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Linda Nazareth

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Contingency planning

Linda Nazareth

TORONTO (GlobeinvestorGOLD) Acknowledging that the U.S. could slide into another recession next year does not mean you believe it will. Call it contingency planning, if you like.

Such thoughts, after all, make you less than a good sport these days. Economists on Bay and Wall Street are as reassuring in their estimates for growth as those forecasters in government employ. Interest rates are miniscule, they argue, and there are no more bubbles to burst. Next year will be a nice solid year.

And they are probably right.

Even the most pessimistic forecasters doubt that there is a greater-than-33-per-cent chance the U.S. economy will contract again in 2003. Then again, the savviest investors are those who make provisions for both the best- and worst-case scenarios. And although the worst case may not materialize, here are a few reasons why it just might:

The malaise in manufacturing:
U.S. Industrial Production from 1997 - 2002For all intents and purposes, U.S. manufacturing is already in a double-dip recession. U.S. industrial production, for example, rose by 2.6 per cent between December 2001 and July 2002, before slipping 0.7 per cent between July and October. By other measures, manufacturing didn't recover from recession at all. October 2002 was the 16th consecutive month in which the manufacturing sector shed jobs, bringing the total number of job cuts to more than 1 million.
The threat of a U.S. war with Iraq:
No one actually knows how this will play out, or what it will do to oil prices. Consider, though, that the International Monetary Fund calculates that a $10 (U.S.) jump in crude prices can wipe half a percentage point off global growth. Never mind consumers, with the U.S. manufacturing economy already in dire straits, a little bit of a push from rising oil prices could mean a big loss in earnings and growth.
The drag from government:
The U.S. federal government may have the wherewithal to pump more stimulus into the economy next year, but the situation for the states is very different. The U.S. National Governors Association now says that state budgets are in the "worst shape since World War II" thanks to the U.S. downturn. As they scramble to make ends meet, look for local governments to implement across the board cuts, with all that entails.
The slack in the global economy:
Japan is entangled in its own crisis, and according to most forecasters, will be lucky to manage growth of 1 per cent next year. Europe (and in particular, Germany) is still struggling with policy-makers being urged to cut interest rates or risk a European recession. For better or worse, the global economy will sink or swim with the U.S.
The housing sector:
It has been mind-blowingly strong this year, with analysts quibbling whether it is a bubble ready to burst or an efficient market reflecting healthy demand and lagging supply. Even if things deflate slowly (and with prices for existing homes up nearly 10 per cent in October from a year earlier, chances are they will come down a notch), the sector is unlikely to provide the same support to the economy that it did through 2002.
Consumer spending:
U.S. retail sales have held up well, but few feel the foundations are solid. For one thing, spending has been supported in part by mortgage refinancing activity, which has taken money from home equity and put it directly into cash registers. Not to mention the frightening consumer debt situation: According to figures from the Federal Reserve, household debt service payments in the U.S. as a percentage of disposable income were hovering near a 20-year high of 14 per cent in the second quarter of 2002. And the problem is not mortgage payments, which have fallen with low rates. Instead, U.S. consumers have been amassing personal debt at such a clip that their monthly payments have risen despite low interest rates.
The U.S. labor market:
U.S. planned job cuts increased this OctoberThe U.S. economy has shed 1.6 million jobs since hitting a peak in March 2001, and there were more than 1 million layoff announcements in 2002 by the end of October, according to outplacement firm Challenger, Gray and Christmas. Thanks to low interest rates, any dip in spending by the unemployed has been offset by a spending frenzy among others. Things may be reaching the breaking point, however. Pink slips are still flowing from such U.S. heavyweights as Morgan Stanley, U.S. Airways and others. Another troubling statistic is that long term joblessness is on the rise. According to the U.S. Bureau of Labor Statistics, the percentage of unemployed without work for twenty-seven weeks or longer hit 20.3 per cent in October 2002, its highest level since 1994. In short, people without work are having a tough time finding new work, and watching their severance packages dwindle in the meantime.

Canadian investors, thankfully, have a bit of cushion against all of these scenarios. For one thing, Canada never actually fell into recession in the first place, so it certainly cannot double-dip. And indeed, all indicators on the Canadian economy suggest growth will be a little too hot next year, rather than too cold. Even so, neither our financial markets nor our economy are likely to resist a protracted U.S. downturn.

The forecast is still bright, and the odds favour an improved economic picture next year. Then again, if investors have learned anything these past two years, it is that playing the odds may not always be the best strategy for building a healthy portfolio.

Assessing the scenarios and making provisions for the possibilities is likely to lead to a much happier and prosperous 2003.

Linda Nazareth is the Senior Economic Analyst for Report on Business Television and Canada's only full time on-air economist.

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