The recent events in Libya and Japan have caused some investor concerns that it might have an impact on the U.S. economy over the near term. There may be some dislocations at the margin, but the economic expansion is very unlikely to be derailed by these occurrences.
Libya – Maintaining oil supply
First, the real need of Arab governments to keep a very young population happy will require oil to be pumped no matter who controls the spigots. Supply/demand dynamics will generally hold sway. As long as Brent oil stays below $150 a barrel for a sustained period of time, the global expansion is not at risk. The price of oil should eventually back toward $100 from $110 to $120 now.
Japanese Crisis & Market Outlook
The Japanese crisis is a very significant human tragedy. However, the impact on global GDP near term is likely to be only 0.1 to 0.5 of 1%! In addition, reconstruction activities are likely to raise Japanese GDP from the June Quarter on, which will then help global GDP on the margin.
In the US
Meanwhile, the U.S. economy keeps rolling along and has officially transitioned from recovery to expansion. It is very likely that GDP growth will continue at least through 2012.
Prior to the two events mentioned above, U.S. economic growth was accelerating. The Index of Leading Economic Indicators was up in February and very likely will be positive in March. The Index has had the biggest two year increase since the very strong 1983-84 recovery.
- Since the start of QE2, M2 money supply has expanded rapidly.
- Capital goods indexes have been particularly strong.
- Weekly unemployment filings are now regularly under 400,000 (which is considered within the normal range of 300,000 to 400,000).
- Credit card delinquencies continue to drop.
Based on all this, a self-sustaining expansion is clearly under way.
- At least over the intermediate term, inflation is likely to remain under 3%.
- Food costs represent only 5% or so of average household income in the U.S. It is a lot higher in other parts of the globe.
- Energy is also @ 5%+ of HH income.
On the other hand:
- Rents (including the cost of home ownership), a much large inflation component, is likely to remain flattish for a long while.
- Average hourly earnings, the other large inflation component, is likely to remain tame until unemployment drops another few points. Average hourly earnings was up 1.7% in March.
I still see U.S. GDP growth in mid 3s for 2011; the same for 2012.
Inflation will run at 2% to 3%.
S&P 500 EPS of $98 in 2011; $105+ in 2012.
The historical multiple for the S&P 500 is 13.5X forward 12 month EPS. That would suggest a closing 2011 target price for the index of 1417.
Longer term, the equity risk premium has come down quite a bit since autumn 2010, when it was at extremely high levels. But at 6.6% or so, it remains above its long term average of 5.5%.
Long term concerns that could affect 2013 and beyond:
Inflation: It usually accelerates as the an economic expansion progresses. The stock market does fine until it looks like it will go over 4%. Will we let inflation solve our deficit issues?
Emerging market inflation: It is happening now. Central banks are currently raising rates. That means that global growth will slow, not end, but bears watching.
“No action on US deficits invites a crisis down the road, with interest rates spiking higher, choking off economic growth or much worse.”
Deficits: This is the big issue for the U.S. It has to be solved in a way so that the fiscal drag is gradual not sudden (i.e. you can’t go to a flat tax that raises or keeps total receipts flat overnight – too many immediate dislocations at once). No action invites a crisis down the road, with interest rates spiking higher, choking off economic growth or much worse.