Economists often use the Latin phrase
, or "other things being equal." This disclaimer indicates that
your analysis or prediction assumes that everything else remains
the same. Unfortunately, the real world follows a Heraclitian logic
and rarely stands still for our benefit; change is the only
constant in the unceasingly complex global economy. Relationships
between economic conditions and the stock, bond, currency and
commodity markets aren't as straightforward and deterministic as
some might imagine.
Plenty of people claim to be able to predict the economy's ups and
downs. In the late 1980s, plenty of newsletter editors made their
names forecasting the 1987 crash. If I told you their names now,
you probably wouldn't recognize them, but these gurus were once
More recently, plenty of pundits and formerly obscure economists
rose to stardom after they "foresaw" the 2008-09 financial crisis.
But here's a dirty, little secret: Most of these supposed
clairvoyants have made the same predictions for years. A broken
clock is right twice a day; if you make the same call for long
enough, you're bound get lucky at some point.
I won't lie to you. I don't have a crystal ball that enables me to
infallibly predict the global economy's fate. As longtime readers
can attest, I readily admit when my forecasts are incorrect. I also
regularly revisit my assumptions when conditions on the ground
stay ahead of the market
, my economic outlook hinges on a handful of economic indicators
that have proved their worth time and time again. These indicators
aren't infallible, but I've found that a consistent approach to
monitoring economic trends is far more effective than
cherry-picking data series to support a preconceived notion.
Economic forecasting is an exercise in probabilities. The global
economy's interrelationships are too complex to be distilled into
any series of equations.
Fortunately, you don't have to time inflection points in the
economy or stock market precisely to succeed as an investor. The
market is a forward-looking system that comprises a mass network of
human emotions and decisions--needless to say, its outlook is often
The recent boom-and-bust cycle is a case in point. If you failed to
position your portfolio against the Great Recession until six
months after it began in 2008, you still would have avoided the
brunt of the subsequent market implosion. If you were three or four
months late calling the market bottom and economic rebound in 2009,
you still would have caught the meat of the bull-market rally.
In short, the challenge isn't to predict economic inflection
points; the real money is made by recognizing these changes once
they occur and positioning your portfolio accordingly.
During this earnings season, management teams from many of the
companies we follow have stated that their outlook remains
positive--provided that the economy doesn't slip into recession.
Management teams remain cautiously optimistic about their business
prospects, but the big picture remains a cause for concern.
Here's my updated economic outlook.
TheUS and other developed economies have been mired in a soft patch
since April or May. Incoming economic data have yet to provide
concrete signs that this malaise has dissipated.
Some of this weakness stems from temporary factors: Oil and
commodity prices spiked in early 2011; adverse weather weighed on
business conditions in parts of theUS; and the magnitude-9.0
earthquake that hitJapan's Tohoku region in March disrupted global
supply chains. These transitory factors should recede in August or
September, setting the stage for a welcome uptick in economic
Despite the recent spate of weak economic data, there's only a 10
to 20 percent probability that theUS will slip into recession.
Inflation appears to have peaked in emerging markets,
enablingChina,India and other fast-growing nations to stop hiking
interest rates in an effort to cool their overheated economies.
Strong global growth should support rising energy demand.
Moreover, many pundits have confused weak economic growth with an
outright contraction. Many of these commentators are repeat
offenders who in summer 2010 warned that theUS would spiral into a
In July the Institute for Supply Management's Purchasing Managers
) for Manufacturing slipped to 50.9 percent and the
Non-Manufacturing version fell to 52.7, suggesting that activity
slowed in both the service and non-service segments of economy. At
the same time, PMI readings above 50 suggest expansion.
Historically, levels of 45 to 47 have indicated an outright
Meanwhile, the market ignored the better-than-expected automobile
sale data released this week. This rebound in sales suggests that
the manufacturing PMI may have bottomed now that the supply-chain
constraints stemming from the Tohoku earthquake have abated.
We also continue to monitor the Conference Board's Index of
Leading Economic Indicators
); three consecutive monthly declines usually indicate that theUS
economy may be slipping into recession. Thus far in 2011, the LEI
has posted only one month-over-month decline.
The Bureau of Labor Statistics' June Employment Situation report
fell well short of analysts' expectations, and the disappointment
weighed heavily on investor sentiment. But initial jobless claims
have trended lower since May, and figures from ADP Employer
Services estimate that theUS economy added 114,000 jobs in July.
Global credit markets remain a concern, though the EU
sovereign-debt crisis has yet to affect theUS corporate bond
market. As I discuss in my
No Recession Looming: Buy Stocks into the Summer
, the EU has demonstrated a willingness to take any steps necessary
to prevent fiscal conditions inItaly--and, to a lesser
extent,Spain--from deteriorating to the point that they have
AlthoughItaly's debt-to-gross domestic product (
) ratio is 120 percent, in 2010 the government ran a deficit that
amounted to 4.6 percent of GDP--well belowGreece's deficit of 10.5
of GDP or theUS deficit of 9.1 percent of GDP.
Moreover,Italy continues to make headway on reducing its deficit. A
new austerity budget that includes roughly EUR45 billion (USD65
billion) in cuts has the support of both the center-right
government and its main opposition. In fact, the size of the budget
cuts increased to EUR45 from EUR40 as the proposal was debated in
the Italian senate.
The package calls for reductions to housing and alternative
energy-related credits, additional payments for health care
services and changes to the retirement age. IfItaly enacts these
measures and follows through with their implementation, concerns
about the country's ability to service its debts should subside.
Italy aims to balance the budget by 2014, but some critics have
lambasted the government for pushing back the most onerous cuts and
tax increases until 2013.
BecauseItaly runs a smaller budget deficit than its troubled peers,
any reductions in government spending won't damage the economy to
the extent thatGreece,Ireland andPortugal's austerity programs have
devastated their domestic economies.
For example,Greece's efforts to reduce government spending and
increase tax revenue enabled the country to secure much-needed
bailouts from the EU and International Monetary Fund. But this
tough medicine also mired the economy in a severe depression;
economists expectGreece's GDP to shrink by almost 4.5 percent in
2011, further pressuring the government's tax receipts.
Meanwhile,Italy's economy continues to grow, albeit at a snail's
pace. The nation's GDP expanded by about 1.3 percent in 2010 and
should increase by another 1 percent in 2011. If the recent global
economic slowdown proves temporary,Italy's economy should be able
grow by 1.25 percent in 2012. Check out Jim Fink's article,
Italy Debt Crisis: Best Italian Stocks for a
, to see which Italian stocks Jim thinks represent the best
Italy can also access the public bond markets--admittedly at
elevated interest rates--a privilege thatGreece no longer enjoys.
In mid-July, the Italian government placed EUR5 billion worth of
new debt, including 15-year bonds that yielded 5.9 percent--3
percent more than the yield on an equivalent bond issued by the
German government. At the same time, the higher yields attracted
1.5 times more bids than the amount of bonds that the Italian
Let's turn our attention to the hullaballoo surroundingUS debt
ceiling. Although the media presented the situation as a crisis
that would have wreaked havoc on the global economy, the incident,
as Jim Fink points out,
The S&P downgrade of US Credit Rating
was politics as usual. The Aug. 2 deadline crated a heightened
sense of urgency, but theUS was never in real danger of a default--
no matter what the editorials said. If this political theater
raised legitimate questions aboutUS credibility, then why are the
yields on US Treasury bonds near multi-month lows?
The recent patch of economic weakness is part and parcel with
the halting economic recovery that began in mid-2009. If economic
growth picks up in August and September, this is an excellent
opportunity to buy well-placed energy stocks.
is the co-editor of The Energy Strategist and is a regular
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