Breakout

A new reason to worry about jobs and stocks

Breakout
Labor Activists Hold A "Pink Slip" Protest
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NEW YORK, NY - MARCH 06: A woman participates in a "Pink Slip" protest in Union Square on March 6, 2012 in New York City. The protest, which supports those who have lost their jobs due to the recession started in 2007, asks others to recognize that "the next pink slip might be yours," and to support the lobbying of congress to invest in US-based jobs. (Photo by Andrew Burton/Getty Images)

A worrisome word is popping up in discussions among some economists: Recession. As in, the next one.

Many Americans feel the recession that began at the end of 2007 never ended, but in technical terms, the economy has been growing since the middle of 2009. Until recently, it looked as if growth might finally hit “normal” levels of 3% or more later this year, as the housing recovery kicks in and employers finally start to hire more. But recent economic setbacks have fed new worries about tapped-out consumers falling even further behind.

“The danger has increased the U.S. economy could pivot from healthier growth to close to recession in the next 6 to 18 months,” Bernard Baumohl of the Economic Outlook Group warned clients recently.

The Federal Reserve seems to share such concerns. It just lowered its forecast for GDP growth in 2014 by half a percentage point, to a range of 2.1% to 2.3%. Even at those lower growth rates, the economy wouldn't be in a recession yet the Fed's projections have been notoriously overoptimistic.

In a press conference following the Fed's recent two-day meeting, Fed Chair Janet Yellen acknowledged one of the biggest problems with the economy: Wages have barely kept up with inflation. "Real wage growth has essentially been flat," she said. "It has not been rising in line with productivity." She did point out, however, that supbar wage growth in recent months may have set the stage for an uptick later this year as wages catch up.

The recovery's missing link: Spending power

There’s no single factor right now that’s dominating headlines and threatening the economy — but that could actually breed complacency and obscure smaller trends conspiring to generate a downturn. The biggest overall problem in an economy driven by consumer spending is that weak hiring and stagnant pay could leave consumers with little disposable income. “The issue is spending power, which remains the missing link in the recovery,” writes Joel Naroff of Naroff Economic Advisers.

If inflation were low, as it has been for most of the past five years, purchasing power wouldn’t suffer much. But inflation has been picking up this year, with the latest numbers showing a 2.1% annual inflation rate and larger price hikes for staples such as food and energy. Some economists point out that rising inflation is itself a sign of an improving economy but when that happens, wage gains are usually part of the reason, which isn't the case now.

During the past 12 months, average weekly earnings rose by the same amount as inflation, which means after inflation, the typical worker is barely staying even. Since lower-income workers spend a larger portion of their money on necessities that are rising in price faster than pay, those people are falling behind.

To make ends meet, more people are borrowing. The total amount of consumer debt rose by $26.8 billion in April, the biggest jump in nearly three years. Much of that was student loan debt, but credit-card debt was 12.3% higher than the year before -- the biggest jump since 2001. Put it all together and it adds up to more consumers using credit cards to cover monthly expenses they can’t pay for with regular income.

The geopolitical factor

In a stable economy, that might be a temporary blip offset by an improving labor market. But now, add Iraq to the equation. The recent instability there has created the possibility of a wider Middle East conflagration that could threaten oil supplies, with prices already up $5 to $10 per barrel since last month, depending on the benchmark. The Iraqi situation could calm down for a while, or it could erupt into something even more dangerous. Either way, the oil price “fear premium” seems likely to linger, driving up gasoline prices for consumers. Again, if there were more slack in household budgets, this might not be a problem. But with many families on the edge, rising energy costs could lead to even more borrowing.

The real crunch would come if interest rates rise this year, as some forecasters expect. That would make revolving debt such as credit card balances, which usually have floating interest rates, more expensive. Since mortgage rates would also rise, homes would drift further out of reach of entry-level buyers, which could derail a housing rebound that’s fragile to start with.

The stock market is the final wild card. Investors have been buying stocks even as money advisers warn of a correction, setting up a test of the broader economy: Will it grow by enough to justify stock prices that are above historical averages? The jagged upward move in stocks this year suggests investors believe the answer is yes — but their conviction may be lacking. If growth falters and catches investors by surprise, that could be the catalyst triggering a 5% or 10% market correction, which many market watchers are calling for. A full-blown recession could trigger even steeper declines.

There’s a case for bullishness, too. "There are many good reasons why we should see a period of sustained growth," Yellen said in her press conference, citing improving credit conditions, declining federal deficits and the Fed's own efforts to boost the economy. Still, the ultimate sign of more stable economy will be the end of the Fed's easy-money policy and the decision to start raising interest rates, which still seems unlikely before 2015 at the earliest. That gives Iraq and other problems a long time to play out.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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