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Is the Economy Returning to an 'Old Normal'?

Casey Quinlan

Before the Department of Labor released its monthly jobs report in early May, economists and executives began touting the idea of the economy returning to an "old normal." The term "new normal" became ubiquitous after Pacific Investment Management Co. co-founder Bill Gross coined the phrase in 2009, writing in a note to Pimco investors that Americans would have to adjust to a new set of expectations for slower economic growth.

Gross also wrote that the government will play a bigger role in the economy and consumers will stop spending so much and start "saving to the grave." This would mark a time in which the U.S. stops making things, forfeits global economic leadership and sees a decline in homeownership, Gross wrote. Much of that prediction still seems valid, but five years later, some analysts see signs that the economy may be stabilizing and returning to a healthier place.

After the April jobs report, which showed 288,000 jobs were created and the unemployment rate fell from 6.7 percent to 6.3 percent, this optimism rose. "We're going to head back to a new destination," said Scott Mathers, one of Pimco's deputy chief investment officers, in a recent Bloomberg Radio interview.

But one of the most influential voices in the dialogue about the U.S. returning to a pre-2008 economy was Neil Dutta, head of U.S. economics at Renaissance Macro Research. "We are returning to an old normal," he said in an April 25 interview with Bloomberg.

During a meeting with the Joint Economic Committee of Congress, Federal Reserve Chair Janet Yellen said the economy is on track for "solid growth" in the current quarter. Despite weak first-quarter gross domestic product growth of a seasonally adjusted rate of 0.1 percent, the Federal Reserve predicts GDP growth of 2.8 percent to 3 percent for 2014.

[Read: How to Invest in the Fed's Slow-Growing Economy.]

However, there are still plenty of reasons to be cautious in the near and long term. In the short term, the unemployment rate is falling, but wages aren't growing fast enough. Labor force participation is poor, hitting a record low for 25- to 29-year-olds in April. And the Federal Reserve will eventually begin to raise interest rates, which could affect the stock market and influence the value of long-term bonds. In the longer term, the U.S. has a variety of unresolved problems, including costly entitlement programs and an aging baby boomer population, a mismatch of workers with in-demand skills and an impassive political environment.

Market strategists remain cautious. Terry Sandven, chief equity strategist for U.S. Bank Wealth Management, says the economy is showing modest signs of improvement with jobless claims falling 26,000 in the week ending May 3, stock valuations at high but fair levels, benign inflation and low interest rates.

"That typically presents a favorable backdrop for equities," Sandven says.

On the flip side, wage growth has been low, and the 10-year Treasury yield is not rising as fast as economic indicators suggest it would, Sandven says. Defensive sectors of the stock market, such as utilities, energy and health care, are performing well so far in 2014, while cyclical sectors such as consumer discretionary, industrials and financials have lagged, which could signal a modest pullback midyear, he says.

"We clearly need to see employment levels improve to improve sentiment, but manufacturing has been positive, housing prices have been stable and retail sales have been stable to positive ... By and large, this market will likely have a period of consolidation until we get better evidence," Sandven says.

James Angel, an associate professor at Georgetown University's McDonough School of Business, offers cautious short-term optimism and long-term concern. "The economy is improving at a glacially slow pace, and the auto industry is humming, and things may not be recovering as fast as we would like. But we're getting closer to normal economic growth," Angel says. "In the long term, we are in a demographic transition, people are living longer and there is an entitlement crisis."

Angel says a 25 percent drop in federal investments in scientific research over the past two years shows that the government isn't investing in knowledge and talent, which will hurt U.S. growth in the long term. Unskilled workers, as well as those not trained for the jobs that are most available, have been neglected as well.

[Read: How Helpful is Your Employer's Financial Wellness Program?]

"There are major challenges, and we need to start looking at the deterioration of our social capital. There is an underclass that has not been given the skills they need," he says.

Although some economists are heralding the country's growing GDP, David Backus, a professor at New York University's Stern School of Business, says GDP is not the measure people should pay attention to in the short term. Backus says there is a 50-50 chance that the unemployment rate will fall below 6 percent at the end of the year.

"The GDP -- its bottom-line, short-term estimates are incredibly noisy, and for that reason, people tend to see the GDP recovers more quickly than employment, so that hasn't served so well," Backus says.

The value of looking at consumer confidence as a sign of economic health is debatable as well, Backus says. "There is a debate about whether or not consumer confidence is useful. The value is from pretty limited to zero. The emphasis on consumer confidence is misplaced," he says.

Angel says focusing on consumer confidence often "leads to looking at what's going on in the blogosphere today" rather than reliable forecasts of sustainable economic growth. "On the other hand, it is an important signal because bad policy can shake confidence in a way that could hurt economic growth," he says.

Sue Marks, CEO of Cielo, a recruitment firm, says structural unemployment has a greater influence on unemployment rates than economists and pundits acknowledge. Structural unemployment lasts longer and is caused by larger changes in the economy, such as a mismatch in the skills workers have versus the skills employers want, rather than a cyclical slump. The unemployed or underemployed have been further hobbled by the fact that they couldn't explore new career options as many lost a great deal of their savings.

[See: 7 Ways to Take Advantage of Your 401(k).]

"The last recession introduced friction into the markets. People's 401(k)s were decimated so they couldn't be entrepreneurial, and people's houses were underwater so they couldn't use their housing equity to move to a new area where they would get hired," Marks says. "And things haven't quite recovered since."

But there is a ray of hope, Marks says, as businesses have begun to realize they need to educate new employees because high schools and universities aren't doing an adequate job. Marks says many employers are looking for the correct "attitude" and then training employees with the necessary skills.

"I believe there are so many transferable skills, and someone who is happy and friendly and smart -- I can train them to do anything. I know many employers who would do the same," Marks says. "We have to be the education because schools aren't going to do that for us."

The economy is slowly making progress, but unless we address its structural problems, it is unclear when we can expect to return to the level of economic health we knew in the years before the recession.

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