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Comerica issues positive economic outlook for 2014

Changes are on the horizon for interest rates, labor force and wealth distribution.

February 7, 2014
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Comerica recently invited two of its top economic experts to talk about their projections for the economy in 2014, and the news was mostly good: The U.S. economy is on an upward trajectory and as long as there are no unexpected upsets, the economic rebound is likely to continue.

“The End of Economic History (as we know it),” was presented by Robert Dye, chief economist, Comerica Bank, and focused on the vast changes to the foundations of the U.S. economy since just prior to the recession and following it.

In his presentation, “2014 Global Financial Market Outlook,” Dennis Johnson, chief investment officer, Comerica Wealth Management, focused on the changing bond market as 30 years of decreasing interest rates comes to an end.

Dye began his presentation by pointing out many significant changes that have created a very different economic environment than people were accustomed to.

For example, interest rates have gone from falling to rising; there is no longer commodity-driven inflation; the labor force is resetting as less men and women are entering it; wealth distribution has changed dramatically; the U.S. is in a state of energy surplus; and the country is now under a highly managed monetary policy with more regulated financial markets.

Dye said interest rates have bottomed out and he projects that, in both the short and long term, they will continue to rise.

Inflation has been impacted significantly by globalization and the growth of technology. He called computerization a disinflationary force that has had a broad reach in the economy.

“Globalization seems to be keeping prices very low. … Almost everything we do is touched by computers in some way,” he said.

Dye said since women began entering the work force in the late ’60s through the ’80s, the labor force has been growing, but with baby boomers beginning to retire, the labor force is decreasing.

“Both the male and female labor force participation rates are falling,” he said. “I think, frankly, a lot of people who were pulled into the work force in the super-charged economy we had back in 2004 and 2005 were not going to be permanently attached, and we are sort of resetting the labor force,” he said. “I think it’s a mistake to say we want to reset to 2004 and 2005 because I don’t think that was normal either.”

Distribution of wealth will continue to be part of the conversation and a long-term issue.

“We had been used to thinking about a broadening middle class — Michigan the center stage of that, the manufacturing industry providing job opportunities to men and women with high school education, and with that high school education they could provide a decent living for their family,” he explained. “That is getting harder and harder and harder. Many forces are pushing in on that pyramid structure from both sides, and we need to think a little bit more about distribution effects.”

A particularly positive change is that the United States is in line to become the largest oil producer, something Dye expects to happen in the next few years. He noted the trade balance would be significantly impacted by the U.S. moving into that No. 1 spot.

“We are used to thinking about the trade balance being a negative, dragging down the U.S. economy,” he said. “We have to import all this stuff. We are already exporting a lot of energy products; if we export crude oil, as well, and we start exporting more manufactured goods because manufacturing is taking advantage of those two energy sources and importing less, that is a knock-on effect that really makes the balance of trade look a little more positive going forward.”

Dye pointed out that a big chunk of the U.S. economy is going through fundamental restructuring due to the enactment of the Affordable Care Act. Health care makes up 16 to 17 percent of the GDP, he noted. The effects of that restructuring remain to be seen.

Some of the biggest economic changes have come through monetary policy, with the Federal Reserve taking a much more active role in managing the Federal funds rate and quantitative easing.

“This is a whole new Fed,” Dye said.

But fiscal policy remains unsustainable. Dye noted the passage of the two-year budget deal takes some of the pressure off, but predicted that in three to four years the pressure would return.

He said $63 billion of discretionary federal spending was put back into 2014 and 2015 due to the budget deal and by mid-2014 the fiscal drag would be neutralized.

The correlative nature of housing, automobile sales, labor force needs and the financial markets is positive right now.

He noted that as housing confidence returns, more people are purchasing cars, and the auto industry has seen a jump from 9 million units to 16 million units. He expects that, although we are nearing the top of the auto cycle, there will still be room to move into the 17 million-units range.

Dye is also optimistic about the global economy.

“My expectation is with the United States showing a little more growth, stepping up from 2 percent to maybe 3 percent growth in 2014, Europe starting to turn the corner, China in the glide path and Japan doing better — that’s about three-fourths of the world economy doing a little better in 2014. So my expectation is that emerging markets do feel that rising tide from the developed world turning the corner this year.”

There is less policy uncertainty for businesses ahead, Dye said. “My sense of it is that we are really starting to clear the decks here, getting most of the regulatory policy changes behind us.”

“That is a key part of the story, I think — allowing businesses to start getting some of their mojo back and have a little more confidence about making hiring decisions going forward. … Businesses, I think, can have a little more certainty planning — making things like employment plans, capital spending plans, borrowing decisions.”

Despite his optimistic outlook for 2014, Dye said he wouldn’t be doing his job if he didn’t make the room uncomfortable by listing the ways things could go wrong: Weak job growth could derail the positive trajectory and the housing market could stall.

Johnson focused his presentation on the bond market versus the stock market, and said he is cautiously optimistic about the stock market.

“We like the stock market,” he said. “We find the U.S. stock market and the international stock markets to be equally attractive.”

Johnson was less enthusiastic about the bond market, which he said is over.

“We have been, and continue to be, very cautious toward the bond market,” he said. “We’ve had this view for 18 months now. We are looking for a normalization of bond rates.”

He said the bond market offered good returns for low risk, but with rising interest rates, the returns are not nearly as enticing.

“You could easily buy bonds and get stock-like returns without taking on the risk,” he said. “What we see is that, historically, that has occurred, but it doesn’t stay in effect forever.

“We aren’t saying stocks are going to go up 30 percent, but stocks are going to do better than bonds.”

There are several reasons Johnson said he likes the stock market right now, including company profits.

“Our view is that profits will continue to go up from here. They will be much more modest than what they have been in the past, but it’s going to be enough to allow the equity markets to advance from current levels,” he said.

He said it’s time for a refresher course on bonds and stocks.

“Interest rates go down — as they did for 30 years here — the value of bonds goes up,” he explained. “So over the last 30-plus years, for everybody who has invested in bonds it’s been a great ride. You got very high yields, so a high current income, and on top of that, interest rates were going down … creating a very attractive total return.

“Here’s the catch: Rates are not going to zero, so the opportunity for appreciation, in our view, is gone.”

Like Dye, Johnson noted risks that could change the outlook: midterm elections, corporate profits stalling or decreasing, and also happenings in China. With the second largest economy, China presents strong implications for the global economy.

“China is going through change, beefing up the military … controlling islands and air traffic in their region — things we need to watch,” he said. “In addition, they are trying to transform their economy from one tied to exports to domestic consumption. That is a big deal for a country with the population it has. The risk of missteps along the way is very evident.”

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