Don't Expect A Double Dip ... This Year

Includes: ACWV, DVYE, HDV, IXP
by: Russ Koesterich, CFA

For the third summer in a row, the US economy is slowing and Europe is teetering on the brink of an abyss. While renewed fears of a US double dip are reasonable, I believe the United States will not see a recession in 2012 for the following four reasons:

1.) Europe is struggling, but it’s slowly stumbling toward a solution. It’s true that Europe is likely to continue to be a chronic source of stress for the global economy. That said, we have seen some tentative signs of progress in recent weeks. The results of the second Greek election mitigated the risk of a near-term Greek default or exit. And while Spain has yet to articulate a definitive plan to recapitalize its banking system, at least it has acknowledged there’s a problem.

2.) Apparent US weakness can partly be attributed to statistical quirks. The weakness of recent US economic data can be attributed to other factors besides an economic slowdown. Take May’s disappointing non-farm payroll report, for instance. The collapse of the construction industry likely is wreaking havoc with how the jobs data is adjusted for seasonal variations, meaning that winter was probably not as strong as the data indicated, nor spring as weak as the headline numbers suggested.

3.) Leading indicators remain stable. While most economic measures continue to be sluggish, leading economic indicators are still signaling positive growth. Our favorite metric, the Chicago Fed National Activity Index, is stuck at zero, close to its average level over the past few years. This is certainly not indicative of a robust economy, but it’s still consistent with US growth in the 2% range or even slightly better. Other leading indicators also confirm a continuation of the expansion. Lost in din of last month’s non-farm payroll report debacle was the May ISM manufacturing report. While weak, it was by no means a disaster. In particular, the new orders component, which tends to lead economic activity, rose to its best level since the spring of 2011.

4.) Gasoline prices are down. Finally, oil prices have come down. While the consumer still faces a number of headwinds, cheaper gasoline prices are providing some relief for stretched middle-income consumers.

While I am cautiously optimistic that the United States will remain in a slow growth mode for the rest of 2012, I have an important caveat for 2013: the fiscal cliff.

The pending fiscal drag – equivalent to roughly 4% of gross domestic product – resulting from tax hikes and spending cuts set to go into effect in early 2013 would arguably be large enough to push an economy stuck at 2% growth back into a recession. Right now, the odds still favor a last minute compromise to avert most or all of the tax hikes and spending cuts. However, if Washington stumbles, today’s recession fears will become justified.

With the US fiscal cliff unlikely to be resolved until after the election and Europe an ongoing concern, markets are likely to remain volatile. As such, I continue to advocate a defensive portfolio positioning through:

1.) High quality, dividend-paying stock funds such as the iShares High Dividend Equity Fund (NYSEARCA: HDV) and the iShares Emerging Markets Dividend Index Fund (NYSEARCA: DVYE).

2.) Defensive sectors such as global telecommunications, accessible through the iShares S&P Global Telecommunications Sector Index Fund (NYSEARCA: IXP).

3.) Minimum volatility funds such as the iShares MSCI All Country World Minimum Volatility Index Fund (NYSEARCA: ACWV).

Source: Bloomberg

Disclosure: The author is long IXP and HDV

Disclaimer: In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Narrowly focused investments typically exhibit higher volatility. There is no guarantee that the dividend funds will pay dividends. The minimum volatility fund may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful.

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