Economic Outlook and How to Invest and Prepare For the Year Ahead

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So what will the year ahead look like for the US and global economy? Last year was a year of recovery, but it was sputtering and many questioned whether the recovery was real and if it could be sustained. As we head in to 2011 things are looking brighter following a booming stock market (up 13%), a new Tax Stimulus package, and housing markets stabilizing around the country.  But the one major area of concern is still unemployment, which is staying stubbornly high around 10% despite improving corporate and small business profits. With all these factors in mind, here’s what to expect for the year ahead and what you can do to leverage the forecasted trends.

Economic Growth: U.S. gross domestic product expanded 2.8 percent, confirming views that the US economy is on the mend. The 2011 tax-cut stimulus bill will pump another $858 billion into an economy that’s already starting to turn the corner, raising the prospects for decent growth in 2011 and 2012 – 3% on average according to forecasters. Consumer spending, a key driver of economic growth, accelerated to above 3 percent in the last two quarters of 2010. Economists are forecasting that it could accelerate up to 4 percent in 2011 on back of the strongest holiday season since 2005 and increasing consumer confidence.

Stock market: 2010 was a good year for the equity markets and 2011 looks to be just as good as the economy continues to improve. According to a Bloomberg survey of 11 stock analysts American equities will rise 11% on average, with many leading forecasters predicting returns above 15%. Equities will be further boosted by the growing number of mergers, acquisitions and stock buy-backs as companies seek to use their record cash stockpiles. All these factors and growing optimism make being invested in the market a must for short and long term investors.

Housing: The housing outlook for next year calls for a slow recovery as the national market continues to clear out inventory driven by the large number of home foreclosures. Some areas where unemployment is lower than the national average, like cities in the North East and North West, could even see home price rises in the summer of 2011. But with expiry of the home buyer credit and the prospect of more foreclosures, home prices are likely stay mostly flat in the year ahead. The good news is for existing home owners though, with interest rates at record lows, is that refinancing provides an easy way to lower their monthly payments and put that extra cash into their 401K or equity accounts.

US dollar: The once mighty US dollar has lost a lot of its sheen and perceived superiority over the last few years due to various government and Federal Reserve actions.  Unless there is geo-political uncertainty or a serious slump in global economic growth, the US dollar is likely going to continue its slow downward trajectory against most major currencies.  However the good news with a weaker US dollar is that our exporters and multi-national companies should benefit from foreign earnings, confirming views that the stock of these sort of companies are likely to do really well in 2011.

Inflation and Interest Rates: Despite scare mongering from the gold bugs out there and Federal Reserve’s quantitative easing actions (akin to printing money) inflation seems to be a problem for the future and should not really be a factor in 2011, or even 2012. However longer term inflation is a real issue and you should look to keep a small part of your portfolio in TIPS and/or Gold.

Interest rates will likely rise in 2011 after touching all time lows this year and sparking many mini re-finance booms in 2010. Interest rate rises will be driven by growing private-sector borrowing and an expectation of a slowdown in the Federal Reserve’s quantitative easing actions. But interest rates, like inflation, probably won’t rise till later in 2011. Still, if you have good credit and a stable job, refinancing in 2011 may be a good idea if rates are expected to go up.

Stimulus and Tax Breaks: President Obama;s recently approved $858 tax package will build on the existing 2008 stimulus package to further pump up the economy in 2011 and 2012. Economists are predicting the new stimulus will add between 0.2 to 0.5% to GDP, driving the expected 3% growth next year. This alone won’t be enough to turn the unemployment situation around, but should create a base for solid growth between 2012 and 2015.

Employment: With 3% growth, the unemployment rate should start to fall in 2011. But don’t expect it to fall fast. For one thing, there are a lot of discouraged workers who aren’t even looking for jobs anymore and, therefore, don’t show up in today’s unemployment statistics. But once growth starts to rise, they may re-enter the labor force, slowing any decline in joblessness.

And then there are those pesky interest rates mentioned above. As they rise, they could act like the governor on an old-fashioned steam engine, choking off growth just as it gets going. The result could be a long period – maybe years – of sub-par growth and uncomfortably high unemployment rates.

National Debt:  With all the stimulus payments and quantitative easing measures it is clear that the government is determined to do anything in its power to sustain and foster economic growth. However the cost of all these measures are borne by tax payers and adds to our growing national debt, which is already at record levels.  The debt reduction commission has put forward a number of tough measures for Congress to take to tackle the national debt, but with a fragile economy and 2012 presidential election ahead, it is unlikely that Congress and the administration will take any serious measures to cut debt levels.

2011 will be another year of change, but there is more reason to be optimistic than pessimistic. Good luck and here’s to a happy and prosperous year ahead.

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{ 3 comments… read them below or add one }

Ralph January 17, 2011 at 3:26 pm

Good post exploring some ways one could look at investments in 2011. I think 2011 could possibly be “another year of change.”

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Frank January 1, 2011 at 9:34 pm

With unemployment stubbornly high, housing still in the dumps, the luckiest of the middle-class household incomes in a holding pattern, lending institutions difficult to find, borrowing a dirty word, and the nation’s safety nets under attack, the days of the spendthrift USA consumer are gone for a few years yet. There will be blips of increasing economic activity as people succumb to replacement needs but look out thereafter. The days of easy credit and home equity loans are behind.

The S&P will not see a new all-time high for at least a decade, possibly a generation. So yes, there is modest upside potential for 2011. Unfortunately, there is also severe downside potential for 2011… and beyond.

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twentysomethingmoney December 31, 2010 at 11:04 pm

This is a high level look at the USA economy for 2011. As a Canadian, these numbers affect me almost as much as you Americans, since they seems to impact our financial sector too.

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