Why It's So Hard to Forecast the Economy: Shilling

Past postwar recessions spawned financial problems, but nothing like the 2008 crisis. The government's reaction was equally severe with the enactment of the 2010 Dodd-Frank Act and other stringent regulations for financial institutions that are only now being slowly relaxed.

In earlier business upswings, a drop in the unemployment rate of anything like the plunge from 10% in October 2009 to the current 3.5% would have spawned massive wage inflation. This time, real wages are barely growing.

Globalization transported many high-paid manufacturing jobs to China. With the growing "on demand" economy—think Uber Technologies Inc. —many people trade flexibility in working hours for low pay. The payroll jobs that are being created are mostly in low-wage sectors such as retailing and leisure & hospitality.

For years, foreign policy was bipartisan and expanding trade was considered highly desirable. Now, globalists have been overcome by protectionists, spurred by voters upset over stagnant purchasing power and rising income and asset inequality in G-7 countries.

Trump's 2016 election along with the U.K.'s "Brexit" from the European Union are among the results. Then there's also the demise of global trade deals, which are being replaced by bilateral agreements or no pacts at all.

The U.S.-China trade dispute will no doubt persist because China, with a declining labor force as a result of its earlier one child-per-couple policy, needs Western technologies to grow and achieve its worldwide leadership ambitions. But the U.S. is opposed to the technology transfers China wants.

Dollar, Disinflation

The dollar's slide from 1985 until 2007 encouraged U.S. exports, curbed imports and gave U.S. multinationals currency-related boosts to profits.

Since then, the dollar index has rallied 33% amid a global demand for haven assets. And it should continue to, given the relatively faster growth of the U.S. economy, its huge, free and open financial markets and the lack of meaningful substitutes for the greenback.

Disinflation has reigned since 1980, but real interest rates were positive until the last decade.  But for 10 years now, real 10-year Treasury note yields have been flat at zero (see my Nov. 19, 2018 column, "Zero Real Yields Are Tripping Up Investors").

This and the flat yield curve have pushed state pension funds and other investors far out on the risk curve in search of real returns, bidding up stocks to vulnerable levels.

Earlier, the Fed was run by Ph.D. economists who clung to widely-held theories even though they didn't work. Fed Chairman Jerome Powell is proving to be much more practical, backing away from rigid Fed policies such as the 2% inflation target and a zero-bound policy rate as well as unsuccessful forward guidance.

In this different economic climate, it's hard to time the end of the current recovery. Still, it will end, due either to Fed overtightening or a financial crisis, like the 2000 dot-com blow-off or the 2007-2009 subprime mortgage collapse. In the current excess supply-savings glut-deflationary world, it's likely a recession will unfold due to a shock before the Fed overtightens.

No financial crises are in sight, but there are possibilities such as excess debt in China and among U.S. businesses, a trade war escalation, consumer retrenchment resulting in widespread deflation, and disappointing corporate profits measured against sky-high stock prices. Watch for specific imbalances, not typical past patterns.

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