Looking back at economic forecasts

Economic forecasters were pretty much on the mark; see turnaround this year
While corporate entities of all stripes qualify all “forward-looking statements” with disclaimers written in obscure legalese, predictions made by financial gurus visiting Milwaukee have been clear, concise and remarkably accurate.
In a 1998 visit to Milwaukee, financial guru Frank Capiello predicted that in the subsequent years, the Dow would crest 10,000 — which it in fact did.
A local financial guru says Capiello’s prediction came at a time when few other analysts would be so optimistic.
“It’s still over 10,000,” Clare Zempel, Robert W. Baird’s chief investment strategist said. “In late 1998 it was the tail end of the Asian-Pacific Rim crisis. There was a fair amount of discussion to the effect that the US would catch the Asian flu and that 1999 would be a bad year. It seems like a bold forecast for the time it was made.”
In fact, according to Zempel, the US economy did catch the Asian flu — in the form of a stronger dollar.
“Like with many things in economics, it has multiple consequences,” Zempel said of the strong dollar. “The dollar has continued to rise. That has continued to be a problem for large multinationals in terms of their earnings. When you translate those foreign currency earnings back into dollars, you get a reduced effect. A falling dollar helps raise revenue.
“A strong dollar also prevents inflation — but hurts in terms of relative prices. It is harder to sell goods to foreigners. It helps imports — a BMW would be cheaper. But the dollar has continued to strengthen in recent days because while the US is slowing down, it is still considered stronger than Japan. The rest of the world is slowing down behind us.”
But even as collapse of Eastern currencies threatened the economy, the US markets surged and crested like a tsunami.
“Looking back at Oct. 1 of 1998, the Dow was 7,633,” Zempel said. “That would have been a low level reflecting the stock market associated with the Asian-Pacific Rim and financial concerns. To predict that we would see an increase of almost 2,500 points — a 30% increase — that was a bold kind of forecast.”
Not every prediction made was on the money, however.
For instance Robert Dederick, principal of RGD Economics, dropped the ball in one arena when he spoke at the Economic Outlook Breakfast sponsored by Milwaukee Western Bank and North Central Trust Company in October of 2000. In what he characterized later as an “offhand political remark,” Dederick predicted that Al Gore would win the presidential race.
“Gore ran a very ineffective campaign,” Dederick told SBT in a recent interview, reflecting on his comments here last October. “He should have done better, and that is why a lot of Democrats are angry at him now. It wound up with a split decision — with Gore winning the popular vote and Bush winning the Electoral College.”
Dederick feels better about his prediction that the vice presidential candidates would outshine their running mates.
“Cheney did pretty well — he did better than Bush did,” Dederick said, referring to Vice President Richard Cheney. “And Lieberman did better than Gore.”
But according to Dederick, the policies of the Federal Reserve, technological advances and rampant optimism among investors have more of an effect on the market than the presidency, and on predictions related to those key points, he was remarkably prescient.
However, according to Zempel, a slowdown may have already been in the works while the candidates vied for position in late 2000.
“The election had an effect in the summer and fall,” Zempel said. “A University of Iowa pool had a gambling thing where you could see the odds go up and down as the campaigns would do well or poorly. And then in October and November there was a spike in energy costs. The slowdown arrived in November — but there was a gradual, gentle slowdown taking place throughout 2000 — until November — when the purchasing index and other economic indicators look very much like things fell off a cliff. In part, the severity and abruptness of it, while there was talk of a slowdown because of rising interest rates and energy costs, most businesses did not think they would be affected. But in November, inventories started piling up — and have continued to pile up. A year ago — and even nine months ago — there were those who doubted there would be a slowdown. But the severity and timing of it belied a degree of confidence and arrogance in the market.
Growth without inflation
Dederick said the new economy would allow for rapid growth without inflation. He pinpointed 1995 as a watermark when technology started to actively affect productivity and economic vitality.
“We can now grow faster without inflation,” Dederick said in October. “It used to be that fast growth accompanied inflation. Not having inflation is what’s remarkable about the new economy.”
“I think that statement is still true — I’ll stick by that one,” Dederick said. “As a matter of fact, I have stuck by that one. Productivity growth is more rapid due to technology. Therefore you are able to grow more rapidly on a trend basis. When you have more rapid productivity growth, you can grow more rapidly with any volume of resources. You can have faster real growth in consequence — real output has grown more rapidly than before.”
Zempel made similar statements about productivity and inflation at an October 2000 talk to Baird stockholders in Waukesha. He recently qualified his statements about productivity given the recent downturn.
“When productivity rises, that offsets increases in prices and costs,” Zempel said. “The context last October was before it was clear that there was a correction or sharp slowdown in the economy. That became clear in November or December. But in the meantime, there was a debate about whether the economy was so strong that it would send inflation higher. People were starting to suspect that the Fed would have to raise interest rates higher. So the economy is going to slow down because of interest rate increases — but in the longer run, inflation is not a problem because of an upward trend in productivity. However — productivity growth has faded since then — this is a normal development associated with an economic slowdown. Even though people are laid off, it doesn’t happen fast enough to overcome the downward pull on inflation. It is the weakness in productivity growth in the last two quarters which makes some people afraid of inflation. But as the economy accelerates later this year, it will once more seem credible that it is a new economic era — one where production grows faster than it used to.”
Economic overextension
Dederick said that even a new economy must rest on the laws of supply and demand, “and the fact is, demand is growing faster than supply, with a tight labor market added in.”
That, according to Dederick, results in price pressure, more so on services than on goods. Therefore, he said, there will be some inflation.
“Even new economies can overdo it — and this economy overdid it,” Dederick said, looking back on his earlier statement. “This economy had grown much faster than feasible, creating some of the old-fashioned stresses.”
Dederick also had said that the economy was coming to grips with the fact that old-economy rules still applied to the new economy – a situation which will lead to trouble.
“There’s still the expectation that the economy will do better than I think it will,” Dederick said, explaining that actual earnings had slowed while price-to-earnings ratios were too high.
“Remember that when I spoke, the stock market had come down — but it had not come down enough,” Dederick said. “I was saying that it is likely to come down further. The basic difference between now and then is that I think the slowdown has been more pronounced than I expected it to be at that time. We had a confluence of factors that gave us more of a slowdown than we wanted.”
Among these factors, according to Dederick, were higher energy prices and the fact that the dollar has continued to strengthen in spite of the downturn.
Also “the great investment boom was playing out — we always knew that it was not going to go on forever,” Dederick said, referring to an influx of investment dollars from those intent on hitting it big in Internet-related stocks. “As a result of these factors, we had a more serious downturn.”
Zempel, who made his predictions at about the same time as Dederick, agrees, but feels the downturn was more pronounced in October than Dederick implies in his statements.
“In the background was the start of the technology stock correction,” Zempel said. “Whereas we could say that those prices had peaked much earlier, there was a gradual decline in the market as well — until January, February and March — when we saw a severe correction due to the realization that the economy slowdown would be worse than expected.”
Fed to the rescue
In his October 2000 remarks, Dederick also stressed the role of the Federal Reserve in managing the economy.
In late 2000, “it was clear that the Fed did not want to cause a recession,” Dederick said. “But in raising interest rates it might have gotten more of a slowdown than it wanted. It wanted to rein in the growth but not break it. The Fed has responded dramatically to the greater-than-expected slowing. Therefore, we have a tax cut. This and other props have been put under the economy, and that makes it look like we will not have a full-fledged recession.”
As interest rates are again lowered, some might expect a rapid acceleration of economic activity, but Dederick does not think that will be the case.
“Some people think it will occur very promptly, Dederick said. “I suspect it will happen more toward the turn of the year — in the fourth quarter of this year or the first quarter of 2002.”
Zempel currently predicts a comeback will happen a little later than does Dederick.
“I think one of the issues that is difficult to deal with for anyone in this environment is the issue of timing,” Zempel said. “We have seen the Fed cut interest rates and they may cut them further. And then you have people like me saying that when stock prices fall, there is usually a positive aspect. There are lags and delays. Interest rates fall and the economy will recover — and I think it will happen soon and in fact it doesn’t. It seems to me like things are pretty much unfolding on schedule. I’ll start the clock ticking March 30 of this year — at that point interest rates had fallen 20%. Historically, when rates have fallen that much, the next three months, things are still pretty weak. During the next three months — weakness has diminished. And during the following three months, the weakness yields to strength.”
Zempel predicted a turnaround is coming around Labor Day plus or minus a few weeks.
“Oil prices are off their peak,” Zempel said. “We have tax rebates and tax cuts. From an investment standpoint, we could see a turnaround in September or October.”
July 20, 2001 Small Business Times, Milwaukee