Anthony Chan is a cautious optimist. He is optimistic that the equity markets will continue to improve in 2010. But he's cautious, too -- because the same level of improvement won't be felt on Main Street. Chan, chief economist for private wealth management at JPMorgan Chase, gave his outlook for 2010 at the 46th Annual Economic Forecast Luncheon, co-sponsored by the economics department at the W. P. Carey School of Business and JPMorgan Chase.
Tepid growth expectations
Since 1954, real GDP growth has averaged 5.8 percent in the first year of economic recovery. Yet according to Chan, the current economic recovery -- which began, by most accounts, in the third quarter of this year -- will be far more modest. He predicts a 2 or 2.5 percent real GDP growth rate over the next several quarters.
The tepid nature of this recovery, Chan said, owes in large part to far-lower consumer spending than is typical in economic recoveries. Chan expects to see consumer spending contribute no more than half or less its historical contribution towards overall real GDP growth. And that, he said, is because of record-high unemployment, credit markets that are still constrained, and a massive loss of household wealth.
High unemployment -- the current rate of 10.2 percent is the highest in 26 years -- holds the lion's share of responsibility for Chan's weak consumer spending forecast. Simply, consumers are afraid to spend when they have lost a job -- or are frightened that they may.
Tight credit markets play a big role as well, Chan said. Consumers can't borrow as much, which means they can't spend as much, he said.
Plus, consumers took a big hit in wealth, which fell $14 trillion from the peak to the bottom of the financial market collapse. It has recovered some, but consumers were still probably $8 trillion in the red in the third quarter, he said. That's significant, Chan said, because American consumers used rising asset values to substitute for real savings. Now, in order to save, they have to spend less.
And while Chan doesn't see the U.S. savings rate rising to the 55-year historical norm of 7 percent, he does see it increasing to 4 or 5 percent, up from 3.3 percent now (and 0.8 percent at its low) as American consumers make up for all of that lost wealth.
Government and business spending will bolster growth
Government spending on steroids, as Chan called it, has been counteracting weak consumer spending. Governments around the world bought themselves out of this global recession, he said. Stimulus spending, in other words, is working.
Yet Chan's enthusiasm is curbed by an understanding that government spending is not free. We won't face it in 2010, but in 2011 and 2012 the costs of the government's massive spending will come home, in the form of higher interest rates that will constrain growth, he said. But he doesn't see a high probability that this constrained growth in 2011 and 2012 will fall into a double dip recession. The administration will bend over backward to make sure that doesn't happen.
Another factor helping to bolster economic growth is business spending -- fixed investment and inventory accumulation. Intuitively, it makes sense that businesses wouldn't spend money on fixed investments (machinery, land, buildings, technology) when capacity utilization (how much of a business's productive capacity is actually used) is low.
Yet in actuality, when revenue growth is weak, businesses look for other ways to increase profitability -- like boosting profit margins and productivity through capital expenditures (including replacing obsolete equipment), Chan said.
Inventory accumulation, Chan said, has also shown positive signs, contributing 0.9 percent to GDP growth in the third quarter. One can easily make a compelling case for the view that inventories will add to growth over the next several calendar quarters.
Good news for Wall Street
In response to the worst financial crisis and economic recession since the Great Depression, companies cut back on labor and trimmed other costs wherever they could, just to survive. As the economy began to slowly grow again, those companies -- still running very lean -- were able to realize profits. Those company profits, in turn, helped spur a revival in the stock market, which is up 50 percent from March (though still down 30 percent from the peak).
Yet that good news on Wall Street hasn't translated to Main Street. That's because companies have not begun hiring again, even though they are seeing rising profits, Chan said. The hope is that there will be a hand-off -- that economic growth will continue to boost company profits and eventually companies will being hiring again, and the benefits of the recovery will filter to Main Street.
Chan sees some positive signs that such a hand-off is on the horizon -- leading indicators of employment growth. But, he said, If we're driving the kids in the mini-van, and they're asking 'are we there yet' on employment growth, the answer is 'no, we're not there yet, but we're headed in the right direction.'
Those leading indicators that the economy is headed toward employment growth include rising overtime in the manufacturing sector and an increase in temporary employment. But we need to see the length of the average work week pick up first, then we'll see increasing employment, Chan said.
He sees the unemployment rate falling to the high single-digits by the middle of 2010 and ending next year around 9 percent. With more positive economic growth and sequential improvements in profits, then companies will start to hire again.
Despite help from government and business spending, the budding economic recovery will be slow in the face of significant headwinds like the struggles on Main Street. It's not clear, Chan said, when the United States will return to normal levels of economic growth. I'm an optimist, he said. But a cautious one.
- The U.S. economy will grow at a modest rate of 2 or 2.5 percent over the next several quarters. It's not clear, Chan said, when the United States will return to normal levels of economic growth.
- Relatively muted economic growth is the result of weak consumer spending, which is caused by high unemployment, tight credit markets, and the loss of about $8 trillion in household wealth.
- Government spending on steroids has bought the country out of the recession. Yet that spending isn't free -- its costs will constrain growth in 2011 and 2012.
- Business spending -- fixed investment and inventory accumulation -- will also continue to bolster economic growth.
- Strong corporate profits spurred a revival in the stock market, which is up 50 percent from March (though still down 30 percent from the peak).
- The unemployment rate will fall to the high single-digits by the middle of 2010 and end next year around 9 percent.