Weekly markets commentary – June 29, 2009

David Joy — Chief Market Strategist, RiverSource Investments

Getting Better, or Worse?

U.S. stock markets struggled last week, unable to overcome a Monday sell-off attributed to the World Bank's downgrading of its 2009 global economic forecast. The S&P 500 Index fell three percent on Monday and spent the rest of the week clawing its way back to end with a loss of 0.3 percent.

Conflicting Economic Forecasts

The World Bank now forecasts that the global economy will contract by -2.9 percent in 2009, revised lower from its previous forecast of -1.7 percent published in March. This represents a steady deterioration from the 0.9 percent growth estimate published in December 2008. The World Bank now estimates a -3.0 percent contraction for the U.S. in 2009, compared to a -2.4 percent March forecast and a -0.5 percent December estimate.

The World Bank now estimates that output will decline by -4.2 percent among the Organization for Economic Co-operation and Development (OECD) countries, compared to a -3.0 percent March estimate and a -0.1 percent December estimate.

Among the only bright spots was the World Bank's forecast of 1.2 percent growth among developing countries in 2009. However, this too represents a significant downward revision from its March estimate of 2.1 percent growth and 4.5 percent growth forecast from December.

Perhaps it is a testament to the fragile state of the recent stock market rally that an updated forecast from the World Bank could have such a pronounced impact on the markets. It never has before.

In 1849, British historian Thomas Carlyle first referred to economics as "the dismal science," meaning "abject and distressing." One hundred and sixty years later, Mr. Carlyle would likely believe that little has changed.

President Harry Truman is said to have lamented, "Give me a one-handed economist! All my economists say 'on the one hand...and on the other...'"

In the spirit of President Truman, the OECD published its own, updated economic forecast on Wednesday, June 24. It now forecasts a 2009 decline for OECD countries of -4.1 percent, an improvement from its March forecast of -4.3 percent. It also upgraded its forecast of U.S. output in 2009 to -2.8 percent from -4.0 percent.

While the numbers in OECD's updated forecasts are not significantly different from the World Bank's, the trends are moving in opposite directions. Perhaps one was previously too pessimistic while the other was too optimistic, and therefore we should all rest easier now that they have arrived at a similar place. But that leaves unanswered the question of whether things are getting better, or worse. The World Bank says worse. The OECD says better.

The Federal Reserve weighed in on the question of U.S. growth at its Federal Open Market Committee (FOMC) meeting in April. The Fed estimated the central tendency of gross domestic product (GDP) growth in 2009 to be between -2.0 percent and -1.3 percent. Taking a mid-point of the range results in an expected decline of -1.7 percent, significantly better than the expectations of either the World Bank or the OECD. In fact, the most bearish forecast among the April FOMC meeting participants was -2.5 percent, still better than either the World Bank or OECD. Furthermore, both of these institutions had the benefit of additional data not available to the Fed, from late April through late June. And, at least in the U.S., that news has been better, not worse.

Lastly, in early June, the Blue Chip consensus 2009 GDP forecast assumed a -2.7 percent outcome, very much in line with both the World Bank and OECD. We know that in the first quarter GDP declined at an annual rate of -5.5 percent. If we assume a consensus contraction of -2.0 percent in the second quarter, then first half performance will be in the vicinity of -3.8 percent annualized, or -1.9 percent in real terms.

This means, to meet the year-end forecasts from the World Bank or the OECD, the second half of the year must be better than the first. The Federal Reserve's forecast is even more optimistic. To meet the mid-point of the Fed's forecast, the economy must actually grow. We believe it will.

California Budget Battle

The budget brinksmanship playing out in California will come to conclusion this week, as the new fiscal year begins on Wednesday. Late last week, the State Assembly proposed a partial solution to closing the budget deficit which was rejected by Governor Arnold Schwarzenegger, who said he wants a full solution or none at all. The State Controller John Chiang has warned that unless an agreement is reached to identify sources of cash, the state will be forced to start issuing IOU's.

Economic Calendar

The U.S. economic calendar is loaded with significant releases, including the April S&P/Case-Shiller Home Price Index, the June Chicago Purchasing Managers Index and Institute for Supply Management (ISM) indices, and May construction spending.

On Thursday, the June employment report is scheduled for release. It is expected that 350,000 jobs were lost and that the unemployment rate rose to 9.6 percent from 9.4 percent. If so, the moderating trend seen recently in the weekly jobless claims data will be confirmed.

Markets will be closed on Friday.