"The Gear Year" (James Paulsen's 2012 Outlook)

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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