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Jim O'Sullivan: Economic Augur — The 2016 IA 25

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Harry Truman, who’s reputed to have demanded a “one-handed economist” because all the economists he encountered said “on the other hand,” would have loved Jim O’Sullivan. The chief U.S. economist at High Frequency Economics not only takes definitive positions on the economic outlook, but is also often right.

MarketWatch has named O’Sullivan Forecaster of the Year every year for the past five and eight of the last 12 years. Reuters has called him the top U.S. economic forecaster for the past two years in a row. And Institutional Investor accorded him first-place ranking in its survey of U.S. fixed income investors three times.

These are impressive accolades given the volatility of the U.S. economy and the global economy during those years and good reason for financial advisors to follow O’Sullivan’s outlooks and analyses.

“The economy is critical to people’s lives and interacts with markets in an exciting way,” said O’Sullivan.

O’Sullivan likens economic forecasting to fantasy baseball: digging through economic data to develop an accurate economic forecast, much like a fantasy team owner analyzing players’ stats in order to create the strongest fantasy team.

Economic forecasting is also “like reading a map,” said O’Sullivan. “The first question to ask is, ‘Where are you on that map?’ That’s the starting path.”

Sullivan himself started his economics career at J.P. Morgan in 1985, eventually moving to UBS as senior U.S. economist, then MF Global as chief economist and finally to High Frequency Economics, known as HFE, in 2012. He was also editor and lead author of “Data Decoder: An Investor’s Guide to the U.S. Economy,” a guidebook for tracking the U.S. economy published in 2002.

O’Sullivan continuously analyzes the steady flow of economic data. “In the end, they are the key drivers of the markets day-to-day and week-to-week. They ultimately set the tone.”

O’Sullivan said he looks “at everything,” but his No. 1 indicator is jobless claims. “They’re almost infallible in setting the tone for the economy broadly […]. There are not many false signals.”

That’s not necessarily the case with the monthly employment data that the financial markets fixate on. Those reports can move “off-trend” for a time, creating false signals and extrapolations about the economy, said O’Sullivan,

The jobless claims report for the week ending April 30 showed a 17,000 increase in weekly claims to 274,000, but a four-week moving average of 258,000, just slightly above the a 42-year low reached two weeks earlier.  “The clear message is that the labor market remains pretty strong,” said O’Sullivan.

O’Sullivan also looks for data to corroborate the economic numbers he’s already analyzed, as well as “technicalities that can vary month to month.” 

Then, using a “certain amount of judgment born of experience,” O’Sullivan analyzes all this data as part of the work that he describes as “a little more art than science.”  That, in turn, includes “judging current momentum, trying to figure out what’s changing in terms of financial conditions, sentiment and policy […] and being open-ended as things change.”

O’Sullivan has changed his outlook on the U.S. economy and Fed rate policy to keep up with changing developments. In January, he predicted the U.S. economy would grow between 2% and 2.5% this year, with core inflation rising to about 1.8% from 1.3%, unemployment falling to near 4.3% by year-end and the Fed Funds rate near 1.50%-1.75% following five rate hikes.

By April, he had downgraded his forecast with GDP growth closer to 2%, core PCE at 2.3%, year-end unemployment at 4.5% and Fed Funds at 1.25% — following three more rate hikes.

“Potential growth has slowed […] and is no better than 2% a year,” said O’Sullivan. It’s “clearly not what it used to be […], not what we’ve seen in past cycles.” Indeed, the initial read on first quarter GDP growth was just 0.5%. 

Citing Economics Professor Robert Gordon, author of “The Rise and Fall of American Growth,” O’Sullivan noted that U.S. economic growth is not likely to return to the levels that dominated in the 1950s or 1960s. The labor force is growing more slowly, in part because of retiring baby boomers, and productivity growth has also slowed, said O’Sullivan. But given that backdrop, he says the U.S. economy is doing pretty well and inflation is starting to pick up.

If that trend continues and unemployment falls further, the Fed will raise rates, so long as global financial markets are not in crisis, said O’Sullivan. The jobs report for April showed a lower-than-expected rise in payrolls of 160,000, but a 0.3% rise in hourly earnings and slight increase in weekly hours. 

“A bit weaker than expected,” wrote O’Sullivan in his brief post-report analysis. “The pattern will naturally be read as evidence of slowing following the weakness in GDP in Q1, lessening the case for Fed tightening, although the lack of an uptrend in claims cautions against extrapolating yet.” Spoken like an economist who continuously decodes the data.

— See the full 2016 IA 25 in the May issue of Investment Advisor, and find ongoing coverage of the honorees, including extended profiles, all month on the IA 25 homepage.