Insight Line—October 15, 2007

“The stock market has predicted nine out of the last five recessions.” – Paul Samuelson, economist and Nobel Laureate

With all the swirling talk of recession, might investors look to the stock market for guidance? After all, some pundits suggest stock prices are a reliable discounting mechanism of future economic activity. But a more thorough analysis of recent historical stock market peaks suggests the track record of stock prices as a predictor of business cycles downturns—recessions, if you will—to be less than stellar. Thus, it appears Professor Samuelson’s quip is a rational piece of advice to those so inclined to think otherwise.

To be sure, the professor’s assessment more than likely arose from in-depth analysis undertaken to support his fervent view of stock prices as nothing more than a random walk (the efficient market hypothesis). However, I believe there may be a less controversial reason for the failings of the stock market as a predictive economic indicator. The fact is large segments of the U.S. economy operate without regard to Wall Street and without a stock symbol.

The largest segment is the government—operating at the local, state and federal levels. Government consumption expenditures and gross investment, in the latest available figures, approximate 19 percent of the nation’s total gross domestic product.

Then, of course, there is the underground economy. Some estimates place these off-the-book activities as an amount equal to 10 percent of America’s measured economy.

The final segment is comprised of privately held firms, and here the numbers are impressive.

According to Forbes’ 2006 annual list¹ of the nation’s largest privately held companies, this final segment is growing to the point that it now accounts for more than $1.25 trillion in sales and 3 percent of the nation’s labor force. And, if the recent surge in private equity transactions is any indication, the numbers for November 2007 may be even larger.

To be sure, this unrepresented economic activity does not exist in a vacuum. The underground economy aside, many listed corporations do substantial amounts of business with the government and privately held enterprises.

Nevertheless, I believe Samuelson’s point on the shortcomings of the market’s predictive prowess remains intact. As our economy evolves from a manufacturing base to a service base, gone are the days when the president of a major corporation can suggest—to a congressional committee (as did Alfred Sloan, speaking about General Motors)—that his company’s fortunes are a good barometer of the nation’s economic activity.

Granted, it’s all but impossible to assign quarterly earnings per share, forecasted revenues, or an analyst recommendation to large and important sectors of the economy. However, that does not mean that this information does not exist—it’s just not necessarily showing up in daily stock prices.

¹ Reifman, Shlomo and Samantha N. Wong, “America’s Largest Private Companies,” Forbes, November 9, 2006. http://www.forbes.com/lists/2006/21/biz_06privates_The-Largest-Private-Companies_land.html

This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy. The forecasts and opinions in this piece are not necessarily those of Van Kampen, and may not actually come to pass. Information in this report does not pertain to any Van Kampen product and is not a solicitation for any product.

Factors Driving the Economy

Economic Acceleration

Economic Deceleration

Latest Available Information
(as of 10/12/07

Employment
^{(Source: Bureau of Labor Statistics)}

Up

Down

The release of September 2007 employment data reminded investors of the difficulty encountered by the Bureau of Labor Statistics (BLS) tracking monthly employment data. Newly updated statistics resulted in broad-based revisions to previous releases. By the time the dust settled, the data showed that despite a 0.1 percent rise in the unemployment rate to 4.7 percent total, household and payroll employment hit new record levels. Household employment now stands at 146.257 million, while payroll employment is 138.265 million. The revisions also offered a healthier than previously reported read on average hours worked and pay levels. One note of caution: economic growth may be approaching the point where new entrants into the labor pool are absorbed at a slower rate, thereby resulting in a rise in the unemployment rate. That said, I suggest the appropriate action on the table is to circle Up.

Personal Income
^{(Source: Bureau of Economic Analysis)}

Up

Down

August 2007 personal income data was weaker than forecast owing to a shift in timing of government transfer payments. Nevertheless, the 0.3 percent increase moved the annualized total of $11.8 trillion to yet another record. Wage and salary totals of $6.4 trillion remain at record levels. The year-over- year growth rates remain well in excess of those witnessed prior to economic contractions. As such, I suggest any talk of economic recession is very premature. Please circle Up on the table.

Retail Sales
^{(Source: Department of Commerce, U.S. Census Bureau)}

Up

Down

September 2007 retail sales data bounced back from the less than stellar report in August. The monthly total of $380 billion was slightly more than forecast. However, the year-over-year trends remain subdued. As such, I expect downbeat forecasts for the upcoming holiday sales might increase in frequency. Therefore, I continue to suggest the appropriate circle on the chart remains Down.

Durable Goods
^{(Source: Department of Commerce, U.S. Census Bureau)}

Up

Down

Durable goods orders for August 2007 reminded investors how volatile this data series can be. July’s strong surge was all but erased in August’s pullback. That said, strength in new orders, if placed into production, bodes well for future manufacturing activity. Nevertheless, the concerns I expressed months earlier over the potential short-lived nature of the second quarter’s surge appear to be correct. Thus any contribution to overall economic activity from the manufacturing sector in the third and fourth quarter may disappoint. Therefore, I am leaving Down as the preferred circle of choice.

Inflation
^{(Source: Bureau of Labor Statistics)}

Low

High

Inflationary pressures remain evident but not elevated. The Federal Reserve’s preferred measure, Personal Consumption Expenditures ex-food and energy price changes, as of August 2007 rested at 1.8 percent year-over-year. August represents the third month in a row that measured inflation remains within the Federal Open Market Committee’s (FOMC) preferred range. Therefore, despite public rhetoric from some FOMC members to the contrary, I suggest the appropriate action is to move the circle from High to Low on the chart.

Government Spending
^{(Source: Congressional Budget Office, U.S. Treasury)}

$In

$Out

With official year-end totals ($-163 b) showing a dramatic drop in the overall deficit from fiscal 2006, it can be confirmed that the 2007 budget deficit was but one-fourth of the original projections. In that the appropriation process for 2008 remains unsettled, a year-over-year comparison is premature. With that said, I believe it reasonable to argue the existence of a federal deficit in fiscal 2008. As such, the federal government continues to stimulate economic activity with deficit expenditures thereby making the appropriate circle on the chart $In.

Monetary Policy
^{(Source: Board of Governors, the Federal Reserve System)}

$In

$Out

The FOMC reduced the overnight lending rate to 4.75 percent on September 18, 2007. The action specifically highlighted tightened credit conditions in the overnight and term lending markets as the primary rationale for the action. In that some lending markets have yet to return to normalcy I suggest a high likelihood of an additional rate reduction following the October 30-31, 2007 FOMC meeting. Therefore, please continue to circle $In.

Yield Curve
^{(Source: Bloomberg, LP)}

Positive

Negative

The difference between the three-month Treasury bill yield and the 10-year Treasury note yield was 51 basis points on October 12, 2007.
Please Circle Positive.

Gross Domestic Product
^{(Source: Bureau of Economic Analysis)}

Above

Below

The nation’s GDP in the second quarter recovered smartly from the 0.6 percent annualized growth in the first quarter. The annualized rate of 3.8 percent came about as government and business spending surged. Net exports were also a surprising source of strength. Nevertheless, anecdotal evidence from the third quarter calls into question the sustainability of the second quarter’s growth. Government spending does not appear to be as strong. Consumer and business spending remain supportive but show few signs of accelerating from that recorded in the second quarter. Exports appear to be the only bright spot on the horizon. Therefore, I continue positioning the appropriate circle as Below.