Interview With Adolfo Laurenti: Sequester's Economic Impact: Minor; Damage To Confidence In U.S.: Major

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 |  Includes: DIA, QQQ, SPY
by: Harlan Levy

Adolfo Laurenti is deputy chief economist at Chicago-based financial services firm Mesirow Financial. Previously he was an associate economist at LaSalle Bank/ABNAmro.

Harlan Levy: What do the latest economic data tell you about the U.S. economy?

Adolfo Laurenti: It's consistent with our view of modest-to-moderate growth, probably more moderate than modest. The Gross Domestic Product numbers for the last quarter will very likely be revised upward, because of new data on exports, so we are not going to have a negative quarter at the end of the year. The current data that we see in real time suggests that growth may be around 2 percent, although some colleagues are more aggressive, thinking that consumption will push growth closer to 2.5 percent, but it's hard to predict. I think 2 percent.

The question is how big is 2 percent. It's moderate. It's not low, but it's not the number that really gives a boost to confidence and accelerates job creation. That's why the best adjective is "moderate."

H.L.: How much of an impact on the U.S. economy will the three March Congressional showdowns have -- first the sequester, then the two other conflicts over raising the debt ceiling and authorizing continued government spending?

A.L.: I'm a little bit out of consensus on this. The direct hit to GDP would not be significant. We have seen estimates that GDP growth would be cut by a half of a percent to 1 percent, which might translate into 700,000 lost jobs, which would be very painful. And sure, some sectors will suffer -- defense and companies related to the federal government.

But overall, there is something that concerns me even more than the direct economic damage from sequestration. My concern is the psychological damage that sequestration will do to confidence in the U.S.'s ability to fix the problem. If we go into sequestration, basically what we are saying is that we cannot take care of ourselves and cannot get our act together. It will be damaging internally for the American public, for the companies that do not invest, and for the companies that do not hire. And I think it will be damaging internationally for all the people around the world who question the health of the U.S. dollar and the U.S. economy. Unfortunately, a resolution to keep government spending going past the deadline would be just a way to kick the can down the road. The real damage is to confidence, and this damage would be much more severe and threatening than just the decline in growth. That's my concern.

H.L.: After the March showdowns are settled, how much of an effect on our economic recovery will the continued paralysis in Congress have?

A.L.: It would be a significant headwind. If you look where we are now compared to 2007, consumption has recovered. Other indicators of activity have recovered. The two areas where we are lagging behind are jobs and investment. That means that businesses do not feel confident enough to go out and hire people or spend money on machinery, equipment, computers, and so on. I do believe that policy uncertainty will continue to feed overall uncertainty, which is holding back the recovery.

But I don't think it will kill it, because we have done a good job to improve in other areas. Corporate American balance sheets are fine. Housing balance sheets are OK. We have had improvement in the job market, not enough, but improvement. I think the uncertainty will prevent the recovery from becoming more broad-based. That is the key. We need the recovery to be felt by more people, homogeniously around the economy. There's inequality. The recovery is only being felt by certain sectors around the U.S. but not broadly enough. And I think we can do better than that.

H.L.: What is the biggest problem the U.S. economy faces?

A.L.: Policy uncertainty and the fact that Washington cannot provide better leadership.

H.L.: What are the strong points?

A.L.: I see strength and potential in the repair of balance sheets in the corporate sectors, where companies are awash with cash and debt is under control. Companies are in a good position if they gain the confidence to go out and expand. It's also true for the housing sectors. We have been able to get a handle on the housing situation. Housing is actually showing signs of improvement, and that's encouraging across the board in construction, home sales, and home prices. So I am confident that these may be the sources of strength for the economy going forward.

H.L.: What do you predict for economic grown next year?

A.L.: We have 2 percent for 2013 and 3.2 percent for 2014. We used to be a little more bullish for 2013, like 2.4 percent growth, and 2014 was around 3 percent but not above that. Because of the uncertainty over sequestration, we have pulled back in 2013, but we still think that because of the strong fundamentals, we see a relatively stronger 2014. Two percent in 2013 is not strong and should be on par with 2012 or possibly weaker.

H.L.: Is the stock market going into a slump, and if so, for how long?

A.L.: I don't think so. It all depends on the corporate sector. I don't think the market is going into a slump, because companies are healthy. They could have higher revenues, but they have costs under control and they have cash, so I don't see any reasons the stock market should crack. On the flip side, without a confidence boost, I don't think there is much upside until things change on the political front. But I'm fairly optimistic that we are not going into a nosedive.

H.L.: What's the status of the European debt problems?

A.L.: It's on hold. Right now the European Central Bank has been able to calm the markets down. We had an election in Italy this past weekend which is very important for seeing which direction the country goes. We have to see how the new government will play out in the next several weeks on maintaining austerity policies. But so far the euro crisis is on hold. We are seeing some improvement, but the risk of the crisis returning still lurks behind the corner.

H.L.: How much of a major disruption are the volatile situations in the world - Syria, Iran, Iraq, Egypt, the Palestinian-Israeli conflict, among others?

A.L.: I think geostrategic uncertainty is a fact of life, so I think we may risk some new tensions, especially in the Middle East, but at the end of the day I don't think it will be something we have not seen before. I do not expect any long-lasting situations to alter the outlook in the medium term. In the short term gas prices may explode because of developments in Iran and Syria, but in the medium term things will go back to a more normal level. But what's normal? I don't know.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.