January 5th, 2011 10:20 AM by Mel Samick
As per the western calendar, the Chinese New Year for 2011 is the "Year of the Metal Rabbit." The three words that best describe the rabbit: Calm and gentle, yet persistent. That's the trait many economists are hoping for insofar as the economic growth during the year 2011. Investor optimism is almost as much of a New Year's tradition as hangovers and resolutions. This January, like last, forecasters see the U.S. economy growing at a rate that is neither too hot nor too cold. However, due to a sudden pick-up in economic activity during the last quarter, overheating is the biggest worry for few investors and economists. Despite those fears, the vast majority of economists, market strategists and money managers say they see indicators pointing to a scenario of modest growth and low inflation in 2011. Stocks are at a two-year high, commodities are rising and bond yields are still very low by historic standards--all bolstering investors' normal start-of-the-year optimism. The consensus outlook for 2011 according to the majority of market pundits can be summarized with the following:
1. Equity markets will bounce after huge stimulus inflow
2. Emerging markets will gain a greater share of global GDP
3. Fixed income assets will feel pressure from inflation fears but less than many imagine
4. Euro and U.S. Dollar will be pressured by fiscal woes
5. Another credit crisis could hit Europe's bond markets
6. The Fed will not raise interest rates by any significant degree in 2011
7. Housing prices will remain stagnant
8. Consumers will continue to spend more than expected
Forecasters' predictions for the economy could range from overheated to cold. For many Americans, with unemployment hovering near 10%, it's hard to feel optimistic in the midst of the current recovery, but investors believe the economy has more to fear from growing too quickly rather than too slowly. While unlikely, if rates rise too much, or prices rise too much, it can potentially stall any nascent recovery process. The big concern at the dawn of 2010 was that the economy's budding comeback would take a nosedive--concerns that were borne out over the summer but were put to rest as the economy rebounded in the final months of the year with the help of the Federal Reserve. Investors may have gotten a taste this fall of faster than expected growth, when Treasury bonds suffered one of their worst sell-offs in decades, driving interest rates abruptly higher. Investors worried about the economy overheating this year say it will be far harder for the Fed to mount another rescue mission, which could lead to a spike in inflation and interest rates that could derail the recovery and market gains. Evidence of too-hot growth showed up in bond yields and commodity prices during 2010. Rather than falling as the Fed had hoped, bond yields surged in the fall, driving up financing costs for businesses and home buyers. Commodity prices jumped in 2010 too--Oil rose 15%, copper 33%, soybeans 34% and corn 52%.
So far those increases haven't shown up much in consumer prices, but prices could surge if companies grow confident that they can pass higher costs on to customers. Meanwhile, faster growth could force companies, which cut staff during the downturn, to hire in greater numbers. A tighter labor market, along with higher commodity prices, would start to drive wages higher, generating broader inflationary pressures--a dreaded wage-price spiral.
Opposite to overheating, fears that the economy will turn too cold, similar to the extreme icy weather in most of the northern hemisphere, are rooted in the idea that debt, particularly money owed by governments and consumers, is still too high to sustain growth. In this scenario, high debt levels leave lenders wary, drying up the credit needed to fuel the economy. If home prices, which started sliding again at the end of 2010, fall another 5% to 10% and unemployment figures remain stubbornly above 9%, bank profits would be depressed and sap consumer confidence. After a flurry of debt-fueled holiday spending, household debt was 122% of personal income at the end of 2010. According to this theory, that's still too high, and without faster income growth, consumers will have to stop spending and focus on paying off their credit cards or face defaults. A retreat by consumers would choke economic growth.
The most desired outlook by investors and economists alike is a "middle of the road" outcome. In this scenario, the U.S. economy keeps growing at a steady pace this year, but not enough to bring unemployment down quickly. With unemployment still high, broader inflation remains in check, despite higher commodity prices (No wage-price spiral concern). The Fed feels increasingly justified in keeping its cash stimulus wide open. Interest rates trickle higher, but not enough to choke off the recovery. The 10-Year Treasury yield remains range-bound and mildly reaches 3.5% by the end of 2011, still historically low. It's a healthy framework for the stock market. Growth would improve steadily enough to boost corporate revenues without requiring massive and expensive hiring. The dollar would weaken very slowly against other major currencies, creating support for U.S. exporters.
The problem with the "rabbits" is that they will not commit to any one right away. Dubbed "Dr. Doom" for his ultra bearish, almost apocalyptic, macroeconomic forecasts, Nouriel Roubini recently purchased a $5.5 million triple penthouse in a posh downtown Manhattan neighborhood. Roubini, who became famous for correctly anticipating the housing bubble, further predicted on December 6, that the U.S. "real estate market, for sure, is double-dipping. At least Roubini seems to be not committed to his forecast. Let's hope that the forecast for the year 2011 remains "No stormy skies or bright sunshine" to "sunny skies with occasional clouds." Information provided bt NYCB Caluital Markets.