If past is prologue, the economy is headed for better things in the third quarter, at least compared with the first half — but it will hardly be robust. Indeed, if history repeats itself, the coming performance will only set us up for dashed hopes once again.
After all, this is the third year in a row in which the U.S. economy has appeared to follow the same broad pattern: Weakness in the first half followed by a stronger second half, notes the global currency strategy team at Brown Brothers Harriman.
Unfortunately, that second-half strength has only served to fuel hope that a self-sustaining recovery is at hand, which has then been followed by another bout of weakness with each new year.
Still, some significant developments occurred this time around in the cycle that could serve up a better-than-expected third quarter. For one thing, expectations are very low.
After growing at just a 1.9% annualized rate to start the year, gross domestic product is forecast to pick up only ever so slightly. Economists, on average, expect growth to hit 2.3% in the third quarter — although it should be noted that such forecasts are typically wrong by being too optimistic.
The outlook for unemployment is likewise dismal, but then it’s no secret that such sluggish growth can’t do much to improve the jobs picture. The unemployment rate, now 8.2%, isn’t expected to budge from the current level.
Naturally, all that slack in the economy is expected to keep prices muted as well. With all the worries about deflation — a far more insidious problem than inflation — we should probably consider ourselves lucky if the consumer price index rises 2%, as the average forecast has it.
What Could Go Right
That said, some recent surprise developments could give the third quarter an unexpected lift. The European summit’s breakthrough plan, announced Friday, to recapitalize its banking sector should ease pressure greatly on the governments of Spain and Italy, as well as give sentiment a lift. If the slowdown and recession hitting much of the continent can be kept shallow and short, that will go a long way toward reversing the global slowdown.
Meanwhile, China, which is being hard hit by the woes in Europe, its biggest trading partner, is launching new stimulus measures that should begin kicking in during the second half. And in another necessary boost to emerging markets, the behemoth of Brazil finally bit the bullet and unveiled stimulus measures at the end of June.
Whether the Federal Reserve follows suit with another round of quantitative easing in the third quarter is anyone’s guess. Michelle Meyer, senior U.S. economist at Bank of America (NYSE:BAC), thinks QE3 is a very real possibility when the Federal Open Market Committee meets in September. On the other side of the ledger, the team at Brown Brothers Harriman doesn’t see the Fed making any big policy moves until at least after the November presidential election.
With the muddle-through recovery set to be as muddled as ever in the quarter ahead, the same investing themes remain firmly in place. Domestic large-cap names with strong cash flow and rising dividends remain attractive. And overweighting the defensive sectors of telecoms, health care and energy makes sense in the upcoming quarter, but probably not utilities, which look expensive.
True, if the market takes off during the quarter, the defensive sectors will lag the more cyclical ones. But a rising tide will still lift all boats. Better to be safe and collect a smidgen of income while the muddle-through economy and market figure out their next move.