You need to listen to CNBC more often.
The Morgan Stanley economic forecast for the U.S. is that real gross domestic product growth averages about 2% over the next two years. The economy expands, but growth is held down by the unfinished business left from the financial crisis: continued dislocations in the mortgage market and the need to delever in the private and public sectors.
With real growth at only about the rate of the economy's potential to produce, the unemployment rate will trend sideways, and inflation will edge lower.
Economic data are volatile and subject to the influence of special factors. Sometimes growth will turn out on the high side, as in the fourth quarter of 2011, and sometime low, as earlier that year. Of late, a dip in the saving rate, a swing in inventories, and some impetus from net exports pushed up the growth of real GDP to 2.75% in the fourth quarter. The fundamental story, though, is that we think real growth is trapped in a channel centered at 2%.
Investors we talk to push back for two reasons.
First, they tell us not to bet against the resilience of the American economy. We agree. Households are itching to spend. Nonfinancial firms have an enormous pile of cash on their balance sheets. New home construction has shrunk to the point where it no longer poses a meaningful drag on growth. However, as much as households want to spend, they are constrained by their balance sheets, which have not benefited from wealth creation in recent years. Firms can fund spending, but they have to have a reasonable expectation of an increase in final sales to have a reason to spend. A shrinking construction sector may no longer be a drag on overall growth, but home prices are still dropping, terms and standards on mortgage lending are tight, and there are still too many vacant homes.
Every time our optimism flutters up from there, a quick reflection on politics shoots it down. The Congress only nailed down payroll tax withholdings and unemployment benefits for the first two months of this year. We are likely soon to see a replay of the partisanship that marked year end, to the detriment of investor confidence. And then we enter election season. In Europe, officials have to cope with an unfolding sovereign and banking crisis.
Second, more than a few optimists tell us that incoming data, while not individually conclusive, collectively point to a breakout of the upper end of the channel. But anyone predisposed to believe that growth will pick up is more likely to have an inflated assessment of current growth. This likely holds true at several levels.
First, the respondents to qualitative surveys, such as purchasing managers reporting on new orders or households indicating their confidence, are influenced by their sense of trend. This is probably why many political scientists hold that it is the change in the unemployment rate, not the level, that helps to gauge the electoral prospects of incumbents. Second, forecasters and analysts are likely to pick among the forest of economic data those indicators more supportive of their view. Simply, the stories we tell ourselves to control the flood of data shape our perception of the data.
Our advice is to be the tortoise, not the hare. The world is a risky place right now. Fundamentals are consistent with a continued advance of economic growth. But, in our view, expansion will be tepid. Slow down and you are likely to realize this.
-- Vincent Reinhart
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