The economy heads into 2010 on a more guardedly upbeat note as compared to 2009. Of course, that was not a particularly high hurdle to overcome. Nonetheless, with the U.S. economy shifting back toward growth, it seems that many believe that the worst may be behind us. That’s not to say that we’re completely out of the woods throughout the country and among all industry sectors.

The real story surrounds the question of where the U.S. economy and capital markets head from here. Of the possible outcomes: a V-shaped, a W-shaped, or a U-shaped recovery, the last one seems the most likely in our view. Specifically, we anticipate a slow-growth environment in which the economy fails to sustain what has been typical long-term real growth of 3.0%-3.5%. The pace of growth in recent years was juiced through the use of leverage to a degree that we believe will not be replicable. Consumers will place a greater emphasis on savings and the reduction of debt that accumulated over a period of decades. We do not believe that it will be easily unwound in a matter of months or even a few years. The process of deleveraging will take time, and is likely to present a headwind to consumption and, ultimately, to growth in the years ahead.

Other headwinds to growth include increased regulation of industry, as the unprecedented intervention by the Federal Reserve, federal government, and regulatory bodies in the financial system is expected to only be the first salvo in this trend. Direct intervention in automobile manufacturing, health care, real estate, energy, and even media suggest that a further expansion of regulation across the economy appears likely. Massive budget deficits will also need to be addressed, and we expect that a higher tax burden in some form will ultimately be part of Washington’s solution. Money printing and greater governmental borrowing demands are expected to create or contribute to inflationary pressures and higher interest rates in due time, while high unemployment appears likely to persist for an extended period.

Broadly speaking, we also anticipate that the financial sector will remain in a tentative position for some time. Most market observers believe that the correction in both commercial and residential real estate has not yet run its course. As such, further difficulties in those sectors will weigh particularly heavily on lending institutions with substantial real estate exposure.

We expect that among those hardest hit will be institutions with exposure to markets that have experienced the greatest price corrections and those who were particularly aggressive in their lending terms (e.g., high loan-to-value deals). The reduction in leverage in the system – whether due to lower consumer demand or restricted credit availability from institutions protecting their capital – will be an impediment to growth as long as that deleveraging process continues.

While conditions today appear less likely to be conducive to strong growth than in the past, we believe that opportunities to profit will still exist in the years ahead. It is the ability to understand the trends and conditions that will shape the economy and capital markets and their practical implications which we expect will be critical to investor success in the years to come.

For a more extensive analysis of our outlook for the economy and capital markets, we invite you to read our “Road Ahead” commentary, which has been published as part of the Plante Moran Financial Advisors Annual Report.


The views and opinions expressed in this article by Plante Moran Financial Advisors (PMFA) are for information purposes only, and are not for the purpose of providing investment advice.