Economic Outlook - 4th quarter 2007 to June 2008

My viewpoints on the economy that you don't hear much in the media:

(1) Unemployment is 4.7% and historically very low (over 6% during the 2001 recession and higher than that during the housing blowup and recession of 1991)

(2) The dollar is at its lowest point to a basket of 6 other currencies, yes, but a low dollar allows our multi-national companies (which make up 45-50% of the S&P 500 large companies) to export more. As a matter-of-fact, exports continue to outpace imports now and are reducing the trade deficit consistently (though it is still an overall deficit). This adds over 1% to GDP growth to make up for the .75% reduction in GDP due to the housing market

(3) Inflation remains low and interest rates were historically low even before the .50% and then the .25% reductions recently made (in the 1991 recession and I refer to it because it occurred after the 1989-1990 housing bubble, interest rates were double-digit and inflation was 9% after coming off double-digit rates at the end the 1980’s)

(4) Capacity utilization (which is rarely reported anywhere) is at 82%. The average for this statistic is 75-78%. What does this mean? It means that factories are operating at near capacity (this number never gets much higher than mid-80%). That coincides with full employment in the economy. Will this slow down? It has to. It is too high.

(5) The sub-prime foreclosures are bad, but folks are losing their house, not their jobs.

(6) The media loves to say that foreclosures are up 100% or 200% but they are coming off 2001-2003 lows. The foreclosure rates, again looking historically, are today not out-of-line with history. All businesses EXPECT about 3-4% of their loans to go bad and reserve for it, but many companies/banks/brokers got used to the low interest rates and low default rates of less than 1% coming out of the last recession.

What these things mean, to me in my opinion, is that the economy is not in bad shape as this bad news all hits. It means that as the economy slows over the next 6-8 months (and I do believe that it will slow), it is coming off of a stable plateau which may allow us to avoid a recession.

Had unemployment been higher, or capacity utilization much lower, or interest rates much higher etc…then a recession may have been unavoidable. But since that is not the case, there is hope that a slow down in the economy will overall be good because these items I have mentioned in points 1 – 6 above, would result in double-digit inflation in a few years had the housing market not blown up.

Why is the stock market down? The market is a “leading indicator” and driven in the short-term by greed and fear. If the “daily trading” investors believe that the economy is going to be slowing down for the next 6 months then they want out now. That brings on fear by others. As soon as investors see the hopes of a turn-around and a pickup in the economy (which may occur in March-June of 2008 for the pickup in the economy anyway), then they will start buying again.

What will it take to believe that the economy is through this turmoil? Low inflation, no more need to reduce interest rates by the Fed, companies rebounding and showing earnings now that these “one-time” write offs of bad debts are over (there are more to come before this is realized), and time.

RECESSIONS and SLOW GROWTH periods are a part of the capitalistic society. We had these periods in 1973-1974, then 1980, then 1982, then 1991, then 2001. They are short-lived (6-8 months typical but 1981-1982 lasted about 18 months). The stock market goes down BEFORE they start and then GOES UP about the mid-point in the recession and has, in the past, ended higher than when the recession started. Any long-term investor will be better off just waiting it out. Why? Because no one can time when the bottom will occur and no one can time when the recovery will occur. In Ric Edelman’s new book, one very interesting statistic was that over the past 10 years the stock market return was 0% if you missed the 15 best days of the stock markets UP DAYS. The recovery of down markets does not occur slowly at a steady pace. If you missed those 15 days, and they were quite unpredictable, then your portfolio would have missed the returns, too.

If you have any desire to change any of your stock asset allocations because of what the pundits are saying about a future recession or the gyrations in the stock market, please contact me as soon as possible. Let's talk.

RECENT HISTORY:

The Dow Jones (the index that many stocks follow since the way the big 30 companies goes is so much how the rest of the U.S. stock market goes) was down almost 7.5% today (before recovering by the end of the day to 6.3%) from the high of 14,198 in mid-October - not even 4 weeks ago.

Worried? Concerned? I hope not if I have done my job in educating you about long-term investing.

As President Ronald Reagan is quoted as saying about the market turmoil in the 1980's: "...stocks go up and stocks go down..." (In October 1987 the stock market lost 22% of its value in one day)

Yes, indeed.

Let's see: The Dow Jones was at 14,029 in mid-July and then retreated to 12,518 by mid-August - a 10% drop. Then completely recovered by mid-October to the 14,198 new high.

Will it drop more this time to a 10% decline? Or more? Will it recover as quickly as it did from August to October? Will it go up from here?

No one knows. And anyone who says they do is not telling the truth.

But, will it be higher in 10-15 years? Though past performance is no guarantee of future results, there has never been a period that the stock market did not beat out inflation over long periods like this.