2012 Economic Outlook: What's in Store?

The ripple from a European downturn could erode the economic pace in the US.

Jan. 1, 2012— -- As the US economy enters the new year, economists expect 2012 will be better than 2011. But don't pull out your party hat just yet.

Growth will be slow – between 2 and 3 percent. To many Americans, it will feel as if the economy is in recession even if it technically isn't. And economists will be warily watching events outside the US borders for any spillover effect here.

"The economy is going to be less than inspiring," predicts Mark Zandi of Moody's Analytics in West Chester, Pa. "But it will still be better than [it was in] 2011."

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There are major ramifications for an economy that is not performing on all four cylinders. Among them: The housing and auto sectors, although expected to do better in 2012, will be operating at well below normal levels. The unemployment rate is not expected to improve much, which is not good news for the 13.3 million Americans looking for work. Investors, who are somewhat more optimistic according to year-end surveys, could nonetheless remain skittish, dissecting every economic statistic until they can get a better handle on the future.

As the US economy struggles to gain a foothold, the slow economic pace will leave policymakers with little margin for error – a bad decision by Congress or the president might be enough to cause the economy to stall.

How America's economy performs may depend in part on what happens in Europe, where nations are struggling with ways to try to save the European Union and embark on a major round of belt-tightening. So far, Mr. Zandi notes, the Europeans have made some progress – mainly ensuring that European banks have access to credit.

"There will be no Lehman moment," says Zandi, referring to the US investment bank whose financial problems ultimately dried up bank lending, which helped lead to the 2008 Great Recession. In addition, many of the highly indebted nations have new governments that have pledged austerity, he says.

European belt-tightening has ramifications even in the United States. Trade with the EU represents about 2 percent of the US gross domestic product, estimates IHS Global Insight, an economic forecasting firm in Lexington, Mass.

At risk are US capital goods such as machines that help companies make other machines, computers, and auto parts, says John Silvia, chief economist at Wells Fargo Securities in Charlotte, N.C.

Even with the problems in Europe, indications are that the US will be in better shape.

Durable goods manufacturers could have a better year. Auto sales in Detroit are expected to increase by about 6.5 percent, and aerospace shipments will rise by 18 percent as the Boeing Co. starts to deliver its new 787 airplanes and its 747-8 plane, says Daniel Meckstroth, chief economist at Manufacturers Alliance/MAPI in Arlington, Va.

Automobile sales are starting at a relatively low level, making a comeback easier. Detroit automakers will sell 12.6 million light vehicles in 2011 and 13.4 million in 2012, estimates Mr. Meckstroth. In a normal year, they sell 16 million.

Housing, another industry that has been flat on its back, may see improvement as developers sell off inventories. In 2012, new housing starts should jump almost 20 percent, predicts Meckstroth. However, the industry will still be building homes at a very low rate.

A large number of foreclosures has been hanging over the housing market for some time. The state attorneys general are close to settling lawsuits brought against the five largest banks for foreclosure fraud. After the suits are settled, the market could see another spurt of foreclosures, says Zandi. But over the longer term – perhaps by 2013 – the legal settlement and subsequent foreclosures may finally eliminate many of the houses hanging over the real estate market, he says.Bearish on Job Growth

With many other businesses facing flattening sales, the unemployment rate is not expected to drop much in 2012, many economists say. Wells Fargo's Mr. Silvia anticipates that the economy will add between 100,000 and 150,000 new positions per month. This would mean the economy is barely keeping up with the natural growth of the workforce. Companies plan to increase their payrolls by 1.5 percent on average over the next 12 months – implying an improvement of about one percentage point in the unemployment rate (at 8.6 percent in November) over the next year, according to a Duke University/CFO magazine survey.

Businesses are likely to remain cautious about adding to their payrolls, agrees Gene Zaino, chief executive officer of MBO Partners, a company in Herndon, Va., that helps professionals operate their own consulting businesses. "Companies are being very conservative about adding on full-time, permanent people to their payrolls," he says. "There is a real sense of hesitation about making really big bets."

Chins Up for Investors, Consumers

Despite the low expectations for new jobs, it appears the economy will enter the new year with some momentum. The economy will grow by as much as 3.5 percent in the fourth quarter of 2011, as consumers open their wallets to spend for the holidays, according to Zandi.

"Consumers and business are more upbeat than you would think from looking at the surveys," he says, referring to surveys that show low consumer confidence.

Surveys also indicate that Wall Street investors are becoming more optimistic. Forty-nine percent of investment managers perceive that the stock market is undervalued, while 45 percent perceive it to be fairly valued, according to a year-end survey by Russell Investments, a global financial services firm based in Seattle.

This optimism helped the market stage something of a "Santa Claus" rally, pushing the Dow Jones Industrial Average up more than 500 points, or about 4.5 percent, right before Christmas.

One reason that the market has had a rough year up until the week before Christmas: Investors have been anticipating a global recession that may not happen, explains money manager Oliver Pursche, president of Gary Goldberg & Co., a financial firm in Suffern, N.Y.

"The markets, to a certain extent, have ignored corporate revenue and profit growth and put too much emphasis on the crisis in Europe and the slowing velocity of GDP growth," says Mr. Pursche, who expects the stock market to rise 10 percent in 2012.

During the past 100 years, the stock market has fallen during a presidential election year only three times. The last was in 2008, as America was going through the financial crisis.

Economists are assuming that Congress will extend for one more year a cut in workers' payroll taxes and will continue to offer extended unemployment benefits. At least part of that assumption came true on Friday when Congress voted to extend such benefits for two months. However, if they are not extended further, economic growth in the first half of 2012 will drop to less than 1 percent, warns Zandi. "Then nothing else can go wrong," he says.

The Moody's economist worries that, even if Congress acts, the political fight over it all will serve to remind business and the markets about the brinkmanship that played out in Washington in August during the controversy over raising the national debt ceiling. The stock market swooned, and Americans' confidence fell. Congress may face the same situation again next September.

"Once we are thrown into the middle of the election process, it becomes more and more difficult for business to step up and be more aggressive," says Zandi.