By Mark Green
With neither President Barack Obama nor Mitt Romney offering campaign ideas that inspire business community confidence, expect the lackluster U.S. economy to continue “muddling through” in slow, low-growth mode the remainder of this year and next year, according to John Augustine, chief economist for Cincinnati-based Fifth Third Bank.
A government-induced recession is even likely, he said, if Washington political gridlock sends the federal budget over the looming “fiscal cliff.”
Despite this, U.S. investors are having a good 2012 so far, with the S&P 500 returns topping 12 percent and average balanced funds up more than 8 percent year to date as of early October. But U.S. GDP is growing at only a meager 1.2-1.7 percent range, and corporate profit growth is slowing into single digits, Augustine said.
Fifth Third’s chief economic strategist presented his annual economic and financial market overview titled “The Financial Summit: Update, Outlook and Challenges” to an invited audience recently at Keeneland in Lexington. Augustine is presenting the information at meetings across 12-state footprint of Fifth Third Bancorp, whose $118 billion in assets make it a top 20 U.S. bank holding company.
Multiple global issues represent ongoing challenges for business and investors, Augustine said, with the U.S. public policy and government’s inability to take fundamental actions topping that list.
In the post-World War II period, average overall nominal growth in private GDP year over year has declined (from around 8 percent to 5 percent) while the federal government’s share of GDP has increased (from 16 percent to around 23 percent). The federal budget deficits and mounting national debt must be addressed via some public policy deal, but this has been unachievable due to the political climate of no cooperation and no compromise
Federal elected officials in 2011 created a now-looming “fiscal cliff” to prod themselves into reaching a deal by the end of 2012. But no prospective deal is emerging, and neither presidential candidate has a solution. The likeliest scenario, Augustine said, is that the large budget cuts in the “cliff” mechanism – roughly 5 percent of total GDP – will take place and send the U.S. back into recession.
European, Chinese policymaking also a worry
Other government policy challenges for investors exist in Europe, which appears to be entering recession because of austerity measures to deal with large national debts in multiple countries, and in China, where a slowing economy because of decreasing exports to Europe requires management to increase domestic demand.
Savvy investors’ task, Augustine said, is to find sustainable equity or fixed-income yields higher that the 2 percent rate of inflation. Fifth Third’s Investment Advisors Division has $291 billion in assets under care and $25.4 billion under management, not including the Fifth Third Securities subsidiary.
Known economic risks going forward, in the analysis of Fifth Third’s team, include global recession developing from debt mismanagement and tight fiscal policy in developed markets; inflation due to fiscal and monetary policy errors; or deflation from government debt in developed countries overwhelming the global economy.
Meanwhile, piles of cash remain “on the sidelines” not active in the U.S. economy, Augustine noted. Public policy gridlock keeps much of this $12.5 trillion uncommitted because uncertainty about business costs for taxation, healthcare and regulatory compliance thwart planning and business projections necessary to commit capital to many areas of long-term investment.
Total bank deposits that were below long-term trends from the end of recession in late 2001 until the beginning of the Great Recession in 2008 have moved back above the long-term growth rate and now stand at nearly $9 trillion. Corporate cash holdings have remain at around $1.8 trillion since the beginning of 2011. A major new segment of inactive capital is the $1.5 to $1.7 trillion in deposits banks now have with the Federal Reserve after the economic crisis in mid-2008; such deposits with the Fed had never previously topped a few tens of billions.
The three major measures of U.S. economic sentiment – the Business Optimism Index, the Consumer Confidence Index and the American Association of Individual Investors index – remain below their 10-year averages, Augustine reported. The investor index has managed several bumps into positive territory the past few years, though, as stock markets on a broad basis have returned to pre-crash levels.
Federal Reserve monetary policy has helped propel assets toward stocks with interest rates that are essentially zero along with its “quantitative easing” program that increases the amounts of cash and pure liquidity in the economy by buying Treasury bills from banks.
The global bond market does continue to purchase all the U.S. Treasury bonds issued to finance the federal budget deficit, including interest payments on the debt. Despite concern about the long-term ability of the United States to meet its debt obligations, Augustine said, there is no more dependable, stable and convenient asset alternative to the T-bill; other nations are either in worse overall fiscal shape or have unreliable government structures.
However, Augustine advised, the bond market is not infinitely forgiving. At some as-yet-unknown level of U.S. debt, he said, the bond market will decide to stop buying T-bills, and that would provoke a financial crisis. U.S. fiscal policymaking power would shift to the collective bond market and its major players.
Congress and the president must decide on and enact steps that take U.S. fiscal policy off its current course toward crisis before T-bill buyers decide it is too late.
Investment best practices in slugglish economy
Here is some of Fifth Third’s investor focus for 2013:
• Determine and maintain a “comfort” cash balance
• Put 10 to 15 percent of salary into retirement plans
• Use a four-part portfolio of stocks, bonds, real assets and absolute-return investments
• Coordinate allocations for clarity, taxation and “compounding maximization” across all investment accounts
• Invest only in what you understand
• Diversify municipal bonds geographically, but clearly understand the reason for any overseas investment
• Go against the crowd with 5-10 percent of your portfolio.
• Assess 401k and IRA accounts also to rebalance asset distribution and themes; trim high and add low in agency and trust accounts
• Monitor distributions to maintain compounding maximization
• Establish trusts to keep wealth intact after death.