Slowing Economic Growth Not Unusual

By Paul Single, City National Asset Management. City National Bank is a member of NorCalPROS as well as the Los Angeles, San Diego, and Orange County chapters of SoCalPROS.

The current economic expansion began about a year ago and, by most accounts, is still under way, although some sectors are moving ahead more rapidly than others. Aggressive monetary and fiscal stimuli, as well as costly government initiatives aimed at stabilizing the financial system, have all played important roles in guiding the economy out of the Great Recession. However, the economy has now entered a new phase, one that hopefully will take it past the stimulus-based expansion of the second half of 2009 typified by programs such as cash for clunkers and the homebuyer tax credit and into a period driven more by consumption and trade. It’s not there yet – economic growth has not reached the point where it is healthy and fully self-sustaining. This is not unusual as studies of past recessions show that cyclical downturns accompanied by financial crises tend to be far more severe and last much longer than most reces-sions. Recoveries from these types of recessions are also far more gradual, since the restoration of banking, business, and household balance sheets takes a long time.

Two economic drivers that usually aid in a “normal” recovery are an increase in consumer spending and an upturn in housing construction. Unfortunately, because this recession was so entwined with the housing bust and high levels of consumer debt, these two drivers are not helping this recovery to take hold. Consumption typically rebounds in a recovery due to rising consumer confidence, pent-up demand, and easier access to credit. (see fig.1) However, because the current high unemployment rate is restraining consumer confidence at the same time that households are focused on reducing debt, final demand in the consumer sector is not nearly as strong as that seen in prior recoveries.

FACTORS IN THE SLOW RECOVERY

Easier access to credit and lower housing prices generally result in increased demand for new and existing homes, which in turn creates jobs in the construction sector as well as related fields such as home furnishings, title insurance, mortgage lending, etc. But because lenders were burned badly during the recent recession, they are not turning on the credit spigot generously. In addition, the supply of existing homes for sale is so large that it is simply overwhelming demand and keeping a lid on housing prices. Stagnant prices, coupled with ongoing foreclosures and defaults, are also keeping consumer confidence from rebounding as it has in previous recoveries. (see fig.2)

These and other factors mean that the economy remains susceptible to developments that could hamper the tentative recovery we are currently experiencing. Some of these developments are:

• The federal fiscal stimulus program that was enacted as part of the 2009 Recovery Act is beginning to wind down.
• The Bush administration tax cuts are scheduled to expire for many taxpayers at the end of this year, meaning less disposable income.
• State and local governments are responding to severe budget shortfalls by cutting programs and laying off employees.
• Comprehensive reform in the healthcare sector, along with the possibility of similar fundamental changes in the financial services industry, has muddied the outlook for companies as they consider capital spending and new hiring.
• The sovereign debt crisis in Europe has led to government austerity programs that are being interpreted as restraints on economic growth in the Eurozone, with follow-on effects elsewhere.
• The Gulf of Mexico oil spill, in addition to its unknown economic impact, has created new uncertainties in the energy sector in terms of possible regulatory restrictions.

POSITIVE SIGNS FROM MANY INDICATORS

While all of these issues make for good headlines and TV chatter, they are unlikely to derail the recovery, primarily because a number of important economic indicators are sending positive signals. Among them:

Employment is growing. Although the upward trajectory is not as great as many may hope for, it is moving in the right direction. Payrolls have increased 882,000 in 2010, compared with a decline of 3.7 million in the first six months of last year.

Inflation remains very low. The increase in Core CPI has been just 0.9% over the past year. Most importantly, inflation expectations are stable. This provides the Fed with more lati¬tude to keep short-term interest rates low for a longer time.

Credit conditions are improving. Businesses, households, and banks have better access to capital than they did a year ago, which serves to facilitate economic expansion.

Manufacturing continues to be the driving force in this recovery; it has expanded for eleven consecutive months.

Interest Rates are at, or near, record lows. The Federal Reserve Bank has reaffirmed that interest rates will remain “excep¬tionally low” for “an extended period.”

Recent economic reports have shown a softening in economic growth. However, as noted above, this is not unexpected. Economic recoveries, particularly those following a brutal recession, do not proceed in a straight line. Although the phrase is much in the news, we see no credible evidence at this point that a “double dip” is in the works. In our last Quarterly Update, we stated: “None of this is to say that the path to full recovery is clear and unobstructed. On the contrary, we fully expect potholes and stumbling blocks along the way.” This past quarter has been one of those stumbling blocks. As always, we will continue to monitor conditions carefully.