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The Gear Year (James Paulsen's 2012 Out­look)

by James Paulsen, Chief Invest­ment Strate­gist, Wells Cap­i­tal Man­age­ment (Wells Fargo)

Although widely con­sid­ered a “new nor­mal,” the con­tem­po­rary eco­nomic recov­ery is closely track­ing the last two eco­nomic recov­er­ies dur­ing 1991 and 2001. As we have illus­trated in ear­lier mis­sives (see EMP Updates dated May 4, 2011 and June 21, 2011), since the mid-1980s, the char­ac­ter and speed of U.S. eco­nomic recov­er­ies have been sig­nif­i­cantly altered by a water­shed decline in the growth of the U.S. labor force. For the third recov­ery in a row, the con­tem­po­rary eco­nomic cycle, like both the 1991 and 2001 recov­er­ies, has been a “slow-starter” with the revival in real GDP growth, job cre­ation, and con­fi­dence all muted com­pared to pre-1985 eco­nomic recov­er­ies. And, like the last two recov­er­ies, many believe (and panic) the recov­ery is sim­ply dysfunctional.

How­ever, if the cur­rent recov­ery con­tin­ues to mimic the last two recov­er­ies, 2012 could prove a piv­otal year. Dur­ing both the 1991 and 2001 recov­er­ies, “year three” rep­re­sented a “Gear Year”! Not a year when real GDP growth surged, but in both cases “the year” when cul­tural mind­sets (among lead­ers, busi­nesses, con­sumers, and investors) finally accepted the eco­nomic recov­ery was improv­ing and was sus­tain­able. That is, after two years of intense debate and gen­er­al­ized wor­ries, year three proved the year when most finally agreed the recov­ery had finally “Geared.”

Will 2012 finally prove the “Gear Year” for the cur­rent recov­ery? If so, what are the impli­ca­tions for the econ­omy and the finan­cial mar­kets in the com­ing year?

Yet Another Delayed Recovery?

The slug­gish pace of the cur­rent recov­ery has been a con­stant source of frus­tra­tion and has kept anx­i­eties sur­round­ing the econ­omy per­sis­tently ele­vated. Chief among the con­cerns have been a lack of any real improve­ment in the unem­ploy­ment rate or in eco­nomic con­fi­dence. These same con­cerns were also pre­dom­i­nant dur­ing the first cou­ple years of the last two recoveries.

Exhibit 1 shows the U.S. unem­ploy­ment rate and the con­sumer con­fi­dence index since the 1960s. Shaded areas rep­re­sent reces­sions. Prior to the mid-1980s, once an eco­nomic recov­ery began, both the unem­ploy­ment rate and con­sumer con­fi­dence would improve almost imme­di­ately. How­ever, begin­ning with the 1991 recov­ery and now obvi­ous for the third recov­ery in a row, the unem­ploy­ment rate and con­fi­dence have actu­ally wors­ened dur­ing the first cou­ple years of recov­er­ies. For the last 25 years, sig­nif­i­cantly delayed recov­er­ies in job cre­ation and con­fi­dence have become the norm. Con­se­quently, pan­icky atti­tudes sur­round­ing whether a recov­ery is work­ing and whether it’s sus­tain­able have also become commonplace.

Exhibit 2 illus­trates two media clips—one writ­ten about two years into the 1991 recov­ery and one writ­ten about two years into the 2001 recovery—both which show a very sim­i­lar cul­tural mind­set char­ac­ter­ized by wide­spread anx­i­eties sur­round­ing the econ­omy existed at this point dur­ing the last two recov­er­ies. Either of these arti­cles could eas­ily appear in today’s morn­ing news­pa­per and fit per­fectly with accom­pa­ny­ing sto­ries. Many believe the cur­rent “dis­ap­point­ing” recov­ery is a “new” nor­mal. It stands out as uniquely sub­stan­dard in most minds. How­ever, wide­spread angst dur­ing the first two years of eco­nomic recov­er­ies has become “nor­mal” in this coun­try dur­ing the last quarter-century!

Exhibit 1

Exhibit 2

Track­ing Pre­vi­ous Disappointing/Delayed Recoveries!

Exhibit 3 shows just how closely two of the most impor­tant met­rics of the economy—real GDP growth and job creation—are track­ing the aver­age of the last two recov­er­ies. Through the first nine quar­ters of this recov­ery, the cumu­la­tive gain in real GDP is slightly less than its aver­age gain dur­ing the first nine quar­ters of the last two recov­er­ies. How­ever, its pat­tern through­out the recov­ery clearly resem­bles the last two recov­er­ies. Indeed, dur­ing the first six quar­ters, the cur­rent recov­ery was usu­ally slightly stronger than the aver­age of the 1991/2001 recov­er­ies. Sim­i­larly, dur­ing the first 29 months of this recov­ery, the cumu­la­tive gain in total job cre­ation has been almost iden­ti­cal to the aver­age gain at the same point dur­ing the last two recov­er­ies. More­over, the total gain in pri­vate job cre­ation so far in this recov­ery is notably bet­ter than the aver­age dur­ing the 1991/2001 recoveries.

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