After correctly forecasting Q2 and Q3 growth I have been arguing for a while that the U.S. economic slowdown will worsen in Q4 and 2007 and lead to a recession by, at the latest, Q2 of 2007. Professional forecasters - who overestimated by a wide margin growth for Q2 and Q3 - most recently deluded themselves into the belief of a Q4 rebound of growth to 2.6%. I have instead been arguing for months now that Q4 growth will be even lower than Q3 at between 0% and 1%. I am now comfortable to forecast that Q4 GDP growth will be closer to 0% than 1%.

My 0% growth forecast for Q4 is based on a series of recent economic indicators suggesting that the economic slowdown is even worse than I had initially predicted. Today's data on faltering durable goods orders and falling consumer confidence strongly signal that the housing recession is spreading to consumption and investment. The housing recession is becoming a non-residential construction recession, an auto recession, a manufacturing recession, a real investment recession and soon enough a retail recession. Today's figures on durable goods and on consumer confidence, together with a more sober assessment that the holiday retail sales season is off to a mediocre start, lead me now to forecast that real growth in Q4 will be 0%. Consider the various components of aggregate demand and supply:

- The housing recession is getting much worse as housing starts fell over 14% last month while building permits fell another 6%. Housing is nowhere near bottoming out as the glut of unsold homes is rising, prices are falling, defaults and foreclosures are  rising. Expect housing to reduce growth by at least 1% in Q4 and throughout H1 of 2007. Expect job losses of at least 700K in housing in the next 12 months. And today's blip upward in pending existing home sales is exactly a noisy blip of no relevance: it does not include the sharply rising home purchase cancellations. In the meanwhile existing home prices are now sharply falling and the glut of unsold homes rising to another high (7.4 months of supply).

- Non-residential investment - that was growing at annual rates of 20% and 14% in Q2 and Q3 - is also faltering - based on the latest non-residential construction spending data - as empty housing "ghost towns" are leading to a sharp contraction of non-residential construction (why to build shopping malls and offices around empty new residential areas?)

- The auto sector and the manufacturing sector are already in a contraction of production while manufacturing capacity utilization is decreasing. Manufacturing is already in a recession with falling output and employment.

- Durable goods orders for the first month of Q4 are showing a dramatic drop, a 8.3% headline fall and a  1.7% fall even excluding the volatile transportation component.  Orders for non-defense capital goods excluding aircraft, a good proxy for future corporate investment, fell a whopping 5.1%. Thus real investment in software and equipment by corporates is off to an annualized 8% drop at the beginning of Q4. Since there is no reason to expect a recovery of real investment in November and December, real investment in software and equipment will be negative in Q4 giving a negative contribtion to growth. Thus, all three components of fixed investment - housing, non residential and software and equipment - are likely show a contraction in Q4 given the recent data.

 - The retail sector  and real private consumption is off to a mediocre start in Q4 and the holiday season in spite of the initial spin - that turned out to be mostly smoke - about a sharp rise in Thanksgiving weekend sales. The fall in sales at Wal-Mart and other indicators actually suggest a weak holiday season for retailers. Same store sales at retailers increased year-over-year 2.6 percent in November, the smallest increase since March, the International Council of Shopping Centers said today. 2.6% y-o-y nominal growth means negative real growth once you adjust for inflation. Consumer confidence is sharply down - based on data reported today - in spite of lower gasoline prices (and oil prices are now rising above $60 a barrel). Consumers are nervous and more pessimistic about their current and future conditions and about job prospects as real median wages are not growing much, the labor market is softening, household savings are negative, housing wealth is falling and housing and consumer debt servicing costs are rising. 

- The labor market is weakening. 92K jobs only created in October, mostly in government, health care and burger-flipping food sectors. Employment falling in housing, manufacturing, retail and temporary jobs. And the labor market conditions of today's consumer confidence report were also weak. The labor market differential (the share of consumers reporting jobs asbeing "plentiful" less the share reporting jobs as being "hard to get") fell from 3.8 in October to 3.4 in November. And forward looking indicators of the labor market (Help Wanted Index and its online equivalent from Monster.com) show a sharp slowdown from the rapid growth of early 2006.  Expect negative job creation in the next few months and a sharp increase in the unemployment rate as job losses in housing, construction, manufacturing and retail dominate modest job creation in some service sectors.

- Inventories increased 0.8% in October. The inventory to sales ratio has steadily increased from 1.30 in December 2005 to 1.40 in October. This rise in inventories relative to sales strongly suggests a likely downward inventory adjustment in the next few months and further manufacturing production contraction ahead as firms cut production to reduce the inventory of unsold goods.

When you add it all together on the demand side and the supply side it comes to a 0% growth for Q4. Hard landing and recession are ahead for the US economy and the  wishful thinking forecasts of the consensus that growth will sharply recover in Q4 from the anemic Q3 level are being shattered every day as the onslaught of bad macro news increases by the day.

Update. I am in good company in predicting a sharp Q4 slowdown and a recession in 2007:

1. As reported in a Bloomberg interview Shiller of Yale Says Housing Downturn Could Lead to Recession 

2. Deutsche Bank is now revising down its U.S. Q4 growth forecast to 0% from its  previous 1%:

Deutsche US Economic Outlook: Downward Revision. Our US economic team just lowered 06Q4 GDP from 1% to 0%. Please see Joe Lavorgna's original text: 

In light of continued weakness in the economic data, we are cutting our fourth quarter real GDP growth forecast to zero from the +1.0% that we were originally predicting.  This is largely due to weakness in durable goods shipments and orders, but also due to weak consumer spending.  Core durable goods shipments, which are a direct input into GDP, declined 1.5% in October, and the level is down 8.2% AR compared to Q3.  This is much weaker than what we had been assuming, and because the growth rate in capex has been slowing since Q1, we do not believe that we will see much if any bounce back in November or December.  Furthermore, contrary to weekend anecdotes, we believe that the weekly measures of chain-store activity were unimpressive through the first four weeks of November.  One survey that we track was actually down on the week. It is clear to us that consumer spending is not getting the boost from falling gasoline prices that many analysts anticipated.

It is good to know that rational minds that look carefully at the data think alike...