Dear Friends of Parthenon:

In these turbulent economic times in which very few folks have any prior personal experience from which to draw upon, we are very fortunate to have our Partner and Chief Economist, Dr. Roger Brinner, on our team to provide us with insight.

In this piece, Roger lays out his forecast and the underlying drivers for 2010. Roger’s macro model has more than 1,000 concepts, but the underlying drivers represent the key factors you should keep your eye on as we go through next year. In doing so, you can track whether we are being overly optimistic or pessimistic. As you will see, Roger was very prescient in last year’s forecast relative to the incoming actual information.

Enjoy this holiday reading. We’re more bullish than many of the pundits and sure hope we’re right!

Best Regards,

William F. Achtmeyer
Chairman and Managing Partner
The Parthenon Group
+1 617 478 2550 | www.parthenon.com

It’s now been three years since the peak of the U.S. housing market, one year after the financial chaos centered on the Lehman Brothers bankruptcy, and six months after the stock market hit bottom. It’s time to reassess the past and future.

The U.S. unemployment rate more than doubled, from 4.4% in December 2006 to more than 10%, as first oil market manipulators sent oil from $25 to an hysterical peak near $150 in 2008. Then American housing starts fell by an astonishing 75%, and finally consumers and businesses panicked late last year. Moreover, contrary to the foolish 2007-2008 hopes of wishful thinkers, the world economy was fully synchronized due to shared exposures to oil, credit markets, and fear.

The third quarter brought official reports of renewed GDP spending growth around the world, and thus a technical end to recession. (High and rising unemployment means the public will not feel the recession is over until much later.) Moreover, the details revealed a story better than the headline 2.8% annualized gain in the U.S. Even excluding the effects of cash-for-clunkers and expiring home-buyer credits, consumer demand expanded more than hoped, business equipment spending flipped to positive territory earlier than normal in the cycle, and inventory shrinkage was still suppressing GDP.

As for the future, we’ve all heard an alphabet soup of alternative projected recovery shapes:

• "L" for stagnation as a grossly debt-weary consumer, coupled with credit crises for small business and commercial real estate, prevent an employment rebound and recovery ignition
• "V" for rapid rebound, following the bigger-the-bust the bigger-the-boom model
• "W", and most creatively the "growth W," for late 2009-early 2010 rebounds that then falter into recession or near-recession again as either fiscal and monetary policy stimulants are:

  1) reversed (the "this is what happened 1933-1938" view) or
  2) kept in place building horrendous deficits and government scale (the worried conservative view)

Each of these is plausible. Each builds on true partial elements of a more comprehensive scenario. I believe the prudent outlook includes a substandard recovery compared to those of the late 1970’s or mid-1980s—following the two largest post-war recessions—because, as the "L" scenarists recognize, there are more serious credit wounds to heal. But the "V" scenarists are correct to recognize pent-up demand and the massive forthcoming short-run stimulus of fiscal policy (to date, we have seen only a quarter of the U.S. legislated stimulus) and the Fed’s indication of great patience before it withdraws its support. So neither L nor V is right. In our view, something in between is most likely for the rest of 2009 and 2010, which puts us significantly ahead of the consensus. That is symmetric with our correct, more-pessimistic-than-consensus view last year, and therefore suggest that you consider more aggressive plans than you now may be planning.

2011 and 2012 are exceptionally uncertain in the U.S., and for our trading partners it is no different. No one knows what the U.S. House and Senate will legislate for health and tax policy, not to mention defense, energy, or trade initiatives. I build the macroeconomic forecast around an assumption that the Federal spending share of GDP will be phased by 2014 to 1-2 percentage points higher than in 2006 before the economic chaos began. This translates into a Federal government role in the economy expanded by about 10%. Higher personal income and payroll taxes are assumed to pay for part of this expansion, so this leaves an even greater unsolved debt burden.

This is a soft dollar, not a dollar crisis scenario, because European and Japanese fiscal finances are no better than the U.S. and the Chinese will permit only a slowing rising Yuan. To sell the dollar, you need to find a currency to buy. This also is not a high inflation scenario. I do believe that: one, central bankers will gradually force their governments to borrow from the public rather than running the currency printing presses, and two, high unemployment rates will keep cost inflation greatly subdued.

The accompanying charts and tables fill in the forecast details, and some of the key supporting arguments for this theme of a guardedly optimistic forecast compared to the media consensus.