I have long talked of the virtuous cycle of an economic recovery, where increased consumer spending leads to more production that in turn leads to more employment and more income that leads to more spending. Once the process is set in motion, it is indeed hard to break.
Although we have seen that cycle begin, I believe the economy is now at a tipping point, about to move into a stronger, more sustainable recovery. Until the third quarter of 2010, consumer spending had been increasing at a steady but anaemic 2% pace, which was not enough to really get the virtuous cycle going with gusto. The cycle was slowed due to remarkable productivity gains during the recession and consumers propensity to spend a lot of their extra dollars on foreign goods. However, things began to change in the third quarter of 2010 as consumer spending accelerated to almost 3%, and early reports suggest it could accelerate to as much 4% in the fourth quarter driven by the strongest holiday season since 2005. And, recent trade data suggest that more of those dollars are being spent on US products as well.
A lot of firms probably could limp along at 2% consumption growth without having to hire a lot of new people, given a typical 1% productivity increase and the fact that some of that demand was satisfied by overseas factories. However, with 3% to 4% growth, better hiring rates are in the cards. Higher employment levels and higher asset prices, combined with a substantial (though largely unrecognised) improvement in consumer financial positions and lower payroll taxes should continue to drive the consumer forward in 2011.
GDP Could Accelerate to 3.5%-4.0% in 2011; Unemployment Could Fall to Under 9%
A strong consumer is the backdrop for my forecast for 2011 GDP growth of 3.5% to 4%, versus just under 3% for 2010. In 2011, the economy will derive more of its growth from revitalised consumer and business spending than from the inventory adjustments that were such an important part of 2010's results.
The lifting of many hiring bans and salary freezes at the turn of the year combined with a great holiday season and better sentiment could drive job growth of 200,000 to 300,000 people by the middle of 2011. This job growth rate combined with a modestly lower participation rate could drive unemployment under 9% by the middle of 2011.
I believe that continued growth in emerging markets, a stronger US economy, and rising commodity prices will drive inflation up by 2% or more, versus about 1% in 2010. A stronger U.S economy combined with modestly higher US interest rates in 2011 are also the backdrop for a stable to modestly stronger dollar, despite some legitimate questions about very liberal US fiscal and monetary policies. The stronger economy will also be responsible for higher interest rates in 2011, despite the Fed's best efforts to keep rates down.
It Is Not All a Bed of Roses, Either
You can count me as an unabashed bull on the economy, but we aren't without risks.
Europe has yet to come to grips with its long-term debt issues, although policymakers have put a major band-aid on short-term issues. China continues to grapple with inflation that is considerably higher than the government would like to see. That in turn continues to flame fears that China will take steps to slow growth in one of the economies that has been a major engine for the worldwide recovery.
Longer-term interest rates in the United States are sharply higher over the last couple of months, with the 10-year bond now almost a percentage point above its low this fall; it now stands at just under 3.4%. This won't do wonders for a housing market that, while struggling, seems to have hit bottom.
Merger Activity Indicates Businesses Are Refocused on Growth
Our equity sector teams are also becoming at least slightly more bullish about 2011 on a fundamental basis, though most teams believe their stocks are close to fairly valued today, with a lot of good news already priced into the shares.
In terms of fundamentals, there are a few common threads among the teams. First, merger-and-acquisition activity remains strong across every one of our sectors. There are a variety of drivers, but the root cause of most of the activity seems to be an attempt to accelerate growth. Whether or not these deals truly add value to shareholders remains an open question, but the good news is that corporations at least appear interested in growth again and not just surviving, as was the case a year or two ago.
Emerging Markets Aiding Worldwide Growth
Emerging markets are another common theme for both 2010 and 2011. Whether its factory capital equipment or fast food, emerging markets remain key growth areas as those countries boast growth rates that are two or three times higher than those found in developed economies. A growing middle class further cements the opportunity in these markets.
However, even a modest slowing of growth rates in China and elsewhere tends to move worldwide markets dramatically. Some of the worst days in the US stock market this year happened when China's hot economy had showed signs of slowing. Hopefully, a stronger US consumer will take some of the pressure off the fixation on growth in emerging markets.
