Krugman's Recession

Paul Krugman is pessimistic about the economy.

Citing our friend Nouriel Roubini—NYU economics professor and head of his own forecasting firm—who has been predicting a housing led recession, Mr. Krugman points to the bond market and the fact that interest rates on long term bonds have fallen below rates on short term paper—in other words, an inverted yield curve.

Believe it or not, I actually agree with Mr. Krugman—insofar as the inverted Treasury curve suggests the Federal Reserve is too tight. Presently, the central bank’s benchmark rate is 5.25 percent. Bernanke & Co. should lower their target rate to around 4.75 percent or even 4.5 percent. The curve is predicting continued economic softness, as is the current decline in the exchange rate of the U.S. dollar.

However, I disagree with Krugman on the record-breaking stock market. He believes stocks are “a notoriously bad indicator of the economy’s direction” and cites Nobelist Paul Samuelson, who once quipped that the stock market had predicted 9 of the last 5 recessions.

But, as we discussed on last night’s Kudlow and Company, the strong, across the board, 5-month rally in stocks cannot possibly be predicting a recession. While the stock market can sometimes emit false positives on recessions, rarely does it give off false negatives. In fact, I think it is predicting a Goldilocks soft landing for the economy.

A glaring omission from Krugman’s analysis is the staggering rise in corporate profits. These are the tax return profits recorded for the IRS—rest assured that no CFO overestimates them. Corporations’ pre-tax profits are up a remarkable 31 percent through the third quarter—25 percent after tax. These are serious numbers and are the mother’s milk of business and the economy.

A question for Mr. Krugman: when in the history of humankind have we had a recession when business profits are rising by 30 percent?

Profitable U.S. businesses clearly have the resources to grow their operations and continue hiring new workers. This, in turn, is the biggest factor sustaining the historically low 4.4 percent unemployment rate, as well as the strong gains in employment and consumer incomes.

Over the past three months corporate payrolls have increase by an average of 157,000. The number of individuals employed as measured by the household survey has grown by an average of 319,000 during the period. It’s no surprise that these jobs gains have significantly increased personal incomes. It has pushed real consumer spending roughly 3 percent at an annual rate above the 3rd quarter average. This also suggests a decent 4th quarter GDP growth rate may be in store.

Meanwhile, inflation readings continue to ease as the overall consumer price index has dropped to 1.3 percent over the past year, following tighter Fed money and the plunge in energy prices. This gives consumers even more purchasing power in the malls and on the Internet for the holiday shopping season. What's more, the big rally in homebuilders stocks suggests that the economic drag from housing is starting to peter out.

Markets are better forecasters than economic pundits or economic models.

Helped by lower energy prices, spectacular profits, and rock bottom tax rates on capital, the message from rising stocks is a soft landing growth scenario for next year’s economy. The message from lower bond rates is lower inflation and an easier Fed next year.

So, I’m still betting on Goldilocks.