UPDATE: MII Economic Forecast for 2008

In January we sent out a newsletter to the MII Hedge Fund Team with an economic forecast for Q4 2007 and FY 2008. What follows is a brief update on how that forecast has held up and some more specifics to add to it.
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From the January forecast- Our call is for Q4 2007 to show growth around 0.5-1.5%, somewhat more moderate that the recent forecasts that we’ve already entered a recession...but significantly slower than the 4.9% growth seen in Q3. Q3 saw a big boom in export-led growth, and without a substantial rebound in the US$ over the last few months of the year one should expect similar results this time around.

Last week's preliminary data on Q4 GDP growth came in at 0.6% (unrevised from the 0.6% advance estimate released in January; GDP data for each quarter is released on an advanced, preliminary, and final basis coming a month apart from each another), which was towards the lower end of our estimate. This was a result of lower than expected growth in consumption which accounts for approximately 70% of all economic activity. As anticipated, growth in net exports (rising exports and falling imports) contributed significantly to GDP growth. What is surprising about this, however, is that the dollar was 'relatively' stable in Q4. The recent change in this factor carries positive implications for our Q1 forecast below.
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From the January forecast- Our projection is for stagnant growth in Q1 and Q2 (0%-1%), followed by a rise in Q3 and Q4 to 1-2%. These projections are simply a blend of forecasts which fall in-line with our beliefs about the underlying fundamentals of the economy.

One of the forecasts which falls "in-line with our beliefs about the underlying fundamentals of the economy" comes from First Trust Advisors. FT Advisors recently released their updated forecast for Q1 2008, so its worth taking the time to note of any meaningful changes and to revise MII's forecast as necessary. GDP growth forecasts can be broken down into forecasts of consumption (70%), business investment (10%), government spending, net exports, housing (4%), and inventories. As FT Advisors notes in their report, government spending has accounted for approximately 0.3% growth over the last 5 years. Consistent fiscal policy suggests this will hold for Q1, so we start with 0.3% growth. MII breaks with FT Advisors in their forecast of consumption growth of 1.6% because the incoming data suggests more protracted weakness in consumer spending than anticipated by most economists. If we take a .8% increase in consumption rather than a 1.6%, and apply the 70% weight to this number, we arrive at .56%. So GDP growth now = (.3+.56) = 0.96. Housing looks to be the biggest drag on GDP growth once again, and FT Advisors forecasts a 24% drop in housing activity in Q1 for a weighted (4.1%) loss in GDP growth of 1%. MII will again forecast a greater decline in housing than FT, 30%, and will arrive at a weighted drag on GDP growth of 1.2%. So now GDP growth is 0.96-1.2= -0.24. Business investment has been sluggish in Q1 according to both surveys and purchasing data, so we forecast a paltry 1.5% growth weighted at 10.5%, resulting in a contribution to Q1 GDP growth of 0.1575. So our GDP growth estimate excluding only inventories and trade comes to a recession-like (-0.24 + 0.1575) = -0.0825. Inventories were down big in Q4, taking off 1.5% of GDP growth. Such a sustained drop in inventories cannot be expected to occur two quarters in a row even in the midst of a slowdown, so we side with FT in forecasting a modest build up contributing to 0.4% GDP growth (FT forecasts at 0.7% contribution). That puts us at a still-anemic (-0.0825 + 0.4) = 0.3125% GDP growth excluding trade. As anyone who has tuned into the financial news knows, the US$ has plummeted recently amid concerns about inflation and interest rate cuts. This should only make the trade numbers stronger in Q1, and here MII will agree with FT Advisors that export-led trade growth contributes 0.6% to GDP in Q1. Thus, including trade, MII forecasts GDP growth to be (0.3125 + 0.6) = 0.9125% in Q1 2008. This is nothing for consumers to cheer about, but it would probably be a pleasant surprise to be welcomed by financial markets which have discounted stocks to include an increased probability that Q1 saw negative or no GDP growth. Obviously then, our 0.9% estimate for Q1 GDP growth falls on the higher end of the January estimate (0-1%), and this can be attributed to the continued deterioration in the value of the US $ relative to its primary trading partners.

Risks to the downside include worse trade numbers due to higher oil prices in Q1 and even a sharper drop in consumption arising from the housing spillover. Also, the inflation numbers we've seen recently are more concerning than anticipated in MII's January forecast. While this may be a boost for trade and GDP in Q1 and Q2, one should be concerned about the viability of any economic strategy that relies inflating our way to prosperity.

Regardless of what the numbers turn out to be (we won't get the advance GDP estimate for Q1 until April 30), you can be sure that the stock and bond markets will react.