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LaVorgna: Wall Street hopes way too high

Deutsche Bank economist Joe LaVorgna thinks his Wall Street peers are being far too optimistic about 2016's growth prospects.

Though the U.S. limped into the end of 2015 with growth likely to be barely positive, and the early year data mixed at best, the Street is fairly sanguine about the road ahead. Consensus is that gross domestic product will grow 2.5 percent for the full year, according to FactSet, with hopes broadly pinned on increased consumer spending.

However, LaVorgna, who for years has held a strongly bullish and often above-consensus view, believes growth is slowing. For the full year he sees GDP rising just 1.2 percent, with risks tilted to the downside. Among other things, he believes companies have built up inventories that will take considerable time to be drawn down.

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"Inventories are the biggest single reason why growth is likely to disappoint, but not the only reason," he said in a phone interview. "The length of the business cycle is a concern, profit margins have certainly peaked and the economy is being led by the consumer. There are plenty of periods where consumer spending has been positive during a recession."

To be clear, LaVorgna, Deutsche Bank's chief U.S. economist, doesn't see a recession as the most likely case for the economy this year, but he does believe there's about a 40 percent chance.

An Amazon.com worker picks orders at an Amazon fulfillment center in Tracy, Calif.
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An Amazon.com worker picks orders at an Amazon fulfillment center in Tracy, Calif.

Wall Street remains upbeat about the economy even though there have been some early trouble signs in 2016.

While housing and employment numbers look solid, corporate profits are in recession, manufacturing data also are consistent with recession and fresh data Wednesday from Markit showed a 49.8 reading on its services index, with a reading below 50 on the diffusion index representing contraction. It was the lowest Markit purchasing managers index and first indication of decline since October 2013.

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On balance, the Markit reading showed optimism. However, the rate of confidence was at its lowest level in 5 ½ years. Services were a key component in 2015's 2.4 percent growth rate, rising 2.8 percent after years of post-financial crisis languishing.

The shaky confidence has led to a sharp stock market decline, with the S&P 500 off about 7 percent year to date and nearly 11 percent from its 52-week high, indicating a correction.

"Credit rating, high-yield spreads, commodity prices, equity market sectors — financials are a good leading indicator — all these markets are telling you the same thing, that there's a growth problem," LaVorgna said. "That's happening against the backdrop of an economy that's hardly booming."

LaVorgna believes the low growth will keep the Fed on hold, with just one rate hike likely this year, in December. That's actually more aggressive than futures trading, which indicates a full hike isn't priced in until a year later. The CME Group's FedWatch Tool indicates just a 26 percent chance of a move all the way out to February 2017.

While LaVorgna's forecast is the lowest on Wall Street, he does have some company in relative pessimism. Nomura expects GDP growth of 1.7 percent for 2016 and a slight improvement to 2.1 percent in 2017.

The market will get the first revisions to fourth-quarter GDP on Friday. The initial reading was 0.7 percent, but few expect that to hold up. The CNBC/Moody's Analytics survey has a median expectation of 0.3 percent, with the first-quarter estimate at 2.3 percent. The International Monetary Fund has pegged U.S. growth expectations for 2016 at 2.6 percent, though that is a 0.2 percentage point reduction from a previous forecast.

Deutsche's "house view" forecast is for global growth of 3 percent, the slowest since the financial crisis, according to a summary the bank released Wednesday.