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Tuesday, December 14, 2010 - 09:30
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Tuesday, December 14, 2010 - 09:30

A Sneak Preview of the Economy in 2011

Tuesday, December 14, 2010 9:30 AM

The recent agreement in Washington to resolve the tax impasse has led many economists to re-check their assumptions about the economy in 2011. Their conclusion: the outlook for 2011 just got a little better. Let's look at the specific economic indicators, and where most think they will be by the end of 2011.

I recently noted that there is a major distinction between 2.5% and 3.5% GDP growth in our economy. Just a few weeks ago, an economics think tank predicted growth of just 2.6% in 2011, which would be insufficient to help get various parts of the economy moving. Now, a different survey of economists conducted by The Wall Street Journal has economists singing a different tune. They now think the economy will grow 3.0% next year. The reason for their optimism: the new tax agreement that should help brighten the fortunes of the middle class, as income tax rates will stay lower, unemployment benefits will be extended, and payroll taxes will be temporarily reduced.

You could argue that these moves only serve to boost the long-term budget deficit. But a number of economists think that rising economic growth is the greatest panacea for long-term budget deficits, as tax revenue increases, so the chorus of deficit hawks has been fairly quiet in recent days.

Here is the latest thinking on several key economic factors. Later on, I'll explain what it means for how you should position yourself going into next year...

Unemployment
It's a bit worrisome that economists keep expecting weekly unemployment claims to keep on dropping, yet they remain stubbornly above 400,000, week after week. The good news: the era of large layoffs appears to have ended. The bad news: it's hard to find any major company that has announced plans for a big surge in hiring in 2011.

These next few months will be crucial. Companies tend to formulate their plans every January, and it's quite conceivable that fourth-quarter conference calls will be dominated by talk of expansion plans. With all that cash sitting on the sidelines, and with economists increasingly expecting a slightly more robust economic picture in 2011, the time for employment gains may finally be at hand. But don't expect a jobs boom.

A look back at the 1990s is instructive. Unemployment peaked in June, 1992 at 7.8%. It finished that year at 7.4%. In each of the next two years, the unemployment rate fell a full percentage point, but stayed in the mid 5% range for a few more years before falling yet further in the latter part of the decade. By that logic, today's unemployment rate may fall to 9% by the end of next year (which is still quite high), and to 7% by the end of 2013. And 7% unemployment is still a rate at which economic growth has traditionally been muted. For a whole host of reasons, it looks increasingly unlikely that we'll see unemployment below 5% again in coming years. And a variety of industries are adjusting to this "new normal."

Oil prices
Filled up your gas tank lately? Where I live, I'm now paying $3.25 a gallon. And that hurts. The upward move comes from a surge in oil from $70 this summer to a recent $88. I was concerned last month that we were headed for $90 oil , but I didn't expect to get there so quickly. My gut tells me we're not done yet.

Economic growth of 3% or higher in the United States in 2011 would be a happy development for investors. But that is also likely to lead many to expect further gains in oil demand. After all, fast-growing economies like China and Brazil are already consuming ever-increasing amounts of oil, and any further increase in global demand is likely to start leading to supply strains.

The International Energy Agency now sees global oil demand for 2011 at 88.8 million barrels a day, up 260,000 barrels a day from its previous outlook. Forecast.org sees oil hitting $106 by next July. Let's hope they're wrong. Simply put, many consumers and a range of industries would come under considerable pressure if oil made another +20% move in the coming year.

Action to Take --> A firming economy, slowly falling unemployment and rising oil prices would have clear implications for investors.

GDP growth at or above 3% is likely enough to keep corporate sales and profits rising at a decent clip in 2011, as many already expect. Discretionary stocks could be the real winners as consumers dine out more, take more trips, buy more home furnishings and -- drum roll please -- start buying more homes. And a rebounding home sector would yield many ancillary benefits in terms of truck sales, local tax revenue, consumer electronics, etc.

Yet investors would also react to rising oil prices by shunning energy-intensive industries such as airlines, agriculture and chemicals (excepting chemicals that rely on cheaper natural gas).

As a final thought, those increasingly bullish economists noted earlier will need to see improving employment trends in the next few months. If the unemployment rate fails to improve at all during the next three months, those GDP forecasts are likely to come right back down and stocks could give up all of the impressive gains they've posted since Labor Day.

P.S. -- Using the same principles that helped trounce the S&P 500 for seven years, one of our top investing gurus, Nathan Slaughter, hand-picked all 10 of the stocks featured in his latest exclusive report, The Top 10 Stocks for 2011. These 10 stocks are not only poised to deliver above-average returns throughout the 2011 calendar year, but also in the years that follow...

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.