Investors and the 2009 Economic Outlook

Bullish investors are focused on the middle of 2009, with many strategists and economists thinking the economy will start bouncing back by then.

If that’s the scenario you’re betting on, however, this dispatch from the Atlantic’s Marc Ambinder ought to be troubling:

It’s quite unsettling to talk to members of Barack Obama’s transition teams these days, especially those who are helping with the economics portfolio. Without going into details, the sense I get from them is that they are very worried that the economy will get a lot worse before it gets better. Not just worse… a lot worse. As in — double digit unemployment without the wiggle factors. Huge declines in aggregate demand. Significant, persistent deficits. That’s one reason why the Obama administration seems to be open to listening to every economist with an idea and is stocking the staff with the leading lights of the field.

It’s in the political interests of the Obama economic team to lower expectations. Dire predictions help win support for aggressive policy responses. But the last year has shown that dire predictions can come true.

BusinessWeek’s Peter Coy talked to a lot of economists about their 2009 outlooks and he got a much more mixed picture in this week’s cover story.*

But, as I think Coy’s piece makes clear (and you really should go read it if you’re wondering where the economy is headed), the chances of a very bad 2009, particularly in the U.S. job market, aren’t exactly remote. Coy writes:

“We’ve got so far to climb out of this [financial] hole that if we start today, then on any reasonable time path we might still be climbing out a year from now,” says Robert V. DiClemente, chief U.S. economist of Citigroup (C) in New York. Predicts the AFL-CIO’s chief economist, Ron Blackwell: “Things will get worse, perhaps much worse, before they get better.” That said, this job bust won’t last forever. There are forces at play that will eventually pull the economy out of its free fall. The key is smart government policy that sets politics aside. It must provide a combination of short-term consumer stimulus and long-term investments without stepping over the line into wasteful and innovation-stifling industrial policy.

There are reasons to be optimistic — Obama’s stimulus plan might work, the Federal Reserve’s efforts to stabilize the financial situation could finally pay off — but there’s a lot that could go wrong.

That’s why I’m a bit surprised by the optimism I’m seeing in notes published by investment advisors and stock strategists. The idea that the economy will start to recover in the middle of 2009 has really taken hold.

Bruce Bittles, chief investment strategist at R.W. Baird, writes:

The combination of falling home values and a drop in mortgage rates will dramatically improve housing affordability and along with plunging energy prices improve consumer discretionary income. This is the first step in the recovery process that is expected [to] stabilize the economy by mid-2009.

Standard & Poor’s Global Investment Policy Committee note from Dec. 3:

Despite ongoing weak global news flow, given that equity performance tends to lead an upturn in the fundamentals by roughly six months, global stock markets have rebounded on hopes the worldwide economic and profit outlook will begin to stabilize by the [second half] of 2009. Time will tell.

Throughout this crisis (and I’m thinking all the way back to late July 2007), optimists have continually insisted that an improvement is about half-a-year down the road. Eventually, hopefully soon, they will be right.

*Coy notes in his piece that economists at “the epicenter of the financial crisis” — i.e. those working on Wall Street or in big investment houses — seem to be much more pessimistic than those elsewhere. If so, it also makes sense that the Treasury Secretary-designate Tim Geithner (and his crew) would be on the gloomy side, given his experience in the trenches as president of the New York Federal Reserve Bank.

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