Is It Steady As She Goes In 2012?

The following Economic Overview is provided by Jack Kleinhenz, Ph.D.

As we transition into 2012, the calendar change provides an opportunity to reflect on the previous 365 days and an opportunity to look forward.   If we could reset the clock back a year, the same issues that we are facing are nearly the same – unemployment, monetary easing, inflation, the European crisis.  While one might conclude that we will tread water and possibly end 2012 as we began, it is unlikely. Our outlook is primarily built on its “steady as she goes” rather than an entire year of a “more of the same” theme.

As we certainly experienced in the 2011 financial markets very few things travel in straight lines. The issues will continue to create uncertainty and volatility but much will be decided in 2012.   Perhaps the most disruptive difference will be the presidential election in the U.S.  From that process, and because of the lack of legislative leadership, a deficit plan and fiscal reform will emerge.  The chipping away of unemployment and improving employment trends will continue. Oil prices are on another upturn, again due to global geopolitical tensions (Arab in Spring 2011 and now Iran).  We expect a European recession is already in play and will slow U.S. export growth and earnings. The Eurozone outcome is unknown but muddling though does not bring about resolution that has global implications.  Markets have little patience for the lack of decision making.  Europe and the U.S. must get their fiscal houses in order or the market will force them to do it.

As we enter 2012, the U.S. economy begins its eleventh consecutive quarter of growth. The economy is improving, but expected to only accelerate modestly for the year ahead (between 2 and 2.5%).  A key premise in our outlook is that consumers will continue to add to economic growth.   Consumers have been resilient and continue to make headway by strengthening their balance sheet and reducing debt burdens. The expected weak-to-moderate real GDP growth through 2012 implies only slow improvement in the labor market and will keep consumers in a cautious state.  The pressures of low income growth, consumer indebtedness, geopolitical uncertainties, a slowdown in developing world economies and political wrangling over domestic economic growth policies are expected to keep growth in check this year.

It is interesting that though consumers felt terrible during most of 2011 and their mood remained at recessionary levels as measured by confidence surveys, the pace of spending did not slow.    If confidence continues to firm and we continue to see financial balance sheet improvement along with expanding consumer credit,  we could expect upside strength on the consumer side.   However, a downside risk is that the jump in consumer credit may also signal the need by consumers to finance consumption as savings has dropped off and income growth remains weak.

Housing is a key part of the household balance sheet.  While most of the economic reports dealing with housing have shown a little more strength, these reports should be treated with caution. Some of the improvement is due in part to unseasonably mild weather. Home sales and home construction should improve slightly in 2012.  With low interest rates, affordability is at an almost 30 year high.   As total debt outstanding as a share of income has fallen, lower prices could create some traction but a broad based recovery is still a bit down the road.

The struggling labor market and weak household earnings growth have kept inflation relatively contained in 2011.  Oil prices pushed up inflation in early 2011, slowing U.S. economic activity to a snail’s pace. More recently, inflation has eased and is expected to be modest in 2012. The persistent unemployment and modest job growth are causing wage and earnings growth to be very subdued. On a year-to-year basis, December’s headline Consumer Price Index (all items) increased by 3.0%, but has moderated over the past few months due to lower energy and other commodity prices. The core index (less the volatile food and energy) increased greater-than-expected and accelerated year-to-year to 2.2% compared with 2.1% in October. The recent increases are sufficiently below the range before the Fed will become concerned and thus a positive in facilitating economic growth.

With modest growth and lower inflation, short-term rates should remain low while long term borrowing rates may begin to rise as investors seek opportunity and demand for credit improves.  Corporate profits benefit from continued gains in economic growth, modest increases in employment wages and benefits and stable interest rates. U.S. corporate health is sound and firms are flush with cash fortifying balance sheets and positioned for new opportunities.

The Northeast Ohio economy, struggling no differently than the nation, is similarly emerging from a very challenging recession.  Nevertheless, the region has experienced a steep loss in jobs and unemployment is expected to remain elevated.  The current turnaround, albeit a modest one, is no doubt due to the area’s diversified industrial base. Manufacturing activity has improved and expansion in capacity is “on the board” for many companies.  Location and cost of living remains attractive.  Unfavorable demographics are compounding the slow speed of economic activity, however.  Meager or declining population growth is expected for the area according to the 2010 Census.  Improvement noted above in the manufacturing outlook will provide meaningful production and employment but in the long run, growth in the region will underperform until newer industries in biomedical, fuel cells, instrumentation, controls and electronics and shale gas get broader traction. Service industries which dominate both the national and regional economies have yet to get employment traction out of the recent recession but are expected to experience growth in 2012.  Recent polls suggest Ohio Business Executives are optimistic about 2012.  Stronger labor market conditions at the national and regional levels are critically important for the regional economy to navigate forward.


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