debt and generally underestimating risks. Instability develops, and the economy becomes vulnerable to shocks. As the downswing emerges and strengthens, people and companies ultimately become too pessimistic, see danger around every corner and overshoot their risk aversion until a positive shock -- sometimes in the form of fiscal or monetary stimulus -- starts a new up-cycle. In his book, Achuthan explains that a recognizable sequence of events transpires in the ECRI indicators before the inflection points of both extremes in the cycles, and he proposes a way that individuals who are neither economists nor statisticians can take advantage of them. 15 stocks for a slowing economy At this point, the economy could probably withstand some modest shocks, including higher oil prices, without slipping into recession. But if a growth-rate slowdown does occur, as expected, its probably not the right time for investors to focus on economically sensitive cyclical stocks, such as technology. Instead, health care and consumer staples would be more appropriate. Here are 15 that have worked this year and may continue to attract capital if the economy slows.
Fine Print ECRI also publishes a Future Inflation Gauge, a Leading Home Price Index and many shorter- and longer-lead indexes domestically and internationally. Click here to view them all. . . . The inflation measure currently forecasts a cyclical upturn, rising from 1% inflation at present to 2.5%-plus. ECRI is not forecasting 1970s-style inflation, however, despite the sharp rise in the price of oil, because its Future Inflation Gauge is not shooting up as it did back then, but rather is advancing in modest fits and starts. . . . The U.S. home price index is forecasting no slowdown in home prices on the six-month horizon. Our research shows that if you are a home seller, you can take a measured approach. The bottom is not about to drop out of the market, so you dont have to take the first offer, said Achuthan. By the same token, if youre a buyer, you dont need to worry that youre going to find yourself in the hole immediately after closing. . . . ECRI has furnished its data to institutions for years, but has just recently launched a $99/year service for individuals called Recovery-Recession Watch that describes the level of concern you should have for the prospects for growth. Data are presented in the form of what it calls an Economic Dashboard. . . . Achuthans co-author on Beating the Business Cycle" is Anirvan Banerji, and the publisher is Doubleday. . . . For the most comprehensive set of economic data from the U.S. government, visit the spectacular Web site run by the Federal Reserve Bank of St. Louis. Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdmmail@fastmail.fm. At the time of publication, Markman had a position in the following securities mentioned in this column: Pilgrims Pride, Sierra Health Services, Gillette. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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