The bottom line message of the 2013 economic outlook forecast was strikingly similar from both Anthony Chan, chief economist for private wealth management at JPMorgan Chase & Co. and Beth Ann Bovino, deputy chief economist for Standard & Poor’s. Speaking at the 49th Annual Economic Forecast Luncheon, co-sponsored by the Department of Economics at Arizona State University’s W. P. Carey School of Business and JPMorgan Chase, Chan and Bovino’s message was this: the economy is waiting.
Hoarding cash, and waiting
Businesses are sitting on mountains of cash and record profits, waiting to see whether policymakers in Washington, D.C. will drive the economy off the fiscal cliff, or come to a tenable long-term solution, says Chan. As a percentage of tangible assets, corporate balances of cash and equivalents hit a high of almost 12 percent in 2010, and remain around 10 percent today. At the same time, corporate profits remain near record highs: as a percentage of GDP, after-tax corporate profits are at about 10 percent; the 50-year average is 6.2 percent. Anthony Chan's slides
Businesses are waiting in part because they want to maintain the freedom to survive the economic recession that Bovino and Chan agree would come if policymakers don’t arrive at an agreement on the so-called fiscal cliff. They’re also waiting because they’re uncertain, says Chan. They’re uncertain about what tax rates will be next year, how much they’ll have to spend on growth. So they’re waiting.
“They’re holding the cash until they feel that it would be a good deal to unleash it. If they don’t feel that unleashing it will generate significantly higher rates of return to justify not holding it, they’re not going to do so. In a world of uncertainty you have less of an incentive to unleash cash. The natural instinct for most corporations is to hoard cash when they’re not confident about getting a good rate of return on that cash,” Chan explains.
The fiscal cliff is a combination of expiring tax cuts and across-the-board government spending cuts scheduled to become effective January 1, 2013 if Congress doesn’t intervene. Because it is associated with uncertainty in a lot of areas, “as soon as [the fiscal cliff] get resolved businesses will start to unleash some of that tower of cash that they’re holding,” Chan says. “Some of that will go into hiring, some will go into increased business expenditures, and that will be in addition to the economic growth momentum that we badly need in 2013.”
The danger of the fiscal cliff
If policymakers fail to come to an agreement that avoids the fiscal cliff, it will likely drive the economy into recession. But both Chan and Bovino are optimistic that won’t happen. Bovino sees a 15-20 percent chance that the U.S. economy could go into recession next year, and that’s based largely on the risk that policymakers won’t come to an agreement. Beth Ann Bovino's slides
“Our base case has long been that Congress would reach a compromise on tackling the long-term federal debt before we go over the cliff,” Bovino explains. “But the detente that Congress reached could easily become a stalemate, in which case automatic spending cuts would kick in just as the Bush-era and payroll tax cuts expire, along with emergency insurance benefits. This would, in our view, plunge the U.S. back into recession and push unemployment back above 9 percent by the end of next year.”
Beyond the economic recession that would likely result if policymakers don’t reach an agreement, the fiscal cliff presents another danger, one that is already affecting the economy, says Bovino. “The uncertainty surrounding the fiscal cliff politics is holding us down like an anchor, keeping us from moving.” If that risk is dissipated by an agreement, Bovino expects a “really nice spring 2013 and into 2014.”
Just as failure to reach an agreement on the fiscal cliff could drive the economy into recession, a better- or sooner-than-expected agreement could jumpstart the economy. Says Bovino, “The fiscal cliff cuts both ways: While it could send the economy back into recession next year, a final credible resolution coming sooner than markets think could also give our economy the greatest chance of taking off.”
But Bovino doesn’t think a big economic uptick in 2013 is very likely; she sees a 15-20 percent chance of a quick economic turnaround. Most likely, Bovino says, the U.S. economy will continue its slow recovery process, growing at 2.3 percent in 2013. “For the past four years, every year the U.S. economy has healed a bit,” Bovino says. “Now we’re finally starting to see self-containing growth.”
The labor market is getting better -- slowly
Bovino sees hope in the job market which, like the economy as a whole, has been recovering slowly. “The Bureau of Labor Statistics’ report showed a headline figure of 171,000 new jobs in October -- much better than the 121,000 that consensus expected and the highest since July. It also comes after upward revisions for the prior two months added another 84,000 jobs to the workforce,” Bovino explains.
The unemployment rate increased in October to 7.9 percent from 7.8 percent in September, but “for the right reasons,” Bovino says. “It was a result of both more people joining the workforce and more people getting jobs.” As more people start rejoining the workforce, their job searches will once again be counted in the statistics, keeping the unemployment rate high for some time, explains Bovino.
Uncertainty and indecision -- and great buys
Where many observers see lemons, Chan sees a tall glass of lemonade. “Equities are, relatively speaking, pretty cheap in terms of their valuations, when you look at price-to-earnings (P/E) ratios today relative to the past. As conditions improve, P/E multiples over the next several years should expand, and that should be positive for equities,” says Chan.
“Price-to-earnings ratios are a measure of investor sentiment -- the more confident you are about the future, the more likely you are to push up P/E ratios. What we’ve seen is that as consumers become more optimistic about the future, investors interpret that as a sign that economic growth momentum will be more positive -- that it’s safe to get back in the water again with regard to stocks. P/E multiples tend to go up in that kind of an environment,” Chan explains.
In particular, Chan sees opportunity in emerging markets. “If you look over the last decade, more than 70 percent of global growth has come out of emerging markets. So if you’re an investor you’ve got to have emerging markets in your portfolio because that’s where the growth is.”
Chan explains three factors that make investing in emerging markets “exciting.” First, he says, “Investing in emerging market currencies is interesting and exciting because when the USD weakens, it usually means that other currencies are getting stronger. And of course if relative interest rates in a given part of the world are higher, that also is supportive of currency appreciation.”
Second, “The growth rates of some of these emerging market economies are higher than they are in the U.S., which introduces opportunities to invest.” Third, “the relative budget positions of a lot of these emerging market countries are more balanced and healthier than the U.S.’ -- these countries have lower debt and deficits. So investing in emerging market debt at the sovereign level and even to some extent at the corporate level is also very exciting.”
Housing market is a bright spot, finally
Bovino counts the housing market as one of the drivers of the more “self-sustaining” economic growth she expects in 2013. “Evidence of a housing rebound continues to build. Housing starts are now up 45 percent over last September -- the largest single month since July 2008. The bounce in housing permits to a four-year high of 812,000 units in July suggests that business will be booming over the next few months,” Bovino explains.
“They’re building for a reason. Demand has picked up, resulting in lower inventory. Existing home sales are now near summer 2009 tax credit-supported levels, which helped reduce the inventory of unsold homes. New home sales have also climbed, by 27 percent since last September, and inventories are at a 49-year record low. It now only takes 5.9 months to clear the supply of existing homes on the market and just 4.5 months to eliminate the supply of unsold new homes. Home sales and construction on new units are still well below historical averages, and prices appear to have hit bottom only recently, but data indicate that housing will finally contribute to growth this year, after weighing on the economy for the past six years,” Bovino says.
Finally, Bovino says, housing will contribute to economic recovery, and that will have many positive “knock-on effects.” She explains, “There is a huge knock-on effect from an improving housing market. When housing demand picks up, homes need to be built. That helps jobs in the construction industry. Plus, with a new home, you need new furniture, new electronics and other appliances -- and more jobs are created in the retail sector. An improving housing market also helps financial markets as more mortgages are made. And even if people aren’t buying a home, when the home they own appreciates, they feel richer, and they feel more comfortable spending a bit more.”
- “The uncertainty surrounding the fiscal cliff politics is holding us down like an anchor, keeping us from moving,” says Beth Ann Bovino, deputy chief economist for Standard & Poor’s. If that risk is dissipated by an agreement, Bovino expects a “really nice spring 2013 and into 2014.”
- Most likely, Bovino says, the U.S. economy will continue its slow recovery process, growing at 2.3 percent in 2013. “For the past four years, every year the U.S. economy has healed a bit,” Bovino says. “Now we’re finally starting to see self-containing growth.”
- According to Anthony Chan, chief economist for private wealth management at JPMorgan Chase & Co., “Equities are, relatively speaking, pretty cheap in terms of their valuations, when you look at price-to-earnings (P/E) ratios today relative to the past. As conditions improve, P/E multiples over the next several years should expand, and that should be positive for equities.”
- In particular, Chan sees opportunity in emerging markets. “If you look over the last decade, more than 70 percent of global growth has come out of emerging markets. So if you’re an investor you’ve got to have emerging markets in your portfolio because that’s where the growth is.”
- Bovino counts the housing market as one of the drivers of the more “self-sustaining” economic growth she expects in 2013. “Data indicate that housing will finally contribute to growth this year, after weighing on the economy for the past six years.”