Down Only 27%? We'll Take It!
Enter the Era of Low Expectations

By Frank Ahrens
Washington Post Staff Writer
Friday, February 6, 2009

Has "not as bad as we thought it would be" become the new "good"?

Has the economy really come to that?

With the Dow Jones industrial average down 8 percent this year, with the national unemployment rate almost certain to rise when it comes out today, and with exports grinding to a halt in Japan and elsewhere, the answer is: Yes, it has come to that. Any sliver of not-terrible news looks like a silver lining. We'll take it.

Consider Wednesday's quarterly earnings report from technology giant Cisco Systems, which builds much of the Internet's plumbing. The company announced profits that were down 27 percent over the corresponding period last year and predicted that sales would sink 15 to 20 percent in the next quarter.

In response, shares of Cisco climbed about 3 percent; the news was not as bad as expected. Some analysts suggested that Cisco's "turnaround" would lead tech stocks back.

The not-so-bad phenomenon extends beyond earnings reports. At the end of last month, the government reported that gross domestic product in the fourth quarter fell at a 3.8 percent annual rate -- its worst performance in nearly three decades. But economists expected it to be down more than 5 percent. A couple of days later, the government report that personal income fell 0.2 percent -- the third straight monthly decline -- but a 0.4 percent drop had been predicted.

The same thinking applied to yesterday's terrible-for-any-other-time retail news. Sales were dismal, but not as dismal as the market expected, which is part of the reason the Dow gained 1.3 percent yesterday, closing up more than 100 points.

What gives?

"I think it's human instinct to be optimistic," Art Hogan, managing director at Jefferies & Co., said yesterday. "And it's natural if you've spent the entirety of last year watching the market go down 40 percent. It's kind of like that joke that ran around at bonus time: Flat is the new up. If you can only get flat compensation on a year-over-year basis, that's the new up."

Call it the era of diminished expectations.

Implicit in the grasp for good news is this: People need to believe that things are going to get better. At this point, the United States has been in a recession for 14 months. Americans want to know whether it's going to be what economists call a "U-shaped" recession, meaning we'll hit a bottom and the good times will return, or whether it's going to be what they call an "L-shaped" recession, meaning we'd better get used to a Dow stuck at 8,000. The latter would mean the era of 20 percent annual appreciation on your home's value is over for good, and, if we're lucky, the economy will again -- someday -- return to the modest prosperity marked by 8 percent annual gains in your stock portfolio.

So we look for signs.

Hogan himself is famous on Wall Street for his gutsy prediction on Oct. 10 last year that the stock market had "bottomed," or hit its low. Recovery was on the way, the thinking went, giving birth to the giggle-inducing phrase "Hogan's bottom."

Economist John Ryding, founding partner of New York's RDQ Economics, published a paper yesterday pointing out that even though the economy is still slowing, the rate of the slowdown is decreasing, according to several indicators.

"Before things can get better, they have to stop getting worse, and that's a key turning point," Ryding said in an interview. "You start to see things getting worse at a slower rate."

Again: We'll take it.

Part of the game is where you set the bar. If Wall Street analysts predict that a company's quarterly results will be down 20 percent and they turn out to be down only 10 percent, then the company will be deemed to have "beaten the Street." The company's stock will rise as buyers rush in, optimistic about the company's future, thereby increasing the value of the company.

And better to underestimate than the opposite. Economists expected that 580,000 Americans would file for unemployment benefits last week, according to Bloomberg. That guess was too low by 46,000, the government reported yesterday.

Pollyanna glasses aside, looking for good news can have actual benefits. It forces a search for obscure data that can provide real insight.

Such as the Baltic Dry Index (BDI), an economic measure that typically would be considered as cold and dull as it sounds.

The index is a 265-year-old London-based survey of prices for transporting metals, coal, grain and other raw goods overseas by cargo ship. Usually overlooked by the mainstream business press, the BDI has enjoyed a star turn of late because it is in fact a leading indicator of economic growth. In good times, when raw goods are flowing into countries and finished goods are flowing out, shipping prices are high, driving up the BDI.

The BDI has plummeted by 90 percent since mid-2008 as the global economy has crashed and shipping has coasted to a halt. But since the end of last year, the BDI has ticked back up, meaning, for instance, that iron ore is being shipped to China so it can start cranking out exports again.

So, back to Hogan and his bottom. How did his optimistic prediction hold up?

Pretty well, it turns out.

On Oct. 10, the day Hogan called as the market bottom, the Dow hit a low of 7773.31. Since then, the Dow has dipped below the number on only two other days, Nov. 20 and 21.

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