Allen Sinai, PhD
Allen Sinai, PhD, CEO and chief global economist at Decision Economics, Inc., a financial advisory firm based in Boston and New York City. He has been an adviser to several US presidential administrations. DecisionEconomicsInc.com
With food and energy costs soaring at the same time that housing activity and home prices have plunged, the economy is threatened by a condition known as stagflation, explains veteran economic forecaster Allen Sinai, PhD. This means a jump in the inflation rate during a time of slow economic growth and increasing unemployment.
Sinai warns that corporate profits will languish, weighing heavily on the stock market. He is concerned about the risk of an equity bear market, which could take the Dow Jones Industrial Average down by more than 15%—to 12,039 or lower—from its all-time high in October 2007. The Standard & Poor’s 500 stock index, he says, could take a similar fall to a little over 1,300. Investors should be very cautious now, he says. After the uncertainty of a presidential election year is over, the market can climb again, with the Dow back up over 13,000 and the S&P at 1,550 or more by year-end.
Here, more of Sinai’s predictions and his investment recommendations…
In 2008, the US gross domestic product (GDP)—the total value of all goods and services produced—is likely to increase between 1.5% and 1.75%. That will be a big slowdown from the third quarter of 2007, when GDP grew at an annual rate of nearly 5%. The country will not technically slip into a recession, which occurs only when the GDP shrinks, but for many people who earn less than they were before or who lose their jobs, the slowdown in growth will feel like a recession.
At the same time, rising prices will hurt consumers. For the year, expect the Consumer Price Index to rise by nearly 4%, compared with the 3.5% increase for the 12 months ending in October 2007. Much of the increase will come from continuing rises in food, health care and energy costs, the latter already up 14.5% in those 12 months.
The weak housing market also will take a toll on consumers. In October 2007, sales of existing houses dropped by 20.7% from one year earlier, according to the National Association of Realtors. This decline will continue in 2008. With a glut of unsold homes on the market, already depressed home prices will fall further. Indeed, US housing prices overall could decline more than ever before. Even if you are not selling your house, the feeling that it is worth less may dampen your enthusiasm as a consumer.
With consumers cutting back on spending, many companies will record weak sales. That will force reductions in hiring and capital spending. The unemployment rate will rise from the recent 4.7% to near 5.5% by the end of 2008. Layoffs will be particularly severe for home builders and retailers that sell housing-related products, such as furniture. The job picture also will be weak for automakers and other companies hurt by rising energy prices. One bright spot: While the US economy will be soft, exports should remain strong. Companies that sell goods to China and other strong emerging markets will see revenues jump and can continue hiring.
Faced with a weak economy, the Federal Reserve will try to stimulate borrowing by further lowering interest rates. The federal funds rate—a key short-term rate that was at 5.25% until the Fed began cutting last September—could drop to 3.5% or even lower by the end of 2008. Unfortunately for consumers, rates charged by banks for loans will not drop nearly as much as other rates. With loan defaults rising, bank profits are shrinking, so bankers are reluctant to cut loan interest rates. Also, lenders will impose tougher credit standards, rejecting more borrowers. Lenders will be particularly reluctant to finance residential and commercial real estate purchases.
As you can imagine, stock investors would be wise to proceed cautiously. I recommend putting only 45% of new investments in stocks…35% in fixed-income investments (only top quality)…and 20% in cash and equivalents.
