Escaping recession in 2008 will be a close call, money managers say.
However, even if a slowdown doesnt technically qualify as a recession, it will feel like one, managers said.
President Bushs fiscal stimulus package and the Federal Reserves willingness to ease credit aggressively should help avoid a downturn. Fed chief Ben Bernanke confidently told lawmakers on Jan. 17 he is not forecasting a recession, but slow growth.
But the difference between a shallow recession and anemic growth may be little more than semantics as the fourth-quarter expansion slowdown is bound to feel like a recessionary environment especially when compared to the third quarters 4.9% growth rate.
It does not really matter if we have slow growth or a recession, said Daniel Frascarelli, partner and director of large-cap core investments at Lord Abbett & Co., Jersey City, N.J. The firm manages $112 billion assets, including about $85 billion in equities.
Said Steven Bleiberg, chief investment officer, Legg Mason Global Asset Allocation LLC, New York, a unit of Legg Mason Inc., Baltimore: We clearly are in for a slowdown. Whether it becomes a recession is an academic point. What matters to us is earnings growth and there is no doubt we are in a period of serious slowdown in earnings. Financial stocks account for almost one-third of all earnings, and these big firms are announcing gigantic negative earnings. Legg Mason has $1 trillion in assets under management.
If we technically avoid a recession, it would be a Pyrrhic victory because earnings are obviously dropping, even if we can look back and say, Hey, we did not have a recession, Mr. Bleiberg added.
However, if the U.S. economy were to experience more than a brief dip into negative territory, this would have serious implications for the investment outlook.
Our forecast of a growth recession in 2007 has been realized. The pressing issue is whether we will experience a bona fide recession in 2008, said Eugene Flood, a strategist at Smith Breeden Associates Inc., a Chapel Hill, N.C.,-based fixed-income manager with $32 billion in assets under management
Consumer spending key
One key factor likely to determine the fate of the long-toothed U.S. expansion, which started in December 2001, is whether the earnings recession many financial services firms are experiencing will spread to other sectors of the economy.
Its difficult to have a recession in the U.S. unless you have a meaningful slowdown in consumer spending, for which there are three fundamental supports: income levels; wealth level; and consumer confidence, said Jeffrey Schoenfeld, CIO at Brown Brothers Harriman & Co., New York, who sets the economic forecast for Brown Brothers Harriman Investment Management, with $44 billion in assets under management, mostly in fixed income.
He noted that consumer spending accounts for two-thirds of the economy.
Income levels on a nominal and real basis have continued to grow at a reasonably good rate. Even with the decline in home values in 2007, wealth levels have reached a new record, and the preconditions for a broad deterioration in consumer spending are not evident yet, Mr. Schoenfeld explained.
Mr. Schoenfeld expects economic growth will slow to 1.5% to 2% in 2008, as consumer spending slows and housing declines. He also expects capital spending to be more cautious and the current account deficit to shrink.
While the popular definition of a recession is two consecutive quarters of negative growth, the independent National Bureau of Economic Research identifies the peak and the trough of a business cycle by monitoring four indicators: payrolls; personal income; industrial production; and wholesale and retail sales. The index for these four gauges, measured by the Conference Board, was up 0.1% in December, still in positive territory despite a drop in manufacturing activity.
Canary in the coal mine
Max Bublitz, chief strategist at SCM Advisors LLC in San Francisco, said even if a recession is avoided, the economic outlook is nothing to write home about. We have a rapidly slowing economy, as the housing problem is compounded by the credit crunch and an apparent slowdown in employment, which was the canary in the coal mine.
Mr. Bublitz was referring to the surprise jump in the unemployment rate to 5% in December, from 4.7% in November.
SCM manages $12.6 billion in assets, mostly in fixed income.
Reports showing rising unemployment, contraction in manufacturing and a decline in retail sales in December all issued in early January gave Fed officials a new sense of urgency to ease credit aggressively and sustain growth.
Fed watchers generally expect the U.S. central bank will respond with a half-point cut in the 4.25% fed funds rate at the upcoming Jan. 29-30 meeting.
Rapid and aggressive fiscal and monetary stimulus is what could make the difference between slow but steady growth and a recession, and between an earnings recession limited to financials or spreading to other sectors.
Diane Swonk, chief economist at Mesirow Financial Holdings, Inc., Chicago, which manages $25 billion in assets, agrees there is a tug of war between aggressive Fed easing and recessionary forces.
I think that, if we get a recession, the second half of the year will look remarkably better, because well see the Fed more than willing to over-stimulate the economy, Ms. Swonk said. But what is equally important is the composition of growth, which has left so many consumers unhappy. We have the greatest income inequality of the last 30 to 40 years If you look at the composition of spending, its Wal-Mart vs. Harry Winston.
Robert Doll, CIO of global equities at BlackRock, Inc., New York, said portfolio managers will need to carefully weigh economic and market developments.
At a Jan. 9 press briefing, Mr. Doll said his firm would retain its overweight positions in equities. Equities are attractively valued when compared to other asset classes, particularly bonds, he said. BlackRock has $1.37 trillion in assets under management.
Dollar as casualty
Some market watchers are also citing the dollar as another casualty of an easy monetary policy, but Rebecca Patterson, a senior global currency strategist at JPMorgan Chase & Co., thinks the U.S. dollar might have brighter days ahead even as the Fed cuts interest rates further.
2008 is likely to be a turning point for the dollar. At these levels, the dollar is very, very close to its all-time low (against a basket of currencies) since it started floating in early 1970s, she said.
Ms. Patterson expects capital flows to go back into dollar assets, in particular U.S. fixed income, which would support the U.S. currency.
Finally, while the U.S. is taking the brunt of the economic slowdown now, it may pull out of it when other countries start experiencing sluggish growth, which would also help the dollar, she said.