After the Speed Bump…

Slow down: Speed bump. After that, accelerate with care.

That’s the essence of our near-term economic outlook. Although a tapping of the brakes is likely, there is virtually no danger of going off the road. The economic engine, having finally gained some sustainable momentum, will probably keep moving at a slow and steady pace, with a general upward trend overall for the rest of the year.

But first, the speed bump. Looking ahead to the first GDP report for Q1 2011(advance estimate), scheduled to be released in late April, our expectation is for a slower pace of growth compared to the 3.0% gain logged in Q4 2011. There are already hints that the economy lagged early in 2012. The Institute for Supply Management (ISM) reported that its PMI national composite index had dropped in February 2012 to 52.4 from 54.1 in January. Earlier this month, it reported a one percentage point gain for March to 53.4, which was still below January levels.

The curious indicator has been jobs. Total nonfarm payroll employment rose by 120,000in March 2012, decreasing the unemployment rate to 8.2%. The rate of job growth did slow compared to average gains of 246,000 per month in the prior three months. Expectations for March had been for 210,000 jobs to have been added. Nonetheless, it’s important to keep perspective, given that the job market was gutted during the recession. There was a time we would have thrown a party for a jobs report of +120,000.

It is also highly probable that the comparatively stronger pace of hiring seen earlier this year reflected the fact that, during the recession, employers cut their payrolls too severely and needed to correct that situation during the early stages of recovery. As we move forward, we would look for employment to improve in pace with economic output.

The Fed, in its Beige Book report, called economic growth “modest to moderate” for the period of mid-February through the end of March. Manufacturing, professional business services, and consumer spending were positive, although rising petroleum costs sparked some concern, particularly the impact on discretionary spending—all the makings of a second-quarter speed bump.

Once we get beyond the speed bump, we would expect improvement, but not the classic recovery days of taking 10 steps forward and then 3 steps back. The pace of growth is more likely to be gradual; 2 or 3 steps forward and 1 back. This will most likely create some market corrections as well. Looking at the ranges for the S&P 500 over the past two or three years, we would expect current pullbacks to stay at the higher end of recent ranges. The pullbacks, however, will hopefully only be step-backs, and not an indication of deeper problems or the start of another recession.

We view the step backs that do materialize as opportunities to re-examine investment decisions. Although we never signal or discuss portfolio moves ahead of time, I will say that we are making more than a simple “buy the market” decision. With asset correlations, as I wrote in my previous blog, returning to more normal, historic relationships, we have an opportunity to make investment decisions across a spectrum of assets, which reflect our analyses and opinions for a variety of markets.

Longer term for the year, we would expect that uncertainty related to the presidential election to impact Q3. Then, as we move into Q4, we would seek to reap the fruits of the portfolio adjustments that we are making now.

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