Economic Outlook: The Case for Cautious Optimism

Wells Capital Management senior economist Gary Schlossberg gave his views on the economic outlook for 2013 today at a presentation to the Redwood City Chamber of Commerce. He began by cautioning that much depends on the outcome of the political posturing which is now taking place in Washington, D.C. Uncertainty surrounding the imminent “fiscal cliff” has weakened business investment spending despite improved consumer confidence. Although there is pent up demand for investment, businesses are waiting for clarity on taxes and economic policy.

Schlossberg expects the posturing to continue right up to the end of December, and suggests three possible scenarios:

• A breakdown in negotiations will bring us to the fiscal cliff which could result in a new recession. Politicians, however, will do what they can to mitigate the damage.
• Our leaders will “kick the can down the road” and push back the deadline with another delay.
• Politicians will work out a compromise. He noted the November elections have left Republicans in a weakened position of influence as they have far more to lose than Democrats. Polls show that Republicans will be blamed if negotiations break down and as a result any compromise on the economy will likely tilt in favor of Democratic policies.

These continue to be difficult times for the U. S. economy. We have been through a number of cycles where recovery was in sight, then put on hold. Japan’s tsunami, problems in the Euro Zone and now Hurricane Sandy have hit hard, and the fiscal cliff looms. We can expect employment and other economic numbers for the remainder of 2012 to be distorted by the impact of Sandy, but required reconstruction after the storm will lead to increased activity.

The bottom line prediction for short term U.S. economic growth is less than 2%. However, by spring of 2013 Schlossberg believes 2 ½ percent growth is possible. This is a threshold number for the economy to show real improvement. He bases his optimism on a number of “good news” indicators: 

• Fuel prices are down, which acts like a tax cut for U.S. households.
• There is increasing strength in housing and auto sales. Autos lift manufacturing production and housing acts as a boost to the overall economy. Although construction itself accounts for only 5% of the economy, the ability to sell a home and relocate is critical to the economy. Also, when home prices rise, the homeowner’s equity and return on investment goes up and helps to spark a recovery. Wells Fargo is already seeing an increase in home equity lines.
• Improving U.S. exports are generating growth. Although manufacturing jobs are not gaining much ground, productivity is making up the difference in manufacturing growth.
• There are early signs of recovery in Asia, with slowly increasing momentum expected in 2013.

Over the long term, we cannot expect explosive growth. The financial markets are still healing and we need to resolve these upheavals. We should worry about the increasing size of government in relation to the economy,  and the size of the federal deficit is also worrisome, although it has been coming down as the improved economy increases tax revenues. Job openings are growing for skilled labor, but the less skilled are still looking for work. The U.S. is on the leading edge of world economic growth with its innovation and entrepreneurship, access to financing and capital and the opportunities multinational companies have in emerging markets. Another factor to put into the mix is interest rates, which Schlossberg describes as artificially low due to the actions of the Treasury and Federal Reserve, and inconsistent with the outlook for inflation. We should expect more volatility in this area.

Schlossberg says although it is difficult to predict shocks to the economy, with pent up demand for business investment and if we can gain more clarity from Washington, if all goes well we should expect an improvement.