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Can U.S. Economy Sidestep Europe’s Recession? (SPY, IEV, VGK, INDEXSP:.INX)

February 27th, 2012

Sy Harding:  The surprises continue in the U.S. economic recovery. This week’s reports include that home prices rose 0.7% in December, an encouraging ending to a year in which prices were down another 2.4% for the full year. And existing home sales rose 4.3% in January. Even more surprising, the inventory of unsold homes has now fallen to its lowest level since March, 2005.

In the employment picture, the important four-week moving average of new unemployment claims fell again, and is now at its lowest level since March, 2008, providing evidence that the big jump in new jobs over the last several months was not a temporary blip.

These reports add to the surprises racked up since October from the auto industry, overall manufacturing activity, consumer confidence, retail sales, and so on.


Yet the recovery remains anemic, with forecasts that GDP will grow only 2% or so this year. That’s down from forecasts of 3.5% to 4% that were the consensus forecasts for 2012 a year ago.

And indeed, in spite of the surprising improvements since last summer’s scare that the economy was sliding into recession, by a number of measurements the economy has not even recovered from last summer’s stumble.

For instance, the important ISM Mfg Index has risen each month since October, reaching 54.1 in January. Any number above 50 indicates growth. But it was at much stronger levels, above 59.5, in March and April last year just before the economy stumbled last summer. It’s the same with the ISM non-mfg Index, which covers the important service sector, which in turn accounts for most of the employment in the U.S. The ISM non-mfg Index has also risen since October, reaching 56.8 in January. But it was at 59.0 in February a year ago.

So as I wrote a couple of weeks ago, let’s not get too optimistic.

A slowdown from current anemic 2.0% GDP growth would not have far to go to reach negative growth (recession). And unfortunately, much of it may be out of U.S. hands. As has been the case for two years now, worries for the U.S. economy will continue to come out of Europe.

In Europe, it looks like the European Union has been successful again in at least kicking the eurozone debt crisis down the road, and perhaps even setting the stage this time for its eventual permanent solution.

However, the agreement that kicks the can down the road also includes elements likely to further weaken the already deteriorating economies of the eurozone. I refer of course to the requirement that additional harsh austerity measures be imposed in eurozone countries, including more cuts in government spending through layoffs, cuts in pay, benefits, pensions, and services.

The International Monetary Fund had already projected that the 17-nation eurozone will be in a mild recession this year, and now has warned that European governments need to be careful how quickly they cut back on government spending in an effort to tackle their record government debt, warning that steep budget cuts now will slow growth further and worsen the situation.

EU officials are sticking to their insistence on the austerity measures, their opinion being that governments must not think about the short-term, but about the long-term problems that will be created if deficit spending continues.

The IMF retorts that it might take 20 years for Europe (NYSEArca:VGK) to pay off the government debt built up during the 2008 financial crisis, global recession, and recovery, recalling that it took that long to pay off the debts Europe ran up during World War II without unduly creating hardships on the population.

In the U.S. the recovery from the Great Depression was delayed several times and the rescue efforts eventually cost more, because each time the deficit spending and stimulus efforts were halted too soon because recovery was underway, the economy stumbled again, and required another round of support.

In another example, President Reagan’s successful 1980’s massive spending programs to pull the economy out of the 1970’s economic mess resulted in years of record government debt that continued well after the recovery was underway, a decade or more before the deficit spending began to come down, and not until the late 1990’s that the deficits turned to surpluses.

Shorter-term, when stimulus programs were allowed to expire in the spring of each of the last two years, the economic recovery stumbled and came close to dropping the economy into another recession, forcing the Fed to rush to the rescue, with QE2 in 2010, and ‘Operation Twist’ last year.

This winter, for the third straight year, the recovery is surprising again with its strength.

But if the U.S. economy stumbled in each of the last two summers on worries that Europe (NYSEArca:IEV) might slide into another recession, even though it didn’t, can it withstand Europe actually being in a recession this summer, a recession perhaps made worse by eurozone countries being forced to cut back on deficit spending too early in the cycle?

The Fed says it’s ready to step in again if the U.S. recovery stumbles. But in each of the last two years it waited until it was almost too late.

That is liable to become the market’s next big worry if indications continue of Europe sliding into another recession before fully recovering from the last one, perhaps dragging the rest of the world down with it.

Related: SPDR S&P 500 ETF (NYSEArca:SPY), INDEXSP:.INX

Written By Sy Harding From Street Smart Report

Sy Harding is editor of the Street Smart Report, and the free market blog, www.streetsmartpost.com. The Street Smart Report Online includes research and analysis on the economy and markets, and provides charts and buy and sell signals on the major market indexes, sectors, bonds, gold, individual stocks and etf’s, including short-sales and ‘inverse’ etf’s. It provides two model portfolios as guides. One is based on our Seasonal Timing Strategy, one on our Market-Timing Strategy.


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