How to Invest for a Weak U.S. Economic Forecast

Article of the Week from Money Morning

by Money Morning Staff

Anyone who hoped the U.S. economy would get back on track this year has been sorely disappointed.

The European sovereign debt crisis and the abysmal failure of policymakers to take effective action have undermined any chance we had at a strong recovery.  And what’s even worse is that we’re seeing more of the same in 2012. Indeed, the U.S. economy in 2012 will be even more sluggish than originally thought – and for the same reasons 2011 was a disappointment.

The Organization for Economic Cooperation and Development (OECD) estimates U.S. growth is slowing to 2%, down from a 3.1% estimate last year. It forecasts growth will pick up to 2.5% in 2013.  Of course, these forecasts are contingent upon Congress finding a way to stimulate the economy and tighten fiscal policy – not an easy balance to achieve. Without such action, U.S. economic growth this year could be as slim as 0.3%, and only hit 1.3% in 2013.

Click on caption graphic for view of a meeting of The Economic Optimists Club, from Joe Heller/Green Bay Press Gazette.

There’s little chance the government will rise to the occasion this year – especially when most representatives are focused more on reelection than they are resolution.

Furthermore, it’s also doubtful that Europe’s debt crisis will be contained enough to not severely disrupt the region’s biggest nations and cause a credit crunch that ripples through the global economy.

That all means another year of major risks.  From Money Morning Global Investing Strategist Martin Hutchinson:

“Uncertainty remains the watchword for the U.S. economy.  The risks are still pretty high because no one’s sure what the Europe outcome will be.”

The likely outcome – U.S. economic growth will fall even lower. Investors should be prepared for a falling U.S. dollar as a result of sluggish growth and the potential for more economic stimulus coming from the Federal Reserve. And a falling dollar means higher oil and energy costs across the board.

Be prepared for oil to spike well above $150 in the next few months. And “pain at the pump” will create even more weight to drag down economic growth. (Take a look at the latest oil report right here to find out more about what’s coming in oil and what you can do about it.)

Europe: The Biggest Unknown

Europe’s weak monetary union is the main threat to the world economy. The OECD’s 34 member nations, including the United States, will grow an average of 1.9% this year 1.6% next, according to the organization’s estimates.  Chief Economist Pier Carlo Padoan wrote in the OECD Economic Outlook:

“Contrary to what was expected earlier this year, the global economy is not out of the woods. Above all, confidence has dropped sharply as skepticism has grown that euro-area policy makers can deal effectively with the key challenges they face. We are concerned that policy-makers fail to see the urgency of taking decisive action to tackle the real and growing risks to the global economy.”

The global growth slowdown has also affected trade. The OECD expects trade to grow just 4.8% – a sharp decline from its previous estimate of 8.4%.   Padoan added:

“The present situation is worse than in 2009.  Trade was the driver of economic growth after the 2008 financial crisis, but now we’re seeing risks of protectionism.”

To ward off the debt crisis spread, the European Central Bank (ECB) has tried to intervene with bond buying and loans, but its actions so far have failed to deliver long-term repair.  Money Morning Capital Waves Strategist Shah Gilani said:

“The real structural problems facing Europe are going to require wholesale lifestyle changes that won’t get done in a year or two.  ECB meddling will only serve to extend the problem while they pretend things will sort themselves out.”

The smaller Eurozone nations’ issues have already spread to the more powerful German economy, evidenced by its disastrous bond auction where barely half the bonds were sold.

As countries teeter on the edge of default and the region’s stronger economies start to slow down, the problems will spill into the already debt-ridden United States.  Just how bad the crisis will be, however, is unknown – and will remain uncertain until it’s on our heels.

What we do know is U.S. banks’ exposure to Europe’s crisis will prevent the United States from being immune in the coming year.  Martin Hutchinson described it thusly:

“If the euro area breaks up, the banking system will spasm.  This will cause a sharp, though probably brief, recession.”

While Europe could deliver the biggest blow to the year’s U.S. economic growth, it’s not the only risk.

A Big Year for Congress

How the U.S. government decides to manage its debt, and how its austerity measures affect consumers, will be the biggest financial concern for U.S. households, not just next year, but for many years to come.   Money Morning Chief Investment Strategist Keith Fitz-Gerald said:

“This is not just an economic challenge, but potentially the greatest political challenge of all time.  It heightens uncertainty because new fiscal challenges are destined to collide with lower potential growth and unfavorable demographics including employment, job creation, and productivity.”

The lack of fiscal discipline and the inability of Congress to come up with a deficit reduction plan have left the United States with more than $15 trillion in debt. The inappropriately named congressional “super committee” tasked with finding at least $1.2 trillion debt reduction savings over the next decade threw in the towel.

While Democrats want a balance of lowered spending and higher taxes, Republicans prefer to reach debt reduction goals only with spending cuts. That’s making consumers even more wary of opening their wallets, unsure of what combination of spending cuts and tax increases might be coming.

The government needs to rein in spending, but a tighter fiscal policy comes at the price of further limiting the economy’s growth. And if Congress does nothing, people will worry about the automatic and arbitrary cuts of $1.2 trillion that will go into effect in January 2013.  From the OECD Economic Outlook:

“A serious downside risk is that no action will be agreed to counter strong, pre-programmed fiscal tightening in the U.S.   Much tighter fiscal policy than in the projection could tip the U.S. economy into a recession that monetary policy can do little to prevent.”

While fiscal policy boosted economic growth in 2008, it pulled it down by about one percentage point in 2011. Growth could be slowed by one and a half percentage points in 2012 as more stimulus measures expire.

Besides driving America deeper into debt, Congress’s continued missteps will beat down consumer confidence. Without the faith of consumers, whose spending fuels 70% of the economy, U.S. growth will again fail to regain footing in 2012.

The Confidence Factor

Unemployment, although slowing, will remain near 8% through the rest of the year. And inflation will continue to weigh on consumers.  Hutchinson expects inflation to hit 6% to 7% by year’s end.

That means consumers will continue to pay off bills and save what they can, a deleveraging process that will further strain economic growth.

Of course, that doesn’t mean the best course of action for investors is to sit on the sidelines. There are investments that tend to thrive in this environment.

Uncertainty Means Opportunity

With the U.S. economy on unsteady footing, gold, silver and commodities are a must-have.  Gold has been trading steadily as investors anticipate further weakness in global economies and paper currencies. Gold prices are on track to climb above $2,500 an ounce.

Interested investors can buy gold coins and bullion, or they can pick exchange-traded funds (ETF) that follow gold prices.  One we’ve mentioned before in Money Morning is the SPDR Gold Trust ETF (NYSE: GLD). You can also try the iShares Gold Trust (NYSEArca: IAU), an exchange-traded fund backed by gold.

Another way to profit while U.S. and European economies remain weak is to move into other parts of the world – emerging markets.

Hutchinson likes iShares MSCI South Korea Index Fund (NYSE: EWY). It has a $3.5 billion capitalization and a price/earnings (P/E) ratio of 6.76. It’ll also get a boost from a recently signed free-trade agreement with the United States, which is expected to give a 0.6% annual bump to Korea’s economic growth.

Hutchinson also recommends Colombia’s Ecopetrol SA (NYSE ADR: EC). The Bogota-based oil company is expanding rapidly as a result of Colombia’s very attractive offshore and onshore oil deposits. It has a market cap of $84 billion and a P/E of 9.76.

You can also turn to multinational companies that have expansive global operations.  Look for companies with “proven business models, experienced management, globally sought after brands and fortress-like balance sheets,” said Fitz-Gerald.  Among those are McDonald’s Corp. (NYSE: MCD), PepsiCo Inc. (NYSE: PEP), which will benefit from higher food prices, and Caterpillar Inc. (NYSE: CAT), with a one-year price target of $114.

Finally, the silver markets are ripe for investment in the current economic atmosphere. The last time this situation happened some made gains of 195% in a matter of a few months. And it’s all because of a massive “short squeeze” building in silver. Take a look at the latest silver report right here to get the details.

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