Special Edition

So Where's the Economy Going Now?

By Michael Mandel
BusinessWeek Online

Don't believe anyone who claims to know. The tough truth is -- and the Fed knows it: The data are too ambiguous. What's an investor to do?

With the Dec. 13 quarter-point rate increase by the Fed, we've reached a difficult and puzzling fork in the economic road. In one direction lies the ugly prospect of a housing bust, leading to a collapse in consumer spending and ultimately a recession. In the other direction is the much more appealing vision of continued solid growth -- a position that's reflected in the statement the Fed released today.

If you're an investor, of course, you want to know which path seems more likely. Unfortunately, there's no map, no set of directions to tell us which way the economy is going to go. Economists are split about which path seems more likely, and not even outgoing Fed Chairman Alan Greenspan or his successor Ben Bernanke have the answers.

Go to BusinessWeek Online to see the worst 2005 forecasts.

FLATTER CURVE.  It's a moment of what I call "fundamental uncertainty," where conventional economic forecasting simply breaks down. The numbers keep rolling in, but they offer few, if any, clues about what will happen next. For example, Manpower released its quarterly employment survey on Dec. 13, asking employers whether they plan to add or reduce workers in the first quarter of 2006. The result: Its "Net Employment Outlook" index is 20.

Is that good or bad news? Well, the index was at roughly the same level in 1998 and 1999, during the boom years of the 1990s. Most American workers wouldn't mind a repeat of those years. However, the Manpower index was also about 20 in early 1989, when a decent labor market very rapidly turned sluggish, setting the stage for the recession of 1990-91 (see BW Online, 11/29/05, Is the Job Market Really 'Buoyant'?).

Other indicators are equally ambiguous. The yield curve is flattening out, so that the long-term rate on 10-year Treasury bonds, at 4.5%, isn't much higher than the new 4.25% fed funds rate. That sort of flat yield curve is often a sign of trouble ahead -- but not always.

BE PREPARED.  And economists know full well -- though they don't like to admit it -- that their forecasting models are absolutely terrible at predicting recessions or even slowdowns (see BW Online, 12/6/05, One Economist's Yin and Yang). At the end of 2000, the consensus forecast was that economic growth over the next six months would average about 3%. In fact, the economy grew at a miserable 0.4% rate in the first half of 2001, even before the September 11 terrorist attacks (see Slide Show, The Year's 10 Worst Predictions).

Given all this uncertainty, the right advice these days might be to hope for the best, but plan for the worst. Be prepared to take advantage of opportunities if growth continues, but don't leave yourself too vulnerable to a deeper-than-expected downturn. People often get caught by underestimating the range of possible outcomes, both on the high and low sides. Don't let that happen to you.

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