The Chances Of A Second Recession

Despite the stock market’s dramatic turnaround, uncertainty clouds the outlook for 2010. With jobless rates eclipsing the 10% mark, and continued troubles in the banking and property sectors, …

Despite the stock market’s dramatic turnaround, uncertainty clouds the outlook for 2010. With jobless rates eclipsing the 10% mark, and continued troubles in the banking and property sectors, investors still have plenty of reasons to worry. Depressed consumer spending will likely limit economic growth to around 2% in the year ahead, and economic indicators are pointing to a slow and sustainable recovery — without double-dip recession. For more on this, see the following article from Money Morning.

Historically, the U.S. stock market has been one of the key leading indicators of a U.S. economic rebound.

With the Standard & Poor’s 500 Index up more than 60% from its March lows – and the Dow Jones Industrial Average up nearly 40% – prognosticators are finally confident that the U.S. economy will dodge the “double-dip” recession that has been the focus of much fear since the Bush and Obama administrations launched their financial counterattacks on the worst financial crisis since the Great Depression.

But those same forecasters are reluctant to forecast a sharp economic rebound for 2010. In fact, as opposed to a classic “V-shaped” economic recovery that would accelerate as the year goes on, many economists are predicting that the rate of growth will slow as the New Year unfolds.

Forecasts from Standard & Poor’s Inc. (NYSE: MHP) and Goldman Sachs Group Inc. (NYSE: GS) illustrate this outlook. S&P recently projected average GDP growth of 1.6% for all of 2010, while top Goldman Sachs economists expect to see the U.S. growth rate decline from 3% early in the year to 1.75% by the fourth quarter.

“We don’t expect a V-shaped recovery; in fact we think that 2010 is going to be a bit slower in terms of annualized GDP growth than the second half of 2009,” Goldman Sachs Chief U.S. Economist Jan Hatzius said during a recent speech in New York City.

For analysts and economists who play the forecasting game, 2010 promises to be one of the toughest challenges in decades.

Unemployment has pierced the psychologically daunting 10% level, placing U.S. joblessness at its highest level in a quarter century. Serious questions remain about the strength of the country’s banking and financial systems. The U.S. dollar is under siege and inflationary concerns are at their highest levels in years. There’s massive uncertainty about the nation’s residential and commercial real estate markets. And even the stock-market rebound – one of the strongest in history – is considered suspect by some analysts: They worry that federal stimulus money and the U.S. Federal Reserve’s “zero-interest-rate policy” has forced bearish investors to become reluctant bulls.

Among the difficulties would-be forecasters currently face economists face is the fact that 4% of the economic growth in recent months is attributable to temporary factors, most notably the replenishing of inventories and government fiscal stimulus, Goldman’s Hatzius said. Those factors are likely to diminish by the second half of 2010, due to high unemployment, budget-conscious consumers, and overcapacity in the manufacturing sector and housing markets.
Despite these obvious difficulties, the outlook for 2010 is far from dismal. Among the bright spots:

  • The stimulus seems to be having its intended effect – one reason the odds of a double-dip recession remain remote.
  • The U.S. housing market – a crucial element of the consumer sector – is showing signs of bottoming out.
  •  The weak U.S. dollar is making U.S. exports highly competitive, giving a much-needed boost to American manufacturers.
  • With their reluctance to hire, businesses are clearly operating in a highly cost-conscious zone – a reality that could bode well for corporate profits, and for stock prices.
  • And the overall outlook for the U.S. economy is much better than it was a year or 18 months ago, and actually continues to improve – albeit slowly – a reality that can feed on itself to further bolster growth.

In this leadoff story in Money Morning’s Third Annual “Outlook” forecasting series, we’ll take a look at overall expectations for the U.S. economy for the New Year, will consider four key challenges, and will give you our take on each one. The areas that we’ll explore will include:

  • Economic expectations and the odds of a double-dip downturn.
  • The odds for maintaining growth with a “jobless recovery.”
  • The outlook for business investment and spending.
  • And the risks and rewards of current central bank policies.

Let’s take a look …

Handicapping U.S. Growth in 2010

A new survey concluded that top economic forecasters have grown in confidence that the U.S. recovery is sustainable. But those analysts also expect that growth will fall short of the typical post-recession rebound, the Blue Chip Economic Indicators newsletter reported in its November issue.

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The U.S. economy should expand 2.7% next year, the consensus estimate of 52 economists polled by the newsletter. That’s an upward revision from the consensus prediction of 2.5% made just one month before.

“The major uncertainty surrounding the outlook for growth next year involves the degree to which private demand accelerates as the positive contributions to GDP from reduced business inventory liquidation and fiscal stimulus play out,” the newsletter said.

Those factors alone pose some significant challenges to a robust rebound. Add in the near-certainty that this recovery will be a jobless one – as well as the fact that most economists believe that U.S. growth will slow, and not accelerate – as 2010 progresses, and it might be overly optimistic to expect a growth rate of 2.7%, which is how well the economic often performs even during healthy periods.

Money Morning Chief Investment Strategist Keith Fitz-Gerald is forecasting growth of, at best, 2.0% in 2010, a key reason he continues to tell investors to look abroad for some of the most-profitable investment plays.

The U.S. economy “will be lucky to do 2.0% ” next year, Fitz-Gerald said. “The economy faces some very difficult challenges. There’s a slight chance – depending on what happens with some outside factors – that the U.S. could do 2.5%, but I really doubt it. China could actually pull us along [to higher-than-expected growth], but those are some long odds.”

That’s not to say that 2.0% growth is bad news. That’s more than enough to negate the odds of a double-dip recession. Indeed, after reviewing U.S. economic history all the way back to the 1850s, Deutsche Bank AG (NYSE: DB) economists recently found that double-dip recessions are exceedingly rare.

And Money Morning Contributing Writer Jon Markman notes that when these double-dip downturns do occur, they happen under circumstances quite different from the ones that we face today. Reprised recessions usually occur in concert with a fight against inflation.

“A repeat of the 1980s just isn’t in the cards,” Markman said.

Money Morning’s Outlook: Overall, the likelihood is that the U.S. economy will experience slow GDP growth. In terms of the average growth rate for the year, investors are most likely looking at a range of 1.0% to 2.0% for all of 2010, as a protracted jobless recovery extends the housing and banking crisis, puts a damper on wages, reduces consumption. And that growth rate will decelerate as the year progresses, meaning that it’s measure investors should watch closely.

U.S. Joblessness Will Stifle Consumer Spending

As we’ve all learned as far back as Econ 101, the U.S. marketplace is chiefly consumer driven. Historically, consumer spending spurred 60% of U.S. growth. In recent years, that number has surged as high as 70%. Given the U.S. economy’s avowed consumer focus – coupled with the near-certainty that we’re facing a jobless recovery – investors who are hoping for stronger-than-expected growth would best keep the champagne on ice, according to economist Joel Naroff.

“We need households to become a little more confident and businesses to start thinking about tomorrow so we can transition out of the government- and Fed-supported economy into a private-sector recovery,” Naroff, president of the Holland, PA-based Naroff Economic Advisors, said in a note to investors.

To that end, Naroff is concerned about the effect a jobless recovery could have on consumer spending.

“Can consumers save the day? Only if incomes grow solidly and that is not going to happen … businesses have some room to expand without hiring lots of new employees,” Naroff noted. “It could take four to five years for the unemployment rate to get back to full employment. There is little reason to expect that happy times are here again.”
The U.S. unemployment rate in October pierced the psychologically important 10% barrier for the first time since 1983, as employers made deeper-than-predicted payroll cuts.

It’s no surprise, then, that U.S. consumers in September cut their spending for the first time in five months, reducing their outlays for products and services by a hefty 0.5%.

Only one other time since World War II has the unemployment rate topped 10% – between September 1982 and June 1983. It hit 10.1% in September 1982, moving up from 9.8% the month before.

The economy, as measured by gross domestic product (GDP), was basically flat in summer 1982. But the economy at that time was actually getting ready to recover.

Then the economy began to surge in early 1983, fueled by tax cuts and, more importantly, substantial interest-rate cuts by the Federal Reserve. By the end of 1983, the unemployment rate was down to 8.3% and dropped to 7.3% in 1984 and 7.0% in 1985.

But that was then and this is now.

Although the official unemployment rate hit 10.2% last month, the employment outlook is actually much worse: If you factor in part-time workers who’d prefer a full-time position, and people who want work but have given up looking, the “real” unemployment rate is actually a record-high 17.5%.

That means that more than 16 million people are now out of work, compared to 6 million in 1982. In July – the last month the government released statistics – there were more than six officially unemployed persons for every job opening. Historically, the ratio is closer to 2-to-1.

What’s worse is that productivity is increasing as employers are successfully getting their existing staff to produce more in fewer hours – making it less likely they will start hiring.

Any improvements will come slowly. In the Blue Chip Economic IndicatorsNovember issue, 52% of the economists surveyed said the unemployment rate won’t fall back below the 7.0% level on a sustained basis until the second half of 2013 – and it may take longer than that.

Money Morning’s Outlook: The recession may technically have ended, but for the millions of unemployed workers the hard times are far from over. Given that almost one-fifth of the U.S. work force is unemployed or underemployed, don’t expect consumers to step up and step in if stimulus spending falls short, or ends. The upshot is that, from this vantage point, GDP growth for the New Year is likely to be severely constrained.

This article has been republished from Money Morning. You can also view this article at
Money Morning, an investment news and analysis site.

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