The Daily Interview: Economic Numbers Don't Lie, Do They?
Truth be told, there's no consensus about where the economy's headed.
Managing Director and Senior Economist,
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For example, recent consumer confidence data have shown that consumer spending remains relatively healthy. Indeed, Treasuries, which some argue are the best predictor of future economic conditions, fell last Tuesday after the consumer confidence numbers were released and doubts crept into the market about whether the Fed would keep up its aggressive rate cuts.
But the bond market rallied on Friday after the combination of a somewhat mixed employment report and a weak purchasing managers' index number triggered hopes the Federal Reserve isn't done with its easing. The picture turned once again to one of economic weakness.Adding to the confusion is that the Fed doesn't always speak with one voice. In a speech before the Economic Club of New York on May 24, Fed chief Alan Greenspan downplayed the threat of inflation, saying "the lack of pricing power reported overwhelmingly by businesspeople underscores an absence of inflationary zest." Greenspan reiterated those comments yesterday. But one day later, Fed governor Laurence Meyer, speaking at a conference in Scotland, expressed concern about the level of prices in the U.S. In a search for more clarity, the Daily Interview talked to Michael Strauss, managing director and senior economist of Commonfund about his prognosis for the economy. The Wilton, Conn.-based nonprofit corporation manages more than $26 billion for about 1,400 educational and other nonprofit institutions, including foundations and health care organizations, representing the largest pool of educational endowment and operating funds in the world. Strauss, an economist who keeps a close eye on both the bond market and the stock market, is skeptical that the economy will recover by the second half of this year. And he thinks the latest employment report belies the health of the economy. But he has faith in the Fed and says that a lower fed funds rate will ultimately bode well for corporate borrowing, a stock market uptick and an economic recovery at the end of the year. TSC: What's your current economic outlook, in light of the latest slew of economic data, such as last Friday's better-than-expected employment report? Strauss: The bottom line is that the U.S. economy is continuing to show that it is growing at a slow rate of growth. We're probably going to see another quarter or two of gross domestic product growth in the range of 1% to 1 %. [Friday's] employment report continues to show some very solid weakness in the labor market. There may be some market participants relieved that the job drop in the payroll series was only 19,000 in May, and there may be others that look at the declines in the March and April numbers as a sign that maybe conditions weren't as bad as we thought they were, but that's an incorrect assessment. This is a month when there were major benchmark revisions to the employment report. While they helped to make the February and March months labor market look a little bit better, there was a massive downward adjustment for the job readings for January that virtually all the press missed. Prior to [Friday's] report, January's numbers had shown a 289,000 gain in payrolls. That number has now been revised to 61,000. The overt weakness in the labor market continues to be centered in the manufacturing sector. And that's going to imply some severe weakness in industrial production continuing. As far as the unemployment rate, my view is that the drop in rate from 4.5% to 4.4% is statistical noise and a distraction. The distortion has to do with the fact that the unemployment rate, which is done out of the household series, shows a drop in size of the labor market of about a half a million individuals. In all likelihood what happened was, because of bad winter weather, some schools that were supposed to be out of season in May were not. And it might be that we simply fooled the seasonal factors for a month. Actual household employment last month fell 250,000 and change, meaning less people were working last month than the prior month. When you get an unemployment rate with a drop in employment and a bigger drop in [the] labor force, that's a sign to question the data. In all likelihood, what we're going to see in the upcoming months is a very big and sharp increase in the labor force that's not going to be met with employment gains, and that's going to push the unemployment rate back up to maybe 4.6%, or maybe even 4.7%, in the coming months. [Employment] is a very important forward-looking indicator as it relates to consumer spending. We've clearly seen a falloff in what had been a very robust consumer. Effectively what kept the economy out of a downturn in the fourth and first quarters was the vibrancy of the consumer. In recent weeks and months, we've seen the consumer move to the sidelines a little bit. So even though the worst of the inventory adjustment and corporate adjustment may be close to complete, the fact that the consumer is decelerating his spending gains probably means we've got another quarter or two of sub-2% GDP growth. I don't think we're going to have a negative GDP ; the textbook definition of a recession is, you need two quarters of negative GDP. But the effects of an economy moving from 6% to 1% is as severe as an economy moving from 3% to -2%. This type of number will continue to put caution flags on the hands of corporate managers and corporations, and the concern about corporate profit margins will continue for the next couple of months. TSC: Which sectors will be the hardest hit? Strauss: The tech-manufacturing-sector-based companies will be the ones feeling the effects. Upscale retailers are also going to be hurt, though lower-scale retailers may actually be helped. It's old terminology, but as an example, the people who were shopping six months ago at upscale retailers may now be going to mainstream retailers. TSC: Are you hopeful for a second-half-of-the-year recovery? Strauss: Do I believe the worst of the storm is above us or a little bit behind us? Yes, but there still may be a couple of nasty storms in front of us as well. Given the time of year we're in, we'll see a greater percent of companies with earnings warnings to the downside, rather than positive surprises to the upside. Four months ago, it was a second-quarter recovery. Two months ago it was a second-half-of-the-year recovery. I think it'll become an end-of-year recovery scenario. And that may be some adjustments to certain sectors. The biggest issue in the equities market is how will we weather this issue of potential misses to earnings? TSC: Has the Fed's intervention helped? Strauss: The Fed recognized in November and December what it probably needed to do. Greenspan probably did not have the unanimous vote to ease in December last year, which is when I first believed the Fed should be moving. But I think Greenspan's made up for it. Greenspan himself and the Fed are learning from their past mistakes. One of the reasons why we had a recession a little bit more than 10 years ago was because the Fed was slow to respond to what was happening in the economy. One of the reasons I think we will skirt a recession here is the Fed's lowering of short rates as aggressively as it has will be providing some monetary stimuli. The long end of the bond market has been concerned about inflation, but the short end has traded very well to the Fed's easing moves, and that's where a lot of the short-term borrowing is done by corporate America. So, short-term commercial paper rates have come down, and that has helped corporate balancing. When you look at what's happening in the economy, as much as we're getting a slowdown in economic activity, we're not in the midst of a major credit crunch, and that's good. If we still had short rates at 6.5%, I'm not sure if I could [say that]. Now, it's a question of how much easing the Fed has to do, and my sense is we'll probably end up in the neighborhood of 3.5% to maybe as low as 3% on the fed funds rate. And it's not going to happen immediately -- it'll take several more months, but I think somewhere in that range [is where] the Fed will end up. TSC: Some economists, citing inflation concerns, see the need for the Fed to tighten earlier next year. Strauss: Not until the economy shows it has turned around on strong footing. TSC: And what would be the best indicator of that? Strauss: A whole slew of things: employment growth, industrial production grow, sales growth, a vibrancy back to the housing market, a vibrancy back to the capital spending market by corporations -- a lot of things. There's nothing wrong with a strong economy if it's not feeling inflation. And we're not in that stage right now to worry about that. Perhaps we'll be in that stage late next year or the following year, but not now. TSC: Are you bullish on the stock market? Strauss: Here's what history tells us: 12 out of 13 times [that] the Fed has eased aggressively -- aggressively being defined as three to four easings in a three- to four-month process -- a year later the market's been higher. That was March and April of this year, and the market is working toward a scenario where a year later it will be higher. But the road to getting there is a choppy one. We'll have a backing and filling process for the market, probably in the next four to six weeks. But the right things are occurring to turn the economy. And if the right things are occurring to turn the economy, that historically has been helpful for the equities side.
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