Is a Financial Aftershock Headed Our Way?
The debt crisis that has rocked Greece and much of Europe is a wake-up call for policymakers and investors not only overseas but also in the US.
The warning that should not be ignored: Nations can’t keep spending more than they take in without suffering painful consequences — to economies and investors. If they do, their government debt gets downgraded and the cost of financing that debt soars. Policymakers often wait until it’s too late to head off a crisis.
Despite a $1 trillion rescue package for Greece from the European Union and the International Monetary Fund, the current crisis has shaken global markets. And it is likely to hurt economies around the globe for months and even years as many debt-ridden European countries are forced to adopt austerity programs or face financial instability.
As debt-burdened European economies remain sluggish, US export sales to Europe will be anemic, especially at a time when the rising value of the US dollar in relation to the euro has made those exports much less of a bargain. That is a big negative because much of the recent growth fueling a solid recovery in the US economy has come from overseas sales of manufactured goods, and Europe accounts for 20% of US exports.
Compounding the problem is that export sales also could slow to Asia, a big customer for US goods — but for different reasons. China’s economy has been booming, with that nation’s gross domestic product (GDP) growing at a nearly 12% rate in the first quarter of 2010. Now Chinese policymakers are trying to dampen inflation by cooling down the red-hot economy and by reducing credit to businesses and individuals to limit borrowing. As a result, demand in China — the third-largest economy in the world — for exports from other countries will likely decline. With export sales to Europe and Asia softening, US economic growth will be muted. After growing by 5.6% in the fourth quarter of 2009, GDP is slipping this year to a growth rate of near 3% for 2010 and less in 2011. That is much weaker than the typical growth rate that followed most earlier recessions.
With the economy growing slowly, employment will pick up only slightly. The US will add about 150,000 jobs a month this year, not including census workers. That is an improvement from last year when jobs were vanishing and the unemployment rate rose above 10%. But the growth in jobs will barely be fast enough to absorb the new people who are constantly entering the workforce. As a result, the unemployment rate will decline only gradually, dropping from the recent figure of 9.9% down to 9.5% by the end of this year and slightly below 9% in 2011.
To appreciate how weak the US job market will remain, it is important to consider the underemployment rate, which is currently near 17%. In addition to the unemployed, the underemployment rate includes those who are forced to work part-time or who have stopped looking for work, possibly because of frustration and pessimism. At best, the underemployment rate might drop to 14% in 2011, still about double the rate of two years ago.
Faced with unemployment and the fear of unemployment, consumers will be wary of spending. Sales of cars and homes will remain weak. Consumer spending will continue growing at a sluggish rate, well below the historical trend of 3.5%.
One bright spot will be corporate profits. Earnings of companies in the Standard & Poor’s 500 stock index likely will climb at a spectacular rate of 25% this year and a solid 10% to 15% in early 2011, before slowing later in 2011 and 2012. The gains are partly due to the growing US economy, which is pushing up corporate sales. In addition, companies have been aggressively fattening their bottom lines by cutting costs dramatically.
The strong earnings growth will provide some support for the stock market. But the risks to profits emanating from the European crisis and the Asian slowdown create conditions for stock market setbacks, including a substantial “correction” in the US and abroad that could take the S&P 500 to 1,000 or below, where it hasn’t been since September 2009. Later this year, I expect the S&P 500 to climb back up to around 1,200, a gain of perhaps 7.6% for 2010 and about even with this year’s highest closing price so far of 1,217 on April 23. By mid-2011, I expect the S&P 500 to rise to about 1,350.
Savers, who have grown weary of minuscule yields on money-market funds, should get some relief when the Federal Reserve starts raising short-term interest rates, probably in 2011 rather than this year. Rates on 10-year Treasury securities likely will climb from the recent level of 3.3% to around 4% in 2011. These rates still will be far too low to lure investors away from stocks and materially weaken the stock market. Complicating the outlook for the global economy, European nations will be forced to pay higher interest rates on their debt as investors see greater risk in their bonds, especially if nations such as Portugal, Spain and Italy are forced to seek rescue packages similar to that of Greece.
For the long run, stock investors should give extra weight to information technology companies, including producers of computer hardware and software. These companies are continuing to report strong sales in the US and abroad. Also consider companies that sell consumer staples, such as food and beverages. Those reliable performers are likely to enjoy steadily growing sales.
With the US and Europe growing only slowly and financial markets in disarray, for the long run investors should focus more than they usually do on Asian stocks and mutual funds, even with China’s attempts to slow growth. Having avoided most of the problems of the credit crisis, Asia should come out of this in relatively good shape.