A trader at the New York Stock Exchange earlier this month, with a magazine cover posted in the foreground.
By VIKAS BAJAJ
THE ECONOMIST JOHN Kenneth Galbraith once said,“The only function of economic forecasting is to make astrology look respectable.”Which leads to a question: When we do hit the bottom - this year or years from now - how will we know?
There’s no easy answer.
Mr.Galbraith was not the first or last economist to acknowledge fallibility at predicting turning points. (Just think back to assurances by top government officials in early 2007 that the growing problems with subprime mortgages were“contained.”)
Forecasting the end of the current recession is even more difficult because it will hinge on how quickly and efficiently governments resolve the crisis in the banking system.
“The things that can screw it up are bad policies,”said Thomas F.Cooley, dean of the Stern School of Business at New York University.
In the end, there’s probably no way to know for sure that we’ve hit bottom until we’re on the rebound. Still, analysts say there are some key indicators that might help in spotting a bottom and recovery at a time when it can be hard to see past the despair.
# Stocks
History shows that the stock market usually hits bottom before the economy does.
In October, Warren E.Buffett, one of the world’s most successful investors, said he was buying American stocks because they usually rise“well before either sentiment or the economy.”But even he acknowledged not having“the faintest idea”what would happen in the next month or year.
Since then, stocks have dropped by another 20 percent, and with the market at levels last seen in 1997, stocks are cheap by historical standards. The price-to-earnings ratio - which investors use to gauge how much they are paying for each dollar of corporate profit - is around 13, about 20 percent lower than the average of the last 130 years.
But many investors remain on the sidelines. Low-risk money market funds have swollen to $3.8 trillion, up from $2.4 trillion two years ago.
“All the indicators suggest you should be buying and not selling,”said Russell Napier, a consultant with Credit Lyonnais and author of “Anatomy of the Bear: Lessons From Wall Street’s Four Great Bottoms.”Still, Mr.Napier acknowledged that stocks, while cheap, could fall further. Measured by their 10-year price-to-earnings ratio, stocks were a lot less expensive in the early 1980s, when the ratio fell to less than seven, and in the 1930s, when it was below six.
Nouriel Roubini, the economics professor from New York University who predicted much of the current crisis, has warned that corporate earnings and stock prices could continue to fall, perhaps precipitously.
# Home Prices
To determine whether home prices are still inflated, economists use ratios that compare the cost of buying a home to renting or to median family income.
If the ratios move sharply higher, as they did in recent years, it suggests home prices might be inflated. When they are falling, as they are across the country and particularly in places like San Diego, Phoenix and Tampa, Florida, owning a home becomes more affordable.
Barry Ritholtz, a professional investor who writes the popular economics blog The Big Picture, has a simpler, more subjective, approach: Assume a young couple earning two modest incomes is looking to buy a two- or three-bedroom starter home in a middle- income neighborhood in your city. Can they qualify for a mortgage and afford to buy it?
“If the answer is no, then you are not at a bottom in housing,”said Mr.Ritholtz, who estimates that the decline in national home prices is only half-complete.
# Consumer Spending
Americans like to buy things, and for at least the last decade, many economists assumed they would continue to spend on cars, clothes and the latest digital toy, good times or not. Consumer spending has rarely declined in the post-World-War-II era and when it has, it bounced back quickly.
The current recession is severely testing that article of faith. Personal consumption fell by about 1 percent in the second half of last year - the first sustained decline since 1980. Economists say consumption will be slow to recover because debt-saddled Americans are saving more or paying down debt. The savings rate - the amount of money consumers did not spend - jumped to about 3 percent late last year, from practically zero, still far below its postwar average of 7 percent.
A sign that consumption has hit bottom may come when the savings rate begins to flatten. Spending should then rebound as pent-up demand gives way. Car sales, for instance, have fallen to levels last seen in 1981, when the population of the United States was about three-quarters of what it is today.
In a study of economic cycles, Edward E. Leamer, an economist at the Anderson School of Management at the University of California at Los Angeles, found that auto sales and home building tended to lead recoveries.
Tobias Levkovich, chief United States equity strategist at Citigroup, has another indicator for spotting when we have hit bottom: When we stop behaving like children in the backseat of the car asking their parents,“Are we there yet?”
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