2011 Q4 Review & Outlook: US Economy

Potential sources of an upside surprise include increased U.S. oil production, a sharper rebound in auto production and aircraft production (Boeing), and a stronger housing market.

Robert Johnson, CFA 14.02.2012
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After smoothing out bumpy GDP results, the economy is probably growing at about 2%.

Potential sources of an upside surprise include increased U.S. oil production, a sharper rebound in auto production and aircraft production (Boeing), and a stronger housing market.

Though corporations continue to remain cautious, consumers have continued to spend.

The U.S. economy grew in 2011, but at a slower rate than I had hoped when the year began. I had predicted that the economy might grow as fast as 3.0% to 4.0% when the year started, and it now looks as if the economy will turn in a more modest 2% or so growth rate on a fourth-quarter-to-fourth-quarter basis.


Even more surprising than the overall growth rate was the pattern of that growth rate throughout the year. Growth plunged to 0.4% in the first quarter and accelerated throughout the year with the fourth quarter now likely to produce annualized growth well in excess of 3%.


A combination of poor weather, a shocking jump in oil and gas prices due to political unrest in the Middle East, and supply-chain disruptions related to the Japanese tsunami all contributed to the pitiful level of economic growth in the first half. As those factors reversed themselves in the second half, economic growth spiked. When the first half and second half are combined, I think the overall 2% growth rate is more representative of the state of the U.S. economy than the first half doldrums or the second half spurt.


Although the overall GDP for 2011 was below my forecasts, given all the first-half shocks, followed by more severe sovereign debt issues in the second half, I am not that disappointed with the U.S. economic performance. I may have started the year too bullish, but I didn't cave into the chorus of economists who were overly focused on manufacturing data and calling for another recession late this summer. Instead I remained focused on the U.S. consumer, which continued to power ahead throughout 2011.


More Upsides Than Downsides (Though the Downside Is Scary)

My overall forecast for 2012 is for slightly higher growth than the consensus, but not by a lot. However, I think the odds of an upside surprise are substantially higher than a downside surprise. Potential sources of an upside surprise include increased U.S. oil production, a sharper rebound in auto production and aircraft production, and a stronger housing market.


Recent news seems to support each of these potentials. U.S. oil production is now growing again after years of decline, led by increased production in North Dakota and Texas and facilitated by higher prices and new technologies.


U.S. auto production is on the mend as consumers can't put off the purchase of a new automobile indefinitely. Further fueling U.S. auto production is news out of Honda that the company will produce substantially more cars in the U.S. in the years ahead, many of those for export from U.S. plants.


Finally, the housing market seems to be ambling its way out of the valley of death, too. Housing starts, housing permits, and builder sentiment have all been improving over the past several months. Inventories are approaching normal levels, and affordability is at a record high even as rents continue to go up in most markets. I'm not calling for a boom, mind you. But I think for once, housing is going to be a positive for the economy in 2012. I would be shocked if housing starts in 2012 aren't meaningfully ahead of those in 2011.


Corporations Are Scared Even as Consumers Accelerate Spending

Another potential positive is businesses' cautionary stance and low inventories even in the face of decent customer demand. It looks like U.S. corporate managers are far more scared about Europe and the economy in general than the U.S. consumer is. Recent reports out of Oracle and Accenture seem to suggest at least some precautionary spending cuts by corporations in the software arena. Managers also seem to be paring inventories to the bone, as inventories were a massive detractor to GDP growth in the third quarter, in anticipation of slowing consumer demand. Instead, it appears that U.S. consumers are accelerating spending as they seem to be "thrifted out" and can no longer delay certain purchases, especially autos. I believe this asymmetric world will resolve itself with the need for greater production both in the U.S. and in other world economies that export to the U.S. sometime in 2012. 


So, If U.S. Growth Were to Accelerate, Could Corporations Handle It?

Even as most economists worry about Europe, deleveraging, and slow economic growth, I am more worried that if the economy does begin to rebound in a bigger way, corporations may not easily meet the new demand. Closed plants, reduced labor forces, and rock-bottom inventories just don't leave much room for upside growth, if it were to occur. The Japanese auto industry has been rocked not once, but twice in one year by major supply-chain issues (the tsunami in Japan and the floods in Thailand six months later). Even the personal computer industry (and consequentially the semiconductor industry) has been shaken by the Thailand issue. The dangers of razor-thin inventories and sole-source, single-region agreements have been laid bare over the past year. Though I don't expect to see change overnight, I've got to believe that a major rethinking of supply-chain issues is going to occur over the next several years.


Europe Remains at the Top of the Worry List

Risks remain, however. Certainly the European sovereign debt crisis remains front and center in investors' minds. The issue isn't so much that a softening in European growth prospects and austerity could kill worldwide economic growth. Instead, the concern is related to the crisis's potential to wreck havoc on the worldwide financial system.


U.S. exports to Europe represent just 3% of U.S. GDP, and a lot of that is for basic necessities that can't be bought elsewhere. However, with a web of lending in which  European banks lend to sovereign governments, and those governments lend the money back to the undercapitalized banks, the failure of any one link could bring down a healthy chunk of the European banking system. The problem is, no one can see inside the relatively opaque balance sheets of European banks, so it is difficult for me or anyone else to provide a lot of reassurance to investors on this front. This type of opacity and cross-lending dependency turned a potentially minor recession in the U.S. into a near catastrophe for the world economy in 2008.


China Slowing Is an Issue for Some, but Potentially Good News for the U.S.

China certainly remains an issue, too, as growth there slows modestly and the construction industry pulls back from its break-neck pace. Slowing there is bad news for Europe, Australia, and perhaps Brazil, which are major exporters to China. It is also bad news for a lot of high-profile capital goods manufacturers in the U.S. But overall, China is an even smaller part of U.S. GDP than Europe. Furthermore, slowing growth in China could mean significantly lower commodity prices, especially in the U.S.--which would be good news for low-end U.S. consumers, who were particularly crippled by rising commodity prices in 2011.



Robert Johnson, CFA, is director of economic analysis with Morningstar.

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Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis with Morningstar.

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