As families upgrade to high-definition TVs and “The Titanic” is being re-released in 3D, it is time to re-envision 2012 in three dimensions.
Most economic models are decidedly two-dimensional. If housing improves, then GDP rises. The line graph points up. If recession spreads throughout Europe, this reduces demand for U.S. goods and services. The graph for U.S. GDP points downward. This sort of two-dimensional thinking goes into the struggle over continuing the 2% reduction in payroll taxes. Advocates for continuing the reduction say that this puts more money in the hands of people who will spend it. Neglected in this two-dimensional thinking are the general equilibrium aspects of where the tax money comes from to pay for the program. Two dimensional thinking, what economists call partial equilibrium analysis, is easy to do, even though it has not been an effective method of forecasting the economy in recent years.
Thinking in three dimensions clearly is more complex. On a piece of paper, we can sketch the base plane with two lines forming an angle and then draw a third line coming to the juncture of the others to illustrate the third dimension. Geometry classes help us think about three-dimensional objects and how they look if rotated in space.
Instead of a cube or sphere, a vortex is a naturally occurring three-dimensional figure that we can help us think in 3D. To visualize a vortex, picture a cyclone, tornado, whirlpool, waterspout, or hurricane. They all circulate in a conical fashion. We’ve all seen leaves whisking around in whirlwinds or seen water draining from bathtubs in cyclonic fashion. Tight twisters like those created for the movie version of The Wizard of Oz, circulate furiously. The visible funnel is filled with dust. Yet invisibly, the wind is also whirling far beyond the visible funnel. The farther one is from the visible funnel the slower is the wind velocity.
If the economy is viewed as a vortex, the speed of the wind signifies economic growth. Vortexes that run into obstacles, bump into crosswinds, or meets crosscurrents slow down. Envisioning the US economy from 2008 to the present as a vortex, it is the pathetically slow wind (read slow growth) that people are complaining about.
What makes a cyclone fizzle out? Well, we’ve witnessed of the impact that land has on hurricanes. Category 1 hurricanes tend to be downgraded to tropical storms after hitting land as the friction of hills, buildings, and trees slows its progress and dispels the wind speed. The fuel for a tropical cyclone is low pressure and warm water. As cyclones travel into colder waters, they diminish in intensity.
A spinning vortex of an economy is slowed by obstacles it encounters. These divert its direction and weaken economic growth. The three main obstacles have tended to be oil price spikes, financial disruption, and war (including war-like assassination attempts and terrorist attacks). These obstacles are always present, but the US economy is subject to these obstacles in 2012.
Oil prices are likely to rise in 2012, in part from threats of blockades in the Strait of Hormuz, from OPEC actions to withhold oil, and from declining sources of domestic oil as off-shore and on-shore sources are cut off through regulation. Alternatively, an economic slow down in Europe, a rising dollar, and moderating growth in Asia could dampen oil prices. If oil prices rise from the high-$90 per barrel to $130, the economic vortex will overcome these obstacles. If the price of oil reaches $150 in 2012, this will clearly slow the winds of growth substantially. My own view it that oil prices will reach $150 in the second half of 2012.
Financial disruption has been the constant theme of economic reports out of Europe. Will the Euro-block continue? Will countries defect from it? The constant Strum und Drang of agreements and failures to put in place austerity measures will continue in 2012, including riots from those who abhor austerity. These vicissitudes will make economic growth in Europe slow further. Recession in Europe is likely and will create a modest impediment to the winds of our economic vortex.
War and terrorist acts are not out of the question in any year. What will Iran or Israel do this year? Could there be homegrown terrorists plotting attacks here? The answers will unfold with time, but it is likely that various skirmishes and attacks occur in the coming year. I expect the US vortex to plow right through these.
What makes a vortex increase in power? Cyclones need fuel. The fuel to increasing the power of an economic vortex tends to come from at least three sources: improving expectations, new investments, and a pro-cyclic environment. These fuels are present as sources of energy for our economic vortex in 2012.
Expectations have risen from their lowest levels. Improving retail business this past Christmas, improving apartment construction, and modestly improving employment are drivers for greater growth in the year ahead.
Measures of new investments are less well observed, like the unobserved wind bands outside of the dust filled funnel, but they are evident if you look for them. IPO’s are sometimes used as a proxy for new investments. Along with juggernaut Facebook, there appear to be many smaller IPO offerings in the pipeline for this year. Yet 70 percent of the 2011 IPOs are still selling below their initial offering price with an average loss to investors in IPO’s of 11.8 percent. So this fuel may be modest.
We have a pro-cyclic fuel, which is the looming event of a Presidential election late in 2012. Election years tend to be good for the stock market, with the average gain in the S&P 500 Stock Index being 11% since 1928. Throughout the span of years from 1926 – 2011, 74 percent of the years were positive for the S&P 500, but in the last 21 Presidential election years in this period, 81 percent of the them experienced positive stock market in Presidential years. After a year in 2011 when the S&P 500 made absolutely no progress, the likelihood is good that we’ll see a better than average stock market return in 2012.
The U.S. economy will continue to spin as a giant slow moving vortex. Some economists expect the speed of the economy to pick up in 2012 moving up to a more normal 3 percent growth rate. But there are obstacles ahead including higher oil prices that are likely to keep growth in the sub-standard rate of about 2 percent. Nevertheless, the forces that propel an economy of improving expectations and the cyclic factor of a presidential election are as likely to lead to a better than average year for investors. After 2011, a year of gyrating stock prices that ended where it started, a year of 11 percent stock price appreciation would certainly be appreciated.
U.S. Presidential Elections & S&P 500 annual returns
AVERAGE = 11.01%
Richard Marcus Ph.D., is associate professor of finance and managerial economics at the University of Wisconsin-Milwaukee’s Sheldon B. Lubar School of Business.