Economic recovery: Probably not too hot, not too cold

Lately, there’s “never a dull moment” in the economy, said William B. Greiner, chief investment officer of Scout Investment Advisors.

“We’ll see continued uncertainty — but nowhere near what we’ve seen for the last 18 months,” Greiner said. “We’ve been calling the (end of the) recession, but the ferocity of the rebound will be a little stronger than we thought (albeit weaker than ‘normal’ after a recession) — probably strong enough for some job creation in the first quarter.”

The unemployment rate is “searching for bottom. We’ll see 10 percent or so, but 11 percent is probably not going to occur.”

The third estimate of second quarter gross domestic product came in at negative 0.7 percent, according to the Bureau of Economic Analysis. Not quite positive as anticipated, but a distinct improvement compared to the first quarter’s negative 6.4 percent.

At this point, Greiner anticipates that third quarter GDP will be 3 percent, and 4 percent for fourth quarter.

(The “advance” estimate of Q3 GDP will be released Oct. 29.)

The six-month rate of change in the leading economic indicators is, he said, one of the more dependable indicators of economic acceleration.

(And here I thought “acceleration” was how to fly by all the tourists driving up Ute Pass.)

“Historically, the U.S. economic growth rate accelerates to the upside whenever the economy has been in recession and the LEI six-month rate of change exceeds 3.5 percent,” Greiner said. “This has been true 100 percent of the time since the end of World War II and has been true in calling the end of the last 10 recessions.”

And, yes, the LEI six-month rate of change grew by more than the magical/requisite 3.5 percent last month.

He expects that GDP will remain positive, about 2 percent to 3 percent, during 2010. But unemployment won’t go below 6.5 percent or 7 percent during the next year or two.

“The conservatives will call this the ‘jobless recovery,’” he said.

The fourth quarter will be “one of the best” during the next four or six quarters, because inventory levels — raw materials, etc. — are extremely low. Industrial production has started to “ramp up” since the beginning of September.

“The slingshot effect, of coming out of recession and pent-up demand, will get inventory levels up quickly,” Greiner said.

The fourth quarter will be driven by inventory accumulation, because the consumer has been weakened and consumer demand will lag.

And for now, there is “so much slack in the system” that inflation will not be a problem.

Demand (pull) and supply (push) are part of the inflationary processes.

“When you’re at full production capacity, then prices rise sharply and quickly,” he said. “Now we’re running at 70 percent of full capacity, but their ability to fulfill orders is high.”

Inflation is not a risk until the nation is above 80 percent capacity rates.

“Inflation is basically benign for the next six to 12 months,” Greiner said.

However, after that, there is a great risk of inflation unfolding on a worldwide level if central banks don’t raise interest rates during the next 12 months. The Federal Reserve and U.S. Treasury need to “tighten down money supply and raise interest rates” during the next year.

Another risk is the potential for a double-dip recession.

“The probability is 20 percent,” Greiner said. “After a normal recession and recovery, the probability would be zero to 10 percent.”

During the next 12 months, there is a 60 percent probability of staying out of recession and not having a major surge in inflation. But there is a 20 percent probability of a rapid rise in inflation.

Although things are improving, it will take time to recover.

Consumers’ balance sheets have been “deeply damaged” during the last two years, so consumers won’t be pulling the United States out of the recession as they normally do.

And the banking system was “damaged dramatically” and will continue to be for the next year or so.

“Last year it was national banks,” Greiner said, but some smaller and community banks will have trouble during the next year because of bad loans and lack of capital.

Overall, he expects that stock market prices will close at higher levels by the end of the year and the “second leg” of the bull market will begin during the next few months.

“These are the odds we’re playing with right now,” Greiner said. “And the stock market has been sensing this. It’s a feel-good Goldilocks environment — not too hot and not too cold.”

Rebecca Tonn covers banking and finance for the Colorado Springs Business Journal.