The U.S. economic recovery has been heading upward, but high unemployment and rising energy prices will weigh heavily on consumers and slow U.S. growth.
Many economists don't think the U.S. economy will maintain the 3.1% growth rate it established in 2010's fourth quarter. The International Monetary Fund (IMF) says that while global growth this year will continue at a rate of 4.8%, advanced regions like the United States will grow at a slower rate than emerging economies.
The IMF lowered its 2011 U.S. outlook to 2.8% from 3%, citing a weak real estate market and a high jobless rate as the biggest factors.
Continued recovery will depend on how well the U.S. economy copes with these headwinds. It also depends on how much inflation takes hold and how much liquidity the U.S. Federal Reserve pumps into the economy.
"My view is that the gloom about the first quarter GDP currently is overdone, and I expect a 3% plus figure when that's announced April 29," said Money MorningContributing Editor Martin Hutchinson. "However, I expect that to be the best quarter of the recovery and expect GDP growth to be lower in the second and third quarters and possibly mildly negative in the fourth. Whether the fourth quarter minus is a blip or a new recession, I'm not sure."
Slowing Signs of Improvement
Manufacturing data and retail sales results show that while the U.S. economic recovery continues, its pace has slowed.
The Institute of Supply Management reported the U.S. manufacturing sector has expanded for 20 straight months, although growth rates are more modest than they were a year ago. Analysts expect manufacturers to spend money on mergers and acquisitions this year to try and kick-start the next stage of growth.
Retail sales increased for the ninth consecutive month in March, but only rose 0.4% after a 1.1% jump in February. The 0.4% gain was the smallest in the nine-month streak, and below economists' expectations of 0.5%.
"The apparent retreat of consumers in the face of higher prices illustrates that the household sector is in no fit shape to take the overall economic recovery to a higher level," Paul Dales, senior U.S. economist at Capital Economics, told The Financial Times.
Higher oil prices also weakened U.S. consumer confidence, which fell to a three-month low in March. The Confidence Board's measure of consumer sentiment fell to a reading of 63.4 from 72 in February.
"Consumers' inflation expectations rose significantly in March and their income expectations soured, a combination that will likely impact spending decisions," Lynn Franco, director of the Conference Board's consumer research center, told Bloomberg News.
Consumer spending accounts for 70% of U.S. economic activity, so strong retail sales numbers are needed to support an economic recovery. But higher prices and disappointing incomes will keep consumer spending from soaring to new highs.
The Heavy Unemployment Burden
Unemployment in March fell to 8.8%, a two-year low, but is still moving at a disappointing pace.
The economy added 216,000 jobs in March, but federal and state governments are still laying off their workers. Additionally, many of the new jobs are in government-subsidized services or temporary services – not the more sustainable permanent, non-government-subsidized positions.
The labor market shed 8.5 million jobs in 2008 and 2009, and has added just under 1.5 million since then. To lower the unemployment rate to a more manageable 6% over the next three years, at least 360,000 jobs have to be added each month.
About one-third of the decline in the unemployment rate since October 2009 is due to those who dropped out of the workforce and stopped job hunting. About half of the unemployed have been jobless for six months or more, and many more are considered underemployed.
The Organization for Economic Development (OECD) said in a report Wednesday that the "unusually high share of long-term unemployment" is a "striking feature" of the U.S. unemployment situation.
"Such developments raise concerns about future persistence of unemployment," the OECD report said.
The stubbornly high unemployment rate also is limiting the number of eligible homebuyers and keeping a lid on the housing market recovery. A weak housing market suppresses construction hiring and stifles spending on home furnishings, appliances and home improvements.
The unemployment rate could improve if cash-rich U.S. companies start using their healthy balance sheets to invest in hiring. Since the credit crisis, U.S. companies had collected about $940 billion in cash by the end of the first quarter. But a recent report by Bank of America Merrill Lynch said that inventory rebuilding, low borrowing costs and tax breaks for equipment buying are encouraging companies to spend, not hire.
"Machines have the upper hand," Neil Dutta, the economist who wrote the report, told Bloomberg News. "You see this huge pickup in capital spending, but there isn't a meaningful increase in employment; it's being grudgingly pulled along. The consumer is not going to perform the way people expect."
Pain at the Pump
Another reason consumers could turn in a lackluster performance this year is rising energy prices.
Oil prices are up about 30% in the past year. After hitting $113.46 a barrel last Friday, they hovered around $106 a barrel this week.
Strong demand in emerging markets, a weak dollar, political turmoil in the Middle East and North Africa (MENA) region, and a strong speculative sentiment will continue to push oil prices higher. In fact, oil prices could reach $150 by midsummer and $200 by the end of the year.
More expensive crude prices pushed the average U.S. price for a gallon of gasoline to $3.81 this week, up from $3.54 in March and $3.18 in February. Gas prices will likely hit $4.00 a gallon this summer.
The rapid increases are creating cost-conscious consumers who could be scared out of spending.
"Whenever we pay more for gas, dollars leave this country to pay for imported oil," Peter Morici, an economist at the University of Maryland, told NPR. "That's money that could be spent on U.S. products, and in turn, it slows demand, slows growth and slows jobs creation."
Some say the rising fuel costs could be enough to trigger the unsteady U.S. economy into another recession.
"I can't predict recessions better than anyone else," said Morici. "But I do know that rising gasoline prices in a country that imports 10 million barrels a day is very detrimental to economic growth and can seriously threaten the recovery."
Worse, if higher oil prices translate to core inflation, the U.S. consumer will have to deal with across-the-board price hikes for consumer goods, which will further rein in household spending.
The Great Inflation Debate
The consumer price index (CPI) in March rose 2.7%, the largest increase since December 2009. That increase was in no small part driven by higher food and energy prices, as the energy index jumped 15.5% and the gasoline index rose a staggering 27.5%.
The so-called "core" CPI, which excludes food and energy, rose just 1.2% in March from the year prior.
Still, it's the core CPI that the U.S. Federal Reserve uses as a basis for policy decisions.
U.S. Federal Reserve Chairman Ben S. Bernanke has maintained that U.S. inflationary concerns are overdone, and low wages will keep rising prices at bay. However, many analysts disagree with that view.
"I expect inflation to take off, in which case the Fed will need to do something severe about it, which could cause a recession," said Money Morning's Hutchinson. "However, if inflation rises only gently and interest rates are increased only slowly maybe we can avoid that."
Some of Bernanke's colleagues have started expressing more hawkish rhetoric, as well.
Federal Reserve Bank of Dallas President Richard Fisher this week said that rising oil prices were a major concern to U.S. growth.
"It is a double whammy," Fisher said. "[I]t slows down our economy" while it "adds to inflationary pressures. It adds to the volatility of the financial system."
Fisher has criticized the Fed's easy money policies and said it's time to start tightening policies.
"There is a lot of liquidity in the system," he said. "[N]o further amount of monetary accommodation would be wise."
The latest round of quantitative easing measures will expire in June, and many wonder if there will be another to follow. Fisher said the Fed likely will discuss "curtailing" accommodative policies at its next meeting on April 26.
Even if the exact path of inflation and economic recovery remains uncertain, there are investments that will give investors the best protection against a rocky recovery.
Investors should consider holding about 10% of their portfolio in precious metals, for instance.
With gold hitting record highs near $1,500 an ounce, silver is a cheaper alternative with a bullish outlook.
"I like the Sprott Physical Silver Trust (NYSEArca: PSLV)," said Money Morning Contributing Editor Peter Krauth. "The silver is stored on a fully allocated basis at the Royal Canadian Mint, which is responsible for the silver in its custody (no financial institutions in the mix)."
Analysts warn that although silver is a good play for now, a change in U.S. economic policy could serve as a signal to sell.
"If/when Bernanke raises interest rates, get out — silver's a low-interest-rate/inflation play, primarily," Hutchinson said.
To prepare for when interest rates do rise, Money Morning Contributing Editor Shah Gilani recommends the ProShares Ultrashort 20+ Year Treasury ETF (NYSE: TBT).
"This is a 'leveraged ETF' whose share price goes higher when interest rates increase, and goes lower when interest rates fall," said Gilani.
Finally, Suncor Energy Inc. (NYSE: SU) offers a way to play rising oil prices.
Suncor has refineries, wholly owned pipelines and specialty lubricant products. It sells gasoline in retail locations in Canada under the Petro-Canada brand and in the United States under the Phillips 66 and Shell brands. But most importantly, it boasts strong and reliable crude oil production from its oil sands operations in Canada.
"Of the Canadian oil plays, I most like Suncor because of its position as the most important producer of tar sands oil," said Hutchinson. "This is only modestly profitable at current oil prices, but if prices run up or a global crisis restricts supplies, Suncor can be expected to increase hugely in profitability.
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