Four Reasons for Economic Optimism

And four signposts to help spot the recovery we see coming around the middle of 2009.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

January 5, 2009

Will 2009 bring a U.S. economic recovery? Yes, possibly starting around midyear, assuming no more unpleasant surprises are lurking. The first half, though, will be tough, with the economy contracting 4% in the first quarter, following a 5% decline in the last quarter of 2008.

There are four key reasons for optimism: First is how low the interest rates are. The prime is at 3.25% and will stay there for a while. That makes it cheaper for qualified borrowers to buy or refinance a home, or to take out a loan for a car or college tuition. And the Federal Reserve's plan to buy up more debt starting in Feb. will help keep interest rates down.

Next up is low prices. Cheap oil won't last forever -- but it will last several months, as will modest prices for food and other commodities, goods and services. Inflation will also be low, in the 1%-2% range for 2009, stretching paychecks for those who still have jobs.

And federal spending will be a big help to the economy. President-elect Obama and Congress plan a stimulus of over $800 billion in tax cuts and spending as early as this month. If the money can be put to work quickly -- a big if -- it will create a few million jobs.

There's also a new sense of public confidence in Washington. About 70% of Americans say they are optimistic that the Obama administration will be able to spur growth. Economists say confidence is a key element, especially as it relates to consumers. That's a big plus if Obama can deliver quickly enough to keep the momentum.

But there are plenty of worrisome factors weighing down the economy, starting with housing. A million homes are in foreclosure now and a million more will be by year-end. Unsold houses are piling up, depressing prices. By the close of 2009, 25% of mortgages will be underwater, meaning the loan exceeds the house's value.

Credit remains excessively tight. Qualifying for a loan is very hard right now as banks worry about the job security of borrowers. As a result, banks are hoarding far too much cash. And when they do get ready to lend, rates will be higher because of the rising federal budget deficits. Few are worrying about the federal debt now, but eventually it'll jack up interest rates.

Several other drags on the economy are declining exports, auto industry blues and reduced demand for oil and gas. The global recession cuts demand for goods worldwide. In the U.S., exports will shrink by 0.5% in 2009. Uncertainty about Detroit's future is a big cloud darkening the entire U.S. economy. As for gas and oil production, as prices plummet, companies have less incentive to invest. That'll mean shortages when the global economy improves and demand rises.

As for the recovery's start, which we think is in the second half of 2009, we'll be watching four signposts for clues over the next several months. Over time, these guides have proven good indicators that a recession is beginning to end.

Let's start with stocks. The markets are a leading indicator. Over the past 70 years, they've started rising four months, on average, before GDP turned positive.

First-time claims for unemployment benefits will be a better clue on timing than job losses, which tend to lag. Applications are running at over 550,000 per week now. When they come down to 400,000 or so, that'll be very encouraging.

Then there are bond rates. The gap between interest rates on low-grade corporate bonds and Treasuries has soared to around 17 percentage points. Normally, it is closer to five points. Until it narrows, businesses with less than stellar credit records will be virtually shut out of the bond market and have to struggle to get cash.

Finally, keep your eye on housing starts. Once the declines level off, look for home prices to stabilize. That'll be the beginning of the end of housing's negative contribution to GDP growth.

For weekly updates on topics to improve your business decisionmaking, click here.