Economic Forecasters Expect Moderate Recovery in 2002 --- Wesbury Led a Group Of Bears Who Called The Recession of 2001

By Jon E. Hilsenrath
Staff Reporter of The Wall Street Journal
1,215 words
4 January 2002
The Wall Street Journal
(Copyright (c) 2002, Dow Jones & Company, Inc.)

It was a rough year to be an economic forecaster. Few economists anticipated a full-fledged recession. Fewer still expected the aggressive response of the Federal Reserve that sent short-term interest rates to their lowest level in 40 years. Then the Sept. 11 terror attacks occurred, forcing everyone to revise their forecasts all over again.

But for a small group of bearish economists, everything seems to have gone as expected, leading them to the top spots in The Wall Street Journal's economic-forecasting survey for 2001.

Atop the pack was Brian Wesbury, chief economist at Griffin, Kubik, Stephens, & Thompson, a Chicago investment bank that specializes in fixed-income securities. Long before the National Bureau of Economic Research finally declared last month that the U.S. had fallen into recession in March, Mr. Wesbury had factored recession into his forecasts. He called for meager economic growth in the first half of 2001 and then a contraction by the third quarter. As it turns out, he was right on. The Department of Commerce reported that gross domestic product, the value of the nation's output, adjusted for inflation, grew at an annual rate of 1.3% in the first quarter and 0.3% in the second quarter, then contracted 1.3% in the third quarter.

Mr. Wesbury was followed by several other bears, all of whom called for slow growth or a moderate contraction during the first nine months of the year. Among them, Tracy Herrick with Jefferies & Co., a Los Angeles-based institutional trading company, was especially sharp with his GDP forecasts. He predicted a contraction in third-quarter GDP back in December 2000.

Not every economic bear finished on top. One perennial bear, A. Gary Shilling of Shilling & Co. in Springfield, N.J., finished in the back of the pack, because he overshot his recession call, projecting a 3% contraction in the first half of 2001. Mr. Shilling also called for recessions in 1999 and 2000.

Finishing dead last this year was Gail Fosler, chief economist at the Conference Board in New York. Ms. Fosler topped The Wall Street Journal's economic-forecasting survey twice in 1999 for her bullish predictions about the economy at a time when growth was surging. But she, like other bulls, underestimated how much the economy would slow in 2001. Ms. Fosler acknowledges she was "uniformly too optimistic about" 2001, and says the big surprise was how severely bank lending to businesses dried up last year. That corporate credit crunch, she says, hampered business activity, causing the economy to unravel much faster than she expected.

To pick this year's winner, The Wall Street Journal looked at average growth forecasts for the first nine months of the year, based on January and June surveys. Economists were also ranked based on their June predictions for interest rates and exchange rates through year's end, and inflation and unemployment rates through November. Economists also were asked another question back in June: Was the economy already in a recession? While the NBER had not yet declared a recession, two key economic indicators, payroll employment and industrial production, had started to fall, signaling that the sharp economic slowdown might actually be something worse. Yet only nine of 52 economists surveyed said that a recession had started. Nearly two in five said the chances of a recession were still less than 30%.

"The whole year has actually been a nightmare for economists," says James Bianco, founder of Bianco Research LLC, who did his own study of 19 years of Wall Street Journal economic surveys and found economists failed to predict the right direction of long-term interest rates 71% of the time. Even Mr. Wesbury was off on interest rates. Like many economists, Mr. Wesbury greatly underestimated the degree to which the Federal Reserve would ease short-term interest rates. Mr. Wesbury expected the bond-equivalent yield on three-month Treasury bills to end the year at 3.45%. Instead, yields on bills ended much lower, at 1.69%. He was a little low on his forecast for the 10-year Treasury note, calling for a 4.75% yield when it finished at 5.02%. But he was close to the mark by projecting a sharp weakening in the Japanese yen to 135 against the dollar; it finished at 132.

"Economic forecasting is like hitting in baseball. Just hitting some of the pitches is good," says Mr. Wesbury, who has been taking swings at the economy since he took an introductory economics class as an undergraduate student at the University of Montana in 1978. He was a fast study, winning a six-month subscription to Business Week magazine for accurately predicting the direction of interest rates, gold prices, the stock market and inflation during that class.

More recently, he served a brief stint as the chief economist for the Joint Economic Committee of Congress in 1995 and 1996, when the government ground to a halt amid budget battles between Congress and the Clinton administration.

Mr. Wesbury says his main clue for 2001 was the sharp upward movement in inflation-adjusted interest rates in mid-2000. When the federal-funds rate, controlled by the Federal Reserve Board, went near 4.5% after adjusting for inflation in 2000, he says he knew the economy was heading for trouble. The last time the inflation-adjusted federal funds rate was that high was just before the 1990 recession. Such a high rate implies that companies are having a harder time obtaining credit.

Today, the inflation-adjusted federal-funds rate is close to zero, thanks to 11 interest-rate cuts in 2001. Mr. Wesbury says that implies that a recovery is on the way. But he doesn't think it will be a strong one. Corporate profits have fallen so sharply and manufacturers have so much excess capacity, he believes that investment in both inventories and equipment will be slow to recover in 2002, holding back the rebound.

Longer term, though, he is among the biggest bulls in the survey. Mr. Wesbury was one of only five economists in the poll to say the nation's potential for long-term productivity growth is greater than 3%. Most see it between 1.5% and 3%. Alan Greenspan, chairman of the Federal Reserve Board, has said that robust productivity growth was one of the key underpinnings for the economic boom of the 1990s.

"We're going to come out of this relatively slowly, but the economy will build momentum behind it," says Mr. Wesbury. He sees the economy contracting in the first quarter, but reaching a 3.8% annualized growth rate in the fourth quarter, which is still below the late 1990s' rate.

                    Star Forecasters
 1. Brian S. Wesbury       Griffin Kubik
 2. Kathleen Camilli       Camilli Economics
 3. Tracy Herrick          Jefferies & Co.
 4. R. Berner/D. Greenlaw  Morgan Stanley
 5. Lawrence Kudlow        Kudlow & Co.
 6. William T. Wilson      Ernst & Young

(See related article: "Growth Is Seen Rising To 3.6% Later in Year, Subpar for Trough End" -- WSJ Jan. 4, 2002)