Zaks Investment Advisory Service

Economic Forecast for 2008

It is that time of the year when serious talk becomes impolite, which is why, by tradition, we will devote our program to prognostication. So what will 2008 be like, from the economic point of view? And what will the market do? Economic forecasts usually make sense, and often turn out being quite precise. The same, of course, may not be said about financial market forecasts. But in honor of the holiday season, we will try to make one of those, too.

Before we begin making forecasts, we have to estimate how much the economy grew in 2007. The fact of the matter is that we will not know this for sure before February 2008: the fourth quarter is still not over and the Commerce Department, which releases Gross Domestic Product data, will take a while to figure things out. So we will rely on economic estimates for the fourth quarter of 2007. According to most accounts, growth slowed to about 1.5 percent in annual terms (in the third quarter, again in annual terms, it gained 4.9 percent – the most in four years.). It looks like the economy grew by about 2.7 percent for the year on the whole. We also only approximate know where inflation stood for all of 2007. According to Labor Department statistics, the so-called “core” inflation rate (in other words, goods and services, excluding fuel and food) was 2.3 percent between November 2006 and November 2007. It will probably be slightly higher for all of 2007, closer to 2.5 percent. The average unemployment rate over the course of 2007 was about 4.6 percent. All of these figures, by the away, represent pretty respectable results. As you know, the real estate market was in dire straits throughout the year, and this was reflected on the economy as a whole: if homes were still being built as quickly as they had been the previous year, our economy would have added at least another one percent. On the other hand, American consumers proved to be an unsinkable force: despite everything, they continued to spend money and support the economy as a result. The weak dollar helped out, too: exports rose by about 12 percent in 2007.

A year ago, I was telling you about prognosticators from the University of Chicago. One of them, Professor Michael Mussa, came very close to hitting the mark. He predicted that the GDP of the United States would grow by 2.2 percent in 2007. This was slightly below the actual 2.7 percent. But he made an almost perfect forecast on inflation and unemployment: 2.7 percent inflation (instead of 2.5 percent), and 4.9 percent – unemployment, which was very close to the actual 4.6 percent.

Professor Robert Aliber, on the other hand, was far more pessimistic. He based his forecast on the fact that the housing sector crisis would affect the entire economy. He thought that in constant dollar terms, the domestic product would drop by 1.5 percent, the unemployment level would grow to 5.4 percent, and that inflation would reach 2.9 percent. Thankfully, he turned out to be wrong.

So what do our prognosticators think will happen in 2008? Mussa forecasts economic growth of two percent. Aliber remains a pessimist and thinks that real estate prices will continue to fall, that this will negatively affect consumers, and that GDP will drop by 0.8 percent, i.e. fall into recession. Both economists believe that unemployment will rise: Mussa – up to 5.2 percent, and Aliber – to 5.4 percent. The inflation level, in their opinion, will stay practically unchanged. All that remains for us to do is hope once more that Mussa is right instead of Aliber.

And what do other economists think? The Council of Economic Advisers to the US president believes that the economy will grow by 2.7 percent in 2008. This is higher than the Chicago economists’ forecasts but lower than the same council’s previous forecast: six months ago, they thought the economy would grow by 3.1 percent. They also believe that unemployment will rise slightly – to a level of 4.9 percent. The president’s Council of Economic Advisers is usually more optimistic than economists are on the whole. The Wall Street Journal surveyed 50 prominent economists. On average, they thought the economy will gain a quite decent 2.3 percent in 2008, with growth starting out slowly before accelerating toward the end of the year. They believe that inflation will be a fairly modest 2.8 percent. Unemployment, on the other hand, will rise to five percent. Real estate prices will fall by 3.5 percent.

What are the odds of recession in 2008? By definition, an economy is in recession when it shrinks for two consecutive quarters. Economists believe that there is about a 30 percent chance this will happen.

This was all on the US economic front. But we live in a world of interdependent economies. What will happen outside the United States? According to International Monetary Fund forecasts, the global economy will grow by 4.8 percent in 2008. Not so long ago, the IMF thought the economy would grow by 5.2 percent. The slower growth rate comes mostly on account of oil prices and the US real estate crisis. China, with 10-percent growth, and India, with eight percent, will serve as the locomotives for development, just as the US economy had done in previous years. On the other hand, IFO, the well-known German economic institute, predicts that the euro zone economy will grow by two percent in 2008, i.e. slightly slower than the United States.

And, ultimately, the markets. The eternally-optimistic Abby Cohen from Goldman Sachs believes that the S&P 500 index will close 2008 at the level of 1,675 points. Considering that the index stood at 1,484 on December 19, she is forecasting 13-percent growth. I can only join her prediction.

In our next program, which will air in what is already 2008, we will take a look back at how the markets performed in 2007. This was Sergey Zaks. Happy holidays to all and until next time.