US economy heads for a hard landing in 2007

By: Nadeem_Walayat

Economists and many market participants continue to mistakenly point to lagging indicators in support of economic growth during 2007 i.e. a panel of 50 economists in a survey released by the National Association for Business Economics predicted that the overall economy, as measured by the GDP, would expand by 2.5 percent in 2007. Unfortunately many of the indicators such as US unemployment hitting a low of 4.7% are lagging indicators. Virtually every recession during the past 50 years was preceded by a low jobless reading.

Other signs of the coming slowdown, are in the housing market, as our last article pointed out (US Housing slump continues as housing starts plunge 27%), where there is no sign to a halt in the markets decline. This has yet to impact on the consumer, which comprises more than 70% of US economic activity, and will show itself in lower company earnings growth numbers during 2007. Consumers are saddled with record amount total outstanding household debt, which has grown from $6 trillions to a record of over $12 trillions in a little over 6 years. Much of this debt is on the back of the housing boom in the from of equity withdrawal for consumption, now that the housing market is falling, equity withdrawals are expected to slump during 2007.

Unlike in 2001, the US is not in the position to to cut taxes or increase spending, due to the large twin deficits hitting record levels. US national debt continues to grow at the rate of $1.6 billions per day, and will demand interest payments of some $220 billions for 2006, which leaves little room for government expenditure to soften the hard landing. On top of this the misguided war in Iraq continues to consume $10 billions per month, which further reduces the options available during 2007.

What are the consequences of a hard landing during 2007 ?
US companies despite generally being in a healthy position cash flow wise, will lay off workers and cut prices of goods and services in the face of weakening demand from the US consumer. This in effect will have a deflationary effect and thus the inflation worries experienced for much of 2006, will be replaced by deflationary worries. This will lead to the Federal Reserve cutting interest rates by as much as 100 basis points by the end of 2007, and a rally in the US bond market can be expected.,

The commodity markets may also initially suffer, but their growth in the longer term depends on continued expansion of the Chinease and Indian economies, so if the lower interest rates start to stimulate the US economy these markets may rebound strongly higher.

Sectors of the economy that are likely to perform well during the period of slow growth are defensive stocks such as Utilities, and Large oil companies despite the weakening oil price are likely to out perform the market. But as a whole the Stock Market is expected to decline, depending on the degree of slowdown in the US economy and reduction in profits growth. The sectors to avoid are growth stocks and banking as bad debts come home to roost during 2007.

The US Stock Market at the moment is trading on a PE of 15, unlike the the PE of 25 during early 2000, the market is not overly expensive, nor is it cheap, so at best the stock market could move sideways during the slowdown, and at worst could correct 20%.

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