Why I Am Chopping My U.S. GDP Forecast to 1.5%

For the past two years, I have maintained a GDP growth forecast for the US of 2% a year. I have not stuck with this figure because I am stubborn, obstinate, or too lazy to update my analysis of the future of the world's largest economy. I have kept this number nailed to the mast because it has been right.

I have watched other far more august institutions with vastly more resources than I gradually ratchet down their own numbers towards mine, such as Goldman Sachs (GS) and the Federal Reserve. So I feel vindicated. But now that they are coming in line with my own subpar, lukewarm, flaccid 2% prediction, I am downsizing my forecast further to 1.5%. This is not good for risk assets anywhere, and may be what the markets are shouting at us with their recent hair raising behaviour.

I am not toning down my future expectation because I am a party pooper or curmudgeon, although I have frequently been called this in the past. After all, hedge fund managers are the asset jockeys that everyone loves to hate. My more sobering outlook comes from a variety of fundamental changes that are now working their way through the system.

First, let me start with the positives, because it is such a short list. The work week is now the longest since 1945, no doubt being helped by on shoring triggered by rising Chinese wages. The car industry is in amazingly good shape, although the vehicles they are selling in larger numbers are much smaller than the behemoths of the past, with thinner profit margins. Credit is expanding, if you can get it. The housing market has finally stopped crashing and might actually add 0.3% to GDP this year.

Now for the deficit side of the balance sheet. The $4 trillion in wealth destruction created by the housing crash is still gone, and will remain missing in action for at least another decade. The home ATM is long gone. Income growth at 1.7% is still the slowest since the Great Depression, and is far below the historic 3% annual rate. Not only do people work longer hours, they get paid much less money for it.

Home mortgages rationed to only the highest credit borrowers has cut housing turnover off at the knees. This means fewer buyers of appliances and other things you need to remodel a new home purchase. It also kills job mobility, trapping worker where the jobs aren't. Notice that vast suburbs remain abandoned in Las Vegas and Phoenix, while thousands live in impromptu RV camps in booming North Dakota.

If you want to understand the implications of the fiscal cliff at year end, watch the cult film, Thelma and Louise, one more time.  That's where the heroines deliberately go plunging into the Grand Canyon in a classic Ford Thunderbird. The noise surrounding the presidential election is going to settle ones nerves about as much as scratching one's fingernails on a chalkboard.

The global situation looks far worse than our own. This is not good, as foreign sources account for 50% of S&P 500 earnings, and as much as 80% for many individual companies. To understand how wide the contagion has spread, look at the numbers put out on a recent JP Morgan forecast.

The European impact on our economy is about as welcome as the 1918 Spanish flu, when millions died. (JPM) cut their expectation of growth there from -0.1% to -0.5%. Italy is shrinking at a -2.2% rate. Their prediction for growth in Latin America has been chopped -0.5% to 3.3%, while China has been pared by -0.5% to 7.7%. Japan is enjoying a rare 0.5% pop to 2.5%, but that is expected to fade once a massive round of tsunami reconstruction spending is done. Overall, global growth is decelerating from 4.5% to only 2%, with 82% of that growth coming from emerging markets. The last time a global slowdown was this synchronized was in 2008. Remember what stock markets did then?

All of this may be why hedge funds are fleeing this market in droves as fast as they can, including myself. Many of the small and medium sized funds I know are now 100% cash, and the big ones are only staying because they are trapped by their size. There are few good longs out there for the moment and fewer shorts. Prices are gyrating on a daily basis, triggered by overseas headlines where every else seems to have an unfair head start.

Suddenly the yacht at Cannes, the beach at the Hamptons, and the golf course at Pebble Beach seem much more alluring. Yes, clients dislike it when their managers are flat because they are getting paid for doing nothing. But they hate losing money even more.