Even Gloomier Times Ahead?

01/15/2009 11:37 am EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

Jim Jubak, senior markets editor for MSN Money, says a recent report includes gloomy economic projections that aren’t reflected in current stock prices.

From an investor's point of view, bad news doesn't count if it's already priced into the markets. If the financial markets already anticipate the end of the world, news that the comet of doom has been spotted clearing Pluto's orbit is, well, no big deal.

It's unanticipated bad news that knocks an individual stock or the market as a whole for a loop.

That's why the Congressional Budget Office's January 8th report on the state of the nation's finances was such bad news.

The budget office projects we won't see a full economic recovery until 2015 and that even then it will be weaker than expected. That's not priced into the markets. The budget office projection, if it turns out to be correct, is the kind of unanticipated news that can and would knock stocks for a loop.

What did the CBO say?

  • It projects the US budget deficit will come to just about $1.2 trillion in fiscal 2009, which ends this September. That's $1.2 trillion before including any of President-elect Barack Obama's projected $700-billion to $800-billion stimulus package.
  • Including the costs of the proposed stimulus package, the fiscal 2009 deficit climbs to almost 10% of US gross domestic product, shattering the nation's post-World War II record (6% in 1983).
  • The total US government debt held by the public will jump 55% from September 2007 to September 2010.
  • Without a big stimulus package, the economy will shrink 2.2% in fiscal 2009, unemployment will peak at 9.2% in 2010, and housing prices will fall an additional 14%.
  • And, finally, the US economy won't return to its full annual trend growth rate until 2015. Worst yet, that trend growth rate for the US economy will be just 2.3% a year.

It's that last item that constitutes unanticipated bad news. That projected schedule for a recovery lags well behind the already gloomy timeline from the Federal Reserve at its December 15-16 meeting. And the 2.3% trend growth that the budget office projects is well below the 2.5%-to-3% speed limit the Fed projected for the economy before the crisis.

If that projection turns out to be correct, it would be a huge negative for the stock market. Right now, investors and traders are assuming an economic recovery that's much faster and much more robust than that.

Almost no one is considering the possibility raised by the CBO: that we could be looking at a long period where economic growth will be below both the long-term and the ten-year averages. A period of lower-than-average economic growth would lead to lower-than-average earnings growth. In that kind of environment, I'd expect-lower-than average price-to-earnings ratios, too. If that's what we're looking at, the market as a whole certainly isn't cheap yet.

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