Meredith Whitney and 13%

Author: David Kotok, Post Date: July 19, 2009

Meredith Whitney moved markets when she called the Goldman earnings and raised her nearer-term outlook for banks.  The widely heralded CNBC interview became a forecast promptly validated by the results of the reporting banks.  Her premier star quality remained intact.

But Whitney also ventured away from her bread-and-butter turf.  In doing so, she may diminish her forecasting success.  In the final segment on Squawk Box, she said that the unemployment rate would reach “13%.”  Readers may find these interviews at, search under Whitney.  Please note that the 13% forecast is found in the 8:50 AM segment on July 13.

We disagree with Whitney.  13% unemployment rate is not in the cards.  By the way, if she is right and we are wrong, the banks will fail the stress tests miserably, there will be another capital crisis and the stock markets of the world will crash.  

Let’s bring in some others to help clarify the unemployment rate and what it means.  Granted, the numbers are pretty bad right now.  The unemployment rate is expected to break above 10% in the next month or two.  That is the consensus view of most economists who specialize in this type of prognostication.  It is our view as well.

But after the double-digit level is reached, there is considerable evidence to suggest that it may peak this summer.  Ed Yardeni wisely notes that the unemployment rate is improperly called a lagging indicator.  He examined the 10 cyclical peaks that have occurred since World War II.  The lagging mantra was applied because of an averaging method, and just two data points cause the average to show this lag.  They are the recessions of 1992 and 2003.  Exclude them, says Ed, and the other eight peaks had an average 1.6-month lag, with 4 months being the longest.  If Ed is right, the unemployment rate and the business cyclical trough will be nearly simultaneous.  No lagging indicator here, claims Dr. Ed.

Bill Dunkelberg uses his survey data of the membership of the National Federation of Independent Business to forecast a future unemployment rate.  He asks the members about their hiring plans and runs the collected results with an algorithm that has a pretty good track record.  Dunk has the unemployment rate peaking soon and then falling to “8.8%” in less than a one-year time horizon

Barclays Capital’s Tim Bond focuses on the payroll report and on ISM data.  His method models a three-month moving average of changes in monthly payroll data.  He believes a “sharp improvement in payrolls should be visible in July and August.”  He expects weekly unemployment claim data to confirm the changes he forecasts.  Tim’s ISM-based regression “displayed an R-squared of 0.87.”

Asha Bangalore of Northern Trust notes that the seasonal adjustments may be sending an errant message due to a holiday-shortened work week and auto industry anomalies.  Asha looked at year-over-year unadjusted jobless claims and concluded that “the worst in the labor markets is most likely behind us.”

We respect Meredith Whitney’s work on banks and must credit her with some very good calls as the financial crisis unfolded.  But when it comes to the unemployment rate we must join Ed, Bill, Tim, and Asha and our other colleagues and disagree with Ms. Whitney.  13% unemployment doesn’t seem to be in the cards.

If she is right and we are wrong, there will be a fierce W in the economy and in the stock markets.  If however the peak of employment deterioration occurs this summer, as we believe, then the stock market rally since the March 9 low is for real and a cyclical recovery is underway.  Such a rally can easily carry the S&P 500 index to 1100 by year-end or early 2010.  At Cumberland, our US ETF accounts are fully invested in accordance with this strategic view.

Since monetary policy makers at our Fed are unsure, they will keep policy rates very low until the economy is safely out of the woods.  That means ample liquidity to power markets higher.  It also means the yield curve stays steep.  Borrowers are wise to lock in their financing now.  Bond buyers like our clients should focus on the spread side of the bond markets and not on Treasuries.

We are in the transition period when liquidity is still abundant and when the economic turn generates strong profit comparisons.  The peaking of the unemployment rate doesn’t mean it will quickly return to the 5% level of yesteryear.  Too much damage has been done, so a high unemployment rate is likely to be with us for a long time.  But not at 13%.

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