Recession Quiz

Story Highlights:

• Most US citizens believe we are either in a recession currently or are headed for one soon.
• The economic data point to no such thing. Take our recession quiz and see how you fare!

______________________________________________________

We read a really fun article in the Wall Street Journal yesterday:

How Well Do You Know...2007's Market Action?
By William Power, The Wall Street Journal
https://online.wsj.com/article/SB119664172000311178.html

In it, folks are tested on their knowledge of market developments so far in 2007. The results will likely take some by surprise. Given today's pervasively dour sentiment, it'll be a revelation to many that markets throughout the world are having a very nice year—even US stocks are up near double-digits heading into the last weeks of 2007. It's been a turbulent (but then again most years are turbulent), but fine year.

Yet, recent polls show better than 60% of US citizens believe we're either already in a recession or headed for one. Even professional forecasters are looking for an anemic or shrinking economy next year.

As such, we've constructed our own 2007 recession quiz, and challenge you to take it. You can be your own judge on whether the procession of today's prevalent worries (housing crisis, credit crunches, falling dollars, and inflation to name a few) are warranted or not.

Good luck!

1) The US unemployment rate is:

A) Between 5 and 7%
B) Between 8 and 10%
C) Between 1 and 3%
D) Between 3 and 5%

Answer: D. US Unemployment has been near historical lows for some time, hovering around the 4.5% mark. The rate even held steady or fell during the time of housing and credit turmoil. In fact, we observe that many employers today are clamoring for talent because the pool of available workers is so tight. 4.5% is close to what the Fed would call "full employment." There is a natural amount of turnover in the employee base, and a rate much lower than today's could actually affect the economy adversely. It doesn't get any better than this!

2) True or False: Inflation is accelerating in 2007.

Answer: False.Inflation has remained benign for over a decade now. In 2007, inflation is tracking well below 3%. Often folks point to spikes in food prices and energy as a sign of rampant inflation. But inflation is not about single goods—it's about aggregate price levels. Plenty of common goods are experiencing significant price drops today—from autos to electronics to textiles. On balance, price increases remain tame.

3) What was GDP growth for the second and third quarters of 2007?

A) 0% and 2.2%
B) 5.6% and 1.8%
C) 3.8% and 4.9%
D) -1% and -5%

Answer: C. Particularly in the last two quarters (the time of the so-called credit crisis and acceleration of the housing slump), GDP has scorched expectations with some of the strongest growth seen in the current expansion. Consumption, exports, and a variety of other factors are showing strength. And the prosperity isn't contained in the US. The global economy is chugging right along with it.

4) True or false: The dollar is having its worst year ever.

Answer: False.Not even close. The dollar is down less than 10% to the euro and other major currencies so far this year. Currency fluctuations, and annual moves bigger than what we've got today are common. Anyway, a falling or appreciating dollar doesn't make much difference for the stock market or the economy. There are plenty of benefits to a weak dollar, including stronger earnings from abroad, and more competitive exports.

5) Because of the credit crisis and market illiquidity, interest rates have spiked this year.

Answer: False.Most major interest rates are flat or down this year—simply not the stuff of a true credit crisis. Short-term Fed funds and 10-year treasuries are well below where they started 2007. Even AAA and BBB rated corporate bonds are flattish. Only high yield debt has spiked of late—but the spike has been very modest by historical standards. On balance, the cost of debt remains well below its 40 year average.

6) What percentage are subprime mortgages of the total mortgage market?

A) 25%
B) 10%
C) 36%
D) 5%

Answer: B. Subprime accounts for only about 10% of the total first-lien US mortgage market. Therefore, a full 20% of subprime defaults (an extremely unlikely outcome) would dent the mortgage market by 2%. The total subprime market is about $800 billion, or 6% of one year of GDP. So, if we wiped out all subprime debt for good, the effect on the economy would total 6% of one year of the country's product. That's pretty tiny in the big picture.

7) True or false: Financials are set to have their second best year ever for earnings.

Answer: True.Despite a big earnings dip in the third quarter tied mostly to one-time asset write-downs, Financials as a sector is poised to have one of its best earnings years on record.

8) S&P 500 earnings growth for 2007 is expected to:

A) Grow well over 5% from a year ago
B) Be about flat from a year ago
C) Contract from a year ago
D) Be about 1% to 2% higher than a year ago

Answer: A.S&P 500 earnings growth will likely remain above the rate of GDP for another year. Again, extracting one-time problems from the Financials industry, earnings have been strong, with many industries experiencing record results.

We think a lot of folks who believe the economy is in dire trouble would fail this quiz. But those are the facts. Maybe this is enough evidence for you, maybe not. Either way, we urge you to follow the data and not the talking heads before proclaiming woe. Economic fundamentals remain strong throughout the globe, as do stock market prospects. It's a great time to be invested.