Consumers Can't Put Off Spending Forever
While our equity research teams largely still see a cautious and frugal consumer in 2010, most expect to see a more resilient consumer in 2011. Some of that optimism is based on the fact that consumers have delayed a lot of non-critical spending during the recession that they can no longer put off. Even our health-care team noticed a marked slowing in health-care spending this recession, as consumers deferred procedures. That same team is now seeing an improvement in the rate of even some elective surgeries. In the industrials arena, our auto analyst notes that it is becoming more and more difficult to put band-aids on older cars and that auto sales and production are more likely to perk up again in 2011.
Some Sectors Poised for Better Results with Improved Employment Data
The better employment data I am projecting should begin to help out the consumer, too. Consumer spending that is more directly related to employment has languished during this recovery. While sit-down, casual restaurants have shown some nice improvements, quick-service restaurants have suffered as the number of factory and office workers dashing out for lunch has failed to increase by much. Likewise poor employment has left fewer consumers with access to health insurance, putting a damper on health-care spending. Both should see an uptick as employment turns around.
Businesses Have Underinvested, Too
The severity of this recession and questions about the sustainability of the recovery had a huge negative effect on business investment spending. Our industrial team outlook highlights just how drastically business spending was cut this recession and has yet to make a full recovery. Based on typical ratios of spending to GDP, the team expects a substantial improvement in capital spending over the years ahead.
Likewise our technology team is seeing dramatic increases in business capital spending, especially for software. However, some of the team's enthusiasm is tempered by slowing government spending, especially in Europe.
High Valuations and Thirst for Growth Will Drive Business Investment and Employment
I surmise that businesses will be much more focused on growth in 2011. While far less prevalent than in 2009, cost-cutting and productivity were still very important earnings drivers in 2010. However, a lot of those easy cost savings are gone. Strong emerging markets are also likely to drive important commodity inputs upward in 2011, further pressuring margins. Therefore, to grow earnings in 2011 and beyond, many industries will need to seek improved revenue growth. At the type of valuation multiples placed on major publicly traded firms, investors aren't likely to sit patiently on their hands waiting for growth to slowly emerge. That is partly why we are seeing the boom in mergers and acquisitions. As the prices of the most likely acquisition candidates continue to move into nosebleed territory, I believe that increased corporate growth will have to be earned the hard way, through increased investment and increased employment in 2011.
US Construction Won't Boost 2011 Much; Off to the Races in 2012?
Our housing team continues to believe that housing starts will have a modest increase in 2011 to the 650,000 to 750,000 unit level. This is up from about 590,000 units in 2010 but well below the annual high of 2.2 million units and natural population-driven needs of about 1.5 million units. In my opinion, we will have a dramatic surge in housing construction over the next five years as production rates rise to match natural demand. However, given that employment data has only recently begun to get better and that lending standards and appraisals remain incredibly stringent, I don't think that 2011 will be the year of the housing boom.
Recovery Progresses Slowly and in Relatively Balanced Manner
As is typical, different sectors have driven the GDP growth each quarter of the five quarters that we have been in recovery mode. Consumer spending and dramatically slowing imports were big pluses for GDP before the recovery officially began in the third quarter of 2009. The first quarter of the official recovery was driven by consumer goods and exports. Then inventory restocking and business investment spending kicked in during later quarters, boosting GDP growth.
Looking back at the entirety of the recovery, a lot of the key categories have now made about equal contributions to the recovery, as indicated in the table below (for each time period, the two best categories are highlighted). Consumer spending, business spending (excluding structures), and inventories have made relatively equal contributions to GDP growth. Exports have been the real over-achiever. Those contemplating protectionist moves should consider the leading role that exports have played during this recovery. Construction, both residential and commercial, has been a small minus this recovery while government spending has been a very small positive.
Now the Consumer Takes the Lead
I suspect that fourth-quarter consumer expenditures, which have been building steadily throughout the recovery, will explode to the upside. Consumer spending that has been expanding at a 2% annualised rate for most of the recovery could grow as much as 4% in the fourth quarter based on strong monthly retail sales reports. Though things could back off some in the first quarter, the 2% reduction in payroll taxes will put more money in consumers' pockets that is highly likely to be spent, aiding consumer spending throughout 2011.
Debt May Not Be as Big an Issue as Some Surmise
A greater willingness for consumers to spend was the key reason that so many prior GDP forecasts of 1% growth or less for the second half were so off the mark. (Actual second-half 2010 growth is highly likely to exceed 3%.) Many pundits missed how damaging imports had been on second-quarter results and extrapolated that disastrous data for the rest of the year, failing to notice the steady-Eddie spending by many consumers.
Better consumer incomes and employment certainly didn't hurt, either. And while many analysts continue to fret about consumer debt levels, ratios of various fixed payments--including mortgages, car payments, rent payments, and credit card payments--dropped from 18.9% of income at its peak to 16.8% in the third quarter of 2010. In fact, that ratio is now below the average of the last 30 years and is back to levels last seen in the mid-1990s.
Putting It All Together, the Consumer Is King
Unlike 2010, the consumer will be the economic driver in 2011 as inventory growth slows dramatically. Business spending and exports will do their part, but they will not have as much influence as they did in 2010. Construction will provide little good or bad for the economy in 2011. Imports, which were so strong in 2010, remain a bit of a wildcard in my overall forecast.
