2010 - In the Midst of a Puzzling Economic Era

Looking forward to 2011, the consensus is for 3% GDP growth according to the following WSJ article.

Izzo, Phil, 2010. Economists predict growth in 2011. The Wall Street Journal, Dec. 13.

Though any economic growth is welcome, 3% will hardly mend deep (and perhaps structural) issues in unemployment, the housing market, national public debt, flat prices, and the over-leveraged condition of the consumer. For example, many believe that anything close to full employment might not happen before 2014 (see article cited below). A similar timing is probably true for a turnaround of the housing market.

For quite some time I have written that investors are overlooking the implications of the extremely weak economic recovery as an indication of longer-term issues for the American economy. Others have similar opinions.

Alan Abelson describes the recovery as experiencing a "lack of oomph."

Abelson, Alan, 2010. Everyone's bullish and that's bearish. Barron's, Dec. 11.

In his weekly column, Mr. Abelson quotes the view of David Rosenberg (see Gluskin Sheff) regarding the puzzling economic era that confronts executives and consumers. In summary, Rosenberg's point is that business cycle seems to be corrupted in relation to historical norms.

These two paragraphs about the current stage of the US business cycle provide deep insight:

"As Dave admits, it's tough to judge what part of the cycle we're in. If, he observes, you look at things like the unemployment rate, capacity utilization, the level of consumer confidence, the work week, and housing starts and sales, you'd conclude that we're still in a recession."

"Yet if you look at profit margins and the Institute for Supply Management index, it seems as if we in the mid- or even late part of the cycle. Trouble is, if we were really entering into a mid-cycle phase, 'the economy would be growing at an annual rate in excess of a 4%, and inflation would be reality, not a debate.'"

It is not clear exactly what is causing this unusual situation. Probably the severity of the 2008 financial crisis along with the over-leveraged condition of the US consumer are leading candidates. In addition, extensive government intervention might play a role. Likewise, the trade deficit can not be ignored as a cause.

In any case, I feel this confusing economic outlook could play into a medium to long term period of restrained economic growth (see 1937), something that Americans will experience across all demographics.

The downside for 2011 is something no one wants to discuss in investment circles. I think this is far too optimistic and represents unrealistic expectations perhaps underpinned by the reassuring flow of easy money into the economy engineered by the Fed.

Mr. Rosenberg mentions the following that is a concise statement of the significant risks the global economy continues to face going forward:

"Meanwhile, the downside risks that spasmodically spook investors, he notes, are still very much with us. Among them, 'the need for dramatic anti-inflationary policy tightening in the emerging market world,' radical surgery at the state and local levels here at home, and the grave fiscal challenges that face Europe."

I do not think all of the demons are gone from corporate balance sheets and income statements, and I think government policies in Asia and Europe will affect the US in 2011 to a larger extent than many believe.

Close to home, public finance at the State and local level will bring the ongoing reality of the 2008 financial crisis into every American living room via higher taxes.