The recession in housing has spilled over to the rest of the economy, in our view. We now expect an outright contraction in economic activity in the first three quarters of 2008. This downturn should be led by consumer spending.
GDP is expected to average 0.8% in 2008 (was 1.6% before) and only pick up to 1.0% in 2009, in spite of $175bn in fiscal stimulus and aggressive easing of monetary policy by the Federal Reserve. As we saw in prior post-bubble de-leveraging episodes, the healing process takes time as the bad debts get extinguished and balance sheets repaired.
Home prices are expected to decline by 15% in 2008 and by a further 10% in 2009, with more depreciation likely beyond the forecast period. The inventory situation has become intractable and home prices are still far above historical norms when benchmarked against other measures such as rent or GDP. Housing starts will probably slide another 30% from current levels, to 700k by the end of 2008 - a historic low needed to clear inventories amid the worst housing financial crisis in decades.
We expect operating earnings to be $80.0, down 8.4% from 2007, and see a modest recovery to $80.50 in 2009. The annual averages, however, mask a 20% peak-to-trough decline, which is typical of recessionary backdrops. We expect that more write-downs will result in a 15% decline in reported earnings this year. As a result, our forecast takes into account the added hit to the consumer balance sheet and equity cost of capital considerations from a normal 25% cyclical bear market in equities that is part and parcel of most economic downturns.
We anticipate job losses in the range of 2.5 million, close to what we saw in the last recession. This in turn is expected to push the unemployment rate up, to 5.75% by the end of 2008 and to 6% by early 2009.
Rising unemployment, $6 trillion in lost housing wealth combined with slumping equity valuations, and the lack of participation from the baby boomers for the first time in three decades likely will result in the worst consumer recession since 1980. We see the YoY rate of real PCE dropping to -1.0% by 4Q 2008, led by double-digit declines in consumer durables.