The Economy -- No Recession This Year

Dec. 21, 2004
The economy is only "sluggish," and the stock market will rebound.

Let us start the New Year off on the right foot. There will be no recession this year. Admittedly the recent statistics do not look very promising. Holiday retail sales were flat, and manufacturing production fell 0.5% in November. Payroll employment hardly increased at all in November and December, and the unemployment rate is finally starting to rise. Consumer sentiment has been falling rapidly, and the National Assn. of Home Builders' housing market index plunged from 65 to 57 in December in spite of declining interest rates. On top of all that has been the stinking performance of the stock market. Nonetheless, I see virtually no chance of recession in 2001, barring some major exogenous event such as war in the Middle East and another oil embargo. If such a catastrophe does not occur, real GDP should rise at an annual rate of about 2% in the first quarter of 2001, rising to 2.5%, 3%, and 3.5% for the remaining three quarters of the year. Why are so many people talking about recession? I figure it has to be the stock market plunge. After all, the plunge in 2000 was the worst decline in the broad stock market since 1974, and the worst decline in Nasdaq ever. It also was the first time since 1962 that the stock market declined over the year without any increase in interest rates. The Aaa corporate bond rate fell about 40 basis points last year, while the 10-year Treasury note rate declined a whopping 125 basis points. Nonetheless, stock prices cratered. Except for the stock market, data are consistent with sluggish growth of 2% rather than an outright recession. Other than cutbacks at auto assembly plants, industrial production has been flat, not down. Both consumption and disposable income in constant prices have risen at a 2% annual rate in recent months, an unimpressive result but once again not indicative of an actual recession. Housing starts are up slightly since July, although the gains have not been impressive. There are simply no signs of the type of decline that occurred in the early months of the last recession, which started in July 1990. Maybe ignoring the stock market is a little like Hamlet without the prince: Stock prices seem to be dominating economic activity, especially consumer spending. However, this is getting to be an old story. The market collapse in 1987 was certainly severe, yet economic growth actually improved the following year. The dip in 1998, although brief, appeared serious at the time but turned out to be only a fly speck on the consumer scene. The Fed eased shortly after both of those debacles, and has all but said it will cut rates early this year. In view of the severity of the stock market plunge and a decline in real growth to about 2% for the second half of 2000, the Fed probably will cut the funds rate to 5.5% this year. While the economy won't respond immediately, that will be enough to lift the stock market, removing much of the underlying pessimism in consumer and business attitudes. For the last 50 years each and every U.S. recession has been preceded by Fed tightening; in the early years the money supply contracted, while in later years the Fed raised short-term interest rates enough to cause the yield spread to turn negative. Neither of these happened last year. Money supply continues to rise at a 6% annual rate, roughly equal to the underlying growth rate in nominal GDP. While the Fed did tighten enough to push the Federal funds rate above Treasury note and bond yields, that primarily reflects a decline in long-term rates because of the emergence of the budget surplus, not a credit squeeze engineered by the Fed. The spread between the Aaa corporate bond rate and the funds rate had remained near 1% until recently, when widespread belief that the Fed would soon ease brought the Aaa bond rate down almost one-half percentage point. That clearly is not an indication of credit stringency. I'm not about to name the day when the stock market will hit bottom and start to rally. Perhaps the trough already has been reached. Once the bad news for fourth quarter profits is out of the way, though, Fed easing should boost stock prices, which by midyear will rise substantially above their levels at the end of 2000. As this improve ment gains momentum, the talk of a recession will quickly come to an end. Michael K. Evans is president of the Evans Group, an economics consulting firm in Boca Raton, Fla.

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