Outlook and Market Review - First Quarter 2012

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The U. S. economy continues to muddle along as predicted in prior Outlooks. Annualized first quarter GDP growth was 2.2% in preliminary announcements by the Bureau of Economic Analysis, following a weak 1.7% growth for all of 2011. Over the entire “recovery” period starting in the third quarter of 2009, the economy has averaged only 2.4% growth. Two bright spots in the first quarter GDP report were consumer spending, with a healthy 2.9% annualized growth rate, and a 19.1% annualized growth in the housing sector. Both of these numbers were aided by a warm winter and may have bled spending away from normal spending patterns in the spring. The boost from consumers in the first quarter is likely to be temporary. Disposable income barely grew in the first quarter, forcing workers to save less in order to support spending. After three consecutive months of relatively strong job growth through January of 2012, employers added fewer workers in March and April while a continued slide in the worker participation rate made the unemployment rate look better than it really is. Even so, the unemployment rate is 8.1% as we enter into the third year of this recovery. If the work force participation rate had remained at the March 2012 level, April’s unemployment rate would have been 8.4%.

Slower growth in the first quarter reflected sharp cutbacks in government spending and weaker business investment. Nonresidential fixed investment, a measure of business spending on everything from plant and equipment to computers, fell for the first time in more than two years. Spending on equipment and software grew at its slowest pace since the recession ended. Massive monetary easing and fiscal stimulus spending in the early phases of this recovery have now run their course without a strong response from the private sector. A return to more normal government spending and efforts to reduce the deficit are now drags on growth that the private sector is struggling to overcome. Housing prices may have hit bottom in the first quarter, although a very flat bottom is more likely than a rebound. A potential QE 3 (quantitative easing three) by the Fed appeared to be off the table at the end of 2011 but the chances are improving as the economy continues to flounder in the face of less expansionary fiscal policy. In fact, the market’s rather muted response to poor first quarter economic performance may be linked in part to increased expectations of monetary easing.

GDP growth is likely to remain in the 2% to 2.5% range for the remainder of the year. The unemployment rate should pick up as the labor force participation rate increases to a normal level. Core U. S. inflation remains modest and weakness in global economies for the remainder of the year should prevent new price pressures. The debt crisis and spreading recessions in Europe will be an added drag on the U. S. economy and equity market. Even with high and growing debt, the demand for dollar denominated securities should remain strong given the more risky alternatives. Global demand for U. S. securities along with the Fed’s announced policies and low inflation should keep interest rates low for the remainder of 2012.