One of the key themes for investors in early 2011 is likely to be a shifting economic picture. For the stock market, things tend to be all or none. That is, either the economy is booming or it’s falling apart – there’s not much ground in the middle. Investors seem to struggle with moderate and uneven economic growth. The tax cut package has taken the double-dip recession scenario off the table, but the data for the next few months are likely to be mixed, suggesting strong growth in one set of figures and more moderate growth in another. That back and forth should create some opportunities for investors.

The housing sector will remain an important factor in the outlook. Some have suggested that we can’t have an economic recovery until we get a housing recovery (as would be suggested by historical patterns of recession). Nonsense. This is not a typical recession (which is usually generated by the Fed raising rates to control inflation). In a normal recession, households postpone purchases of autos and new homes. Once the economy starts to recover, the pent-up demand in homes and autos leads the way. That’s not going to happen this time.

 

 

Ultimately, a recovery in the housing sector will depend on jobs. We haven’t seen enough job growth to provide much of a rebound in housing. Job destruction has been relatively limited. New hiring is restrained, but appears to be picking up a bit. The recent rise in long-term interest rates has brought 30-year mortgage rates back to where they were in May – not terribly high, but the recent increase isn’t going to help. Not surprisingly, home prices fell after the expiration of the homebuyer tax credit. They should be stabilizing. If not, and they continue to head lower, housing problems are likely to get worse, as more homeowners will be underwater their mortgage. This has important implications for consumer spending growth. However, just because someone is underwater on their mortgage doesn’t mean that they’ll default. The more critical factor is a personal event, such as a loss of job or a divorce.

Gasoline prices are a major risk in the consumer spending outlook for 2011. Oil prices were mostly range bound in 2010, but have moved a bit above the high end of the range in recent weeks. Part of this is due to cold weather in North America and Europe. Oil futures, which give some indication of where market participants expect oil prices to be, suggest about $91 per barrel for the end of 2011 and for the end of 2012. The average price of gasoline, on a national level, is now a little over $3 per gallon. That’s a level that has caused some slowing in consumer spending in the past (post-Hurricane Katrina, and in the summers of 2006, 2007, and 2008).

 

 

Oil prices have risen a number of times over the last decade. However, in contrast to the inflationary episodes of the 1970s and early 1980s, oil price increases are now seen as more likely to dampen economic growth than to fuel a higher trend in underlying inflation. Oil prices (and gasoline prices) may back off in early 2011, but if they don’t, the consumer spending outlook would be more cautious.

Part of the federal fiscal stimulus was aid to the states. That support will go away in 2011, but budget strains will remain. Job losses at the state and local level are likely to be a small drag on overall growth in the near term.

For most U.S. investors, credit market concerns abroad are not a major worry, but they should be. The European debt crisis is far from over and will continue to make headlines in 2011. Federal Reserve officials have been concerned that credit disruptions there could have implications here – mostly through the availability of credit to households and businesses.

In short, investors should be optimistic, but not entirely comfortable, with the economic outlook for early 2011.

 

 

 

(c) Raymond James

www.raymondjames.com