Hembre's Farsighted Forecasts

Economist Keith Hembre was one of the few forecasters to call it right for 2007. What does he think 2008 has in store for us?

When economists made their forecasts for 2007, many failed to appreciate housing's impact on the economy. Contrary to the consensus, Keith Hembre, chief economist at the asset management firm FAF Advisors in Minneapolis, expected the housing slump to crimp economic growth all year and to spur the Federal Reserve to cut rates more than anticipated. The focus on housing helped make Hembre the most accurate economic forecaster, based on a 2007 economic forecast survey conducted by BusinessWeek last December, edging out Robert McGee of U.S. Trust and David Resler of Nomura Securities International.

Looking at last year's forecast survey, "underlying everything was the supply imbalance in the housing market," says Hembre. He believed the excess number of homes for sale and falling home prices would hamper economic activity in a few ways: It would lead builders to scale back further, cause more layoffs in housing related areas, and lead consumers to dial back on their long-running shopping spree. And although no economist did a good job tracking the exact pattern of economic growth this past year, Hembre was pretty accurate with his call on a general slowdown.

Signs of Recession

Another surprise that Hembre and every other survey respondent didn't see coming was $95 oil and the upswing in overall inflation. However, he did see softer growth and global competition restraining corporate pricing power and wage growth, thus leading him to correctly pencil in a big slowdown in prices outside of food and energy. It was this combination of cooling core inflation and weaker activity that also led Hembre to expect more rate cutting by the Fed than others anticipated.

Before honing his forecasting skills over the past eleven years at FAF Advisors, Hembre obtained a masters degree in economics from Baylor University, and spent a couple of years at the Federal Reserve Bank of Minneapolis. Because Hembre's forecasts directly affect investment decisions, "it puts added pressure on my outlook to be accurate at least in direction if not in magnitude," says the 40-year old economist.

So what does he expect in 2008? Hembre is making an even sharper break from the consensus as one of only two economists—Richard Berner of Morgan Stanley (MS) is the other—who see a shallow recession on the horizon. Hembre admits forecasting two straight quarters of declining economic output is "going out on a limb" but he points to four factors that "tip the balance."

Tops among the warning signs is corporate profits, which Hembre views as a leading indicator of hiring. A third-quarter decline in profits and expectations of another fall in fourth-quarter earnings points to an even weaker labor market in 2008. The ongoing stretch of more than a year with the Fed funds target rate exceeding the 10-year Treasury rate is also a "pattern that's typical of recession," says Hembre. The sharp drop-off in consumer confidence and the dramatic fall in home construction and prices round out the list of indicators pointing to more turbulence ahead.

When Hembre isn't poring over the latest data, he enjoys spending time at home with his family. He's the proud father of a 14-month-old daughter, which means an occasional sleepless night. If his forecast is accurate, many investors may do a lot of tossing and turning as well.

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