Your Best Economic Forecast

Intrade.com—the UK website featuring bets on almost anything—currently rates the odds of a US recession in 2013 at 22 percent.

That’s a bit below the 30 percent likelihood currently signaled by our Personal Finance Recession Radar indicator. But it reflects the same conundrum faced by all economic forecasters at a time of historic uncertainty.

On the one hand, based on the most recent numbers, things are looking up. Initial unemployment insurance claims—the only labor market indicator not subject to wild revisions—were a seasonally adjusted 335,000 for the week ending January 12. The four-week average, meanwhile, was 359,250.

The weekly claims figure was the lowest since January 2008. Both numbers are far below levels indicating rising recession pressures, and likely portend a further drop in the unemployment rate.

The crash in the US housing market was at the heart of the market crash and credit crunch of 2008—as well as the two consecutive quarters when the overall US economy shrank by nearly 9 percent in late 2008 and early 2009. The sector, however, is clearly surging now, with U.S. home prices soaring 7.4 percent in November for their largest gain since pre-bust 2006.

Housing’s rally has carried over into strong performance in scores of other industries as well, from construction to raw materials. Health care hiring too has accelerated, as the industry gears up for a massive boost in insurance rolls.

Most bullish are numbers coming from China. For more than a year, the country’s declining growth rate has been a major concern for the global economy. Fourth-quarter gross domestic product, however, rose at an annualized rate of 7.9 percent, well above the third quarter’s 7.4 percent and paving the way for the country to reach a target of 8 percent plus for 2013.

China is now by far the most important market for many natural resources, and soon will be for virtually all others including oil. It’s the world’s biggest market for many manufactured goods as well, including automobiles. When its economy picks up steam, there are positive repercussions everywhere.

That adds up to a very strong push for the global economy in 2013. The only question is whether it will be strong enough to overcome the pull of several negative factors, including still-lagging European economies and austerity in the US.

Atypical Indicator

A typical economic forecasting model inputs a range of numbers deemed to be useful in gauging current and future activity. Those numbers are run through formulae to arrive at an aggregate figure that constitutes a forecast.

In stark contrast, Intrade’s current 22 percent reading reflects the odds laid by the betting public. Investors essentially buy a contract for 22 cents on the dollar, which in this case will pay off at the full $1 if there is a recession declared in 2013. If there’s no recession, the contract expires at zero and investors who buy in now lose their 22 cents.

The current price of just 22 cents for the recession contract means the market is only willing to assign a lesser possibility to a recession, essentially less than a 1-in-5 chance based on all available information available to speculators. That amounts to a forecast that the push of positive economic forces will offset the pull of negative ones, at least enough for the US economy to grow in 2013.

A conventional economist will no doubt scoff that a handful of wager-happy Brits and other “punters” could ever hope to forecast US growth as accurately as they can. But there are two very good reasons to pay attention here.

First, Intrade actually has a very solid forecasting record. As I pointed out several times last year in Mind Over Markets, its contracts proved unfailingly accurate as forecasters of the outcome of US elections. They were also on target when it came to the US economy and stock market.

That’s certainly not a claim most political prognosticators can make, other than perhaps New York Times political statistics blogger Nate Silver. And one could have emerged from 2012 quite wealthy by earning a dollar for each of the market/economic doomsday forecasts that proved so wildly off the mark last year.

Perhaps more important, there’s a very good reason for Intrade’s accuracy. Mainly, the value of these contracts is based on expectations that in turn are derived from all of the best information available to speculators, which includes the individual forecasts of various economists.

The Intrade number is dynamic. That is, its value is constantly changing along with the expectations of its bettors. As a result, its movements are very similar to those of what’s consistently been the most accurate forecaster of economic activity over time—mainly the US stock market.

Not Set In Stone

As I’ve written many times before, I’m no fan of pat theories—or of attaching too much importance to a single indicator or forecast. And I’m not willing to completely discount the possibility of a recession in 2013 with so much uncertainty overhanging the economy now.

Challenges include the need for Washington to accomplish three difficult goals: raise the federal debt limit to avoid an unprecedented default; deal with spending cuts under the “sequester;” and provide funds to keep the government running past the first quarter of 2013. And let’s not forget that much of Europe is still mired in a recession made more severe by relentless austerity.

The combination of better growth numbers and Washington’s deal on taxes has, however, driven down the value of Intrade’s recession 2013 contract, and helped the stock market move higher so far in 2013. A breakthrough in lifting the federal debt ceiling may also be in the offing, with Congressional Republicans attempting to shift the battle to spending cuts.

That still leaves the impact of combined federal government austerity measures, which are projected to equal roughly 1.9 percent of US gross domestic product. The first of these likely showed up in many Americans’ paychecks this week for the first time as higher Social Security taxes. But we’re not going to know their impact until later this year.

Fourth quarter and full-year 2012 earnings of recommended companies will give us a good idea of where we stand as austerity takes effect. And these will start coming in over the next few weeks.

My prognosis for investors, however, remains much the same it’s been the past several months: Remain cautious and stick to companies that have proven their mettle in bad markets with reliable revenue. The Great Recession’s nadir in 2008 was a great proving ground.

I’m also wary of companies with large amounts of debt to refinance in the next 12 months or so. Any weakening in the economy will make lenders more cautious, and that could really drive up borrowing costs for those with no choice but to go to market.

As for a recession, I echo the Intrade bettors, insofar as I give an official one no more than an outside chance. But remember the lesson of the past few years: Companies may stumble in lower numbers when growth is plugging along than they do in full-out recessions. The stumblers will still punish unwary investors. Stay vigilant and watch your stocks!